Weekend Edition: An oil glut amidst geopolitical uncertainty

There is just too much oil, hardly surprising them that we've seen prices falling, so is this the pattern now as inventories get added to each day? Does it influence the impact of geopolitics like Iran, for example, if something happens there? We'll look at all of that today. The morning call from NAB with Phil Dobby, the weekend edition. So supply, gluts, cuts in demand, geopolitics, including wars, or ends of wars, tariffs, storms. I mean, there's lots of factors influencing oil prices up there, and it seems like we've had the full set of them over the last 12 months. But what I'm curious about is why do such long-term factors, as these often are, drive such short-term changes in prices, and with so many competing influencers right now, rising inventories, but also potentially falling demand, or falling supply, which has the most influence. Well, Roy Johnson is an oil market researcher. He's a lecturer at the University of Toronto's Munk School of Global Affairs and Public Policy, and he's the founder of Commodity Context that provides deep data-driven analysis of the oil market. You may enjoy his substantive content at commoditycontext.com. And Roy is with me now from Toronto. So, Roy, I mean, WTI has got over 60 to a barrel this week. Brent's over 67. You know, even 60, again, over 60 seems like a win for WTI lately, but four years ago, you know, we were talking about $100 oil. So even though we're starting to get back up again now, there has been quite a slide over recent years. Yeah, well, and thanks for having me, Phil. That's exactly right. So the oil market today, as you noted, we're sitting in the low 60s on a WTI basis, high 60s on Brent, and that's down considerably over the past couple years. And the main thing that's been driving that is, as you hinted at the kind of start of the show here, is that there's too much supply for the given amount of demand in the market. One of the things that's driving, anyone that follows the oil market at all right now has heard about the glut. And what we've been talking about, is essentially the emergence of the largest surplus of supply over demand or a supply glut in the market that we've experienced since the 2020 COVID crisis, which obviously itself was historic. And absent that, this is one of the largest gluts in the record of the oil market. And that puts a lot of tremendous downside pressure on prices, and both flat prices of the price to see on your screen and also term structure, or essentially the shape of the futures curve, which gives us a lot of signals about the fundamental health and what's going on beneath the surface of oil prices. So that's, you know, too much supply, not enough demand, prices and structure are going to need to weaken in order to both reduce the pace of supply growth, and hopefully to incentivize more demand. And these markets eventually need to come into alignment. Otherwise, we build an unsustainable volume of inventories. So when we have geopolitics of play and there's, you know, the fear that it's going to impact oil supplies, I mean, does that really matter when we've got so much supply anyway? Who cares? It's a great question. And I think there's, it's important to differentiate between what we'll talk about, like, realized losses and supply. And what we're talking about here, so let's say the big factor over the past couple of weeks has been Iran. And the concern that the protest that have grown increasingly, kind of devastatingly, deadly in Iran, and the threats from the Trump administration of pulling the trigger on some kind of intervention on behalf of the protesters, obviously, with markets taking the White House even more seriously these days following the kidnapping of Venezuela and President Nicolas Maduro. And Trump's obviously, you know, massive bombing campaigning against Iranian nuclear facilities last summer. So I think they're, they're taking this seriously. And the issue with Iran is that well, it's obviously a sizeable producer in its own right. What we're, what the markets really trying to hedge against. And I think that's what we're really talking about here is, is it's not so much a realized supply loss in the litter, the academic literature. It's talked about in this idea of a precautionary demand shock. Essentially, that people try to get ahead of this. And this is just classic hedging. But the scale of the hedging required with anything related to Iran given that roughly a third of all oil in the global market travels past Iran through the state of Hormuz. Even a one to, you know, even a couple percentage points increase in the odds of a disruption in the state of Hormuz is, you know, implies kind of a multi dollar move in the price of oil because an actual shuttering would probably push oil prices even in their currently oversupplied state. If Hormuz was actually shut for any period of time, we would be easily 150, 200, 250, like the numbers don't go high enough because we're just talking at such a massive, massive loss of supply would essentially be roughly double the size of supply loss as we saw a demand loss at the peak of 2020 in co-the shock. So like just, so it's the transport of oil that's the concern. Then rather than Iran itself, because you look at, for example, Kazakhstan has been offline, has it had a major power plant fire, which shut down oil production, that's about 360,000 miles a day. We haven't really seen that reflected in oil prices at all, have we? Well, I think that's really interesting, right? Because I think Kazakhstan actually has been the largest realized loss of supply in the oil market. But I don't think that it's been moving prices as much as we've seen Iran do, just because we're talking about the realized loss of even a million barrels a day of cosmic production because it wasn't just the fire you're referring to was essentially a fire at the largest oil field in Kazakhstan called ten geese. But even before that fire, we had actually already lost most of Kazakhstan's production from the market or supply from the market because the main marine terminal through which Kazakhstan ships its crude to market called the Kaspian pipeline consortium terminal or the CPC pipeline, that was actually bombed by supposedly, you know, at least, at least assumed Ukrainian naval drones that essentially bombed the, what they call the single point moorings or essentially the loading terminals for this facility. And that, in that combined with a lot of really bad weather in the Black Sea, had already actually taken most cosmic production offline. And, you know, so even before this fire, they were already dealing with a lot of issues. But that, I think, is a great example that that was a realized loss of supply. And I think did fundamentally support the market over the past, call it month or so. But just in terms of the scale of the hedging risk, what we see in, if you look at the call skew or essentially the options market for crude, if you look at it, you see a couple movements here and there, but the two things stand out over the past couple of years, like a sore thumb. And that is last June, when Israel and Iran were engaging in their 12-day war. And most recently, again, with this protest flare-up. And again, it's just this deep, deep concern that if something goes wrong, it's still probably only a sub 5% probability. But it's probably gone from, let's say, a 1% chance to a 4 or 5% chance, and that's enough to really push up the price of oil by 5 plus dollars a barrel just on that risk. And yet, just on that risk, and yet we're saying that there's a glut of oil. If we find that in one part of the world, oil production comes down, OPEC could just get together and say, well, we're going to pump up our targets for the Saudis, for example, could say, well, we've got loads of the stuff. We'll just make more, we'll cover the difference. It's not as though there's a shortage of the stuff right now. Well, and I think that's what's interesting, right? And I think not only is there not a shortage, but the price spikes we get from the Iran risk and this hedging risk, which again, I think is understandable mechanically in the market. That doesn't change the fact that now the U.S. shale patch, which is a big part of the way this market was going to begin to balance, was lower prices were going to disincentivized drilling in the U.S. shale patch, which is the fastest responding source of production. But these price spikes on this Iran risk or whatever are throwing these additional lifelines to those producers so they can lock in pricing, they can hedge, essentially eroding any of that decelerating impulse that lower prices would or should be providing in this stage. So any additional price gain we get now in the current market is just going to make the glut last longer and be bigger all else equal, which I think is the worry that we're seeing right now. And it really is an engineer glut, isn't it? I mean, it's OPEC plus. And is it because they are trying to stop that share of production in the United States? So they're trying to keep them out of the game. It's interesting, right? Because I would almost reverse it. I would say that the the period of relatively tight markets we've had basically since the last couple months of 2022 through the beginning of last year, I would say that that market was relatively tight and that was an artificially kind of manufactured tightness. And that's because when OPEC historically prior to COVID, if OPEC was going to be cutting production to support prices, they would do that if prices were slipping below 60 or $50 a barrel. At the end of 2022, OPEC cut production when Brent prices were still above $90 a barrel. So they were very clearly attempting to hold these prices at $90 a hundred dollars a barrel for longer because they thought, wow, those prices we saw in 2022 were really, really awesome for us. Maybe we can keep them going. Maybe US Shale's going to peter out faster than everyone's been saying because that was a storyline of 22 that US Shale didn't accelerate as quickly as expected because of a whole bunch of other issues. But I think the issue is that they left, they kept cutting back production. And between the end of 2022, and essentially the end of 2023, OPEC had cut back something on paper. It's like six million barrels a day or six percent or more and just under six percent of global supply. That I had called this kind of sort of damically hanging above the market. There was obviously an unsustainable volume of crude, particularly given that the market still wasn't as tight as they would have hoped. So prices kept gradually slipping and they kept losing market share. So eventually they kind of had to ignore and by they, I mean, OPEC had to acknowledge that this was not working out as they had hoped. They needed to essentially do an abrupt about face to try and regain market share and push non-OPEC supplied to the market. And I think in some ways they actually got lucky in this because I think they triple or massively accelerate the pace of production hikes after Trump's announcement of the reciprocal tariffs. This is the liberation day tariffs that were announced in April of last year. Essentially at that stage, it looked like demand was going to go through the ringer. The global economy was potentially going to tip on the verge of recession. And OPEC was like, wow, this is bad news for oil demand. Mine as well just pulled the bandaid off and they went from increasing production from around 137,000 barrels a day each month to 411,000 barrels a day each month. And they actually kept accelerating. So that is essentially what created this glut. And on paper, this glut is very, very large. Definitely excluding COVID larger than I think I've seen realized in my own career to date. In case I'm getting added to each month. And it keeps on getting added to, yeah, I mean, by my own numbers, I mean, we're looking at more than three million barrels a day of surplus of supply over demand at the end of last year, which is a lot of oil relative to say the glut that crushed oil prices in 2014 to the 2016. That at its peak was only probably around two million barrels a day. So it doesn't take a lot if sustained for any period of time to really put a negative factor in prices. And that's what we expect is going to keep happening. But as I mentioned, I think OPEC got lucky here because I miss the other thing I've kind of been pushing as a talking point right now is that everyone's been talking about how Trump is bearish for oil prices because obviously, if you listen to him for any period of time, he talks about how much he wants to see oil prices down. So everyone thinks therefore he is bearish for oil prices. But I would argue that everything he's realized or actually physically done policy wise to date has actually tightened the oil market. And it's those clamped down to sanctions on Iran on Venezuela that turned into a foeble and block aid and Russia that have essentially inflated the amount of sanctioned oil that's stuck floating around the world's oceans or what we call floating storage or oil and water. Those barrels have been produced but haven't become kind of realized supply that can actually be accessed by buyers. So that is essentially captured or caught some of that surplus without a negative price effect. Now, the assumption here is that eventually that oil and water will decline and then not only do have the prior glut, but you also have the draining of this oil and water they have to deal with. But the other thing we can see here is if those sanctions are tied enough for long enough, we could see that push and force shut-ins or kind of production losses like we've been talking with Kazakhstan, we could see that happen in Russia or Iran and we've already seen it to a degree happen in Venezuela. So there are some losses supply that could help winnow down some of that glut. But so far we're talking small pieces of a very, very large pile right now. And Donald Trump is, I mean, he wants his cake and eat it, doesn't he? Because he wants to get the price down because he wants that, you know, obviously lower oil prices is good for the economy. It's good for his support because people can see prices are coming down, it's good for containing inflation. But he also wants it up to a level where he can start more domestic production. We can't have both because it's expensive to produce sale oil. And I don't know what it is, but there's a price point, isn't there, which is just not viable. And I think that I mentioned earlier that if it wasn't for this latest Iran risk cycle, that the lower prices we would be facing are specifically intended to decelerate the investment of US shale. And I think the reason that shale responds faster as a source of supply than most other sources is, let's say, like I'm in Toronto, for instance, Canadian oil stands production, you know, it takes, you know, five plus eight years to kind of move from investment to production and kind of do everything all together. Whereas in US shale, you can get a, you know, drill a well, finish it, complete and get these barrels to market in, let's say, six to eight months. So you're talking, like, 10 to 15 times faster a supply response. And because of the quick fall-offs in their own production, each shale well produces, you know, 80, 90% of its total production in the first, let's say, 18 months. So there's a quick fall-off of investment to clients. And that's, I think, what keeps being expected. So you're noting, like, yeah, Trump wants low oil prices, but he also wants drill baby drill. But no one's going to drill baby drilling at these prices. And if you look at the forecast from all the major, you know, the International Energy Agency or the US Energy Information Administration, which is part of the Department of Energy, they all are now calling for US shale production or US crew production overall to plateau this year and begin declining next year, given these lower prices. And I think that is obviously very counter to that narrative. And is there a magic figure, the drill baby drill threshold where actually it would start to reverse? It's aiming. Yeah, there's no one number because it's obviously a distribution, but I would say as a rough rule of thumb, I think that prices need to be above $60 a barrel WTI and probably over 70 to really grow. I think if you're sub 60, I think at that stage, we would expect production to start declining. And I think that's roughly where we're lingering right now. And I think again, to remind listeners, you know, we're currently at $67 a barrel Brent today, but that's still baking in a lot of a Ron risk, still baking in a lot of this cosmic disruption, et cetera. Those things theoretically are temporary. And once they unwind, we'll likely kind of fall back down into those kind of low 60s, high 50s trajectory. Tell me about the difference between WTI and Brent then. So obviously, I mean, because the price differential can be quite large. And I mean, and some part of it is geography. I think there's a difference in oil as well. Just talk about the difference between the two products. Yeah. So, I mean, just for for listeners, crude oil, it's not really just one thing. There are all these chemical soups of different qualities and specifications. But actually in the scheme of things, Brent and WTI are actually pretty similar grades of crude. They're both light, which means that they don't require a lot of expensive refining to get a high yield of gasoline and diesel. And then they're sweet, which means they don't have a lot of sour or a lot of sulfur in them. Sour crude is a lot of sulfur. Jucks to pose that against say, Canada's main export blend, or Venezuela's main export blend. Canada's WCS in Venezuela is Venezuela and Mary crude. These are heavy sour grades of crude when they require more expensive types of refining techniques to get the same proportion of gasoline and diesel other high value products. And similarly, they also have higher levels of sulfur in them. And sulfur is bad because of sulfur rain or a sulfuric acid rain. So, we want to get, we want to remove that from gasoline and other things. So, that is also another expense. So, light sweet crude is typically traded to premium, to heavy sour crude. But to your point, the main factor that actually creates a spread between WTI and Brent is that Brent is what we call a seaborne crude. It's hosted, it's kind of priced in the North Sea off the UK and Norway. Whereas WTI is actually priced at a tank farm in Cushing, Oklahoma. So, it's an inland benchmark. That's the main difference. And the main thing that typically drives spreads or splits between the value of WTI and Brent is actually more around transportation logistics between the U.S. Gulf Coast itself, basically between Cushing and Oklahoma and down to Houston or wherever else where you're shipping those barrels. The final thing that's complicated this is that, well, historically, they used to be completely two different pools of crude over the past couple of years because the actual volume of crude oil produced in the North Sea can be used to decline. They actually have started adding and pricing and including WCS barrels shipped out of the Gulf Coast. They call it WTI Midland, which is the specific benchmark for basically Permian basin crude that shipped out of the U.S. Gulf Coast. They actually started including that in the Brent basket. So, there's actually more of a direct connection than there used to be. And that's kind of also kind of theoretically harmonized that more than it has been historically. And imagine also how well respective economies are doing. So, if the U.S. economy is doing well, does that push up the price of WTI or vice versa, if I imagine that Europe was doing well in the United States, wasn't it? I can't imagine a well where that would happen. But that presumably would push out Brent prices. Yeah, what's interesting is that WTI, while I think is the benchmark that's most familiar to people in North America, Brent is actually the barrel of crude that is arguably the most important in the world. It's not like 50 or 60 or 70 percent of all bilateral contacts. Because again, most crude isn't actually traded, isn't Brent. Obviously, the North Sea produces a small smidgen of the total volume of crude globally. But most other crude globally are all priced on some kind of basis or differential to Brent in their contracts. And it's just because it has so much of this financial and paper market infrastructure surrounding it that has made it this kind of long durable contract, which is why they actually eventually included WTI into the contract. Because so many long-term contracts are linked to Brent, it'd be very, very challenging to get rid of the benchmark anytime. So you talked about the difference with Venezuela and all being a bit more like Canadian oil. And I mean, I don't know whether he did or not. The impression was given by a lot of people that Donald Trump actually, you know, his main reason for getting into Venezuela was to grab the oil. And then, of course, we had a lot of oil producers saying, well, it's just not economic for us to do that. Some of that would be the uncertainty, the political uncertainty about, put building an infrastructure where the infrastructure was grabbed by the state in the past. But the, it's a large part of it as well. It's just the cost of processing is just it's just an economic. So I would say in, I mean, and to the tier, your prior comment, I think that Trump himself has been pretty open about that. He went into Venezuela for the oil. Yeah, yeah. Why has he done that? Is it because he's going well, hang on a minute. It's just not economic to do it domestically. Then we're going to have to get oil from elsewhere. I mean, when I was thinking, you can really twist yourself in dimensional pretzels, I think, attempting to add too much rationality to the, you know, current policy discourse coming out of the White House, but in terms of consistency. But I do think for Trump, it was two things. One, I think it's this kind of like neo-imperial impulse that, I think we've seen this as the, you know, the Dunro doctrine or kind of whatever framing you want to put around this, that Trump thinks, you know, if you're in the Western hemisphere, you're in, you know, Washington's backyard and you need to essentially bow the knee in somewhere the other two. You know, you can't be seen as essentially a proxy outpost of Russia or China or whatever. And obviously, Venezuela had become that given the kind of wall of sanctions that the United States had put around it and essentially forced it into that alternative ecosystem, if you will. But I think that also, I think that Trump just thinks, well, if Venezuela had a bad government, and that's why they're not producing more oil, if I get rid of their bad government, they'll produce more oil. And that will mean that pump prices will be lower. Again, I think it's hard to trace how much, I don't know if he fully appreciates that like, that would also mean that the US producers would produce less. But I think for him, he's like, yeah, okay, we're going to do this and they're going to, they're going to produce more oil and they're going to ship to the United States and we're a good deal on it. That's not how it works. But I think that's how he sold it to himself. And I think this, the, we're still going to see exactly how it all turns out, because there's still a lot of unanswered questions about the exact specifics of it, what that future relationship is going to look like. And whatever happens, OPEC can always turn around and say, well, we are going to pump more or we're going to pump less. And that's, I mean, aren't they the ultimate determinant of price? They are. And I think that at this stage, my working assumption for what will end up actually, quote, curing the glut in this year is that I think that eventually OPEC will probably end up cutting production again. I think they're the only ones that can move quickly enough to kind of via discretionary policy rather than kind of forced via economics. They can say, okay, this is enough. We'll cut back production. But I think that in order to do that, they need to wait to see US production really begin to kind of stall out and begin declining. Because otherwise, this has all been for naught. And they're just going to end it back in the situation inevitably. That's the problem with when you, I kind of said this at the time when OPEC kept cutting more and more production, like it's a very obvious challenge they're going to have to get these barrels back in the market. And now we're dealing with that kind of inevitable friction process. So on your website, you talk about how you do a lot of data-driven analysis. And yet, a lot of what we've been talking about today has been politics and OPEC. It's like, so there's a lot of data available. And we talked at the very beginning about all of these factors that could influence price. And it's multi-layered. But it seems like when we talk about OPEC and we talk about politics, they're sitting across all of that. I mean, how useful is all that deep level analysis when it's overridden by these factors? I think it's similar to the way you talk about like fundamental analysis in the equity markets. I think that for long periods of time, you'll have manias or various kind of narrative drive things. But I think what's useful at the oil market is that at the end of the day, it's a physically kind of cleared market that when you have a surplus of supply over demand, then the market needs to eventually slip into contango or the contango is actually where you have lower prompt or kind of front of the curve prices than further down the line. That structure is evidence of weakness and is needed to kind of pay for the necessary storage to clear the market. You don't have that with a lot of other, I think right now we're talking, the market broadly is talking about precious metals price rallies or what's happening with the equity market. Both those things can continue to trade along a narrative for a very, very long time. Inevitably, they will end up needing to reconcile at one point, but there's no hard pressure point on when that's going to happen, whereas the physical oil market does need to reconcile every single month at basically settlement of these major contracts. That's why I think what you've seen is that the futures curve has looked very, very strange for the past six, eight months. Normally, you have a pretty steady backwardation, so a downward sloping curve or a steady contango, which is an upward sloping curve. Again, the interpretation of those is backwards than you would actually intuitively believe that a downward sloping curve is actually a positive market and upward sloping curve is a bad or a weak market. But what we've seen over the past six, eight months is the huge current kind of looks like a smiley face that it's really, really steeply curved pointing downwards at the front of the curve and then upwards for basically most of the curve down the line. That is evidence that I think shows that the market keeps believing that these fundamental views that this fundamental surplus of supply of demand is coming will inevitably crush prices and force us into contango, but a whole variety of unexpected disruptions from Venezuelan blockades to CBC, terminal outages to sanctions against Russian majors like Ross, Nefton, Luke Oil, or more recently the blockade of Venezuelan crude. All of these things have basically kept kicking the can of that surplus down the road and the market, I mean, they basically the trillion dollar question in the oil market is when do we really start to actually feel that glutton a real way. And so far we haven't because if we did, prices would probably be sub 50, if not sub 40, not in the 60s where they are right now. And that glut would get worse, of course, if demand for oil was to fall even further, if we saw more of a shift to renewables, that's obviously not going to happen in the United States in the hurry, but maybe in other parts of the world. But I mean, I don't know how old I was when I first started hearing about peak oil, but I think peak oil was back then was, you know, would have happened 10 years ago by now. But the IAA thinks that oil will still be growing in demand until around 2030. I think OPEX says that their economic oil demand is going to grow until about 2045. I mean, this is a long way off. The still still continued demand, doesn't it? There is. And I think so using 2025 as a reference, my own numbers kind of show roughly a million barrels a day of year-on-year growth in 2025. That is stronger than I think a lot of people expected. Last year to be given the tariff, bruhaha, and everything else that was happened in the macro side, I think there was more concern that it would be weaker. And that was stronger than I think some of those fears had indicated, but that's still notably weaker than what we would have considered normal pre-COVID. Pre-COVID, we were probably growing at somewhere in the ballpark of one and a half percent every year. And that was just steady state if nothing else was going on. And about half of that was China. Now we're looking at probably more like, you know, sub 1% of growth. So we've shaved at least kind of a third of our growth rate off. And China is kind of eking out minor gains rather than kind of driving half of global demand growth like it was previously. I think the big question going forward is how quickly China plateaus into clients, because that's going to be the first place that really doesn't, given what we've seen in the penetration of electric vehicles and China sales mix and everything else we've seen. Gasoline in China will be the first major fuel in the first major economy to peak and probably start to decline. But I think then the question becomes, is there anyone else that steps up to the plate? And I think the most natural single jurisdiction that everyone talks about is India. But India is also, I mean, people have been talking about India being the next major source of global demand growth for as long as I've been the market as well. And last year as an example, initial expectations were for Indian oil demand to grow between 225 and 275,000 barrels a day. And they ended up only clearing about 100,000. So two or three times under performance of those expectations. So yes, in order for the market to tighten in a real durable sustainable way, we're going to need demand to grow faster than it is right now. And that's likely going to mean more demand in Asia, which we just aren't seeing yet. And therefore the glut just gets worse unless OPEC does something, which we're saying is likely to be the outcome. And you think it's going to be this year. So does that mean that we can expect that all prices will move as that glut starts to diminish because production's cut? Yeah, I think my expectation kind of generally for the year is that we're going to right now we're tighter than I think we should be. And I think that's because of Ron. I think that says the CBC, et cetera. I think that will and Venezuela. I think that will begin to wrap itself up. And I think we're probably going to see further weakness through same through the first couple months of the year. We might tighten up a little bit into the summer just because sort of summer demand tends to be stronger. But I think that if we saw cuts again, it might be third, fourth quarter of this year. It might be early next year in early 2027. But I think that's the question is how we need prices to get weaker again in order to put that pressure on U.S. shale. And if we don't get that, then we're not going to have the impulse for OPEC to cut. Right. But on the flip side, OPEC wouldn't need to cut because prices wouldn't be low. So in their best case scenario, yeah, prices are just going to hang out here for longer and they just get to kind of keep holding on. Roy, it's been fascinating. Lots of useful insights. We have to talk again. If that's OK with you, maybe in six months and see where we are. But thanks for your time today. That's been great. Thanks for having me, Phil. Now next week, Amina Rosenberg, hair hedge funders outperform many. How is she doing that? Well, she's invested less in the U.S. than many and less in the mag seven. Isn't that a bit risky when this seems to be the only place we actually seen growth lately? Well, let's hear her views on all of that next week on the weekend edition. I'm back on Monday, of course, for our daily Ray Atrial. We'll be up bright and early for that one. I'm Phil Dobby. I'll see you then. Before seven on Monday. Thanks for joining us. The weekend edition