Energy prices up, markets down

0:09Rob Armstrong: We have war in the Middle East again. Operation Epic Fury. This time, after a slow burn, it's doing some real damage to markets, which suggests some real damage ahead to the global economy, or perhaps more accurately, to the economies of Europe and Asia. Now, before you email us to tell us we're terrible people, no, we don't think markets are the most important thing about the bombing of Iran by the US and Israel or about Iran's retaliation that's affecting other countries in the region. People are dying, it's grim, and we're not monsters. But the reality is that the economic impact on the world from what happens in the Middle East really matters too.

0:50Rob Armstrong: Now, on this podcast, we know what we don't know, so we're leaving the geopolitics to wiser colleagues. Today on the show, we're picking apart the hit to markets and why it all matters. This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist at FT Towers in London, and I'm joined down the line all the way from New York City, yes, by the big guy, Robert Armstrong, off of the Unhedged newsletter. Say hello, Rob.

1:19Katie Martin: Hi, guys.

1:20Rob Armstrong: But I'm also joined back by popular demand. We have Jamie Smith, FT Oil Nerd, to tell us what's really going on. Hi, Jamie.

1:29Jamie Smyth: Hello, Katie.

1:30Rob Armstrong: So let's do a really quick recap. Rob, what is the score? What is going on? And listeners, just so you know, we're recording this on Tuesday, March the 3rd in the London afternoon. Situation's moving around a lot, but this is the situation as we have it. Rob, what is it?

1:46Katie Martin: From the provincial point of view, just of markets, I think what we've seen in the last 24 hours is a change in basic expectations. I would say Monday morning when markets opened, market prices of everything from oil to natural gas to stocks to gold to treasuries were telling you that we were looking at a short, tidy conflict in the style maybe of the intervention in Venezuela earlier this year. And what's happened since then is that Iran has demonstrated some ability to drag things out and widen the conflict. And so markets retaliated, right?

2:34Rob Armstrong: So the bombs fell on Iran. The leader who'd been, you know, been leader for decades was killed. A lot of other the top military and political leadership were also killed. civilians lost their lives and Iran retaliated and started chucking rockets in the direction of the United Arab Emirates. So as you say, it kind of went from just an Iran thing to a regional thing.

2:59Katie Martin: Yes. And there's been hits on things like oil infrastructure. There's been hits, you know, across the Gulf region on US bases. So the markets are struggling now to reprice a rather more unpleasant reality than they were expecting a day or so ago.

3:19Rob Armstrong: So, Jamie, let's start on the sort of energy side with oil. We've seen oil prices come up quite a lot. The European benchmarks, that Brent is$84 a barrel. The US benchmark, WTI, is at$76 a barrel-ish. Is that a lot?

3:38Jamie Smyth: Well, I think if you compare it to December, it is a lot because then you had oil, you know, just hovering around$60. So that's about a$25 geopolitical risk premium that's been bid into the price. So that is a significant amount. But I think, you know, what most analysts are really concerned about is, do you get to the$90 to$100 level? And that's really the level which starts to bite into economies across the world, you start to get a lot of inflation. And it starts to put a question on the central banks and whether they can cut rates again. So I think, you know, if this is a long drawn out war, we're certainly going to see those oil prices creeping up to those levels.

4:23Jamie Smyth: So that I think unnerves investors.

4:25Katie Martin: Just to give a bit of context here, in 2022, which is the year Russia invaded Ukraine, oil peaked at 115 natural gas which you should also talk about with jamie really went bananas and there was very significant world economic implications but so jamie like for people who

4:51Rob Armstrong: you know don't know the details here why hasn't oil just gone straight to a hundred dollars a barrel because you know i think actually a lot of people overestimate how much oil iran supplies into the global system. It's just not as big of a deal as it used to be. But all the same, this is like a regional conflict. So why hasn't oil just gone crazy?

5:12Jamie Smyth: I think there's probably two reasons for that. One's political and to do with geopolitics. I mean, I think most investors thought this was going to be a short, sharp war like Venezuela. And particularly with the Ayatollah, you know, being targeted and killed early, there was hopes for that on Monday. But certainly we've seen a resilient response from the Iranians. They've hit oil infrastructure and that's really important. They've hit LNG infrastructure yesterday.

5:42Rob Armstrong: So that's liquefied natural gas for the uninitiated.

5:45Jamie Smyth: Yeah, sorry, I'm nerding out there. But yeah, so Qatar Energy had this massive LNG plant, Ras Laffin, which supplies a fifth of global production of what is a really important fuel. And that is offline at the minute. So I think that attack really unnerved people, you know, and you've seen the gas prices now. European gas prices are up over 80%. They hit$64 per megawatt hour today. So that is a huge jump and that really will cause problems for Europe and Asia as they compete, buyers compete to get gas to refill storage.

6:23Katie Martin: One oil analyst, I spoke to Rory Johnston, who you might know, Jamie, in any case, He's not as clever as you, but he's moderately clever. And he pointed out that there's a lot of talk about closing the Strait of Hormuz, which is this choke point in the Persian Gulf where a lot of oil, not just from Iran, but all the Gulf states has to be tankered out to the world through. And Iran can and seemingly has asserted its control over that little strait, this little bottleneck. but that bottleneck can be opened if things change. Whereas if you blow up an LNG plant or a refinery or transport hubs for oil, the like on ground infrastructure for moving oil around, that takes time to repair, right?

7:15Katie Martin: You can't just wave a magic wand when the war is over and get the plant running again. So infrastructure seems like a particularly important point.

7:21Jamie Smyth: Yeah, exactly. I mean, there was in the aftermath of the Kuwait war, Saddam Hussein did a scorched earth policy and blew up a lot of the oil facilities and it burned for months and months. And it caused a real hit to, you know, global supply. So if you get the Iranians successfully targeting Saudi refineries, Saudi infrastructure, that could have a really significant impact in a way which lasts for a while. Now, the Strait of Hormuz is crucially important. It's this choke point through which 20 % of oil and 20 % of LNG flows through. So if the Iranians manage to keep it closed, it appears to be effectively closed at the minute.

8:05Jamie Smyth: If they could do that for longer than three weeks, that would be a serious and significant issue and quite unprecedented. And why three weeks?

8:14Katie Martin: Is that just because there's a certain amount of oil sitting around in oil tanks around the world? and that's how long it takes to burn through those reserves?

8:21Jamie Smyth: Yeah, and actually, you know, Iran and Saudi rushed out a lot of barrels prior to this. You know, they suspected that there was conflict coming. So a certain amount of oil has actually gone out, entered the system. But as we go through the weeks, then that will, you know, there'll be more demand and it won't be able to get a lot of this Gulf oil through. So that's, I think it's, you know, most analysts say three to four weeks really would be problematic. and you start to see potential shortages in countries at that stage, you know, particularly in Asia.

8:52Rob Armstrong: So just to stick on this point about the Strait of Hormuz, it's not as if Iran closes it by like putting a piece of rope across it with a sign saying Strait of Hormuz shut. The reality of modern warfare is that it's actually pretty straightforward to have drones buzzing around, that if you are piloting a ship full of oil or LNG, you're not hugely keen to have hit by some sort of strike. So it's actually, you know, three weeks sounds to me pretty plausible, you know, as an amount of time they could keep this shut just by keeping that threat in the air over the ships. So it does feel like quite a volatile situation to me.

9:33Jamie Smyth: Yeah, certainly. And, you know, if you hit one of these LNG tankers with a drone or a missile, they're really going to go up, you know, and oil tankers, maybe, you know, they'll catch fire. they could sink, but the LNG tankers would be very nervous about passing through that. And there's the potential for mining this sort of strait. In the past, there have been convoys set up when there's past regional crises, where you'd get allied ships that would go through and escort the tankers. Perhaps there's some way they could do that. And there is potential to shift some oil through the Red Sea and through pipelines, but there is a capacity constraint there to that.

10:16Jamie Smyth: So there's a limit to how much they can do that.

10:18Katie Martin: Jamie, I have the impression that this region almost punches above its weight with the oil price. In other words, you're talking about it's 20 % of LNG or it's, you know, how much of the oil supply goes to this trade? One barrel in five, another 20%, something like that. But it seems like these are the world's marginal barrels. Like if the world needs a bit more, this is where they come. So it's like they have an even bigger effect on price than the numbers would suggest. Is that fair? Am I getting the right impression there?

10:54Jamie Smyth: Yeah. I mean, Saudi's usually considered the sort of swing producer and the one that can sort of increase capacity. OPEC, you know, and OPEC actually did meet just on Sunday and it approved a further increase in production, 206 ,000 barrels. So OPEC has a little bit of spare capacity. But can they get that out? Well, that's the problem. That's the problem. You've still got the Strait of Hormuz problem. So that is the choke point. And that's what makes it pretty risky. And this quite an unprecedented situation. It hasn't really happened before.

11:27Katie Martin: If things were different, could Russia fill some of this gap? Does that figure into the equation here, Jamie?

11:32Jamie Smyth: I think, yeah. I think this is definitely going to benefit Russia and Vladimir Putin because it's pushing up the price of oil. So Russia will benefit from that. It was actually creaking at the seams, its economy, a couple of months ago when the price was low. But also, if this was a prolonged stoppage here, I think you would then get a lot of countries turning to Russia. India, for example, was already very dependent on Russian oil, but the Americans were trying to steer it away from that. And it was beginning to do that. But if oil is short, they'll certainly turn to Russia. So they, I think, are a potential big beneficiary.

12:12Rob Armstrong: And the gas as well, right? I mean, and I think it's worth sort of sticking on this point around gas. So the U.S., for example, has got plenty of oil. So it's not that reliant on the international oil price. You know, it can make it work. Jamie, correct me if I'm wrong, but it doesn't use enormous amounts of this natural gas that comes from the Middle East. It's Europe and Asia that are going to really feel the pinch there. So I think I'm right in saying that UK natural gas prices have doubled in like two days or something. It's a really massive jump in gas prices. But we're still nowhere near the crisis levels that we had in 2022 when, as Rob said, that's when Russia launched its full scale invasion of Ukraine.

12:58Rob Armstrong: But could we get back to 2022 style prices? Is that a possibility, do you think?

13:04Jamie Smyth: I think if it's prolonged, if this is a really prolonged stoppage, I think we could get back there. The UK is actually quite dependent on gas, more so than European economy. So that's probably why you've seen the price going up. And at the minute, storage levels are at their lower point because we're coming out of the winter season. I think they're about 30%. And this is typically the time that you refill gas storage in the UK and Europe. But of course, now you've got this big increase in price. So that's, you know, affecting that. So yeah, I think we are vulnerable in Europe and the UK to these types of blockages in the system.

13:44Jamie Smyth: And of course, American LNG has really helped to fill the gap and really did help to fill the gap after the Russia-Ukraine crisis. but there is a lack of capacity. You can't just bring on LNG capacity quickly. In the United States, you're going to build these terminals. It takes time. So there's a certain amount they can do. They can squeeze a little bit more out of their terminals but not too much and not rapidly enough to meet this challenge.

14:14Rob Armstrong: Now this is a problem for the global economy, right? Because, you know, we've seen this movie before in 2022 when energy prices like really rocket higher, you end up with inflation. And, you know, OK, 2022 was different. We were just coming through COVID, yada, yada. But nonetheless, this is a potentially a source of rekindling of inflation, which central banks and governments have only just kind of got a handle on. And that is a complication for markets, right? Because normally you have some horrible geopolitical incident like this. investors rush into safety, which means they buy government bonds.

14:53Rob Armstrong: But the thing that government bonds hate more than anything is inflation. So government bonds are in fact weakening on this. So we've got quite a horrible situation where government bonds are weakening, and that's supposed to be the safe bit of an investor's portfolio. And also stocks are falling quite hard, not so much on Monday, but on Tuesday, this has really got some momentum behind it, down about 2-3 % in Europe. US has opened sharply lower. I feel like the market's been caught with its pants down a bit here. You know, it was very much expecting interest rates to keep on falling. This puts all of that into doubt.

15:29Rob Armstrong: I mean, Rob, what are the jungle drums saying to you in terms of the mood and the market at the moment?

15:34Katie Martin: Well, this is just to reiterate what you just said in a slightly different way. This is the dreaded positive correlation between stocks and bonds. What really saves a portfolio is when your stocks are going down, your treasuries are going up and vice versa, or your bonds are going up. And when they are locked together, as they tend to be in inflationary situations, that leads to a very bad time like it did in back in 2022. So everybody is keen to avoid that. Now, in the U.S. economy, for example, energy prices directly are not a huge amount of our, a huge weighting in our measures of inflation.

16:16Katie Martin: Like in CPI, energy and energy services together are something over 6 % of the total inflation basket. But if those move quickly, 6 % is enough to have an effect if the prices move a lot. And there's a lot of indirect exposure to energy prices. So you know something, your family knows something about farming. I worked on a ranch for a long time. I always like to remind people that food is basically made out of energy, right? You know, you use so much petroleum in running a farm that a spike in energy prices does eventually show up in food prices. So it's not just the direct exposure, but the indirect exposure that matters.

17:00Katie Martin: And also it just spooks people. There's a kind of mental aspect to this, but whatever the weightings are, whatever the actual impact is, people see energy prices go up and they start worrying about inflation. And those kind of spooked sentiments can matter almost more than the actual economic realities in some way.

17:22Rob Armstrong: You know, by the time you start seeing this inflation actually trickle down into higher grocery prices or higher prices for filling your car up at the petrol station or fill it up with gas, as you Americans insist on saying, by the time that's happened, it's almost too late to do anything about it. So normally, you know, you might harbor some sort of hope that stock markets would fall hard enough for Donald Trump to look at this situation and say, well, this is bad. Maybe I shouldn't be doing this. My sense, shout if you disagree, Rob, but is that markets have not fallen anywhere near enough to make Trump think this is a bad idea or should I have a rethink or should I more clearly articulate my strategy?

18:07Katie Martin: I do agree with you there. It's not enough to give him a red light. but energy will scare him. And Jamie, we're expecting an announcement from the White House today. Uncle Don is going to save the day on the energy prices?

18:22Jamie Smyth: Apparently so. Rubio said yesterday there's going to be some announcement today as to measures to mitigate the price increases in energy, but there's no details on what's actually going to be happening yet. I mean, things to note in America are that the natural gas price is only up 3 % or 4%. This is nothing like Europe. And that's because America is very dominant in natural gas. We're swimming in natural gas. Yeah, so that's not a problem. However, diesel prices are rising. That affects transport costs. Gasoline prices, which are really been the feather in the cap for Trump, said he was going to get your prices down at the pump.

18:59Jamie Smyth: They were very low. They were below$3 on the national average. They have now just gone above that. And it looks like we could see, you know, 15 to 25 cents over the next couple of weeks. That'll hurt.

19:11Rob Armstrong: Yeah, but it does rather feel like the US started this war. It's the rest of us that are going to take the economic pain from this, right? It's Europe and Asia who are going to feel this to a much greater extent than the US. So thanks for that, guys.

19:27Katie Martin: But just to bring back to Jamie one point, what can the president do?

19:32Jamie Smyth: So they do have a strategic petroleum reserve, which they did use in the aftermath of Russia's invasion of Ukraine. They did a big release of 180 million barrels from that to calm and soothe prices. They have that, but it's a little bit depleted because they never refilled it after that. Trump pledged on the campaign trail, we're going to refill the SPR right full to the brim, the 700 million barrels. hasn't happened. It's only 58 % full. Now, they could release some of that, but they don't have as much firepower as they could have. Other measures, I mean, I think actually what, you could see things like escorts, try and reopen the Strait of Hormuz some way there.

20:17Jamie Smyth: There might be some military escorts. There could be some reinsurance products brought in for tankers. You know, at the minute, the tankers won't go into the strait because they can't get insurance. Maybe there's a way to provide some sort of insurance policies to allow that to happen, particularly if there's convoys.

20:33Rob Armstrong: Yeah, Bagsy, I'm not on those boats, though. That's a big ask, isn't it?

20:37Jamie Smyth: Exactly. And then on the domestic level, you know, we've seen a few, should I say, almost socialist style policies from the Trump administration. Maybe they could subsidize energy for American consumers.

20:50Katie Martin: A policy that's worked very well elsewhere.

20:54Rob Armstrong: So, Jamie, let me ask you, like, you know, Rob and I spend most of our time talking to people who buy things like stocks and bonds for a living. The prevailing narrative in those sorts of markets is this will pass quickly. You know, this could be grim, but we don't think this is going to be a grinding conflict. And we think we'll come out the other side and then stocks will bounce back and so on and so forth. Are people in the oil industry saying kind of the same thing or are they more pessimistic?

21:21Jamie Smyth: Initially, the first day or two when things looked like they were going well, I think there was some thoughts that, you know, this could potentially have some benefits for the US oil industry. You know, if Iran becomes a liberal democracy and opens up to American capital, well, the oil majors would love that. People were saying that out loud?

21:43Rob Armstrong: That's amazing.

21:45Jamie Smyth: Unbelievably, yes. Yes, there was an American Petroleum Institute meeting and there was a statement made about how there could be an opportunity there. But I think now people are concerned. They are concerned that I think what really concerns people is that there's a lack of preparation from what I've seen. And what are the war aims and the goals? People have heard a lot of the goals. There's so many goals here. there's the regime change, stop the nuclear program, stop ballistic missiles, bring democracy. But no one knows what's the real goal. And then yesterday Rubio said, actually, we went in because Israel was going to act and the US felt they should follow.

22:25Jamie Smyth: So no one knows how long it's going to go on. No one knows when the war aims will be achieved. So I think that does make people a bit nervous.

22:34Rob Armstrong: Listeners, I'm sorry we haven't got anything very cheerful for you here. Perhaps we'll be able to cheer you up in just one second with Long Short.

22:49Rob Armstrong: Okay, listeners, after all that doom and gloom, it's time for long, short, that part of the show where we go long, a thing we love or short, a thing we hate. Rob, what are you saying?

22:59Katie Martin: I am long the turmoil in private assets. Those of you who've been following markets know that there's all this huffing and puffing about private credit specifically and whether people are trying to exit funds and not being let out and what's the future of the industry. and I just feel like private is private and public is public. And the products that are in trouble are trying to do both. Like this is a private asset fund, but also you can have liquidity and frequent pricing and everything. That's never going to work. It was never going to work. And now we're coming to the reckoning. I think private assets are great.

23:42Katie Martin: I think public assets are great, but you can't have both. And it's time we all realize that.

23:47Rob Armstrong: It's neither Arthur nor Martha. That's very cerebral of you, Rob. Jamie, what are you saying?

23:53Jamie Smyth: On a lighter note, I'm a massive rugby fan. And the Irish rugby team, who everyone had written off at the start of the Six Nations tournament, have just beaten England in a test match last week. And they're poised to play Wales and Scotland. And I'm Long Ireland. I think they're going to win those two games, probably come second in the Six Nations.

24:16Rob Armstrong: I seem to remember last time you were on the show, you were being mean about the English cricket team. So you are nothing if not on brand. Listeners may recall I have a fondness for Greggs. I've been long Greggs, the British bakery chain for some time. And I am doubling down. The entire stock market is on fire. Everything is awful. Everything is terrible. Greggs is up 2 % as I speak. It's the new safe haven. And the market has decided that shares in purveyors of sausage rolls are the way to go if you're looking for safety in a crisis. And I'm here.

24:51Katie Martin: I want Greg to come to America so bad, Katie. I love that stuff.

24:55Rob Armstrong: I really don't think it would be good for you, though.

25:00Rob Armstrong: With the best will in the world, I just don't think that's a very good one.

25:03Katie Martin: Here lies Robert Armstrong, who died of a sausage roll overdose.

25:09Rob Armstrong: Yeah, it genuinely could happen. And listeners, assuming that has not happened by Thursday, we'll be back in your ears then. Jamie, thanks so much for coming on. We know that you're really busy. And yeah, back on Thursday. So get us wherever you get your podcasts then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's Global Head of Audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free and a 30-day free trial is available to everyone else.

25:49Rob Armstrong: Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

26:08We'll be right back.