How oil got to $90 a barrel

0:06Pushkin. While we were all busy gawking at NVIDIA and where interest rates are going, oil, it's been creeping up. It hit$90 the other week. It's down a little bit today, but it's still high. It's been up about 15 % this year. This is a big deal. Oil goes into everything we make, everything we use. It's a key input into the global economy. Today on the show, why oil is at$90 and why you should care. This is Unhedge, the markets and finance show from the Financial Times and Pushkin. I am reporter Ethan Wu, here in the New York studio, joined from London by FT Markets columnist, Katie Martin. Hey, Ethan.

0:47How's it going? Hey, it's going good. I mean, I don't want to take away from the episode. We're two stock people talking about oil, but it's important, right? Like this is something that matters. I mean, I've been paying attention to oil. As you say, it's had like a hell of a run so far this year. So one tiny kind of thing here is that like, so the Brent oil price, which is effectively the European benchmark, that hit$90 a barrel. The WTI US benchmark, without meaning to sound like a kind of boring nerd, that hasn't quite got to the same level. But the two generally move in lockstep and they've moved by very, very similar degrees.

1:24So, I mean, we are definitely sitting at the tail end of like really quite an impressive run higher in oil prices. The oil price increase has been a surprise, right? Like there are some environments where there's a lot of predictions and then oil ends up going up. But this time it took people, you know, a bit off guard. So, you know, one way to make that point, right, is you look at the forecast put out by the International Energy Agency, the IEA. This is like the kind of, Katie, how would you describe them? Like the foremost authority on the oil. They should know what they're talking about. They know one end of the oil market from the other for sure.

1:58Yeah, they got energy in the name. All right. So they know what they're talking about. In January of this year, they were projecting a quote unquote substantial surplus of oil supply. In March, they changed their forecast to a slight deficit. Right. So that's a big change going from we're going to have too much oil to we're not going to have enough oil in the span of two months. Right. That forecast from the leading global energy authority changed. Why is that? Right. So we had a look at that recently in the Unhedged newsletter. And I think it comes down to three general factors. There's demand, supply, and geopolitics.

2:33And, you know, I think the demand story is like the most intuitive. And in some ways we've been talking about it on the show, Katie, just things are going better than I think a lot of people thought that they would. And it's not just in the US. No, I mean, you just cannot hold the US economy down, seemingly. And that's obviously a massive source of supply for oil, as you say. You know, everyone's been beating up on China for the longest time, but there are potentially signs that that economy is possibly bottoming out around now and that things have stopped getting more and more terrible and that might be a meaningful source of demand picking back up again.

3:08Investors are not super keen to get their fingers burnt on China all over again, but the economic impact of it being a big source of potential oil demand is not to be sniffed at. Yeah. I mean, we just got first quarter GDP numbers a few days ago from China. They beat expectations by, you know, not a ton, but like a little bit, 5.3 % growth. That's above the Communist Party's growth target. Now, there are ways to like shit on the report. And, you know, it's not a clean number. But it does show that, especially in the manufacturing sector of China's economy, things are doing a little better than they were last year.

3:41What do manufacturers need? A whole lot of energy to make stuff, right? And so that's kind of helped oil demand along. You've also seen a lot of energy out of India, which is supposed to be one of the fastest growing oil consuming economies in the world for the next several years. So between those three, right, the US, India and China, you throw Europe on there, which, you know, it's not doing amazing, but the bottom hasn't totally fallen out at the very least. You've got a pretty decent global demand picture right there. Exactly. These constant repeated calls for a recession have been greatly exaggerated, as we've discussed in the past.

4:17So then you move from demand to supply. The main player when it comes to supply is a little cartel affectionately known as OPEC. Katie, what is OPEC? So OPEC is like a grouping of big oil producing nations, kind of effectively led by Saudi Arabia, which is one of the world's biggest oil producers. Now, this grouping doesn't include the US. So the US kind of has to, you know, tag along pretty much with what the rest of the world decides. But they very explicitly agree on what output levels are going to be, right? How much oil they're going to suck out of the ground and produce and spit out into the global economy in an effort to control the price.

4:57They don't want it to shoot too high too fast because that will kill demand. They don't want it to be too low because they need the money. So they kind of keep this balance in check. Yeah, it's a weird thing where like if Exxon and Chevron and like all of the frackers in Texas decided to make a cartel, that would be enormously illegal. And like the FTC would be showing up at their door tomorrow. Right. If a bunch of sovereign states do it, what are you going to do about it? Invade them? Like, no. Right. It's fine. Yeah. It's fine. This is just how the oil market works. The oil market has a large number of weird idiosyncrasies.

5:31And this is one of them. Yeah. And so, you know, importantly, Saudi Arabia wants to see high oil prices to kind of fund its budget. It's got like a big ambitious domestic economic diversification plan where they're building this like Neom, this like ridiculous futuristic city. They're building like, do you remember the line, Katie? Do I ever remember the line? It's like a really long line in the desert that is like hundreds of kilometers long. And it's like a really tall, thin building. I understand they've scaled back plans for this, but it being Saudi, it's not just any old kind of tower complex.

6:06It's like the world's biggest, most spectacular, huge mirror in the sand development complex. Yeah. And to build this kind of futuristic stuff, they need high oil prices. So what they do is they limit the amount of oil supply going onto the market to support the price. The output cuts that OPEC has done right now have been, if you ignore the pandemic, which was a unique situation, obviously, have been the deepest since 2008, right? So these are deep oil cuts. They're really restricting supply. They want to see oil at 80, 90 plus dollars a barrel, and they've been successful in that. Just the other month, they extended those production cuts through June of this year.

6:46There's some expectation they'll do it again in June. So that's been a big part of the story, is that in the face of hot demand, OPEC is pulling back supply, which kind of increases the efficacy in a certain way, right? If everyone wants oil and you're like, whoa, there, settle down one at a time, 90 bucks, please. Then, you know, it's more effective. Yeah, exactly. But yeah, the real sort of near term trigger for things going a little bit bonkers in the oil market is the elephant in the room, which is the Middle East, right? You cannot talk about oil prices without talking about Iran. Iran is making friends and influencing people in its So in a very special way across the Middle East right now.

7:27And the more tension there is between Iran and Israel, the more jittery the oil market gets. But one thing that's really notable to me is that we had the attempted missile strikes on Israel from Iran just the other day. And the oil price did pick up, but it soon fell back again. So we've got this weird dynamic where traders and oil consumers are kind of looking at this market and saying, yeah, this could get really nasty. but we don't think it's got really nasty yet. So I was just reading a note from Sopjen, the French bank. They slapped another$10 a barrel on top of their previous oil forecasts on the back of the attempted attacks just the other day.

8:09But that still leaves you at just under$90 a barrel at the end of the year. But what they are also saying is that prior to April the 14th, they thought there was a roughly 5 % chance of direct conflict between Israel and Iran. They now think that probability is more like 15%. And they say, look, to be clear, if this were to happen, the oil price would go straight to$140 a barrel and then some in a straight line. So what you've got is this horrible, for many reasons, tail risk that's sitting there in the market. And were it too crystallized, that would be absolutely explosive for the oil price and extremely damaging for the global economy.

8:51Yeah. Yeah. And we should spell out like why it's so important that Iran has gotten pulled into this conflict in Israel. And there's a couple of reasons. I mean, one is that the Strait of Hormuz, which is a major international waterway through which a fifth of global oil flows that borders Iran. Iran conceivably could close it if it wanted to. or perhaps there could be conflicts such that it wouldn't even intentionally close the Strait of Hormuz, but it de facto would be closed. That's one way things could go wrong. Another way things could go wrong is that Iran's supply itself is actually up a lot in the past year or so.

9:22Well, that's the thing. And, you know, in a full-blown conflict, you would have to imagine that that supply of oil would dry up very quickly. But right now it's exporting at the fastest clip in about six years. So its output was about 400 ,000 barrels a day not so long ago, like in the sort of COVID period, which again, there was some weird stuff going on in COVID. But nonetheless, that shot up to something more like one and a half million barrels of oil a day. So it's obviously in Iran's interest, again, to keep filling its own coffers and to keep that oil expo. God, I can't speak today. And to keep those oil exports going.

10:01So what you don't have, You obviously have the geopolitical risk in play, but you don't have the signs of constrained supply from Iran yet. And that, I think, is what's stopping the oil market from being super ugly right now. Yeah. So, I mean, I think we've laid out demand, supply, geopolitics. OK, oil's at 90. That all makes sense. But we should ask the sort of bigger question, Katie, which is like, why do we care? Who cares? Should anyone like if you're not a commodities trader, which I don't recommend unless you're really, really smart, which I'm not. who needs to know about this market? Let me tell you who cares, Ethan Wu.

10:36Americans. Americans. You lot care about this stuff like a really disproportionate amount. It is a topic of conversation. Have you seen the gas price lately? Oh my God. Like petrol that you put in your car. Excuse me, petrol. Yeah, petrol. Petrol. Yeah, it's like a big deal. And it's like a really kind of hot potato politically, right? We don't really do that here? So this is an American thing. Yeah. I mean, the salience of gas or petrol in America cannot be overstated. I mean, it's like probably a top three or top five political issue when people think about inflation. Largely, they're thinking about gas prices and food prices, I think.

11:13And it directly affects consumers' pocketbooks, too. If the price of gas doubles, that's a huge chunk for people, especially people on fixed incomes, but also people that are wage earners, your purchasing power has just decreased because oftentimes the amount you need to drive around, it can't be decreased that much. A lot of people in America drive to work. There's not that much public transit. It's how you get around. You see family or friends. If it's suddenly vastly more expensive to do that, you have to cut back in other areas. Exactly. Yeah. You're not eating out. You're not buying your new clothes, whatever it is.

11:46You're not treating yourself. You are paying for the absolute basics to get around. You guys should try having some public transport. I mean, it's just an idea. Maybe you should have like infrastructure week. Maybe we should have it every week, actually. This is a great idea. I would love if there was more American public transport. And here in New York City, we have the greatest train system in the world. Greatest ever. But it's a big country. There's a lot of land. Come on, Katie. Also, you are late for this recording like every time we do it because you've been stuck on a train. That information is on a need-to-know basis.

12:20I'm going to tell Rob Armstrong. I think Rob is late more often than I am. Okay. So let's give you another opportunity to be wrong about things on the internet. Just love it. $100 a barrel this year? Yes or no? What do you reckon? I'm going to say yes. And I'm going to say yes because there are just so many ways it could get there, right? There are like various supply disruptions that are sort of on the horizon. So we talked about the Middle East. But another one is like, is Biden going to sanction Venezuelan oil? again. This has been like a he will, he won't story for a while. I saw a story in Bloomberg earlier this week saying that Biden officials are kind of on the verge of doing it.

13:00That would take more supply offline. You know, I think there's between strong demand, which seems to be kind of a global pattern and really traveling in one direction and various supply disruption issues looming on the horizon. I think 100 is not unreasonable. I mean, we're today at 87. We were 90 a couple of days ago. So it's it's it's trended down a bit, but it would just take a couple more bludgeons on the head to the oil price to get us up to 100. So we're just not that far. That's why I'm down to say 100. I'm glad you said that because I disagree. I think for what it's worth, I think unless there is another really ugly escalation in the Middle East, I can't see a sufficiently big trigger.

13:39And so then I can imagine it being like a really hot political issue in the States, particularly in the run up to an election. But I, at the moment, can't see it being much of thing that, for example, bond investors that I speak to or stock market investors that I speak to are like super animated about because unless the price gets high enough to really mess up the US inflation profile, then it's going to be something that is kind of on the periphery. But yeah, I think without a huge escalation, I don't see$100. All right, listeners,$100, not$100. Let Katie know. Katie.Mart. Let Katie know because, Ethan, you have some information to share with the class, I believe.

14:16I do. I do. I'm heartbroken to say this is the last episode that I will be appearing on the Unhedged podcast. I'm shaking my head. I know. Katie's usually looking disappointed, but today she looks extra disappointed. I'm moving on to some exciting new opportunities. But launching this podcast, doing this show twice a week for the better part of a year has been just so incredibly fun. And doing it with Rob and Katie has been sort of the highlight of my week every week. And I think I'm leaving it in good hands. but with that Katie we have a long short to get to so I think we need to take a break yeah let's go to long short let's do it

14:59welcome back this is long short that part of the show where we go along a thing we love and short a thing we hate Katie long short I am short the departure of Ethan Woe from the On Hedge podcast I think it's a bad thing. I'm long and short in the sense that like we made a thing and it's been a good thing and it's been fun and it's been really nice chatting to you and apparently entertaining and educating people. So I'm very sad to see you leave. However, as of now, you are Ethan who, as far as I'm concerned. And I feel sure that people are going to carry on listening. So don't let me down, listener, because if our numbers go down now that Ethan Hu has gone, it's going to look really bad for me.

15:42And that's not allowed. Listeners, you can't see it, but Katie is currently doing the Stalin thing where you like etch out the people from the back of the photo to all photos of us together now. Who? Ethan Hu? Who? Well, I came with a substantive long short, Katie Martin. Unfortunately, I'm also short. I'm short Kathy Wood. I know this is so overdone, but she just keeps doing it again and again and again. People might know, Cathie Wood, head of the ARK Innovation ETF. It's kind of like an early stage promising tech investor. She's had good times and bad times, more bad times than good recently.

16:18But notably, for somebody that runs the biggest innovation ETF in the US, she did not catch any of the AI wave. And so what she has done, she did this last Friday. is she bought a stake through their venture capital firm in OpenAI, possibly at the peak of OpenAI's valuation, while having completely missed the AI windfall everywhere else. I just, I mean, is innovation investing real? This is news to me. I didn't realize she'd missed this way. Even I knew about AI, and I'm not like a kind of innovation specialist. She got out of NVIDIA before the stock went crazy. It was just, I don't know, brutal.

16:57Oh, no, no, no, no. I'm not convinced innovation investing is real. Someone will have to call me and make the case because I just don't know. Can you do it? Maybe. I don't know. I'll call you while you're working on your little magazine somewhere else in future. I'll call you and let you know. Well, Katie, I think this brings us to the end of Longshore and to the end of my time on Unhedged. I'm repeating myself, but thanks again to all the listeners who wrote in over the past couple of months. We loved hearing your comments. And you should please keep writing to Katie, katie.martin at ft.com. She reads all your emails.

17:28Keep it polite. Keep it nice. Nice things or unpleasant things all to Katie from now on. And you'll be hearing more from Rob too. But thank you so much for listening. It's been a real blast. And well, Katie, I guess... Leave it with me. I think it's going to be fine. I guess I can't say catch you next time because I certainly won't. Catch you and non, you still owe me a beer. That's true. Not till Q4. Not till Q4. I look forward to catching you next time on the Katie Martin Hosted Unhedge podcast. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein.

18:03We 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. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.