Did we stop worrying about the oil price too soon?

(Gunshot) The Australian Financial Review. Petrile prices are in the news again. Millions of Australians are going to be paying more at the petrol pump from this week with the temporary discount to fuel excise ending overnight. The government's decision on the weekend, not to extend the discount, is already being felt at the baza. Good evening. Fuel prices are climbing and let it has shot past $2.00 a litre in some towns as the end of the excise relief kicks in. The price risers may be tempered by news this week that a peace deal in the Iran war will be revived. To the Middle East crisis now, a new as President Donald Trump's top economic advisor says he thinks a deal between Washington and Iran on the straight of hormones is imminent. But it's hard to get too excited, given the on again. It's a great deal. It's a memorandum of understanding. Off again, negotiations. We'll go right back to dropping bombs, rates smack in the middle of their head. We were very close to a deal. And even if a deal is reached, there's no guarantee it will last or end the chaos in the straight of hormones. The all price disruption isn't going anywhere. This is probably what a major oil crisis actually looks like in the 21st century. It's going to be a kind of slow burn that's going to wash through the economy over time. And it's effects will be incremental, but they will be significant, especially the inflationary effects. Welcome to the Fin. I'm Lisa Murray. This week, senior resources writer, Angela McDonald Smith, and energy and climate reporter Ryan Crom. On the reasons we all stopped freaking out about the oil price, and why that was premature. It's Thursday, August 6. (soft music) Hi, Ryan. Hi, Angela. Thanks for coming back on the podcast. Hi, Lisa. Good to be here. Angela, at the start of the Iran War, we were all bracing for one of the biggest oil price shocks in history. There were lots of headlines, lots of forecasts, but somewhere in the last five months, everyone stopped worrying so much. Why? Yes, it's a pretty interesting situation considering those dire forecasts from quite respected analysts when this war broke out in late February. We heard forecasts then of $150, $200 a barrel of oil or even higher, but the reality is Brent peaked at about $126. That's well below the 2008 all-time high. And more recently, prices have been trading below $100, below 90 even, despite the disruptions in the state of Hamouk's lasting much longer than anticipated. Look, some people initially were saying the effect of this would be worse than the disruption when the Ukraine war started in 2022 and the twin oil shocks of the 1970s. Back in the 1970s, oil prices quadrupled during that first shock and then more than doubled in the second oil shock later in the 70s. But there'd been a few factors that have actually come into play here. Firstly, on the supply side, although the state of Hamouk's closure takes about 20 million barrels a day of oil out of the market, so that's about 20% of global supply, there's still about two to three million barrels a day getting through in this dark fleet operation. And then there's another four to five million barrels a day getting out to global markets through alternative routes such as through the Red Sea. And we've also seen an increase in oil exports from other countries, US, Canada, Norway, Brazil, have all-uped exports. And the easing of US sanctions against Venezuela earlier this year also allowed more exports to come from there. And then on the International Energy Agency initiative, we had a record 400 million barrels of strategic reserves released under that initiative. - And Australia was part of that. - Absolutely, yeah. And then several things on the demand side have also helped us just better balance the consumption of oil with what's actually available. The biggest factor here has been China, which dramatically cut back oil imports as it preferred to draw from its own huge stockpiles of oil, rather than buy even more at high prices. There's also been a pullback in consumption and some more price sensitive countries, particularly in Asia, and then just generally softer demand from the aviation sector. It's all really meant that on the global market, this imbalance between supply and demand hasn't been nearly as stock as initially feared, and that's really taken some panic out of the market. - And Ryan, meanwhile, individual countries like Australia were marshalling their own response and those had an impact as well. - The Australian government at the start of this crisis basically made a decision that they would pay anything to stop this becoming a major political issue. I mean, the biggest and most expensive response was a cut to the fuel exas, which is the tax you pay, the government, on every liter of petrol and diesel you buy at the service station. Now that cut 32 cents a liter off the price of petrol and diesel, and that cost the government about $3 billion over three months. They also set up mechanism that allows the government to underwrite purchases of fuel on international markets. So that gave big refiners like Ampoll and Viva the ability to pick up cargoes, even if the prices were un-economic. So Australia was just picking up cargoes on the spot market, making sure we weren't going to run out. The government didn't put a precise figure on this one, but it could end up costing another several billion dollars. - Okay. - And then at the budget. - The Prime Minister has unveiled a $10 billion plan to boost our national fuel supplies. - They announced building up a new nationally owned supply of diesel and jet fuel, like a reserve stock. And the idea behind this was to raise our minimum stock levels to 50 days up from around 29 days pre-crisis. - Okay. - And all of that, and particularly the fuel ex-ice cut, has had the effect of basically neutering this as a first-order political issue, everyone seems to have forgotten about it. And because you know the one touch point for this at the petrol bowser, that has gone away. That has faded away as a problem. People have just stopped thinking about it. Now that may change this week, the fuel ex-ice is coming back on. This issue may re-retest again. - Yeah, I think it's meant that everyone's got a bit of a distorted view about what's really happening, I think, because those government policies have actually been pretty effective. It's enabled everyone to continue pretty much as normal. You know, a few months ago we were talking about people cancelling road trips. - The fuel crisis has forced 40% of us to change or cancel Easter plans. - Perhaps having to buy fuel only on alternate days. - Everything from fuel rationing to COVID style emphasis on essential services, that's on the table. - But that's just really disappeared totally from the conversation now. It definitely feels a little bit like the early days of the COVID pandemic to me. When that event initially happened, there was kind of mass panic, pochaliptic sentiments, huge drama, government TV addresses, everyone was quite worried. You know, there had major economic and physical shocks to the economy. And then it kind of settled a bit. People were kind of hoping that it would go away, but it just had this kind of long tail. And this feels very much like how this has played out. - Global energy crisis is beginning to bite in Australia. - You had big shocks of the petrol pump. - With hundreds of petrol stations out of at least one type of fuel. - You had energy minister Chris Bowen and our refineries are working full-pill. - Giving daily press comers as updating us on fuel reserves. - Victoria 51 without diesel, Queensland 49, south of Australia. - You know, I have petrol stations running out of diesel and then it's kind of faded away, but it's still happening there in the background, right? - It's not the kind of thing that's going to go away overnight. It appears the geopolitical situation in the Middle East appears unresolvable at the moment. And so by that kind of crude logic, there's every chance this players up again. - Mm-hmm. - You know, on Sunday we saw the government basically let this fuel exercise cut roll off. - Petrol prices will soar across the country this week. - $2.00 a liter from midnight tonight. - All of that tax relief has now come to an end. - Yeah, prices are coming back up. There are predictions that we're going to be paying around $2.20 a liter for petrol, $2.60 for diesel. You know, and interestingly, actually on Saturday, Chris Bowen's weekly press conference, there were a few more questions than usual. I think this is coming back onto the agenda. - It is coming back on the agenda, but Ryan, just on the government measure to subsidise purchases of fuel. This might have worked a little too well. You reported this week that there are ships waiting offshore to unload some of that fuel because there's no storage. - That's right, Lisa. So the government's plan to subsidise fuel was always about bringing in additional supplies of petrol and diesel. So that's over and above what we would ordinarily import. So think of that as a kind of insurance policy against another major supply shock like the one we saw in March and April. But over the last 15 weeks, it's underwritten 19 shipments of additional fuel cargos. And that's actually done what it was intended to do, which is to ease the panic and bring down prices. But it's also brought in a lot more fuel than Australia actually has the capacity to store at any one time. And we reported this week that one vessel has been anchored near Queensland sunshine coast for several months with at least some of the huge costs of those delays being picked up by the government. There's another vessel near Jalong, for example, that's been on the water for 86 days. So it looks on the surface like the government may have slightly overdone its response here and that taxpayers are picking up the price. But I guess from the government's perspective, That would argue that that's actually quite a small. price to pay to ensure that our fuel supplies are really rock solid and that actually rather have too much fuel than not enough. And so given the risk of fuel shortages is showing few signs for baiting, they'll be thinking that was probably a pretty good bet. But Angela, what else has changed? Why are we starting to see global markets on edge and some analysts even coming out and forecasting those big highs again of potentially $150 a barrel? There's definitely been a bit of a tick-up and nervousness, I think, in the market. People have really realized that the P-steel signed back in June really doesn't mean that much. I think it's important to mention here that the price everyone focuses on is actually the futures price of oil. That's a sort of speculative price. But we all hear, you know, in the lightly news about Brent crude oil rose to whatever, but that really is just the futures price. You've also got the physical market. And I think in that physical market, a lot of the traders and participants have really perhaps had a bit more of a realistic view about the impact of these ongoing disruptions and risks to supplies. So the price we hear in the daily news updates is actually divorced from what's happening on the ground. Yes, I think it can be. And then just in the last few weeks, we've seen these renewed Iranian attacks on tankers and the state of Hummus and American strikes in Iran. We've also seen Yemen's Houthis seek to block the Saudi link shipments passing through the southern end of the Red Sea at the Bab El Mandeb straight. And that's forced some shipments instead to go northwards through the Suez Canal despite the match lengthier sort of shipping time tables that involves. So it's not just the straight up Hummus that's being affected. It's these alternative routes that helped to absorb some of the shock in the first place. That's right. And then even at the end of last week, we saw that attack on a port in Egypt near the Suez Canal. And that's pretty worrying because it's the first strike on Egypt. And it also suggests that that waterway is also really vulnerable of this conflict escalates. At the same time, we've got the ongoing war between Russia and Ukraine. So increasing strikes by Ukraine over the past several months against oil processing capacity in Russia. And that's caused Moscow to extend restrictions on exports of petrol and diesel. This is all just dragged on. Clearly strategic fuel reserves that we spoke about earlier are just being worn down. And that's sort of reducing the protective buffets that we have in the market. Yeah, it's so hard to predict because there's just so many things happening at once. This is no longer a purely Middle East and story right. I spoke to someone in the government this week who's dealing with all of this. And they pointed as an example to the recent Ukrainian drone strikes on Russian oil revineries, which have led to a ban on Russian diesel exports and then put further pressure on global markets. In the May budget, the government actually provided a scenario in which oil prices peaked at $200 a barrel by September, which is roughly double where they are now. But under that scenario, that would lead to a peak headline inflation rate of 7.25% like these are not easy situations for the government to deal with potentially if this goes on. So I've been asking people for months, should we be worried? And the answer always just seems to be we're not really sure. Like we global crises like this one is always so much uncertainty and it's not just about the Middle East. With markets stretched, a decision like that made in Ukraine can have material effects on water striers for trading partners in Asia, do with their crude and refined oil supplies. And that's not something entirely within Australia's control. We can't insulate ourselves from this forever. And it's something the governments haven't managed week to week. We're talking about why oil markets are once again on edge as the Iran war drags on. Ryan, as you say, Australia is managing this week by week. On Sunday, it opted not to extend the fuel excise discount and petrol prices are a political hot potato. How worried is the government? I think if you look at the way the governments responded to this crisis so far, it's pretty clear that if they can, they're not going to let petrol prices go to the moon. Above $3 a litre for example. I'd say if there was another emergency situation like we had at the start of the crisis, they wouldn't be shy to step back in with another cut to the excise, even if it's going to cost burns of dollars to the budget. I think the bigger risk at this point though is not so much at the Bowser, but in the broader economy and the inflationary impacts are already filtering through oil is in everything. It's in all these products that we import. It's an input cost into all kinds of products. Fertilize the for food, petro chemicals, diesel for transport. Those broader price pressures have obvious political implications when it comes to things like interest rates, housing, cost of living. But then again, it's not all downside for the government, I think. I mean, one positive impact, depending on which way you think, is that we've been doing all this fuel diplomacy with Asia, right? We supply a lot of gas to these Asian trading partners. They provide us with refined fuels, shoring up supplies. We could be on the cusp of a massive gas boom in Australia. Huge new investment boom as these countries turn to safer Australian gas that they can't get from say Qatar, for example. So there's an opportunity. One of the other happy outcomes has been this huge surge in electric vehicle sales. Now last month, almost one in every four cars sold was fully electric from just 7% 12 months ago, like a massive change in bi-behavior. And at the margins, like that's going to have an impact eventually on our reliance on imported fuels. It's kind of one transformable outcome of the crisis, but it remains to be seen how sustainable that is, of course. I mean, already you're seeing the headlines fuel excise cut, EV drivers don't care. Exactly. Angela, one of the issues that has come up in this debate over fuel security is sovereign capacity. Australia is down to its last two oil refineries and both are calling for more government support. Should the government subsidize domestic refining? Well, it already is to a certain extent, but I think we're going to see that rise to a totally new level. Remember, we had eight refineries in the early 2000s, but that snowed down to just two, operated by Ampole and Viva. So there's been a massive reduction in our ability to refine oil here. That means we're dependent on imports now from more than 80% of petrol and more than 90% of diesel, which is a fuel that's just critical for our economy for so many areas, defense, agriculture, mining, not to mention cars. And basically the reason for those closures was economic. Those plants were just really small, old and inefficient and there've been so many big new refineries built in regional Asian markets in India, Singapore, Korea. Huge plants with much better economies of scale. So the two refineries that are left here are really just hanging on a lifeline of this government support package, but that really only guarantees their operations for the next couple of years in any case. And so under discussion at the moment, we've got the second phase of a refinery fuel security package that should be finalized by the end of the year. And it looks if it's going to mean a big increase in the actual support in order to try to keep those two remaining refineries going. It is quite odd because this push for more support is coming as profits from oil refining have soared with the disruption of oil flows through the strait. Yeah, we've seen some huge results. I mean last week we saw Viva flagging earnings for six months to June more than doubling. And ampoles first half earnings are going to triple on some measures. But those two refineries say that much more certainty is needed on returns from refining in order for them to invest in the plants. So your huge amounts are needed to maintain the plants, help them keep on running. And perhaps just adapt them a little bit better for the future. So perhaps orient them more towards diesel rather than petrol, for example. I mean, a closure of ampoles little refinery in Brisbane or Viva's gelong plant would put Australia really at the mercy of overseas suppliers and what's become a tremendously volatile and tight global market for petrol, diesel and aviation fuel. That really gives the refineries a pretty strong bargaining position in these discussions with government. Last week we also heard this talk about a potential new refinery in West Australia. It would be the first refinery built here in six decades. But as to how realistic that is, I'm not sure. It would take years to build an estimates of how much it would cost have ranged from about $7 billion to as much as $15 billion. Australia is a really high cost destination to build big plants like this. And the same reasons are there why those refineries closed in terms of just the size of the Australian market, etc. So I think it looks really difficult. And I think that announcement last week about the feasibility study for the new oil refinery in WA, it does go a bit to the domestic politics of all of this. The opposition at a federal level have been waging a bit of a culture war over energy and the fuel crisis. They've been leaning heavily into this kind of trump style, drill baby drill type stance. Why aren't we leaning into our fossil fuel advantage? And so I think the government has in its response tried to ward off this sense that they're just trying to end fossil fuels and lean right into renewable and we're all about this. Now whether or not this all refineries going to get built is another question, but you know they're clearly using this as a bit of a wedge to be like look we are leaning into this like we're not just focusing on wind farms right. We're going to build an all refinery if we need to. question for both of you, do you think that far from avoiding the oil crisis that analysts were talking about at the start of the Iran war, we might just be in the middle of it? And what will be the impact? I think it really remains highly uncertain. Just no one knows and everyone is doing all sorts of scenario planning on all the options that could play out from here. I think one thing is certain that we're just not going to go back to the situation that we're in before this war broke out. There's a real risk that prices could shoot higher again if those alternative transit routes like the Suez Canal are blocked. Or if this really some sort of major damage to actual oil production infrastructure in the Middle East, we haven't really seen that yet, despite having seen ships blown up and missile strikes, we haven't really seen any major hits on global oil infrastructure that could take years and years to actually get remedied and you know, for that oil supplied to go back to normal. It's hard to compare what's happening now, I think, to oil shocks in the past. There've been so many other ways of mitigating what's happened in the market and adapting that we just didn't have back in those 1970s oil crisis. So we've just got a much more sophisticated market and interconnected market now. We've been able to work around a lot of that. But I think in terms of the ongoing impact, we might just be at the start of this. I mean, who knows? As I was saying, no one is expecting things to go back to what they were in January and February. So it just looks as if we've got these extra costs and extra risks really baked into the market now. It's going to be interesting as to, you know, how Australia decides to respond to all of this. I mean, do we really start to boost efforts and, for example, sustainable aviation fuel? Do we do renewable diesel? All sorts of those alternative fuels that we really haven't spent much effort on so far, that could really tick off now. The boss of the International Energy Agency came out to Australia in March, right in the midst of the crisis, and spoke with the National Press Club. He kept saying, you know, this is a bigger oil shock than all the 70s shocks combined. But one of the points he made was that the International Energy Agency was actually established because of those crises, right? It was like, okay, well, in the event of this happening again, we need some coordinating body or some mechanism to absorb these shocks and have stocks so we can manage a crisis like this. So I think that partly explains why the world is somewhat better prepared to deal with this even though the extent of the shock is actually larger in absolute terms. But even so, I think it's worth noting that this is probably what a major oil crisis actually looks like in the 21st century, and that's not to downplay it. It's just that it's going to be a kind of slow burn that's going to wash through the economy over time, and its effects will be incremental, but they will be significant, especially the inflationary effects. Everything's going to start costing more. And I guess one final broader point is there's been this lurch back towards economic sovereignty as a result of these global crises, doing things on shore. Crassies like this one and the COVID pandemic and the global financial crisis. All of that is well and good, but it does add cost. And if we think about globalization as a cost lowering exercise, then it's sense to reason that re-nationalization will go in reverse. I think the things to watch in coming months will be these cost pressures. Thanks Ryan, thanks Angela. Thanks Lisa. Thank you for listening to The Fin. If you want to read more about the fuel crisis, check out the show notes, and don't forget you can listen to all financial review podcasts on the AFR app. The Fin is produced by Mandy Cooler. Fiona Bafini is head of premium content. Our theme is by Alex Gow. For more stories about markets, business and power, subscribe to the financial review at afr.com/subscribe. I'm Lisa Murray. See you next week. The Australian Financial Review