Gas Is Back Above $4 — And Could Keep Rising

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2:01Welcome to Prof G Markets. I'm Ed Elson. It is July 21st. Let's check in on yesterday's market vitals. The S &P 500 and the Dow declined as conflict in the Middle East escalated. The Nasdaq was flat. Oil was volatile. More on that in a moment. The yield on 10-year treasuries rose. SpaceX stock hit a new low of$120 per share. And finally, Warner Brothers shares fell nearly 4 % after a judge temporarily halted its deal to get acquired by Paramount. The judge said the sale likely violates antitrust laws and scheduled a hearing for next month. Okay, what else is happening? Conflict over the Strait of Hormuz keeps escalating, and now it is spreading to Saudi Arabia.

2:53As of Monday, the US had bombed Iran for nine consecutive nights in response to Tehran's attacks on oil tankers, and Iran had retaliated with strikes across the region. But yesterday, Iran's Houthi allies in Yemen declared a naval blockade against Saudi Arabia. This blockade stands to threaten the primary way in which oil has been able to get around the Strait of Hormuz through a Saudi pipeline to the Red Sea. These developments immediately shot the price of oil back up. Crude is now about$89 a barrel, and the national average for a gallon of gasoline has yet again hit$4 in America, up 15 % in just the past week.

3:36So, to discuss what is happening in the Middle East and also how it's affecting the price of oil, we are speaking with Matt Smith, Director of Commodity Research at Kepler. Matt, great to have you on the show. A lot happening here. If you could just give us your initial reactions and a quick rundown. What has unfolded and how is it being reflected in oil prices right now? We're tracking those tankers that are passing through the Strait of Hormuz here. Our job has become increasingly more difficult as there's been different routes to try and traverse the Strait. And so what you've essentially got is you've got the Iranian route, which is right at the top, kind of the north.

4:21And then you have the pre-conflict highway, which was straight through the middle and then at the bottom you've got the Omani route which is the kind of the southern corridor as we've seen escalations increasing here and you've seen some of the tankers being hit that were passing the Omani route all we're actually seeing now is is it's essentially traffic grinding to a halt again except for those Iranian tankers and friendlies that are passing the Iranian route so it's been undulating right over the last few months you know March, April, and even into May, the traffic was very, very slow. And then, you know, just over the last month or so, we've really seen it pick up because of the signing of the Memorandum of Understanding between the US and Iran.

5:04Now that has basically been, you know, dissolved. And we're seeing an escalation here in attacks, as you mentioned, it's been nine consecutive nights, will probably have the 10th today. And so this is causing all prices to start to kick back higher again. Just looking at what happened with Saudi Arabia and that blockade, it seems as though oil supply was figuring out a way to kind of reroute itself away from the Strait of Hormuz or around the Strait of Hormuz. I guess my question is, to what extent was that successful? and to what extent has that now been kind of blocked now that we've got this new development?

5:50It was working pretty successfully and so it was able to reroute about three and a half million barrels a day of Saudi crude across to the Red Sea and so Saudi was exporting about seven million barrels a day out of the Mideast Gulf prior so it was able to reroute half of that crude so that put them in a better situation more than most so that has definitely helped somewhat cushion the supply shock because all of that crude was then going across to the Red Sea and was heading into the likes of India, China, South Korea, these countries that were otherwise getting their crew from the Mideast Gulf and it had stopped.

6:21And so it was definitely providing some support there and helping, you know, in terms of support in terms of supply and then helping to keep prices in check somewhat. Now, the Houthis are threatening to do that blockade. they're not actually doing it yet we're not seeing tankers or anything being being hit but this essentially is the ace that iran has in its pocket because we've had this escalation that's been happening over the last few months here and some have said oh we know they could close babam and deb but they've kind of held that back until the point where the u.s would essentially start perhaps attacking infrastructure energy infrastructure bridges and and that's kind of the point that we've got to so then it's for iran to up the ante here and that's basically bringing bab al-mendeb into play and so it's really just a sign that essentially iran has is getting to the point where they've really got not nothing left to lose or you know they're they're just getting to the point where they're willing to do this kind of scorched earth tactic and so we'll have to see how this plays out but the threat of stopping these flows will definitely have a bullish impact on prices.

7:29So the memorandum of understanding has been dissolved. We are now fully at war, striking Iran on multiple consecutive nights. Now they are, as you say, playing their ace card. They are trying to block any of the other supply routes that have been resorted to over the past several months. I mean, it doesn't look good. And we're at$89 a barrel. Gas in America has gone back up to$4. Why should we believe that that number is going to come down within the next, I don't know, several weeks? Yeah, no, we shouldn't. And actually, what has developed over the last few months here, or essentially since the beginning of March when this has happened, is everyone's been watching that oil price, and you haven't felt the biggest impact on that oil price.

8:29And the reason for that has been a number of different reasons. China has really come out of the markets. China has just stopped buying oil. They dialed back on their imports by about five, five and a half million barrels per day. So that has been hugely helpful. You've also had essentially a lot of these refineries dialing back on their activity, so they haven't taken that crude. And that has largely offset the production loss we've seen from the Middle East. But what that has meant is that the pain has essentially been transferred from the oil price across to the products. And so when you talk about gasoline at$4 a gallon on the national average, we see diesel at$5, breaking above$5, And that's going to be really pushing higher because in barrel terms, it's about$170 a barrel for a barrel of diesel.

9:14And so that's where that pain is coming through is in the products because we're not seeing those produced. Whereas the crude market is somewhat remains somewhat in balance because of this rerouting and because this lack of refining. When you look at that number,$89 a barrel, to you, does that say that investors are feeling optimistic about the current state of affairs or pessimistic? I mean, does that number hold any biases inside of it? one huge bias that it holds is that even if you are bullish on oil markets you're not going to go and buy a paper barrel because you could have president trump tweet something in five minutes time and oil prices could drop by 10 15 so i'm not saying prices are manipulated per se but they are definitely under the influence here of things other than fundamentals and so because of that You've got some that are simply not getting involved in the oil trade, and that has been happening for a good number of months here.

10:22There's a lack of liquidity there. The flip side of that, that's why I point to the diesel market again, is because the US administration is fixated on the oil price, super fixated on prices at the pump. It's not necessarily paying that much attention or putting that much emphasis at all on diesel prices. And so that's perhaps the least influenced market out of all of the petroleum complex. And that's the one that we're seeing absolutely ripping here. I mean, this is essentially the most important question for the US economy right now, which is what's going to happen to the price of oil? What's going to happen to the price of fuel?

10:56As we saw in the previous inflation report, it was lower oil prices as a result of the memorandum of understanding that made the number go down more than the previous month. But now we know that whatever pricing was being priced into the market at the time was incorrect because the memorandum of understanding is over. We're now back at war. Some would argue we continue to be at war the entire time. I won't get into it. But it seems that what we have seen over the past week is going to have material impact on U.S. consumers and the U.S. economy. And perhaps that isn't being fully reflected or appreciated or priced in by investors and traders right now, how impactful and how bad do you think it will be going forward?

11:46Well, we could just continue in the status quo, right? In that there's this back and forth between the US and Iran in terms of the attacking of tankers by Iran, the attacking of infrastructure by the US. And then in the background, there is talks and whispers of diplomacy, which helps keep oil prices in check here, which in turn helps keep prices of the pump in check. But when we came into this thing, there was expectation you can't close the Strait of Hormuz for two, three weeks, it will cause like Armageddon. Yet here we are four and a half months in. And so it's really realistic to try and consider the scenario.

12:23Could this still be closed in November and December? Yes, there are workarounds. There's medium term plans here to reroute crude, but we really could be just continuing to scramble over the next four or five months here. And that's a reality. If that happens, you're not going to be in an environment where prices at the pump and diesel prices are moving lower. What kind of price do you think that that would result in if we find ourselves in the same situation that we're in today? And to be clear, I mean, it seems like a couple ships are making their way through the Strait of Hormuz. I mean, is that right?

13:02Or is it just zero? There was like a week or so ago, or even just before the weekend, where you were seeing some getting through there. But the Iranians have turned their focus to targeting those because they were going through the Armani route, they were getting like a US naval escort. And so they're trying to deter any kind of traffic. So the only traffic that we're seeing going through right now is related to Iranian or Iranian, and it's just empty tankers. And so, but to your point, we were seeing over the last month, this increase in traffic going through, increased confidence, increased risk taking, and that really helped the oil market, not necessarily on the oil price, but in the differentials, you really saw the air being let out of the tires there, the pressure taken out, as we saw the stranded cargoes in the gulf getting out of there but then again with it's one step forward two steps back here where we're back to to essentially the doors being shut again so i'll return to my question which is if we find ourselves in the same position that we are in today four or five months from now what would you estimate the price of oil uh will will look like it's got to be higher you know i'll hold up my hands here and you know in march you if you'd ask me that question you may have done absolutely I mean, like, you know, oil prices should be$120,$130,$140 if you close the strait for months and months.

14:24And so perhaps I've been burned by saying that, right? But maybe if we're going to be pushing above$100 here, that doesn't seem unrealistic at all if we're in the same scenario that we're in now in four or five months' time. If we are in the same scenario that we're in now and it isn't above$100 a barrel, what would have had to have happened to get it lower than that? What truths would need to exist in the world for oil to not be more than 100? Well, we'd be drawing down inventories absolutely everywhere that we could. You'd be having tankers sneaking out of the Strait of Hormuz, however that was possible, rerouting of crude as much as possible too.

15:07But it's just difficult to see a scenario where you're not pushing into triple digits if this is still the situation in four or five months' time. All right. Matt Smith is Director of Commodity Research at Kepler. Matt, appreciate your time. Thank you. Thanks, Ed. After the break, why investors are so worried about the latest Chinese model. And for even more markets insights, you can subscribe to my weekly newsletter, simply put at simplyput.profgmedia.com.

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18:04We're back with Profity Markets. China just gave Wall Street its second deep-seek moment. Chinese startup Moonshot AI released Kimi K3, the world's largest open-source model, on Thursday. On some benchmarks, including front-end coding, K3 beats the best models from OpenAI and Anthropik. But the biggest story may be the price tag. Running K3 costs roughly a third of what Anthropic charges for its flagship model, and businesses are starting to notice. On OpenRouter, a marketplace for AI models, Chinese open-weight models now occupy the top five spots by weekly global token usage. The Nasdaq fell about 1.5 % on Friday as US tech stocks sold off following the release of Kimi K3.

18:54So we wanted to speak with an expert who works hands-on with both open and closed models. So joining us is Charlie O 'Neill, co-head of model training at Base 10. Charlie, thank you for joining us. So this Kimi K3 model that was just released has everyone kind of with their hair on fire. We obviously saw the NASDAQ erased 1.5%. Chip stock sold off. a lot of people saying that it was a problem. David Sachs, the former AI czar, called the release, quote, concerning. What do you make of Kimi K3? Yeah, I think the big story here is not necessarily Chinese models versus American models. I think the big story here is open source versus closed source.

19:40So obviously the story we've been told for the last several years is that closed source is going to continue to dominate. The American frontier closed source labs are going to continue to pull ahead and open source will never catch up to that. And I think what we're seeing with Kimi, with other Chinese models like GLM, GLM core is a very, very big wave. It may not have done the rounds in the same way that Kimi did, but it was certainly a great model. And even like releases like Inkling from Thinking Machines, which is an American company, what we're seeing is that basically the recipe to build these things, there's no secret source.

20:13The big labs, they don't have anything that the open source labs don't have. And open source is going to continue to improve the capabilities and intelligence of the models they release as we scale up the size of these models and the amount of data and compute that goes into them. And so, yes, from one kind of aspect, it's concerning that this is like a Chinese model that is leading the charge with this sort of like open source versus closed source debate. But I think there's really promising signs for the open source ecosystem in general. And I think a lot of people are starting to realize that that's potentially a better world to end up in compared to where you have maybe a duopoly with open-air and anthropic having these models that pull away from everyone else and they dictate all the terms of access and control that intelligence.

20:53Just for the uninitiated, what is the difference between an open source model and a closed source model? Anthropic, OpenAI, Google, their flagship models are what we refer to as closed source in the sense that I can ask it a question, that question gets sent off over the internet, goes to their GPUs which run the model, they do the number crunching and then they send the answer back to me. I never get to touch the model weights which you can think of with this big collection of numbers that do a bunch of multipliers to give me my answer. Whereas with open source, I can actually download those numbers.

21:24Not only can I host that on my own GPUs, I can also do things like continue to train it myself for specific tasks. So it's really about being able to download the actual weights of the model rather than just being able to send a question to it. So you can think of this as like, you know, owning the disk for an Xbox game versus like having that Xbox game installed through the cloud on your particular Xbox. I can actually see the physical disk. What would be the pros for developing a closed source model instead of an open source model? Why would OpenAI and Anthropic pursue those methods instead?

21:59I guess there's two answers here. The first answer is the one that OpenAI and Anthropic will tell you, which is that these things, as they become increasingly intelligent, we have to think very carefully about how they're applied in society. There's obviously real safety concerns, there's cybersecurity concerns, there's biological weapons development concerns. And so we should really think about who we trust to build and control this intelligence. And Anthropic and OpenAI's argument is you should trust us. We are the best at developing this intelligence and hence we should be the ones to dictate how it's used and how it's applied basically in perpetuity.

22:31There should be a very small number of actors who can choose what we do with LMs and intelligence. And I think the real argument is that obviously this stuff is so lucrative that if you do manage to prevent anyone else from developing it you can capture insanely high margins on the tokens that you're producing so anthropics rumored to have you know margins north of 80 percent um i think like when there is a case or a world where there's only two major players and you end up in a duopoly that is a very real possibility to to continue and i think that's obviously very very lucrative to open an anthropic so open source is a threat to them in the sense that those margins aren't going to remain at 80 % for long.

23:11Of course, there are security concerns. We have to really think carefully about how these things are used. But at the moment, it doesn't seem like open source versus closed source. The intelligence ceiling that we've gotten to hasn't led to any increased concerns around, you know, can I use this model through open source or closed source? Like the risk of developing a bioweapon, for instance, is about the same in either case. It seems that there has been kind of a shift towards both Chinese models, but also open source models. Most of these Chinese models are open source or open weight. Why is that happening, do you think?

23:46What is the value proposition that developers are deciding is greater when they use these types of models as opposed to one offered by OpenAI or Anthropic? I think there's developers who have a very inelastic demand for the frontier intelligence. We'll always want to use the most intelligent models. And then there's the ecosystem and the economy in general. The way I like to think of it is that for all the economically valuable tasks that we could plausibly use an LLM for, there is some intelligence threshold at which below that it's very difficult to do the task. And above that, you're getting very diminishing returns to having more and more intelligent models.

24:22And usually intelligence is correlated with cost. So the obvious argument here is that there is margin pressure on all these startups, all these companies, even enterprise now who are doing these particular tasks with LLMs. They've hit the threshold of intelligence probably even a while ago with open source. Open source has been accelerating rapidly and you just don't need a Fable or Mythos level model in order to do some of these things. And you get exactly the same performance if you use a model that's a tenth of the size or even a fiftieth of the size. Post training is also really important here because it means you can teach a much smaller model to do one thing really, really well, as opposed to taking an off-the-shelf open source or closed source model and trying to prompt engineer your way to doing that task.

25:01So post-training really changes the economics here. And of course, you can only post-train on open source models because you can actually touch the weights as opposed to closed source. And so I think margin pressure is a big one. Another one is like Anthropic and OpenAI, I think are realizing that the recipe is the same amongst all these companies. Like there is no secret sauce. Yes, there's probably a long tail of optimization, small optimizations that Anthropic and OpenAI AI have that the rest of the ecosystem doesn't have. But their moat is no longer in them being the only ones who can train these very, very large multi-trillion parameter models.

25:32Their moat now is starting to shift towards, okay, well, if we have a little bit of a headstart, what if we try and hit particular verticals? And so Anthropic is very clearly doing this. They're going after the verticals of finance and legal, OpenAI as well. And so I think companies are really feeling this pressure. If you're a startup or a company in legal or finance and you're using LLM to do these particular things and you have previously just been an Anthropic wrapper, you've just got some logic calling Anthropic models, you don't have a distinguishing moat between you and Anthropic. And so you're starting to think about, okay, what's the one thing I have that Anthropic doesn't have?

26:05And that's a really nice feedback cycle. I have users who love and hate my product for various reasons, and they will tell me what they love and hate. And I can use that to improve the intelligence of a model. And again, you do that through training. And the only real way to do that is with open source models. And so I think it's this combination of margin pressure and companies wanting to develop their own mode to protect themselves against their vertical being eaten by these closed source frontier labs. It seems like a big piece of the story for an enterprise, for a company that's trying to leverage AI as much as they can.

26:35And Alex Kopp talked about this in his interview with CNBC that has since gone viral, is basically just the price. uh anthropic tokens are expensive open ai tokens are expensive tokens from chinese model providers are less expensive so my question is to what extent is there a relationship between price and being open source why is it that these chinese models and these other models that aren't you know frontier lab models, how is it that they can offer a product that does the job pretty well, but at literally a fraction of the cost? The answer to this used to be simply that the Chinese and open source models were much smaller.