Think Tank: Hormuz tensions bring renewed threats to oil and chemical markets

With Iran and the US battling it out for control of the state of Hormuz, the much trumpeted piece deal seems to be dead in the water. Crude oil shipments and supply are likely to come under renewed pressure, with crude oil prices already heading back above $80 dollars a barrel on Tuesday. Ukraine's attacks on Russian refineries are also gathering pace, creating fuel shortages domestically and impacting its exports. I'd like to understand what might happen next to oil, products and chemical markets if traffic grinds to a halt once again through the strait while global stocks are steadily depleting. Welcome to Think Tank, the weekly ICIS podcast which helps you make sense of chemical markets. I'm Bill Beacham and this week I'm delighted to be joined by two great friends of the podcast, our regular commentators, Paul Hodges, Chairman of New Normal Consulting and Tom Brown, our insight editor. So gentlemen, last week the international energy agency warned that renewed hostilities in the Gulf could derail the rebound in crude supplies and delay the return of normal market conditions. This report pointed out that the world crude output remained $9 million dollars a barrel below pre-war levels and it also pointed out that although crude exports have recovered to 75% of pre-war levels, exports have refined products and LPG from the Gulf remained less than half in June. So Tom, let's start with you this week. Perhaps you could bring us up today on exactly what's going on between Iran and the US and how crude oil and chemical markets are reacting. Yes, absolutely, thank you Will. And on the IAA commentary, it's funny because it says delay the recovery but kind of if things continue on the current path, later what? It's less clear what the final outcome could be at this point kind of thing unless the US can brute force for the straight of whimmers open and keep them open kind of thing. But indeed, what a difference a week makes in the previous edition of the podcast we were talking about how the waiver on Iranian, petrochemicals, fertilizers or products exports could heap additional pressure on EU producers just as Brussels prepared to cut US duties to zero. And no, soon after we recorded that, then US President Donald Trump's rhetoric on Iran became harsh at the NATO summit in Ankara and he declared the ceasefire over even as negotiators prepared to resume talks for the Iranian period of mourning for it all to come in. So last Tuesday, Brent and Crude Price futures were hovering around $71 about on a down trajectory and now they're close to $85 with oil prices climbing sharply overnight and to get seen maybe $8 since kind of Thursday for the last week. A lot of this seems to be based around the US exasperation with the IRGCs actions in the straits where Iranian troops have told ships to travel along a road close to its shores while the US has advised vessels to follow a lower road close to a man where it can more easily provide air support. Iran has like understandably been resistant to relaxing its grip on straits' traffic while peace talks are ongoing and the US has been keen to make sure ships pass through the straits safely. The terms for vessel fans it could have been agree before peace talks started but the black explicit guidance there has led to numerous attacks on boats leading to retaliatory strikes on Iran which has escalated into tip for task solvows of missile and drone fire for several consecutive nights now. So even oil prices have been surging chemicals and stockmarks have been a little less responsive so far. So for example the stock 600 chemicals index which is a kind of basket of the biggest listed European chemical firms that now that's dipped midweek last week but it's kind of nearly back to where it was last Monday before the remarks Nancara and in general like crude research yesterday and equity markets were fairly unmoved with European indices showing violent movement up or down. Now we've seen the surge today and stock markets are down but it's not as dramatic as you expect and movement hasn't been as major as we're seeing it all so far and it could be the oil markets have always responded most strongly to the currency from Trump or it may be that oil is a leading indicator right now. As none of the issues that exist when the US announced peace talks with Iran have gone away and in fact a major factor in the move toward the ceasefire was the imminent threat of crude prices tensing surging $100 a barrel or higher due to amount of supply locked out and big standard that's pretty reserved to be drawn down. And nothing has fundamentally changed since then meaning that disaster is once again looming on horizon and that's compounded by intensifying hostilities between Russia and Ukraine which is leading to Ukraine's increased success and striking infrastructure in Russia is knocking out kind of more oil products production and in general there's wider refinery outages mean around 8 million pounds a day of the world of financial capacities offline. So even before this, finding products pricing was already higher than the oil price would indicate and on top of that we think of both countries around the US vying to declare the straight either open or closed, protraphic and both attempting to launch protection rackets for the straight with Iran wanting to institute permanent tolls and Trump now declaring that the US requires a 20% cut to the value of cargo for the price of providing safe passage. So yeah it seems like once again we're off the reservation and it's all to play for in terms of what happens next and some very dramatic potential outcomes from here. How do you just any thoughts Tom and how you think it might play out if the straight remains closed? I mean Trump's got his midterm elections obviously it's very unpopular the war in the US the petrol price prices are going to go back up again. Do you think that that pressure might cause him to be a bit more reasonable in terms of his negotiations? Well it feels like, I mean we don't know if this is the only reason but a factor behind the timing of the ceasefire talks was that it did come just after several well-exempted war and bad oil prices could hit hundreds of dollars a barrel or higher in a space of a few weeks just due to how depleted reserves are kind of thing. And again there's been some rebuilding of reserves but governments have been careful not to drive the oil price that much higher when things were kind of starting to calm down a little bit. So the question for what comes next is there's that prospect of an in-brewness condition secondally that drove the US to the ocean table hasn't changed and nothing has fundamentally different since then. And if crude prices continue to climb and we'll see a shock to chemicals producers as well as likely driving inflation kind of consumer demand all the things that we're talking about before the start of these talks. So the question is like is Trump touching the stove before being reminded why talks seem up the best course and will search oil prices drive a renewed focus on reaching a deal. I mean talks are continuing so is this just rhetoric to present a strong stance and potentially reduce the concessionist grantees in the dream of the round which has been very unpopular among Trump's allies so far or has the US simply lost patience diplomacy and chemical markets also we've spoken to so far have expected limited output impact for chemical prices in this which and chemical prices in Europe are still substantially both where they were pride of the conflict. But there's no there was a perception that tension could slow down the downward trajectory that pricing has been on. But that was depends what what's next and how dramatic it is. Obviously if we would just say 150 if we're fine products continue to surge you know if there's no end in sight then we could see you know a complete reversal of that kind of downward trajectory at a point where demand will be hit even harder kind of thing and like and it could be ruinous for the second half of the year or is this you know it seems like right now like crude markets are kind of panicking and equity markets are kind of leaving room for this to be kind of a bump in the road and there's one is one of those situations where it could be you know more stern and drang in what's a very rhetoric heavy conflict before you know these cease-fire deals go through as expected or it could be you know turn into a war who can keep the keep a straight open and what it takes to keep a straight open kind of thing all closed or it could be a situation where all prices go sky high or products get even higher demand is slashed inflation jumps the way that it did after the onset of the Russia Ukraine war it could be incredibly dramatic situation or it could be you know a brief upset before I think for things changing again but again you know the kind of scope for what it could be is has widened both dramatically suddenly and you know some of those outcomes are I think deeply unpalatable to push everyone in the global community be you a consumer or a producer. Well thanks thanks Tom for setting the scene and giving us those scenarios so clearly I'm going to turn to Paul now you've been blogging on this very topic in your latest post so with the cease-fire looking like it's in Tattas how likely do you think a swift resolution to this conflict is Paul. Oh! Totally unlikely. I don't think we've ever thought that this was going to end in a sensible way. You start from the point of view that says every single war game, the Pentagon, the US Department of Defense or anybody else has ever played on the straight-of-all moves, shows that if you attack Iran, then you get the straight-of-all moves closed and the world economy is in danger. Everybody knew that. That was what Trump was told by the military before he gave the order to invade and he said, "No, no, I have a close gut feel according to the New York Times and he went to head at which point the Daisy chain began to operate." And I don't think we've seen anything change over that period. What one has to remember is that a lot of people don't understand oil markets. They've been taken over in the last 10-15 years by financial markets and people have got into two very simple bets. One is that if the oil price goes up, then the dollar goes down and if the dollar goes up, then the oil price goes down. That is very simple because the idea is, which has got some credibility to it, obviously, is if the dollar is cheap and oil is priced in dollars, people will buy more of it and if the dollar is expensive, then the opposite will happen, people will buy less of it. So it's not a bad theory, but it doesn't encompass the whole range of supply and demand, obviously, the second is that since 2008, the financial markets have got in the habit of believing that the federal reserve and the central banks will always bail them out. It doesn't matter what happens whether it's COVID, whether it's just that or the other. So we'll always get a supply of funding injection. So the great thing to do is to buy on the dips. Now, if you take those two factors, and I'll close here with just a thought, what that has done has meant that markets are not fulfilling their main role in life. Why do we have markets price discovery? I want to buy something Tom wants to sell it and we agree a price, but Tom is saying, but actually, I know that the federal reserve is on my side, so I don't have to worry about what Paul's saying anymore because I know that the buying on the dip will be okay. And so that's where we are today. And so I don't agree. I don't think there is any way that Trump can get out of this one. And that's, that I think is the key issue as we go forward into the second half of the year. So assuming the straight does remain closed for weeks, much longer, how do you think this will play out in oil and chemical markets? So we're also bearing in mind the added fact that Ukraine is successfully disrupting Russian binary output too. And remember, there's another thing, fact to going on here, which is we've seen the, you know, the bubble of our lifetimes in AI, and that bubble is now bursting pretty clearly. You look at what's happening to the Korean stock exchange, for example, which is heavily boosted by AI. That's perhaps you look what's happening to Nvidia and so on their share prices. They're all coming down. So you have, and we did talk about this in the past, you know, on the blog, that you've got a particularly disruptive situation, potentially ahead, which is that people realize after a while that actually there is no way out here. What, what, what, what, yeah, we're into a binary world. Isaac Trump pulls out and allows Iran to continue to charge tolls for the state of all moves. Well, that's not a great result. Or he tries to escalate and he puts boots on the ground and American soldiers, Marines get shot. That's not a great outcome either. How do you invade, I say in the blog, how do you invade a country of 93 million people from the other side of the world? You can't do that with a few thousand whatever, however brave and, you know, well-trained they are, Marines. You know, you haven't got the supply chain. So that, the idea of invading Iran is a non-starter, but that's what's going on. And you keep threatening it and so on. On the other hand, pulling out is a non-starter because now you've handed over control to Iran. They will charge tolls, they're talking about two million, but Trump has just escalated the cost. He said, no, no, America is going to charge 20%. So why shouldn't Iran charge 20%. You see what I mean? Well, I can't see, no, I'd love to be able to come up with a brilliant solution that said actually none of that's relevant at what's going to happen is this, but I can't. Those are the facts on the ground, I can't see my way around them. So in this scenario, could you give any comments on oil price, oil price and maybe, I mean, the impact on chemical chemical. Yeah, all we have to do, I mean, you know, I've created a world I've worked in Houston and doing that and so on. Yeah, I followed oil for a long time and if you follow oil, there are various patterns that you learn to watch for one of them is infantry. Now, we know that cushing in the state, which is the largest storage place in the states, is down at tank bottoms. Now, what does tank bottoms mean? Tank bottoms mean you can't because oil is liquid and it collects gums and so on as you're putting it moving around the zone and tanks create gums. You can't have your pipe right at the bottom of the tank because it would get blocked. It's like a drain on your balcony or something like that. You know, it gets blocked with leaves and so on. The same sort of thing happens with oil. So you have to have your pipes somewhere above and the number is something like where we are today. So in other words, we are at tank bottoms today. Now, exactly how far down you can go. Nobody quite knows. Again, if we look at the strategic petroleum reserve, what we've been doing over the past five or nearly five months now, after all, is we've been supplying the states has been supplying not from just its production, which is why it is the biggest producer in the world. That's good, but it's also been supplying Europe and the states and the Europe and Asia with product from its reserves from the strategic petroleum reserve. Well, thank you very much for that. That's kept the European and the Asian economy going. That's that's fine. But what happens as that strategic reserve goes down to its tank bottoms? Now everybody says, you know, tank bottoms is 300 million barrels. We're at three three 40 or something today, I think, but you know, we'll get some new numbers this week. We don't know what where we are, but what we do know is that supplying out of reserves is not the same as supplying out of production. So the logical thing that's going to happen at some point is that if this continues, which I think is now inevitable, the states will impose an export ban because what you're seeing today, if you look at, you know, the thing to do is not particularly to look at oil because oil is dominated by this financial trade of the dollar and so on and so forth. So it's not really giving you a clear reading on what's happening, but look at what's happening to gasoline. Look at what's happening to diesel. Look at what's happening to distillate the products, right? And they they are moving up very solidly and they never fell back in the way that crude fell back. And of course, there is the Joker in the pack, just as you said, Will, which is that Russia is really having major problems with its refining because Ukraine has got its drones working and every single refinery has been hit by Ukrainian drones. And if you look at the numbers, it seems that refining is about refining runs are about 25 percent below where they were a couple of months ago for this data around. It's probably reasonably reliable because you can monitor the ships going in and out and so on from satellites and people do that. So you've got that position going on and what you can see, therefore is Russia has abandoned diesel exports. Now does diesel matter now? I don't drive a diesel car. Do you drive a diesel car nobody? And so on. So well, hang on a moment, who drives diesel? Well, the trucking industry uses diesel and farmers use diesel and they can't get hold of it. So what does that mean? If if trucking can't get hold of its fuel, if farmers can't get hold of fuel for their their tractors, what does that do for prices? What does that do to food availability? It's an open question. It's not particularly open because it's pretty obvious. It's it creates shortages. and could you just comment on, so if we got another oil price. shock and supply shock. How does that play out through downstream through the chemical markets? Obviously, just for my perception of what watching things over many years, there's a delays and there you've got an almost instant reaction in the very upstream chemical feed stocks and raw materials and then it feeds down gradually, more gradually down the chains. Would you say that's how it works? Well, I think we are in new territory here, Will, in that one of the things that has happened, and I think we can be reasonably confident about this today, we couldn't have been a couple of months ago, is that China seems to be in a major economic slowdown. We look at auto sales, for example, auto sales are down 20% in China and all sorts of things, retail sales are down and so on. We know that the economy has been kept going by stimulus and so on, all this borrowing that's gone on, but you have had the property collapse now going on for six years, so people have lost a vast amount of money on that. So what we're seeing today is that China really isn't importing anymore. China is things like polyethylene, as you discussed last month, last week, sorry. China is becoming an exporter or close to an exporter of polyethylene and it doesn't look as though the economy is going to recover. So you've got China out of the game exporting like mad, I mean, it's exported last month in June, it exported a million cars. There's an incredible amount in the world, a market of 70, 80 million cars, just in one month and so on. So one part of this story is that China is now short of oil. It's got reserves, but it doesn't seem to be using them, according to everybody you talk to in the oil industry. The reserves are still, as they were. So the economy, the domestic economy is slowed and it's trying to export or die. Now, so if coverage of the European Commissioner responsible for this area went to China a couple of weeks ago and told them by, you know, you've got to October, you've got to stop this because we're not going to allow the European car industry to be destroyed by your exports. America has already done that. So one of the things you've got here is a trade war for a chemical point of view of is China going to continue to expand his exports? Are governments particularly in Europe going to allow that to happen? Or are we going to move, as I think, to a full scale trade war and tariff barriers and so on and quotas? That seems to be the direction of travel. I mean Biden introduced that in the States. Trump has followed that up. We've got new tariffs coming at the moment and so on. So the second question from a petrochemical point of view is therefore what happens with a higher oil price? Does that destroy demand or does that encourage inventory build? And I suspect that there will be some inventory build, but I suspect also that the destruction of demand will be faster. You know, in previous oil price shocks, what you've seen is that we have to go back to 2007 to 2008 or if you like, go back to the 1970s and 80s. What you tended to see was that as the oil price went up, so petrochemical prices went far ahead because everybody down the value chain could see that if I buy, well, you know, here we are in the middle of July. In my way to August, it will be more expensive. So I'll buy today. Now that seems to have stopped. We're not seeing any sign of that. We saw that in March and April, but we didn't see any of that in May and June. So that suggests to me that demand at the consumer level is much weaker than we think it is or that's being reported. And that's not a surprise. If you remember in 2008, we didn't, the US didn't actually declare a recession until the end of the year. And then it went back and it looked at the final numbers and it declared the recession has actually started at the beginning of the year. So, you know, we're navigating blind here. But if you ask me, what I think is going to happen, I think I think we're going to see higher oil prices, I think we're going to see continuing disruption in Russia and refining, refined products. I think we could well see an export ban on oil and products from the states, which would include obviously, potentially polyethylene and so on. You know, who knows how that might play out? I don't know. I'm speculating here. And I think you'll also see a downturn in actual in consumer demand. None of which I'm afraid is very optimistic view. But the worst thing that can happen is that you imagine that it might all thought itself out and that don't worry, we don't need to do anything. I really do think that this is like the summer of 2008. The people who get active and work through holidays on making their businesses more resilient are the people who do relatively well. And the people who say, oh no, I can trust Trump. He'll always tackle Trump always check chickens out. So people who do nothing, I think they'll be the people who are hit. Fascinating analysis. Thank you Paul. Just come back to you. Tom, any final thoughts on what Paul was saying? The idea that terrible downstream demand is going to put a cap on any on chemical price increases despite what's happening in oil markets. Yeah, absolutely. And like I love an interesting stuff from Paul as always. And it just feels like an infection point right now. I mean, what we saw earlier in the conflict is that there was this kind of panic buying and then which then people looked at the purchases they've made at the price they paid and how things evolved and kind of lamented. But that purchasing which did drive a decrease in purchasing in the future because people think, well, it's fallen this much but there's still further for it for especially if there's a an abiding piece deal which is which is agreed kind of thing. And so obviously things are uncertain. But I think people will be slow to return to to the markets kind of thing because obviously it looks like things are said to surge and if things start to really increase then that could drive some horizontal and panic buying. But also people, people think, oh, well, this could be a blip and maybe if I buy products at this price then that will be a bad purchase. We've shown to be a bad purchase in a few weeks kind of thing. So I think people will be conservative on bad to kind of thing. And also I thought Paul was coming to about an oil products and crew export ban in the US as an interesting one because one thing which has, I mean, a lot of controversies around the White House of late have not really impacted Trump standing at the ballot box but one thing which does always matter tremendously is the price of gas and the tank kind of thing. That's a very, that's a metric but everyone pays attention to it. Everyone is confronted by every day and the fact that it was kind of gasoline in the US was averaging kind of a dollar and a half before the like before the conflicts and is now still well over $3. If we saw crew prices surge $150 a barrel and suddenly it's like five, six, higher at the pump then that is one of the big metrics which would actually kill Republicans in the midterm elections kind of thing but there are levers there, you know, there's export bans, there's subsidies for the oil price, there's kind of bans on how much profit the oil companies can make kind of thing. I'm sure that that's probably would happily lean on producers if it meant that prices could be kept. Are they or contained at least kind of thing but yeah, the fact that right now we're at a point where what comes next is like you imagine that the US will try and keep the straight open kind of thing but what does that require kind of thing? It's been a bigger version to boot some of the ground but can that remain the case especially with carg island if the straight turns into even more required way but it has been so far kind of thing and I think in both cases if it gets into boots on the ground then you're looking at a multi-year war and a complete kind of remapping of police. global trade once again, kind of thing, and a huge impact on the economy. And, you know, it's always like right now, people are trying to plan outcomes between this will go away in a week to this is kind of change after again forever, kind of thing. And I think that's very tough to map. And I think in that, I think in that kind of environment, at least until they're forced out, people will be fairly cautious when it comes to purchasing. And that demand disruption effects is only going to intensify kind of thing, which puts producers even more between a rock and a hard place because they'll have no face substantial output pressure. But, you know, at also at a time when no one really is buying kind of thing. But it seems like, you know, there has been some margin clawback. If you look at kind of hedge-couple pricing versus oil pricing and how much oil and natural has fallen compared to how much chemical prices have fallen so far. So it seems like we go, but there has been some uptaken probability in some cases anyway, kind of thing. But I think in general, people are going to be treading extremely carefully and not making any sudden moves unless they have to right now. Tom and Paul, we'll have to leave it there for this week. Thank you very much for joining me. And thanks to you for listening. And it's very easy to subscribe to our podcasts. Just go to any podcast app and search on ICIS Chemicals Podcasts. [Music]