Speaker 1 (00:03):
Welcome to Carpool Chats, a podcast brought to you by the Fuels Institute.
John Eichberger (00:13):
Hey, everybody. Welcome back to Carpool Chats, I'm John Eichberger with the Fuels Institute. Today, we are actually going to do a quick flashback. I think one of our first episodes ever was talking about the oil markets, and it seems like on a cycle, things happen. Everything changes, every time you turn around, something's going on.
John Eichberger (00:29):
We've got record-setting oil prices here in the first quarter of 2022, things we haven't seen in a long, long time, representing gasoline prices. So we brought on two of our board members, Stephen Jones of the Argus Media and Denton Cinquegrana with Oil Price Information Service to talk about what's going on in the oil and petroleum markets.
John Eichberger (00:50):
Gentlemen, thank you very much for joining us today.
Stephen Jones (00:52):
Thanks for having me.
Denton Cinquegrana (00:53):
John Eichberger (00:54):
So I guess the first question, Den let me throw you the softball, what's going on? It wasn't too long ago, we were talking negative trading in the oil markets. Today we're under 100, but we've been above $100 a barrel again. I mean, what foot to switch?
Denton Cinquegrana (01:13):
Yeah. So I mean, a lot of it can point back to the Russian invasion of Ukraine. But again, we were on a little bit of a crash course for, at least maybe a brush wood, triple digits before all that was taking place. So that just kind of put us over the top. And now it's probably amongst the multiple wild cards out there, probably the biggest one right now, obviously the US sanctions of Russian crude oil and Russian products was mostly symbolic.
Denton Cinquegrana (01:41):
I think the market did a lot of the dirty work for the president and the Biden administration by banks not issuing letters of credit, shipping companies not willing to move it. So they did all the dirty work. But now we're at a point where, okay, that's mostly symbolic. What happens next? If say Europe, which obviously needs the Russian molecules follows through and does the same thing, then we turn the page into a whole new ballgame. So yes, we're down right now, but we could be back up in a matter of days, if something like that happens again.
John Eichberger (02:19):
Yeah. Stephen, what are you thinking?
Stephen Jones (02:21):
Well, I agree with Den, I mean, we were already in a market situation where supply was lagging the rate of demand recovery. Post COVID, if you will, if we want to call it that, post lockdowns since true reopening of the economy, we were already starting to see demand outpace the rate of OPEC adding 400,000 barrels a day, month on month back to the market.
Stephen Jones (02:46):
The issue was they weren't even meeting that full 400,000 barrel a day target while demand was out stripping it. And so the market was already getting anxious and then with the Ukrainian conflict, it just put it on steroids. It just blew it out. And the market was reacting to that exposure for what could happen to supply interruptions. And I think the reality is, and the reason prices came off is that there hasn't really been a true supply curtailment.
Stephen Jones (03:16):
There's been supply trading interruptions, but the barrels haven't come off the market. Matter of fact, the Russian loading program has still continued so far. The issues getting raise are spot on, the financial sector put sanctions in place and made it hard for any trade activity to and from Russia to occur. But there's still barrels moving, to some extent, and production as far as most people see hasn't been cut out yet.
Stephen Jones (03:47):
And I think the bid up to recent record high prices were really on the tail of the US announcement sanctions, "Oh dear, what's Europe going to do? Is Europe going to follow suit immediately or not?" And quickly, it came out that may, but not till the end of the year, if then. And so quickly, it deflated that sense of an immediate real disruption and prices have normalized back to the upper ranges, Denton mention we're heading towards, due to of the pre-conflict supply, demand, and balance.
Stephen Jones (04:23):
Our views, when we ran the analytics and the outlook, were that eventually the supply was going to keep this pace up with OPEC increases. And the rate of demand growth was already going to begin slowing pre-conflict due to supply chain problems, inflationary tendencies, and the fact that we had already recovered a good portion of the demand since COVID.
Stephen Jones (04:49):
So you can visualize a tape ring of the rate of increasing demand and supply, eventually catching up to normalize and allow for potential reinventory restocking that we still put prices in the on crude oil basis in the mid to low 80s, potentially by the end of this year into next. Obviously now, it's game over, who knows? Until we really see what kind of supply interruptions might manifest itself.
John Eichberger (05:21):
So Den, I mean, if Stephen's right, we've not seen any shortage or reduction in supply, why are we seeing the prices go up? I guess it really comes down to the base question everybody's asking is, who sets the price of oil? And I think there's a lot of misinterpretation, misunderstanding out there of how the price is set. Can you kind of walk us through how the price of oil is actually determined?
Denton Cinquegrana (05:42):
Yeah, sure. I mean, it starts at the New York Mercantile Exchange owned by the Chicago Mercantile Exchange, CME. That's where the futures market trading seen in trading places with the frozen concentrate, orange juice. That's where the crisis began.
Denton Cinquegrana (05:58):
And John, I knew that would've been right up your alley, so that's why I threw that one in there for you. So you have now, again, it's not guys yelling back and forth at each other anymore. Not that organized chaos that was just always fun to watch, but it's all electronic now. The argument now, or at least the observation is that a lot of this stuff is getting done electronically and it's just momentum carrying and following. It's the FOMO and the money chasing money idea of it.
Denton Cinquegrana (06:29):
So you start there. Most physical oil is traded as a differential to that West Texas Intermediate price or that Brent price, and that's usually how some contracts are set and how oil gets into the various pipelines, et cetera, and gets to the refiners or to the export markets.
John Eichberger (06:48):
So it's traders.
Denton Cinquegrana (06:49):
I mean, [inaudible 00:06:49] a lot of different pieces along the way that sets the price of oil. What we he had was just basically the fear of not enough. And now what's kind of happened here, it's almost coming full circle where the exchanges have to protect themselves. Because we don't want to see a situation in the oil markets like we saw with the London Metal Exchange, where the nickel markets were shut down for several days because of just high volatility.
Denton Cinquegrana (07:19):
So the CME and the Intercontinental Exchange, the ICE, they're raising all the margin requirements to play in the sandbox, if you will. So with higher margins comes less market participation, which you can make the argument brings about more volatile even. So these wild swings that we've been seeing over the last couple weeks, I don't see how they go away other than maybe Vladimir Putin wakes up and says, "Oh my God, what happened with this horrible dream I was having. I attacked Ukraine." And someone says, "You did." And he's like, "Okay, let's stop that." I don't think that's going to happen.
Denton Cinquegrana (07:57):
But I mean, that's kind of what would really cool off the markets right now and bring those margins back so we could have kind of the normal flow of participation. Also one more point to that and Stephen, I'm sorry, I'm taking up all the time here. But also you've had the phrase capital group of [inaudible 00:08:20] from producers, and they have not been ready to rush in and just produce and crash the market like they have done in the past.
Denton Cinquegrana (08:29):
So at the same time, you don't have that class, the producers, not the Broadway Play or the Mel Brooks movie, selling into the market to hedge and lock in prices. So you're missing that element as well right now. So a lot of different moving pieces that are setting the market, but these oil prices go up 30, $40 and then drop 30, $40. John, you know I've been doing this for a long time, and never seen anything like this.
John Eichberger (08:58):
Yeah, it is. I remember when I first got into this business, if the oil markets moved two to $5 in a day, people thought, "Holy cow, look the movement." And now it's just, that's just a yawner now. It moves $5, you say, "Yeah, it'll come back. No big deal."
Stephen Jones (09:17):
I won't hate myself because if it moved a quarter and 50 cents in my day, it was like, "Something's broken."
Denton Cinquegrana (09:24):
[inaudible 00:09:24] fine product side on the gasoline and diesel side, a penny, two cents, that was a big move. Now it moves that in three minutes.
John Eichberger (09:36):
Yeah. It's crazy. And Stephen, when we think about it, the media is always all over increasing energy prices, politicians as well. So we've had some releases from the Strategic Petroleum Reserve, we've had calls to suspend the gas tax, we've got calls to impose windfall profits tax and oil companies.
John Eichberger (09:57):
We have all of these proposals coming out under the cloak of, let's help the customer. I mean, we talked to bring in oil from Venezuela, we're talking about trying to encourage more production domestically. I mean, where do we go? I mean, if we haven't seen a significant change in supply availability yet, what are the options available to us with the exception of Putin waking up from [crosstalk 00:10:26] nightmare?
Stephen Jones (10:26):
Yeah. I think the examples you cite, they're very real, they've been kicked around in the political circles and been visited even in person, like visits to Venezuela to see what can be done, revisiting the Iran nuclear situation to see if an agreement can be reached, which has been derailed twice now.
Stephen Jones (10:49):
There are a lot of, I don't know what you'd say, long bomb passes, trying to figure out if there's something to really shore up the supply side concerns. And trying to add consumer relief by tax relief policies or things of that nature is just a short term factor, you may as well rip the bandaid off at some point and let it play through.
Stephen Jones (11:18):
From a try it all strategy, the only real thing that's going to work is price. Price will eventually slow the demand and allow the supply side to find that balance and allow prices to begin to ease once that becomes evident to the market. Almost everything we've talked about here in this conversation has been market sentiment, and hasn't really been a true interruption yet. It's a concern around supply being lost with demand continuing its current trajectory.
Stephen Jones (11:47):
Demand under these high prices and the inflationary pressures we're seeing is up to slow. If we stay above $100 a barrel, it's going to take a hit to global GDP and slow energy requirements due to the economy cooling. Now, the US consumers, as we've all three talked about before, pricing elasticity in the US for gasoline is almost nonexistent historically. We blew through $4 a gallon retail, how high has it have to get? Six bucks before we start seeing true consumer behavior in US change?
Stephen Jones (12:23):
Well, that's not the way the rest of the world works. And already there are countries that have fixed product prices where their demand hasn't been affected yet. And yet they're buying imported oil at international price levels and their coffers, their basically reserves of cash are being drawn down because they're paying international price oil and allowing their consumers to buy gasoline and diesel and whatnot, at their internally fixed number. Eventually, that has to change and then you begin to see demand grow slow.
Stephen Jones (12:59):
China, and Asia broadly is the larger consuming center of the entire globe. And already, you've got literally tens of millions of people about to go through lockdown with the current COVID contamination, the virus potentially spreading. And it's not like the open market where we live and enjoy the Western world lifestyle, where you can't put the genie back in the bottle.
Stephen Jones (13:25):
I doubt we could make most Americans go back into full lockdown mode, like we experienced back in 2000. And the high prices hasn't curtailed the demand, but the rest of the world will slow some demand if prices persist and allow that balance.
Stephen Jones (13:42):
Now, where can other supply come from? It's not going to come from Venezuela. They had the expertise vacate the country. They haven't had capitalization investment to restore the facilities and have probability even available in years of timeframe, let alone the need for now.
Stephen Jones (14:03):
From other supply sources, it's not going to be the US producers, the capital discipline from the financial sector that warrants a return for investment without the certainty that these prices are sustainable for the duration of that capital deployment mean, am I going to get paid for spending this money on just trying to help solve a prompt market supply concern that hadn't, again, happened fully yet? It isn't going to be the solution or the pathway.
Stephen Jones (14:33):
If it's viewed as a sustainable high price level in the $80 to $90 plus range, Ad infinitum, we'll start to see the drilling come back and other things. But keep in mind, the US drilling sector is seeing the same inflationary cost pressures that we are in the grocery store and at the pump. It's costing them more to operate, and are you going to deploy capital in that type of market environment to chase pricing in light of all the climate change initiatives and other things that you have to deal with, you have to have certainty of payback and that discipline's I think, well exerted at this point.
John Eichberger (15:15):
So Denton, that brings two things to my mind. One Stephen talked about Venezuela, Iran, you talked about Russia. What about Canada? Why can't we bring in more oil from Canada? He talked about, there's a lot of hesitancy on an increasing domestic production because of the need to return on capital to the investors.
John Eichberger (15:36):
All those things come into it, but at the same time, we're in a situation where we're looking at the price of oil is not necessarily driven by an actual physical supply constraint. It's the fear of a future supply constraint. Would signals like opening up the US to more Canadian imports, would that create more of a calming effect on the markets and provide some relief long term?
Denton Cinquegrana (16:03):
I think it probably would. And obviously, that goes to possibly the biggest political football out there right now is Keystone Pipeline. I don't think it gets finished, obviously. I think it's a non-starter at this point, but again, and this is my own personal theory. This is not the opinion of OPIS.
Denton Cinquegrana (16:21):
But honestly, if more Canadian crude came from the not built... finished, or not finished, Keystone XL, that oil would just go right down to the Gulf of Mexico, get on a ship and get exported. So while yes, importing more from Canada would be good, but I think we're just about pretty much maxed out of what we could do. Probably more trains. We saw what happened with crude by rail several years ago when there was that unfortunate accident where train exploded and killed a bunch of people in a town.
Denton Cinquegrana (16:55):
Again, these are one offs. They don't happen all the time, but you increase the risk with that. But again, we're importing quite a bit from Canada already, roughly in the three million barrels a day area, according to the EIA. And also to Stephen's point about the US producers, one, you don't just snap your finger or wave a magic wand more oil comes out of the ground. It takes time, takes several months. Plus he mentioned the inflationary pressures that they're facing. There's also labor shortages there as well, so we've heard about it all over with everything.
Denton Cinquegrana (17:32):
Couple weeks ago, got the pleasure of seeing [inaudible 00:17:35] speak at an event. And he was talking about the convenience store industry of how they're suffering with significant labor shortages. So it's no different there than a lot of other industries. But also again, to Stephen's point and he was saying this, the conversation has not necessarily turned from increasing supply, it's turned to how do we destroy demand? And $4 gasoline in 2022 is a lot different than $4 gasoline in 2008 last time we were above $4 when you consider wage inflation, et cetera.
Denton Cinquegrana (18:07):
So where is that pain point? I think we found it a little bit when we got up to about 4.30, 4.35 nationally, California's laughing at everyone saying, "4.30 [inaudible 00:18:18]." Again, it's one of those things, I think we're starting to find that 4.30 number might be that pain point. So again, it's one of those things where time will tell obviously, but I think we're working through that, "Okay, supply is not necessarily increasing. There's not really a need to increase supply as much as some think out there." So now we got to go to the process of destroying demand. It's a painful process, but we're going to end up finding out.
Stephen Jones (18:50):
I think, Den, that spot on. I mean, the key question is where does that demand get destroyed? And there's no doubt that we, as American consumers feel the pain in our wallet. The question is, is it painful enough to change our behavior? And I guess even as we were racing towards the current high retail price just recently experienced, all indications were still that demand was still moving upward.
Stephen Jones (19:17):
So we may be getting close to that pain point, but I think it's going to have to be a pretty remarkable number for US gasoline to be affected. But that being said, the rest of the world doesn't operate that way. And there is, even if the demand begins to revert in terms of the support for growth from high price pressures, the market's going to have to be convinced that is allowing a rebalance or allowing excess supply to become apparent and appearing in stock levels around the world.
Stephen Jones (19:48):
The OECD market, the developed economies of the world that carry inventory have been pretty much at record lows for gasoline and distillate primarily. And so with the market price time structure, for those that are listening [inaudible 00:20:08] somebody's ringing.
Stephen Jones (20:15):
So with the market price time structure for people that aren't familiar with that, the Ford period for the price of oil is much, much lower than even the escalated prices we went through and operators cannot afford to carry inventory and rebuild stocks and hold onto that, an inventory to cover for a supply interruption, if the market price time structure isn't flattered.
Stephen Jones (20:43):
So if I buy oil today at 130 and it drop like it did to sub 100 and I built a barrel, I just lost $30 plus a barrel by holding onto it during that time period. And so there has to be a flattening of the curve. So either the outward price incentive needs to come up, or the prompt period needs to get comfortable, that there's not going to be a future supply disruption or that demand is slowing and it will correct itself.
John Eichberger (21:11):
Last time we talked about flattening the curve, Stephen, we entered a massive drop in oil prices and demand. So let's stay away from these trigger words like that. But I also want to think back last time we got to the $4 gallon, gasoline 140, $150 barrel, oil, it was 2008. And six months later, oil was down in the 20s and 30s, gasoline was down in the $1 range. Den, you talk about demand destruction, nothing kills demand like a recession. And that we're not giving any predictability here. I don't want to be forecasting anything here, but man, that scares me.
Denton Cinquegrana (21:49):
Yeah. No, absolutely. That's the scariest thing. And while the mainstream media and the business media, especially will focus on crude oil, local TV stations, local newspapers, they're going to focus on gasoline, it's the consumer facing product. But no one is really talking about, maybe us nerd here is diesel.
Denton Cinquegrana (22:10):
And that's what scares me right now. I mean, the fact that diesel prices are so high, it's going to keep that inflation, trucks are going to have to continue to issue these fuel surcharges that's going to keep prices elevated, inflation elevated. And that's what, in my opinion would potentially tip us towards that R word.
Stephen Jones (22:31):
Yeah. I agree. Some of the factors that we saw in 2008 are comparable to the current circumstance, but the analogy is a little misinformed to some extent. 2008, we had demand growth on fire, pulling on supply that wasn't there, that propagated price to the point. And then we had the great recession, which was really perceptive by financial markets and other things, as opposed just merely high energy prices.
Stephen Jones (23:05):
We're in a whole different set of basic financial fundamentals now. We have prices driven because supply uncertainty as demand's been measuredly recovering as opposed to being on fire and supply can't keep an up with it. It's the threat of an interruption. But I think Den nailed it is that, we are exposed to inflationary pressures that could slow the economy that therefore kills demand. And we have to keep in mind that it's not just fuel, but it's food. With this crisis in Ukraine, we're missing the planting season.
Stephen Jones (23:40):
Wheat season is enormous for the feeding of the that whole part of the world and beyond, and we could have tremendous inflationary pressures due to the loss of harvest when it comes time, because we hadn't planted. There's nothing to harvest. And the fuel requirements to plant and harvest are now more expensive on top of that.
Stephen Jones (24:02):
And so you could end up with a rapid inflationary pressure if some of these factors can't be clarified or resolved soon, and we're in the middle of where this crisis ends and what shape it leaves the world in general, and that is a very real exposure. And the underlying demand growth just merely from COVID, COVID's not contained yet.
Stephen Jones (24:26):
And for part of the world, like I said, just previously not to be repetitive, they have the latitude of just telling everyone and demanding everyone stay home, unlike other parts of the world. And that's where the demand growth was assumed and already trending to occur. So we've got two or three main headwinds to deal with on the demand side that no matter what happens on supply side, it starts to soften the balance.
John Eichberger (24:57):
So everything I've heard so far kind of comes down to this, that we don't have a supply challenge right now we have fear of supply challenge which is driving the contracts up. Denton, years ago there was a strong push on behalf of some in the fuel marketing industry to put some constraints on speculative investments in the oil markets. And then market traders I spoke to said, "Look, it's price discovery." You have to have discovery, and that's why you have these positions.
John Eichberger (25:29):
Is there any type of concern that the market is reacting in this fear of the future in a way that may not be reflective of what the market really is dealing with? Or is it truly just, look, they're looking at all potential variables and trying to bake in prices based on what they think the future's going to be. I mean, is that legit or are we in a area where there may be a reason for some concern?
Denton Cinquegrana (26:01):
Yeah, no. And again, it goes back to that old phrase, the market is the market. And like you said, it's price discovery, et cetera. There have been some limitations put in place to reduce excessive speculation. But one of the things that I've been kind of keeping an eye on, this is maybe a little too inside baseball, but we'll break it down and try and make it as easily as understandable as possible.
Denton Cinquegrana (26:23):
But every week the Commodity Futures Trading Commission puts out data on people trading futures positions. It could be nickel, it could be aluminum, and rolled steel and oats, and whatever. But watching the diesel one, and again, I just keep staying on the diesel train here, you have your money managers, your hedge funds, your ETFs, et cetera, those that are trading on behalf of well healed clients.
Denton Cinquegrana (26:53):
But then you have this also, this other category called non-reportable. These are like if the three of us pulled our money together and said, "Hey, let's buy some ULSD futures." Be the stupidest thing we've ever done and I've done some stupid things in my life, but anyway.
Denton Cinquegrana (27:06):
So positions that are open and have not been closed, amongst that class of trade is almost 16% of the entire long side of it. They own these diesel futures and options contracts right now. Just to put it in perspective, that's a lot. It's almost one fifth of the entire market when you consider there's producers in there, there's hedge funds in there. And then you have the little guys, the doctors, lawyers, fire chiefs, who have almost 20% of this market.
Denton Cinquegrana (27:44):
I think in the pretty massive pullback that we've seen over the last several days, that's the group that probably got hit the hardest. Those are the ones who got the margin calls and had to liquidate, and et cetera.
Denton Cinquegrana (27:57):
I think some of the sentiment has changed, that it's maybe not going to be as bad, as like Stephen was saying, that we haven't really seen any real supply interruptions already. I think what happened in the grand scheme of things was, "Okay. Yeah, the US gets one, two, 3% of their oil from Russia." But at the end of the day, it's still a global market. And at the end of the day, there's the potential for three to four million barrels a day of oil availability from Russia that could be off the market at some-
Stephen Jones (28:29):
Yeah. I think that's an excellent point that we ought to confirm, or clarify for our listeners. When we say there haven't been supply interruptions, that means basically we haven't been able to identify oil being cut back in the ground or unable to move out of storage immediately. What we are seeing are our trade interruptions and disconnects between markets, and that is very real. And those interruptions between trade regions add tremendous costs to the cost of doing business and therefore the cost and therefore the price we see at the pump.
Stephen Jones (29:11):
And so even though we're saying the market supply hasn't been affected, the trade and therefore the movement of barrels or gallons into a given region is seeing higher cost structure to ultimately fulfill that demand. And the cost of freight's been escalated, the cost of trade, who you can do business with, as we said at the front end of the visit, letters of credit and financial institutions and others, many people haven't done to write it themselves instead of the conventional way of trading; high risk, high cost, the price goes up.
Stephen Jones (29:45):
So we're in a regime of higher price operability, despite the fact and I think we're all in agreement, there hadn't truly been an apparent supply disruption. There are major changes in trade patterns that are affecting the cost structure. The price of diesel in Europe relative to cost of crude is so wide or was so wide during the peak, and the US didn't follow suit in the same spread. It went up, but not same proportionality.
Stephen Jones (30:15):
Same thing with gasoline. Gasoline is basically been in the dump in Europe and yet, it's been strong here. There are major dichotomies between the refining operating cost and the trading requirements and expenses that will create large gaps in pricing between shores, and that's affecting and allowing for the supply that is available to get where it needs to be, who has it, who wants it, who gets it, and at what price.
Stephen Jones (30:48):
And Europe's running 60% refinery capacity, meaning they have lots of upside to process more, but their cost of natural gas is like equivalent to $50 MMBtu compared to our $5 per MMBtu price here. You can't afford to boil the oil there and meet the demand for distillate. And if natural gas gets cut off to Germany and they have to burn more fuel oil, up goes the price of diesel that bid up the old gas oil prices.
Stephen Jones (31:18):
Whereas in the US, we have enough extra diesel that we're shipping into Latin America, and we're running 90% utilization with economies of scale and refining cheap operating costs, and water frontage to take in a variety crude and so forth. So it really comes down to the trade being grossly interrupted, despite there not being any supply disruptions yet.
Stephen Jones (31:43):
The incremental supply can come out of the Middle East for refining to provide diesel and gas oil and whatnot, to Europe. India's already shifted trade patterns to provide diesel towards Europe. And it takes a price to bid it away to allow a new equilibrium to be sought in the market, and that's what we're dealing with right now.
Stephen Jones (32:04):
So I just wanted to make clear that there are high cost structures that we're all dealing with in the market that aren't going to be easily relieved. There's no magic bullet here to solve a lot of the supply exposures and trade stresses that we're seeing in the overall price structure in the marketplace right now.
John Eichberger (32:29):
And I think that's key in general. I really appreciate you joining us today. I mean, there is no silver bullet. There is no easy fix. We're going to have to ride this out. My hope is, because I think what I've heard is stability breeds, confidence breeds, rebalancing, and the system. I really hope that I don't have you guys back on in a couple months to talk about a massive drop in oil prices. We don't want them to be $150, but we also don't want lose 60 bucks in what's the currently in there, because that signal's a completely different problem.
John Eichberger (33:01):
So let's cross our fingers that we get some stability, we get some indicators and the global economy that things are going in the right direction. Some predictability in the market so we can get some relief to the pump, to the consumers. I think, ultimately we can predict more effectively what the future markets look like, that stabilize the market [inaudible 00:33:20]. Denton and Stephen, thank you guys very much. Thank you [inaudible 00:33:25] the Fuels Institute and for joining us on the Carpool Chats. [inaudible 00:33:31].