Rory Johnston on How Oil Could Surge to Over $200 a Barrel

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16:10Joe Weisenthal:So the other thing I wanted to ask you about, Rory, is so we have strategic stockpiles that are supposed to help us get through these types of near-term supply shocks. And, you know, the release of which is supposed to not only push down the price of stuff like gasoline, but also maybe help the refiners keep going so that they don't have to start preemptively shutting down capacity. At the same time, we now have G7 countries that seem to be very reluctant to release from the stockpiles. And I should just mention that we're recording this on March 9th. And, you know, there are all these headlines flying around.

16:44Joe Weisenthal:So who knows what will happen by the time this episode gets out. And then at the same time, we also have the U.S. where there's a lot of chatter about releasing from the SPR. Talk to us about the pros and cons of actually dipping into those strategic stockpiles right now.

17:00Tracy Alloway:Yeah, so I think it's important to note that this is the mother of all supply risks. This is the boogeyman for every oil analyst when they're kind of learning the ropes. This is the purpose-built reason, the scenario precisely that the SPR was kind of created to mitigate the risk of. To me, it's insane that they haven't yet tapped the reserve already. And I think speaks to the fact that particularly Trump administration has tied itself in knots criticizing the Biden administration for releasing SPR stocks in 2022 to offset the Russian supply shock. Now, just on that very briefly, I was a big supporter of that release.

17:35Tracy Alloway:I thought that was a clear national security threat and global economic threat that Russia posed when invaded Ukraine. And we thought we're going to lose so much oil from Russia. But it wasn't executed perfectly, in fairness. But still, I think that was a good purpose of it. And now this is also a very good purpose of it. we could have refilled more in the interim and we should have. Congress needs to allocate more money to the SPR, to the Department of Energy. Most of the money that was earned from the Biden era sale of the SPR has essentially been remitted to Congress. So you actually need to get that money back again.

18:07Tracy Alloway:But I think what we've seen, so this morning, the IEA and G7 countries were talking about this coordinated release of 300 to 400 million barrels was what the Financial Times reported as I saw. But yeah, they come out and said, no. Now, there's a couple of reasons that you could explain why they could say no. One, they could be hoping and fearing that things could get even worse. So holding it closer to the chest. On that, I would say one of the big problems is that the collective release rate of the SPRs around the world is not 20 million barrels. So the crisis is already really, really bad. And you can't actually fill the gap entirely with SPRs, even if it was unlimited, which it isn't.

18:45Tracy Alloway:Just the flow rate itself can't keep up. So if anything, you kind of need to almost start easing earlier rather than later. On the other hand, I think there's this question of like maybe, you know, repeatedly we hear that like Trump thinks it's going to be a short lived shock. Last night when I was driving into Ottawa, you know, they were talking about, you know, this could be short, sharp, and then we're going to get rid of the Islamic Republic in Iran and we're all going to be better off. But this is not nothing. Nothing that we've seen so far indicates it's going to be short and sharp. again, I'm shocked we are this far down the road.

19:15Tracy Alloway:I didn't think the president had the appetite for this kind of true and utter chaos. And we're going to see how long he remains to have the appetite for that. But that's essentially the best read I could have is they think this is short, a short lived geopolitical sentiment disruption when this is really just the largest physical supply disruption we've ever seen. The other thing they're reportedly musing, which is even more insane and terrifying, is renewing the export ban on both crude oil and refined products. So something that the Biden administration kind of mused about in late 2022. And I wrote a piece then on commodity context that was all about the reasons that that was a really, really bad idea, that I appreciate the impulse towards autarky, particularly given the fact that the United States is the largest oil produced in the world now.

20:00Tracy Alloway:But not only are crude quality issues at play, you know, the U.S. produces too much light and doesn't and still needs to import heavy. But also there's regional issues that the U.S. Gulf Coast is a net exporter of diesel. The U.S. East Coast is a net importer of gasoline from Europe. So basically, if you start closing these borders off, all of these individual regions start to basically shut down and kind of ossify in a way that is not at all what I think President Trump would want. But I no longer have much faith that they are fully thought in this through, because if you had, you would have thought about the SPR.

20:33Tracy Alloway:You would have thought about insurance. You would have thought about all of this already. And they just clearly haven't.

20:36Rory Johnston:Yeah, this is one of the striking things to me, at least from everything I've read. It sort of seems to have taken them a little bit by surprise, some of the market. I mean, it's almost hard to believe that there wasn't more anticipating of this when you're going into war like this. But it does not seem I certainly get the same impression as you. By the way, everyone should pull up that chart of Singapore jet fuel prices. It almost looks fake. It's just like, you know, we're$90 a barrel. at the end of February, broke 220 recently. It's come in a little bit. So talk to us a little bit more about the sort of relationship between the duration of the war and the ability to flip the switch back.

21:22Rory Johnston:Because the president's communication does seem to be like, yeah, we're paying a price right now, but it's going to be worth it. And then prices are going to come down. As this goes on longer and longer, to what degree does everything compound and make it more difficult to go back to normal?

21:40Tracy Alloway:And I think this is a topic that I was listening to actually your podcast on the Strait of Hormuz flow with the shipping experts exactly on this topic. And I think you guys nailed it there that this gets worse every single day it goes on. But let's talk through the ways it gets worse. So when we talk about the Strait of Hormuz, like you could think of it very simply as like the world's largest pipeline or like a big giant garden hose, you know, through which 20 million barrels of petroleum flows. When the strait was closed initially, for the first day, two, three days, it's kind of like a kink in the garden hose.

22:10Tracy Alloway:If the conflict had ended then, which is honestly when I expected it to end, you would unkink the garden hose and things would get back to normal pretty quickly. No harm, no foul. Some issues, but you can make that up pretty quickly. But now, 10 plus days into this, we now have the equivalent of a 200 million barrel air gap in the global flow of petroleum, first of all, not to mention that in addition to this kind of kink in the garden hose, that pressure has built up because these countries can't export out of this region anymore. Countries like Iraq and Kuwait in particular, both of which lack sufficient domestic storage capacity because they just export the stuff all the time.

22:47Tracy Alloway:And for decades and decades, they have been forced to shut in production. Now, Iraq, as of yesterday, shut in over 3 million barrels a day of production from its southern Basra fields. That is alone, just Iraq alone so far, that is the same size as the feared loss of Russian supply in April of 2020, 2022, that sent the market, you know, ripping higher above 120 Brent, just for perspective. And we didn't end up losing that supply in the Russia case. We only lost one briefly and it came back. But in Iraq, we've already lost Kuwait, we've already lost it. In the Emirates and Saudi Arabia, they have more storage capacity and a bit more optionality.

23:24Tracy Alloway:They can get, you know, there's a pipeline to the West Coast in the Red Sea in Saudi Arabia that can divert some of the flow. Similarly with the United Arab Emirates, you can divert some flow out the port of Fujairah. The pipeline to the West Coast of Saudi Arabia can get bombed. If we get to an existential battle, you know, this keeps grinding. Same with the ports of Fujairah, I think. But again, these systems can all be broken. So you've lost that. So you've lost supply structurally, at least for weeks, potentially a month, even if the thing resumed, even if flow resumed tomorrow. And then on the refi - that's on the exporter, the supply side, on the demand side and the importers in Asia.

23:59Tracy Alloway:Like I said, you've already begun to lose refining runs. And because the jet fuel is very particular, I think rightfully so. So you don't store as much of it typically. So I think part of that giant spike in fuel prices, in jet fuel in particular, was this sudden kind of loss of supply, not a lot of inventory cover. And all of a sudden, you had all of these airlines all across Asia. It's like, wow, I'm not hedged for this. I need to get every barrel I can right now. So I think even if this resolved right now, which it doesn't look like it's going to, but even if it did, now we have a big air gap in the system that's going to need to work itself out.

24:32Tracy Alloway:And all of these different supply chains will probably end up taking two, three months minimum to get back to something resembling normal. And it doesn't look like we're about to kind of resume flow through the state of our moves right now, despite what the White House says.

24:45Joe Weisenthal:I have what is perhaps a silly question, but does demand destruction actually exist when it comes to higher oil prices? I mean, you know, seriously, I know that airlines will go bankrupt eventually because of high oil prices, but it feels like it is one of those things that you want to keep using for as long as you are physically or financially capable of doing so.

25:09Tracy Alloway:I'll talk about three different angles here. So the first is the difference between the elasticity of price versus the elasticity of income. So I think there's the one question of I think when we typically think about demand destruction, we think primarily through the lens of like prices got too high. So I'm not going to drive to work today. There's also the angle of prices got so high they crashed the economy and you lost your job. So you no longer have to drive to work. So that is one angle. If this goes on for much longer, we're not talking like we're talking serious recession, if not like outright global depressionary conditions, if the strait remains closed for a month plus two months.

25:41Tracy Alloway:So that's that one angle. But when we talk about, you know, I agree, I'm not going to stop driving my kid to school. I have a fairly high tolerance for high prices. But we live in wealthy, advanced societies. I think what you saw, for instance, in 2022, I think, is illustrative this in the LNG market when there was a very, very high profile event when a contracted LNG tanker that was supposed to land in Pakistan got diverted and ended up in Europe because the Europeans were willing to pay way, way more. And basically, the LNG supplier broke the contract to service that, which economics dictated.

26:15Tracy Alloway:But I think the human cost was very real. Pakistan just couldn't afford it. So what you're going to see here, let's say, again, in this horrible scenario where the Strait for Moves remains closed until 2027, this is what the world would look like. What you would end up seeing is massive demand destruction from lower-income countries that can no longer afford to get those barrels and attract them to their shores in the first place. So you and I would see this as massively surging price of the pump, and we would grumble, and it would sap our consumer spending energy, et cetera, et cetera. But the barrels would likely be there.

26:47Tracy Alloway:We are in the countries that will attract the most supplies because we're willing to pay the highest prices. But other lower income countries in the world, it's not going to be a price issue for them. It's going to be an outright shortage. And that, I think, is how demand destruction in this particular instance would work.

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29:19Rory Johnston:Talk to us about$200 barrel. So this is in the cards, potentially. Can you walk us through the math of how we get there or why that seems like where it could go and not just say 150 or it's Talk about how you why that number seems realistic.

29:34Tracy Alloway:Yeah. And I should say, I mean, like 200 is you guys kind of said in the intro, like these are just kind of placeholder numbers. Sure. Like the numbers stop meaning something when they reach that high. But just to this point that you're going to need to keep ratcheting the price are higher and higher and higher until a couple of things happen. So, one, even if this continues, even the war continues, a lot of this was predicated in this assumption that the strait remains completely shut. Important historical context is that even during the tanker wars of the 1980s, at the peak of the kind of Iran-Iraq war, when you had, I think it was over 450 ships attacked, 250 tankers, and like 50 of those tankers were either sunk or scuttled entirely, like a much bigger, more explosive situation than we're currently even seeing in the Gulf today.

30:14Tracy Alloway:During that period, you never actually had a stoppage through the Strait of Hormuz. You had military escorts, you had other things, but the oil continued to flow. In this instance, it's effectively shut. You're seeing minor, like, let's say, 5 % to 10 % of the prior flow go through, but it's effectively shut. We've never really seen this before. So if this continues, you're going to need to keep bidding up prices to do one of either two things. We talked about demand destruction, so I think that's one way the market solves itself. Or prices get so crazy high on the other side of the straight. And the other thing I should note here is crude prices are probably effectively negative prices right now on the wrong side of the straight, because those are stranded barrels and no one can get to them.

30:51Tracy Alloway:But if you can basically arb that between effectively negative prices and potentially the highest prices we've ever seen in the market, that's a really compelling economic incentive to take the risk to cross the strait or to pay your crews, you know, the sufficient amount of money to cross the strait or to afford the exceptionally expensive war insurance. So it's like that mad money meme. It's like, that's what the money is for. It really is that we're trying to basically incentivize between two awful scenarios, either seafarers and tanker owners risking their lives and their ships going through the strait to deliver this fuel, or you're asking people to basically stop moving, stop moving around the planet.

31:28Tracy Alloway:And neither of those is a very attractive solution, which is why, again, I just fundamentally can't see this continuing. I think I keep saying, like, Trump's going to taco because he has to taco. And people keep criticizing me. They're like, no, no, it's no longer just Trump's call. It's Netanyahu. It's the Iranians or whatever. I think that's probably true. It's not just Trump's call anymore. But he's still, one, the person that's probably movable on this by market reaction. And two, he's still probably the most important incremental voice in that conversation. So if he pulled out, I think that does a lot to deescalate the situation.

32:00Tracy Alloway:I think that's probably where we need to go here.

32:01Joe Weisenthal:I realize we have I don't think we've mentioned OPEC once in this conversation, which probably says something about OPEC's relevance today. But, you know, to what extent can OPEC respond with a big supply increase and maybe shift some production away from the Gulf and start firing up output elsewhere?

32:22Tracy Alloway:Yeah, so I think it's a great question. And unfortunately, the Strait of Hormuz is a risk concept, kind of short circuits the OPEC's normal reaction. But we're talking about spare capacity. Virtually all the spare capacity in OPEC is on the wrong side of the Strait of Hormuz. It's in Iraq, Kuwait, Saudi Arabia, and the UAE. All of that is currently caught up in this. So I think that's part of the challenge and why the Strait of Hormuz was always the boogeyman scenario was there's no real normal way that the market can get around it. The one major producer that's within OPEC Plus that is likely the single greatest beneficiary of this is actually Moscow.

32:56Tracy Alloway:So the Russians had been under increasing pressure during, you know, the Trump administration put a lot of pressure on all of the kind of what I call the big sanction three. You've got Iran, Venezuela and Russia. Venezuela, we have a regime change. Iran were in the process of doing so or trying to. And then in Russia, they said that they were prioritizing the war in Ukraine and they were at various points. But now they had actually been putting a lot of pressure on the Russian oil trade. India, which was one of the largest importers of Russian crude, the largest seaboard importer of Russian crude after the invasion, with the price cap and everything else, they got under increasing pressure on two fronts.

33:33Tracy Alloway:One, the Trump administration issued blocking sanctions, or like the hefty, really, really tough sanctions that were on Iran, issued those on Rosneft and Lukoil, which are Russia's two largest crude oil exporting companies. In addition to that, so the Indians didn't like that and they started pulling back purchases there because they're afraid of the sanctions risk. But in addition, Trump actually imposed a specific punitive 25 percent tariff on India for being such large importers of Russian oil. So over that kind of between October and, say, January, we saw Indian imports of Russian crude drop from over 2 million barrels a day to about 1 million barrels a day.

34:10Tracy Alloway:So they halved. That Russian oil wasn't really, it was a little bit going more to China, but it wasn't finding many other buyers. So Tracy mentioned that, you know, we were building up lots and lots of oil and water. That's where a lot of this was ending up. So the prices for these, the discounts that were kind of suffered by Russian barrels were exploding. They were building up on water. Russia was kind of the oil industry was on its back foot and probably going to start contracting pretty meaningfully if that continued. Now, what are you seeing? Well, all of a sudden, one of the major places that has any incremental supply at all to share around the world is Russia.

34:41Tracy Alloway:So India is back in the market for Russian crude, and the White House actually explicitly gave them a waiver for those sanctions that I mentioned previously. So they're going to start importing a lot more Russian crude because they need to. And even the Europeans have started clamoring about easing sanctions or reopening flow on the Druzba pipeline to Eastern Europe and into Germany. It's a mess. And again, it's a mess that overwhelmingly serves the interests of the Kremlin above any kind of other single national actor in this oil market.

35:13Rory Johnston:It is pretty striking turn of events with that, isn't it? You brought this up earlier, but I feel like this is going to come up, so we should talk about it more. There actually was a headline already, this idea of curbing exports. And I think in a lot of people's head, it's like, oh, we produce more oil than we need. We export them. Let's just keep it all at home and then prices will come down, et cetera. Like, I feel like if you're not thinking second order, it sounds like a totally fine thing. Walk us through why you think that's like a disaster scenario.

35:45Tracy Alloway:Yeah. So I think what would be compelling to Trump is that in the first two or three weeks, it would result in very meaningfully lower pump prices for U.S. consumers. I think let's just get that out of the way. But in a way that's kind of too much of a good thing in that what you see is like as an example of the U.S. Gulf Coast, which is the major refining hub of the United States, where you have all of the outlet from the Permian and all the rest of the oil fields and directly into that refining hub, much of which is exported. You see a lot of diesel exports, about a million, million and a half barrels a day of diesel exports out of the region, largely going to Mexico, Latin America and other areas.

36:21Tracy Alloway:If you banned exports, let's say across the board, what you would do is you would start building those inventories at that pace in the U.S. Gulf Coast. So you would start overflowing your tanks of diesel. Diesel prices would crash. That would be great very briefly for your kind of, you know, drivers of big, your big diesel trucks and shipping, et cetera. That's great. But eventually you reach the stage where it's the same kind of thing as you're seeing from the Gulf exporters. You run out of storage space and all of a sudden you can't produce any more diesel. You can't put it anywhere. That begins to overflow your tanks.

36:51Tracy Alloway:You need to cut runs. That's when things get bad because then you're starting to lose gasoline supply. You're starting to lose everything else as well. And all of a sudden you're going to get turned into an importer of various fuels. Now, there's also the issue that you have a lot of trade between regions. that like maybe you could put excess fuel out of the Gulf Coast into the East Coast. Ah, well, then we get back to your favorite topic, the Jones Act. So I think there's a way that you could design a very specific policy that was selective with certain fuels and everything else. If this was a true, like if Trump wanted to do this for months, then yeah, I expect him to do something along these lines.

37:30Tracy Alloway:And it's going to get extremely messy. I also don't know if they can kind of stick handle the specifics of this industry in the way that they would need to. But you could create a scenario that the US basically cuts itself off from the world and does so in a way that doesn't completely destroy the industry. Let's say you still allow US Gulf Coast diesel exports. But I think the other thing here is that over time, the system just continues to break and erode that all of those imports into the US East Coast, well, those barrels will get incentivized elsewhere. If you can't incentivize, like let's say he goes full Nixon a la the 1970s oil shocks And not only do you have an export ban, let's say you have price caps or price fixing at the pump, not outside the realm of possibility with the current administration.

38:13Tracy Alloway:I think that is where, again, you short circuit that mechanism I mentioned earlier that in the current situation, we likely in the United States, Canada, where I'm up right now, these countries likely will not run out of fuel. They'll just get very, very expensive. These policies that the White House could impose could create a situation of outright scarcity and shortages in North America in a way that we wouldn't be able to pay to get around them because his whole point, his whole purpose is to avoid that pump price spike. But in doing so, you would end up creating outright shortages instead.

38:45Rory Johnston:Rory Johnston, it's been too long. I was going to say we should chat more often, but, you know, I don't want to chat again too soon because that would be a very bad sign. But it's very possible that we might be calling on you again. But thank you so much for coming on Not Lost. That was great. Thanks for having me, guys. Always a pleasure.

39:14Rory Johnston:Tracy, I really like talking to Rory. I thought that was great. I think one of the interesting dynamics, which I hadn't fully appreciated, is that spread between the products and the price of crude. I mean, I didn't totally understand why the jet fuel market had blown out quite so crazy, but it makes intuitive sense that when there is such concern about the capacity at all to get the input, that they have to already just sort of start slowing down their pace.

39:44Joe Weisenthal:Let me just say, I don't like it. I don't like talking to Rory about how the hypothetical doom scenarios that every oil analyst has been thinking about for decades and decades are now coming to pass and turning into actual reality. That's not very fun. But if we're going to talk to one person about what's happening right now, I think Rory is a very good person to talk to, someone who is not naturally doomer-ish in his thinking, but is nevertheless quite concerned about the current state of affairs.

40:16Rory Johnston:I think the risks from a sort of global stability perspective are very bad when you start thinking about, OK, here is this war that the U.S. and Israel launched. And then the ramifications could be that a lot of the world's poorer countries just get completely shut off or have to deal with like crippling oil austerity. The fallout from that, again, setting aside the specific market fallout and how long it would take to get the oil market back to normal, this sort of broader fallout from that dynamic specifically that everyone's oil prices go up massively or get cut off strike me as a very disturbing potential.

40:58Joe Weisenthal:Well, the other thing that's rather disturbing is this idea of Russia as the new swing producer. Right. And, you know, Russia, we all know, has strategic goals. You can imagine a scenario where it becomes very strategic and political in its decisions of who gets oil where. So lots to think about.

41:17Rory Johnston:Lots to think about. Yeah, because you especially if Europe starts to soften a little bit on Russian energy, I don't know, all kinds of weird dominoes that I think are going to be knocked over because of this beyond just the extraordinary price surge.

41:33Joe Weisenthal:And meanwhile, lots and lots of episodes that we need to record. So not just oil. We also want to talk about fertilizer. And given the news from today, it looks like we're going to have to do a Jones Act episode as well.

41:46Rory Johnston:Jones Act, SPR. We have a lot to come.

41:48Joe Weisenthal:It's all coming. All right. Shall we leave it there for now?

41:50Rory Johnston:Let's leave it there.

41:51Joe Weisenthal:This has been another episode of the Odd Lots podcast. I'm Tracy Allaway. You can follow me at Tracy Allaway.

41:56Rory Johnston:And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow our guest, Rory Johnston. He's at Rory underscore Johnston. Follow our producers, Carmen Rodriguez at Carmen Armand, Dashiell Bennett at Dashbot, and Kale Brooks at Kale Brooks. And for more Odd Lots content, Go to Bloomberg.com slash OddLots. We have a daily newsletter and all of our episodes. And you can chat about all these topics 24-7 in our Discord, discord.gg slash OddLots.

42:22Joe Weisenthal:And if you enjoy OddLots, if you like it when we churn out these emergency episodes, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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