Rory Johnston on the Sanguine Strait Stoppage
This week, our guest is Rory Johnston, a Toronto-based oil market researcher, the founder of Commodity Context, and, among other things, the host of the Oil Ground Up podcast.
Peter and Jackie open the show with highlights from the federal government’s economic update, Polymarket bets on the Middle East conflict, and the shift in AI companies toward pay-per-use models over unlimited access.
They then turn to oil markets, asking Rory: What’s your take on the UAE’s announcement about leaving OPEC? You recently wrote on your Commodity Context Substack that the oil market reaction has been shockingly sanguine; why? How do you interpret broader equity markets trading near all-time highs? What might upstream oil and gas investment in the Middle East look like under a fragile post-conflict scenario? With some Western countries shutting down refineries and becoming more reliant on imported products, which is now obviously a vulnerability, do you expect renewed investment in refining capacity? And in Canada’s pipeline debate, with expansions and greenfield projects proposed, which direction should be prioritized: routes to the U.S. or west-coast access to tidewater and Asian markets?
Content referenced in this podcast:
- Futurism, “Bosses Are Blowing More Money on AI Agents Than It’d Cost Them to Just Pay Human Workers” (April 27, 2026)
- Rory Johnson on Commodity Context, “Sanguine Strait Stoppage” (April 23, 2026)
- Oil Ground Up Podcast
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Episode 325 transcript
Disclosure:
The information and opinions presented in this ARC Energy Ideas podcast are provided for informational purposes only and are subject to the disclaimer link in the show notes.
Announcer:
This is the ARC Energy Ideas podcast, with Peter Tertzakian and Jackie Forrest, exploring trends that influence the energy business.
Jackie Forrest:
Welcome to the ARC Energy Ideas Podcast. I’m Jackie Forrest.
Peter Tertzakian :
And I’m Peter Tertzakian and welcome back. It is recording time Thursday, April the 30th in the morning. And looking at the oil prices, they’re certainly bouncing around. There’s generally strength as this Strait of Hormuz saga drags on yet another week. We’re certainly over a hundred dollars a barrel, both for Brent and for WTI, solidly over.
The difference between spot barrels you buy in the physical markets versus the front month is still distorted on the other side of the world. I’m sure they’re paying north of 150 bucks, more flight cancellations in Europe. So this is not a situation that’s getting any better. We’ll talk about this and a lot more with our special guest here coming up in a minute. But before we do that, Jackie, you want to talk about the Prime Minister’s economic update first?
Jackie Forrest:
Yeah. So April 28th, we had the Canada economic update. There was two items I thought that were worth mentioning. First of all, the 2025, ’27, so this fiscal year deficit will be 11 billion lower than expected. And one of the reasons for that is the higher oil price, which has resulted in more revenue to the government. And so it’s still a huge number, by the way. It’s 11 billion smaller, but it’s still a $67 billion deficit.
So it’s still a huge, huge number. The other thing I wanted to mention is there wasn’t much for new policy, but there was something interesting there. The investment tax credit for carbon capture storage now applies to enhanced oil recovery. And that was an issue a lot of people saw is kind of unfair. You’re sequestering CO2 when you’re doing enhanced oil recovery, and the Americans were giving a subsidy for that. So now, there is a tax credits half of the size as if you are doing the pure CCS without the enhanced oil recovery, but I think that’s good news.
Peter Tertzakian :
That’s some good news. Yeah, that’s some good news. Well, I’m not surprised the deficit is lower. Certainly on our real time indicators here at our studio, we are now looking at $46 billion in royalties in taxes for this year, which will be an all time high. And a large part of that goes to royalties, but the taxes are definitely much higher, not surprising given the higher oil prices lead to higher margins. Okay. Did you predict any of that stuff from the Prime Minister in the polymarkets?
Jackie Forrest:
No, no, but I did have a look at polymarkets.
Peter Tertzakian :
Did you bet on anything in the polymarkets?
Jackie Forrest:
No, because you got to get cryptocurrency first. And then I tried to go down that whole path and I got distracted. But I have to say, I do look at it once in a while and I find it interesting that the number of questions around the Middle East and the oil market situation have just exploded, but some of them are kind of insightful as well. So I thought I’d highlight Trump announces US blockade of Hormuz lifted by May 31st, 43% chance according to the people that are betting on polymarket.
So here we are at the end of April, so this could go on another month. And certainly from the news coming out of the US, there is certainly a growing expectation that this Strait closure could be extended. I also found another funny one. Trump will rename the Strait to the Strait of Trump by May 31st.
Peter Tertzakian :
What’s the percentage on that one?
Jackie Forrest:
4%.
Peter Tertzakian :
4%. Okay.
Jackie Forrest:
I think it’s more likely it’s going to be the Trump Iran Strait. I don’t know. And there’s lots of other funny ones. There is even like how many ships will transit the Strait this week is a bet. Anyway, there’s a bet for everything. Regime change, not regime change.
Peter Tertzakian :
There’s a bet for everything. It’s just crazy. And there was, I think it was in the Wall Street Journal yesterday, an article about how most people who bet on the polymarkets lose. In other words, there’s only a handful of people who are actually using a lot of bots and things that are actually sweeping the money off the table on those poly markets. So anyway.
Jackie Forrest:
Yeah, it is really betting for sure.
Peter Tertzakian :
It is betting. Speaking of bots and AI, some interesting news in the last week or so and some good podcasts that certainly I listen to as I immerse myself in AI even more. And that is something we talked about over a year ago on the podcast. Remember we were talking about how something has to give because this tremendous growth in data centers and power demand is just not sustainable.
And also we were talking about how crazy it is that you can make these prompts and it gives back these answers and it’s just getting better and better, but that behind the scenes, the power consumption is huge and it’s all for 20 bucks a month. And we were amusing that that’s completely unsustainable. It’s not any longer like a simple Google query like we were used to. This is now turning from a few seconds of computations to now minutes.
Jackie Forrest:
Well, especially as you get these agents going that can be running like-
Peter Tertzakian :
These agents going, it’s just like an exponential usage of this compute power. And the compute power is in short supply, as is the energy behind it. And hello, the realization sets that somebody has to pay for all this stuff. And so increasingly there’s tokenization. It’s probably even going to come to ChatGPT and OpenAI where you’re going to have to pay per use, which is something that we talked about over a year ago.
And in some instances, some people are conjecturing that all these agents working together may actually cost as much as hiring a human. So we shall see how this story plays out, but there’s no question at a time when the cost of energy is going through the roof and the supply of computing power is insufficient to run all these agents that somebody is going to have to pay for all those crazy prompts that we put into these machines.
Jackie Forrest:
Yeah. And people are just kind of running stuff that like, I don’t know, do you do this? And I’m not even very advanced, but do things and I’m like, oh, barely look at it. So if I had to pay, I would be more selective about what I do.
Peter Tertzakian :
Or you use the deep think mode by accident to ask what the weather is in Calgary and the thing grinds away. The thing grinds away for two minutes. Anyway, let’s talk about the energy situation because it’s getting a lot more serious. And I want to invite to the podcast Rory Johnston, founder of Commodity Context, someone whom I’ve known for quite a while. Rory’s got a Substack, which we will post on the site and a podcast as well. So we’re delighted to have you straight from the center of the universe. Toronto, welcome Rory Johnston.
Rory Johnston:
Well, you guys are in Calgary, the center of my general universe. So thank you so much for having me on the podcast, Peter and Jackie at longtime listener, first time caller. So big honor.
Jackie Forrest:
Great. And I started listening to your Oil Ground Up podcast. We’ll put a link to that in the show notes, but I recommend people to check that out as well.
Rory Johnston:
Thank you.
Jackie Forrest:
So your phone has been just ringing off the hook, I would say. I just see you everywhere. How has it been since the end of February for you?
Rory Johnston:
I’ve been saying that I thought that the busiest I could get was January of this year after the Trump administration kidnapped Nicolas Maduro and there was all this interest in Venezuela and oil industry and there was this Canada angle. I thought that was about as busy as I could get. And the joke this year is like, absolutely not.
Now Iran is far, far busier. And I think the ongoing joke is that Trump doesn’t believe in weekends. We haven’t had a weekend really since the year started. Every weekend we’ve had major news breaking. It’s just been unyielding. So I think myself and I would argue the broader oil market at this stage is just acutely exhausted by what’s been going on.
Jackie Forrest:
Yeah. You talked about a Substack. We are subscribers to it and it’s been really valuable. So you’ve been doing some great work. So thanks for helping to keep us informed over the last while.
Peter Tertzakian :
Yeah. Let’s just pick it up with a big news where the UAE United Arab Emirates dropped out of OPEC. What’s your take on that?
Rory Johnston:
Yeah. I saw that news as I was about to get in the shower in the morning and I’m like, wow, okay. So that’s what’s happening for today now. I had other plans. I had other plans for my Tuesday. And again, the market just never stops. So I think it’s important to kind of split it into near and longer term consequences. The near term consequence is basically nothing.
I think people are like, “Oh, is this going to justify oil price selling off because the UAE is going to produce more?” No, because the vast majority of the UAE’s production is still on the bad side of the Strait of Hormuz. It has this offset pipeline to Fujairah, but that’s already been maxed out. So the current thing restraining Emirati production is not OPEC quotas, but rather the Iranian kind of closure of the Strait. That said, in the longer term, this almost guarantees more Emirati production than we otherwise would have expected.
And I think importantly for OPEC, I would argue this is the largest schism or kind of crack in the producer group since it’s founding. We’ve had large members go to war with each other multiple times and we’ve never had such large members leave the alliance, the producer group, the organization, and this is not just any member. This is not the same as you know when Angola left in 2024 or even Qatar left in 2019. The UAE arguably was the second most important member of OPEC broadly.
Peter Tertzakian :
Yeah, let’s put some numbers to it. I think they’re producing just a little over three million barrels a day. They have spare capacity up to five now because they’ve built more infrastructure, they’ve been drilling, but they’ve been choked back because they’ve been part of OPEC. And so now that they’re out notwithstanding, they can’t get their oil through the Strait of Hormuz yet.
They’ll probably bypass it with a pipeline here in future almost guaranteed. So this is not really today’s story other than, as you point out, the major fractures. And it’s even bigger than just an OPEC story. It’s sort of the rivalry or the contentiousness in the Middle Eastern politics between the Saudis and the UAE and the different factions, but it is a longer term story.
Rory Johnston:
Absolutely. And I think to your point, you hit on the nail there that the primary reason that the UAE wanted out was that it has invested in upstream production capacity expansion well ahead of any other member of OPEC. It’s expanded production capacity by over a million barrels a day since 2019, outstripping any of the other major OPEC members. And the ADNOC, the national oil company, puts its estimate at five million barrels a day by 2027.
I think the IEA puts it around 4.3 million barrels a day right now, but still notably higher than where we are. And I think the other important thing here is that the kind of least well-kept secret in the oil market is that the UAE has been kind of a thorn in the side of OPEC policy for a while now. It’s been chronically cheating its production quota by between three and 500,000 barrels a day, pretty well since 2021, 2022.
So it’s always kind of had one foot half out the door. And it was very clear that OPEC leadership in Saudi Arabia was trying to placate the Emiratis to keep them in the tent. But I think at this stage it’s kind of failed, I think clearly. And two, the kind of positive side of this, I think the Emiratis were right that if this happened, if they announced this outside of the war, this would have been all I would be doing for the next weeks or month, was talking about the UAE and now this is going to kind of get swept under the kind of Iran and Hormuz closure storyline.
So I think they can bury this to a certain degree, but no doubt. I think it’s pretty savage, I think to the sense that like even the prior couple days, OPEC was talking about this unified front opposing this kind of collective enemy in Iran and the closure of the Strait and potential for it being told or whatever. And then they’re like, “Ah, actually we’re gone.” So yeah, I would say the politics are less than ideal for the producer group, but I think this is also far from the end and many, many premature obituaries have been written by OPEC over the years.
Jackie Forrest:
Right. Well, and it was funny when you heard all the different views, there was everything from no big deal to this could be the biggest price war. So I think there’s a lot of dispersion in terms of analyst views on what this really means.
Peter Tertzakian :
Yeah. Have you been to the OPEC building?
Rory Johnston:
One of my career highlights was just before I left Scotiabank in 2019, I got to present the Secretariat on Canadian oil production outlooks, and that was very, very cool. I have sadly not been invited back since. I have become a little more critical of OPEC’s policies in the interim years.
Peter Tertzakian :
Yeah, I’ve been there. It’s on sort of a non-descript street with a bunch of luxury cars parked in front and it’d be interesting to know what they’re talking about today because in some ways the supply is being controlled in some undesirable ways. So let’s talk about that. How much supply is now gone given the choke point has been choked?
Rory Johnston:
Yeah. So let’s just quickly kind of do our top level barrel counting math of what we’ve lost from Hormuz today. So the headline number, I think everyone’s heard at this stage if you’re even peripherally following the oil market is roughly 20 million barrels a day of oil flowed through the Strait of Hormuz prior to the war and the closure, 15 million barrels a day of that was crude and five million barrels a day was products roughly split between middle distillates like diesel and jet fuel heading to East and West Africa and into Europe, and then another chunk of roughly two and a half million barrels of natural gas liquids and condensates that were largely going towards Asia for petrochemical feed.
So that’s kind of our total initial hit to exports and supply was 20 million barrels a day. There have been offsets, very importantly, most notably the Saudi East West pipeline, which transits from the Gulf side of Saudi Arabia to the Red Sea. That pipeline has a rough capacity of seven million barrels as a total, but there was already about two to two and a half million barrels flowing on the line prior to the war. So your switching capacities more like four, four and a half, five.
You also have a bit of switching capacity on a similar pipeline that roots around hormones to the Emirati port of Fujairah on the Gulf of Oman side of things. And then you also have, I mean, up until very recently, you had Iran continuing to ship one and a half to two million barrels a day of crude and products through the Strait. So all in all factoring for all these physical rerooting offsets, we still have about 13 million barrels a day of gulf production across the six non-Iranian Gulf states that has been forcibly shut in for lack of any available egress.
And I think anyone in Western Canada would be very familiar with when you do not have egress, you can’t just spill it onto the ground, you need to shut in these wells. So they’re experiencing effectively that same thing, forced curtailment like Western Canada saw in 18 and 19, and just to a completely different scale. So 13 million barrels a day. And again, I think that took hold within the second week of the war. Those shut-ins were basically maxed out. And so to date, we have roughly 600 million barrels of oil that was supposed to be produced this year that now has not been produced.
And factoring for the lagged restarts of these projects, which I’m basically modeling on a three-month basis where you have a front heavy, like 70% recovery, then 20, then 10, that recovery path, if we assume that the restarts started May 1st, which was my kind of optimistic base case model, and now I realize that’s tomorrow and that’s not happening. But even in the kind of optimistic scenario that we got to restart starting on May 1st, the total lost barrels will be about a billion barrels of oil that we expected to have this year that now is not going to be there and is going to need to be taken from the collective pool of global stocks.
Jackie Forrest:
So I have to give you credit because you came up with that billion barrel number like a month ago. And now in the last week or so, we got all these other analysts kind of using the same number, but it was your number first. And it is optimistic because you also assume not only that things get going May 1st, but that it’s like we get right back to full production, which I think there’s some questions around that as well.
Rory Johnston:
For sure.
Jackie Forrest:
I look at it like you have a bathtub that was full of water where we’ve drained the bathtub and when the Strait does open, and I do think it will open at some point, that water, when you open up the taps, it’s just going to go right out the drain. We don’t have the ability to build that storage back up. It’s going to take a very long time to do that. So the markets are not taking this as seriously a billion barrels lost. And you recently wrote in your Substack that the situation is shockingly sanguine and explain why you think that.
Rory Johnston:
Yeah, it’s a good question. I would say over the past month, my life has been dominated by why aren’t oil prices higher? Because I think I would have expected oil prices to at least initially overreact to kind of this shock, given the kind of scale of the shock that we’re facing, the largest supply shock in the history of the oil market, and the kind of narrative and symbolic weight of hormones, given that not only is it a huge shock, but to Peter’s earlier point, it basically it short circuits OPEC’s normal capacity to fill in to supply losses with spare capacity, because all the spare capacity is on the wrong side of Hormuz.
So yeah, I would say that my expectation was that we would have grinded higher faster. And the reasons that I think that we’ve fallen back from our, when dated Brent hit its highest level in history on nominal dollar barrel level on April 7th, the day the ceasefire was fined of over $144 a barrel, we’ve fallen back from there. And I think there are a couple good and not so good reasons as to why that is. And then I think it’s important to kind of take the market for what it is and try and explain what’s going on rather than just saying, “The market’s wrong.”
So I think the most fundamental reason, I think the structural reason that we can explain a way to a degree, the lack of immediate price reaction is that while we often talk about financial markets as forward looking at their core, physical commodity markets are not as good at being forward-looking. I think you look at former Goldman Sachs commodity research head who basically said that these commodities are not anticipatory assets, that the core purpose of prices and the shape of the future’s curve, what we talk about as term structure or time spreads, is basically to facilitate the clearance of the physical spot market.
So when you are oversupplied, the spot prices get discounted relative to later dated cargos and that pays for storage. And in under supplied markets like we find ourselves today, that is basically just manifesting in backwardation or a premium on spot purchases effectively creates an opportunity cost for holders of inventory, forces those barrels in the market to fill the hole. I think basically I kind of ran it through my fair value model and given the fact that we started the year oversupplied with surplus and kind of rising stocks, we did have a little bit of time, a little bit of buffer to draw those down before the model started pointing to really, really spiky prices.
Now, if you assume a four million barrel a day net draw, now again, that’s a fraction of the 13 that we’ve lost the market, but if you factor for a four million barrel net draw on OECD commercial stocks and the important visible kind of residual stocks in the market, that kind of makes sense that we’re kind of 100, 110 Brent in April. But if that same model holds and kind of assumes the same decline in stocks right through the end of June, that puts us near $200 a barrel on fair value. Now we could be slightly lower than that on optimism. We could be slightly higher than that on precautionary demand and panic, but I do think that the inexorable logic of lower stocks drives higher prices is going to eventually win out here.
Peter Tertzakian :
Yeah. But isn’t there another way of looking at this? Okay, first of all, there was a big surplus, I think it was like a billion barrels, which sort of nets up before we went into this and everybody was super bearish at the beginning of the year. Now the tables have providerally turned, but actually the price of oil is much higher on the other side of the world. WTI is in Texas. Brent is in the North Sea. We’ll call it the North and Western hemisphere, but in the South and Eastern hemispheres, they’re paying north of $150 a barrel because they need it.
You take into account the transportation times from the Northwest to the Southeast, which is like 45 plus days. I mean, people are mopping up whatever barrels they can find in Southeast and we don’t hear about it much here because we’re in our own little bubble, right? Even most of the traders here are in their own little bubble, I would argue, but the wave of higher prices is starting to creep into the west. And when the inventories really start to diminish and when the strategic petroleum reserves, which we’ll talk about, start to diminish, then the whole world is in more trouble if this thing doesn’t get cleared up pretty soon.
Rory Johnston:
Yeah. Brent and WTI, Europe and North America are about as far from the epicenter of the shock as possible. So there is a kind of a natural lag here. And I think that part of the challenge is that the volatility of the news flow in this war has operated at like the speed of light or the speed of tweet, I guess speed of true social post. Whereas these barrels take months to clear these arbitrages and the pain that we’re feeling that Asian importers are feeling. The highest confirmed barrel of oil purchase that I’ve seen, I think it was the head of one of the big Asian banks talking about how there was a barrel delivered to Sri Lanka that factoring for all of the import and everything, it was like $284 a barrel landed.
Peter Tertzakian :
See, there you go.
Rory Johnston:
These are crazy, crazy high prices and you have physical spot that are even higher. I think that for the broader market, despite how we kind of assume that the market can see a lot of stuff, I would say it’s generally blind to that. And it’s watching WTI and Brent as the kind of benchmarks of this. I think the other thing that’s important here is the fact that the other kind of two factors I had mentioned with this that kind of help explain the more sanguine price.
One, I think the ceasefire did legitimately take off a little bit of the tail risk. I think again, obviously Hormuz and the crisis is deeply unsustainable in the largest in history, but it could have gotten worse. There was always the potential that we did see US troop boots on the ground in Kharg Island or the Iranian mainland, and then you start firing missiles at Abqaiq or other Saudi upstream facilities.
It could have gotten worse. And I think at this point it seems that the Trump administration is not interested in reramping that kinetic activity. I think that does shave a little bit of that tail risk off. I think the final element here is that Trump has kind of had an unprecedented degree of verbal intervention in this market, which I definitely hadn’t expected. We had seven, eight moments where we’ve had a true social post or comments to press in the White House that prompted a 10 to $20 a barrel intraday sell off.
It explodes volatility and makes it more expensive for financial participants to hold those future contacts in the first place. But also, I think if I was a futures trader and thank goodness I’m not, if I was holding Brent at 110 or 115, sure, fundamentals are rock solid right now, but if I can get blown out to the downside of 15 bucks in the span of 15 minutes, that’s going to make me pretty nervous to hold those positions with most much conviction. I do think that the trader behavior is kind of further kind of driving this a little bit.
Jackie Forrest:
Right. And back to your $200, your view of that is because when the inventories draw down and there is no more oil in a lot of countries, we need demand destruction, right? And that’s fundamentally what’s driving the need for higher prices because I think the IEA is saying in the month of April, maybe two million barrels a day of demand destruction. Well, that’s nothing close to the 13 million barrels a day loss. So we need that, but at the same time, yeah, this is very unusual. We’ve had numerous episodes of $10 changes just like that.
Rory Johnston:
Yep.
Jackie Forrest:
I think it’s because the view that this could just all change very quickly, and that’s sort of been the thinking that is out there and maybe that’s starting to change with the idea that the White House, or at least reports that the White House is expecting this closure could be for a while. So maybe that changes.
Rory Johnston:
Yeah, I would agree. I think the New York Times reported that the advisor in the White House were pushing for, that Iran would buckle on its demands after two more months of blockade, which I saw that and like my jaw dropped. Yes, I think we’re all going to be buckling with two more additional months of this. So yeah, but I think it’s clear that both sides view themselves as winning this war currently, which makes any compromise, necessary compromise at this stage, very, very difficult to achieve.
So my base case is that eventually this conflict will end when the White House makes some kind of unpalatable concession to the Iranians in order to reopen the straight, but in order to do that, I think you’re going to need more external pressure on the White House than the market is currently providing. And going back to that kind of paradox of this kind of, you get a $15 a barrel sell off on an assumption that Trump is about to end the war and then in doing so reduces the pressure on him to end the war. And he kind of is most sanguine of all, thinks this is kind of entirely fine.
So I do think that’s part of it. And I think we saw the president get very obsessed with these maps of tankers heading to the US Gulf Coast, kind of this sign and kind of heuristic for US energy dominance in this crisis. And there’s no doubt that North America is the most energy secure region on the planet remaining in this crisis, but the only reason those tankers are going to the United States is to pick up oil that other people in the world are willing to pay a higher price for than our Americans right now, which is why we got a 24 million barrel inventory draw in the IEA data yesterday. It was crazy.
Peter Tertzakian :
The pre-conflict inventories were above the five-year average, but they’re not going to last very long because the tankers that were at the mouth of the Straits of Hormuz immediately after the war, the captain probably got a satellite phone call from the ship owner and said, “Okay, this doesn’t look like it’s going to end anytime soon. Head to the United States takes 45 days to go from the Gulf to the Gulf of Mexico.” So I’m going to say because Gulf of America, Gulf-
Jackie Forrest:
Even from the Strait of Trump-
Peter Tertzakian :
From the Strait-
Jackie Forrest:
Gulf of America.
Peter Tertzakian :
Okay. Whatever we’re calling these things. All right. 45 days to go from Gulf to Gulf. And so yeah, it’s probably going to accelerate these drawdowns and then that’s really when the prices are going to start to go up.
Jackie Forrest:
But I think it’s worth just visiting. If this goes into late May and even June, the situation I think becomes quite painful. We’re talking about shutdowns of industry, I think blackouts in countries, big parts of Asia where there’s no flights at all.
Peter Tertzakian :
Europe too.
Jackie Forrest:
What does that look like, Rory? And I tie that back to the overall equity markets, which are just still, I know they’ve come off a little bit recently, but near all time highs. And it’s not just the North American ones. If you look at indicators of global public equities, they are also very, very high. And it seems like the broader market is not sort of seeing the effect because of course a lot of these companies are not going to produce the widgets, they’re going to have supply chain issues. I liken it to like COVID. Do you remember at the beginning of COVID, there’s like no problems because we had all this kind of inventory and then it was like eight or nine months into it where suddenly you couldn’t get like-
Peter Tertzakian :
Toilet paper?
Jackie Forrest:
Yeah. Or shingles that you needed or like building supplies weren’t available.
Rory Johnston:
Children’s Tylenol?
Jackie Forrest:
Yeah. So like are you-
Peter Tertzakian :
Auto chips, auto chips. I think that the semiconductors for specialized purposes are going to be in short supply, they’re saying, because of the helium that is in behind the Strait of Hormuz. Helium is a very valuable and hard to get commodity, and so it’s going to be manifesting itself here in the next couple months.
Rory Johnston:
There’s no doubt. I think that like for a little while, there was at least kind of almost a perfectly inverse relationship between oil and equities that when oil prices spike, equities fell back through like let’s say March, that was the trend. Now it seems to be that we’re making kind of all recent or fresh crisis highs for oil and fresh all time highs for equity.
So clearly I think like the market, I think a lot of the pushback on this kind of more concerned view on the oil market and the Hormuz crisis is coming from that macro kind of more equity-driven or focused participants and investors that there’s such a deeply held view right now that equities should go up because of AI or whatever else, that the oil, the Iran war and Hormuz crisis are a deep inconvenience to anyone that wants those prices to go higher.
So it seems like we’re going to have to kind of keep going on that Wile E. Coyote goes over the side of the cliff and it takes them a month or so of running there to realize that there’s no ground underneath them. I won’t embarrass myself by saying too much about broad S&P 500 because I’m not an equity strategist, but I do think that the fundamental view is that oil needs to go higher here to this question about demand destruction and everything else, there will be some supply adjustment like we probably were going to expect one and a half million barrels a day of growth from the Americas this year between Canada, the United States, Guyana, Brazil, and Argentina.
Those are your kind of big five America’s non-OPEC production growth source. But again, one and a half million barrels a day versus 13 million barrels a day shut in. Even at its peak of US production growth in 2018 where total liquids growth grew by two million barrels a day year over year, which is the fastest pace of growth of any oil producer in the history of the market, to my knowledge, at least organic growth, that’s not nearly enough.
So clearly, we’re going to need to either fill with SPRs, which we’re going to do in the interim, but that’s temporary. And then after that, we’re going to need to destroy demand. Now, when people typically talk about demand destruction, they talk about, let’s say 2022 or any other kind of recessionary or high oil price recessionary environment, we’re talking about a one, two million barrel a day oversupply. We’re talking about, that’s kind of what we need to destroy on the margin. That’s pretty easy to do in the scheme of things with low triple digit prices.
The challenges is in this crisis, we’re talking about even charitably, 10% of global demand needs to be cut back. We’ve never done that before. So all of I think our historical literature around price sensitivities like, “Oh, a 10% increase in prices will drive a 1% reduction in demand.” I just don’t think that applies because we’ve never tested how far we’d need to go for comparison. And again, you can’t take it all from one product, but if you could, you could ground every airplane on earth for the next year and it would not cover the Hormuz stop shortage.
Peter Tertzakian :
Yeah.
Rory Johnston:
That’s how large we’re talking about.
Peter Tertzakian :
Well, the closest we came was during the pandemic. And on an instantaneous basis, I think there was a curtailment of 20 plus percent of demand. On an annual average, it was 6%. But that took the lockdown of the entire world at least for a couple months to do that. So yeah, 13% is absolutely huge. But let’s take it a bit forward. Okay. So the Strait of Hormuz gets going again, but it’s a new world.
And let’s just say in whatever deal is struck, Iran does start charging tolls with the ships going through. So what does that world look like? Higher insurance rates, higher tolls, higher risk premium for all the oils that comes through, higher cost of capital, sort of less willingness to invest in that whole region by multinationals. What does the world of oil and gas, LNG prices look like after that?
Rory Johnston:
The first thing I’ll say is there’s been a lot of controversy around the tolls thus far. The reports indicate that Iran may be saying that lots of people are paying the tolls, but there’s no confirmation of the full extent of how much tolls are being paid. And the US Treasury recently issued, I want to say earlier this week, guidance that basically clarified that, yeah, paying the IRGC passage of tolls is a sanctions violation.
So that is an additional complication to this. But let’s say in a world where part of the deal to reopen the Strait that Trump, one of these unpalatable concessions the White House would have to make would be seeding go forward control of the Strait to Iran, which charges some kind of tolls. The first thing is that if they actually got to charge tolls on all the ships coming out of Hormuz, I’ve seen estimates that basically indicate that that could basically create an equal parallel source of revenue for Tehran equal to its entire oil industry.
So obviously a massive fiscal boost for Iran, which if we’re in a world of trying to constrain and kind of curtail Iran, not exactly the direction you want to go. But I think more importantly, it’s just deeply politically unstable. Now the Gulf is not going to tolerate it, but I would argue they don’t have a lot of a choice in the near term. But I think in that situation, you basically just set up a deeply unbalanced, unstable situation that just begs for the next crisis.
If you had asked me at the beginning of this year, what are the odds that Hormuz has closed this year? I would’ve put them at negligible odds, like 1% maybe. Going forward, Iran’s broken that seal now. And I think if it’s seen how it can do that, it’s learned over this process as well. If it’s in a position of go forward control, I would say that that ups the odds of a closure in any given year to maybe five or 10%, which is still small. But for a disruption this large, it’s gigantic. To your point, Peter, I agree. I think that it’s going to permanently nerf the investment attractiveness of the region.
Jackie Forrest:
But what you said earlier was a more fragile situation in that the supply from the Middle East going forward, if that’s the situation, people are always worried about this happening again. And of course that results in people trying to find alternative sources of supply. I also think it makes it harder for Middle East countries to invest in new supply.
Now, many of them are national oil companies that maybe can invest their own cash flow and don’t rely on foreign capital, but countries like Kuwait and Iraq are probably going to need foreign capital to grow their production. So I think it results in OPEC spare capacity maybe declining. I think another really interesting thing is over the course of the last decade, there’s been this real move to not have as many refineries in Western countries. And meanwhile, Middle East has been building refineries and instead of exporting crude, exporting more refined products.
And now many countries are dependent on jet fuel from the Middle East because they can’t produce it themselves. And you see countries like Australia that have shut down a lot of refining capacity, realize the risk of not having your own refining capacity because when times like this happen, all suddenly no one is sending out refined products. India has really constrained their exports of refined products as well.
California is another area that you read about because they’ve shut down refineries that they are kind of exposed now because they used to import refined products. So it’ll be interesting to see if we see a resurgence in investment for energy security reasons in a lot of these countries to get these refineries back online or rebuild them. I don’t know.
Rory Johnston:
I actually wrote a paper, contributed paper to the Macdonald-Laurier Institute, I want to say two years ago now with, I think you’ve had Heather Exner-Pirot on the podcast before, kind of talking about refining our hedge. And that there’s always been this debate about like, should we refine more product in Canada? Should we export products, value add, et cetera, et cetera.
And I’ve always generally pushed back on that overarching thesis that that’s the value we should be adding or where our comparative advantage is, but we are roughly self-sufficient as Canadians in refined products, two million barrels of refining capacity, roughly two million barrels of demand, which even if we’re not every barrel refined is consumed in our borders, at least we have a GDP hedge against these explosions in refining margins like we are likely going to see right now, particularly for middle distillates like diesel.
So I think this has been one of those moments where middle distillates in particular has been the center point of pain in the oil market ever since 2022. And it comes core from the view that we do not have the refining capacity we need anymore and the changes in crude slate overwhelmingly towards light sweet crude from the United States is weaker in that middle distillate yield compared to say, I’ve heard referred to as the champagne of North American crudes, which is Canadian synthetic crude, which is a predominantly heavier portion in the middle distillates.
Jackie Forrest:
Right. Well, you need the right refineries to be configured for that. We do have some exposure though. I was reading an article about the lower mainland that they do import refined products. So although the country is generally well served, I think there are probably pockets that are reliant on imports. And I’m sure it’ll all get worked out because we do have enough in the continent, but maybe we’ll re-look at some of that. This brings me to another risk that I worry about when we hear stories that maybe the White House is thinking, “Well, this is going to go on for quite a long time.”
Of course, they’re going to come under pressure for gasoline prices, which are already over $4 a gallon on average, and in some places the US even higher. So at the pain point that Peter talks about that people complain a lot, and one way that President Trump could lower gasoline prices is by restricting US crude exports, maybe not all exports, but some, that would very quickly create an oversupply in the continent and lower gasoline prices and solve his problem. Now, of course, it would create a whole domino of other problems. What are the risks of that?
Peter Tertzakian :
It’s called hoarding. The hoarding behavior happens when there’s supply crunches, and the last time that happened meaningfully wasn’t during the pandemic. We were hoarding everything from toilet paper to all sorts of other vaccines and things. And so yeah, when you start getting critically short, you start hoarding and restricting exports. Chinese have already done that, right?
Rory Johnston:
Yeah. So China did, I want to say in the first week, announced that it was restricting exports. Although the latest murmurs, they’re actually considering re-easing those export restrictions. So there’s a bit of movement on their end as well. I want to say the FDA report that yesterday, but Jackie’s core question about export restrictions and trade restrictions to the Trump restriction, that is also near my very top of my list of policy worries.
I personally don’t think it’s as likely with crude oil specifically, because again, there’s such a large exporter of crude now. And I want to say there’s enough people in the Trump orbit, refiners, crude traders, et cetera, that can kind of say like, “Look, we really, really can’t process all of this light sweet domestically. It would really screw things up.” So we’ll export the crude, but I think where my bigger worry is refined product export and controls, that you could see bans, limits, quotas put on exports.
Peter Tertzakian :
Like jet fuel.
Rory Johnston:
Like jet fuel, all of these fuels. And I think that in particular, kind of adding to that vector of worry is the moves that the Trump administration’s been taking on the Jones Act. Now the Jones Act was initially suspended for 60 days and they just announced another 90 day extension of that waiver for oil products through mid-August, which again, we’re getting well into the summer here in terms of timelines.
Peter Tertzakian :
So the Jones Act is … Explain the Jones Act.
Rory Johnston:
Yeah. So the Jones Act is this 100 year old piece of US legislation that basically protects the domestic shipping industry. And it basically says that for any good, there’s transport between two US ports. The ship needs to be owned by the US, built in the US, flagged by the US and crude by US citizens.
So that is obviously very restrictive and dramatically reduces the fleet available to those ships, which is why you will much more frequently see, say, exports from the Gulf Coast to Latin America, and then imports to the East Coast from Europe, because it gets around those Jones Act restrictions that the system optimizes. But if you were, let’s say, let’s go through the scenario where you put a hard cap or a hard block on the export for fine products, given that the US Gulf Coast is a net product exporter, it needs to get rid of those barrels.
If it didn’t get rid of those barrels, you would temporarily build up surpluses in the Gulf Coast and depress prices, but you would also eventually force refinery shut-ins and everything else because you couldn’t get rid of the barrels. So removing the Jones Act to a degree allows those exports to continue, but just instead of going to Latin America or Asia or wherever, looping around and going to the two coasts and displacing those offsets as well.
Now, again, I think there’s so many distortions, this would be a bad idea on so many levels, but I see the export ban on products as more likely than crude. But if they did go to crude, it would absolutely smack Canada as well, given that if that would depress WTI and WCS is linked to WTI as a benchmark, and we also depend on US re-export capacity out of the Gulf Coast for our barrels, and even as we learned back this time last year during the trade war worries that we shipped all of our barrels or Western Canadian barrels into Ontario via the Enbridge mainline that goes down through Chicago.
There were concerns then like, will these barrels get tariffed? If the US puts tariffs on Canadian crude, the trade lawyer answers I got were technically no, but the Trump effect and the answer is no one knows and he could do anything. So I think there is a direct angle of Canadian concern here, given our dependence on that US monopsony of the Midwest.
Jackie Forrest:
Yeah. And if we have a situation where the product tanks are full and refineries are cutting runs, oil price in North America could be a lot lower than what’s happening. It’s very substantial. So that would hurt Canada for sure. That comes to my next question, which of course there’s been numerous pipeline expansions and greenfield pipelines being proposed here in Canada. We’ve got companies that want to build pipelines to send more to the United States.
We’ve got expansions more to the United States, but we also have expansions on the existing Trans Mountain coming and the potential for a Greenfield West Coast pipeline that’s being led right now by the Alberta government and of course is subject to this MOU getting assorted here. And hopefully by July or early July, we’d have some sense of that project and what it would look like. But when you look at it from a crude oil market perspective, in your view, which direction should be prioritized?
Rory Johnston:
This is actually the subject of, I had the pleasure of joining Peter at a presentation to the House of Commons Standing Committee on Natural Resources exactly on this topic, which is we have all these different paths and options for our crude to flow, but we have choices to make. Let’s go through those four different options. So we have Enbridge mainline, roughly 400,000 barrels a day of capacity expansion or expansion capacity there, 360 on Enbridge, I think what’s 550 on the Bridger expansion that would basically link in with those Keystone XL assets, and then maybe this million barrel a day pipeline, the Northwest Coast oil pipeline that’s currently being championed by the Danielle Smith government of Alberta.
All of those do different things. And I think it’s important to note that. I think the most similar are the Bridger expansion and the expansion on the Enbridge mainline. Both of those are going to be reasonably inexpensive in the scheme of things. I guess Bridger’s going to be slightly more because it’s a new greenfield pipe, but again, building the United States going to be cheaper, but it further entrenches us into that US kind of monopsony market and doesn’t allow us any strategic flexibility for our barrels.
The Trans Mountain expansion, that 360,000 barrels is good and further allows us to get evermore oil into the Pacific Basin, but it only does so through limited infrastructure. We can’t get VLCCs in and out of the Port of Vancouver. It’s not a deep water port. So for instance, we can’t service the Indian oil trade right now that way. We’re depending entirely on VLCCs out of the US Gulf Coast to service that trade. So then you get to this greenfield northwest coast oil pipeline, which is a million barrels a day, at least on paper, but we’re talking likely 30 plus billion dollars to get this pipe built.
Now, hopefully we can get for cheaper than that, but I wouldn’t be holding my breath. And I think that it’s really hard for that to compete on a pure economics basis with any of those south facing pipelines. And that’s, I think, fundamentally the reason if we let the private sector entirely drive the direction, they’re going to drive in the direction of the lowest net backs, the highest profitability, the most optimized system, which is good for them in good times, but doesn’t provide any strategic optionality in bad times.
So we were talking earlier about Saudi Arabia’s East West pipeline, which was built in the 1980s during the Iran-Iraq war and the tanker war exactly for this eventuality and this risk. It did not go fully utilized for 40 years and then all of a sudden, it became arguably the single most important piece of energy infrastructure on planet earth.
Jackie Forrest:
Right. It went from being insurance to being very valuable, right?
Rory Johnston:
Yes. And I think that is a lesson we can take here because people will say like, “Oh, well, what if the pipeline is underutilized? Won’t that be sunk cost, sunk capital?” And the answer is yes, but it’s valuable in that insurance. And if we had had that pipeline, let’s say, available during last year’s tariff fight, one of the weird things about that terrified is that if you look at most other exporters in the United States for most other products, the research showed that 90 plus percent of the incidents of those tariffs were falling on US consumers and US companies through margin compression.
When it came to Canadian oil exports though, we were likely going to eat 50% of that tariff on our side of the border through wider differentials, just because we don’t have any other options to send those products. If we had another pipeline, we could have had more optionality and we could have had more market power in that dynamic.
And I think that’s the thing that I want the United States to be a good reliable ally going forward, but I think hope is not a strategy. And I think that we do need strategies here and the private sector alone can’t incorporate that strategic optionality into its own calculations. It has to look purely at profit. And I think that’s where we get a jaw, a role for either the Alberta government or the Crown. I think they think that they have to serve a role here.
Peter Tertzakian :
We’ve talked a lot about this, Rory. And as you said, we talked about it at the standing committee, but broadly speaking, this conversation’s been about the consequences of military action, military warfare, but really now what we see is just an extension of these global economic warfare, Whether it’s started with tariffs and sanctions, invasion of Venezuela, so on.
We’ve talked a lot about mercantilism coming back on this podcast. This economic warfare that’s coming from the Strait of Hormuz is really causing a lot of collateral damage all around the world. And the issue of geo economic warfare, and what we’re talking about now also is the state capitalism where the state aligns with its strategic industries to provide everything from national security to diversification of exports and what have you, which is part of national and energy security.
These are the topics to jour. These really are a consequence of what our prime minister calls the rupture, the decline of the international order and into a world of realism where it’s almost like every country for themselves. And when it’s every country for themselves, you also see the sort of hoarding type behaviors and all sorts of other things that really we haven’t had to think about much over the past many decades, but here we are. So thank you for your insights.
I can tell you that the industry has lost a lot of analysts, really good banking analysts over the last 10 years, especially Canadian ones. And Rory, I really commend you on the work that you do. You’re one of the few analysts left and certainly one of the very few that we can have such a great conversation with. So keep up the good work. We’ll point to your Commodity Context, Substack and podcast, and I am sure we’re going to have to have you back to follow this ongoing and evolving situation. Thanks again for joining us.
Rory Johnston:
Thank you both so much for having me. It was an absolute pleasure.
Jackie Forrest:
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