Gas in America has gone back up to $4. Why should we believe that that number is going to come down within the next, I don't know, several weeks?
Yeah. No, we shouldn't. And actually, what has developed over the last few months here, or essentially since the beginning of March when this has happened, is everyone's been watching that oil price and you haven't felt the biggest impact on that oil price. The pain has essentially been transferred from the oil price across to the products. And so when you talk about gasoline at $4 a gallon on the national average, we see diesel at $5, breaking above five, and that's going to be really pushing higher because in barrel terms it's about $170 for a barrel of diesel.
Welcome to Prof G Markets. I'm Ed Elson. It is July 21st. Let's check in on yesterday's market vitals. The S&P 500 and the Dow declined as conflict in the Middle East escalated. The NASDAQ was flat. Oil was volatile. More on that in a moment. The yield on 10-year Treasuries rose. SpaceX stock hit a new low of $120 per share. And finally, Warner Brothers shares fell nearly 4% after a judge temporarily halted its deal to get acquired by Paramount. The judge said the sale likely violates antitrust laws and scheduled a hearing for next month. Okay, what else is happening?
Conflict over the Strait of Hormuz keeps escalating and now it is spreading to Saudi Arabia. As of Monday, the US had bombed Iran for nine consecutive nights in response to Tehran's attacks on oil tankers, and Iran had retaliated with strikes across the region. But yesterday, Iran's Houthi allies in Yemen declared a naval blockade against Saudi Arabia. This blockade stands to threaten the primary way in which oil has been able to get around the Strait of Hormuz, through a Saudi pipeline to the Red Sea. These developments immediately shot the price of oil back up. Crude is now about $89 a barrel, and the national average for a gallon of gasoline has yet again hit $4 in America, up 15% in just the past week. So to discuss what is happening in the Middle East and also how it's affecting the price of oil, we are speaking with Matt Smith, director of commodity research at Kepler. Great to have you on the show. A lot happening here. If you could just give us your initial reactions and a quick rundown, what has unfolded and how is it being reflected in oil prices right now?
Yeah, absolutely. So, you know, we're tracking those tankers that are passing through the Strait of Hormuz here. Our job has become increasingly more difficult as there's been different routes to try and traverse the strait. And so what you've essentially got is you've got the Iranian route, which is right at the top, kind of the north, and then you have the typical or the pre-conflict highway, which was straight through the middle. And then at the bottom, you've got the Omani route, which is kind of the southern corridor. Now, as we've seen escalations increasing here, and you've seen some of the tankers being hit that were passing the Omani route, all we're actually seeing now is essentially traffic grinding to a halt again, except for those Iranian tankers and friendlies that are passing the Iranian route. So it's been undulating, right, over the last few months, you know, March, April, and even into May, the traffic was very, very slow. And then, you know, just over the last month or so, we've really seen it pick up because of the signing of the memorandum of understanding between the US and Iran. Now that has basically been, you know, dissolved, and we've seen an escalation here in attacks. As you mentioned, it's been nine consecutive nights; we'll probably have the 10th today. And so this is causing oil prices to start to kick back higher again.
Just looking at what happened with Saudi Arabia and that blockade, it seems as though oil supply was figuring out a way to kind of reroute itself away from the Strait of Hormuz or around the Strait of Hormuz. I guess my question is, to what extent was that successful, and to what extent has that now been kind of blocked now that we've got this new development?
Yeah, sure. So it was working pretty successfully, and so it was able to reroute about three and a half million barrels a day of Saudi crude across to the Red Sea. And so Saudi was exporting about seven million barrels a day out of the Middle East Gulf prior. So it was able to reroute half of that crude. So that put them in a better situation than most. So that has definitely helped somewhat cushion the supply shock because all of that crude was then going across to the Red Sea and was heading into the likes of India, China, South Korea, these countries that were otherwise getting their crude from the Middle East Gulf, and it had stopped. And so it was definitely providing some support there and helping in terms of supply, and then helping to keep prices in check somewhat. Now, the Houthis are threatening to do that blockade. They're not actually doing it yet. We're not seeing tankers or anything being hit, but this is essentially the ace that Iran has in its pocket because we've had this escalation that's been happening over the last few months here. And some have said, oh, you know, they could close Bab el-Mandeb, but they've kind of held that back until the point where the US would essentially start perhaps attacking infrastructure, energy infrastructure, bridges, and that's kind of the point that we've got to. So then it's for Iran to up the ante here, and that's basically bringing Bab el-Mandeb into play. And so it's really just a sign that essentially Iran is getting to the point where they've really got nothing left to lose, or, you know, that they're just getting to the point where they're willing to do this kind of scorched-earth tactic. And so we'll have to see how this plays out, but the threat of stopping these flows will definitely have a bullish impact on prices.
So the memorandum of understanding has been dissolved. We are now fully at war, striking Iran on multiple consecutive nights. Now they are, as you say, playing their ace card. They are trying to block any of the other supply routes that have been resorted to over the past several months. It doesn't look good. And we're at $89 a barrel. Gas in America has gone back up to $4. Why should we believe that that number is going to come down within the next, I don't know, several weeks?
Yeah. No, we shouldn't. And actually, what has developed over the last few months here, or essentially since the beginning of March when this has happened, is everyone's been watching that oil price and you haven't felt the biggest impact on that oil price. And the reason for that has been a number of different reasons. You know, China has really come out of the market. China has just stopped buying oil. They've dialed back on their imports by about five, five and a half million barrels per day. So that has been hugely helpful. You've also had essentially a lot of these refineries dialing back on their activity. So they haven't taken that crude, and that has largely offset the production loss we've seen from the Middle East. But what that has meant is that the pain has essentially been transferred from the oil price across to the products. And so when you talk about gasoline at $4 a gallon on the national average, we see diesel at $5, breaking above five. And that's going to be really pushing higher because in barrel terms it's about $170 for a barrel of diesel. And so that's where that pain is coming through, is in the products, because we're not seeing those produced, whereas the crude market has somewhat remained in balance because of this rerouting and because of this lack of refining.
When you look at that number, $89 a barrel, to you does that say that investors are feeling optimistic about the current state of affairs or pessimistic? I mean, does that number hold any biases inside of it?
Yeah, absolutely. One huge bias that it holds is that even if you are bullish on oil markets, you're not going to go and buy a paper barrel because you could have President Trump tweet something in five minutes' time and oil prices could drop by 10, 15%. So I'm not saying prices are manipulated per se, but they are definitely under the influence here of things other than fundamentals. And so because of that, you've got some that are simply not getting involved in the oil trade. And that has been happening for a good number of months here. There's a lack of liquidity there. The flip side of that, that's why I point to the diesel market again, is because the US administration is fixated on the oil price. Super fixated on prices at the pump. It's not necessarily paying that much attention or putting that much emphasis at all on diesel prices. And so that's perhaps the least influenced market out of all of the petroleum complex. And that's the one that we're seeing absolutely ripping here.
I mean, this is essentially the most important question for the US economy right now, which is what's going to happen to the price of oil? What's going to happen to the price of fuel? As we saw in the previous inflation report, it was lower oil prices as a result of the memorandum of understanding that made the number go down more than the previous month. But now we know that whatever pricing was being priced into the market at the time was incorrect because the memorandum of understanding is over. We're now back at war. Some would argue we continue to be at war the entire time. I won't get into it, but it seems that what we have seen over the past week is going to have material impact on US consumers and the US economy, and perhaps that isn't being fully reflected or appreciated or priced in by investors and traders right now. How impactful and how bad do you think it will be going forward?
Well, we could just continue in the status quo, right, in that there's this back and forth between the US and Iran in terms of the attacking of tankers by Iran, the attacking of infrastructure by the US, and then in the background there is talks and whispers of diplomacy which helps keep oil prices in check here, which in turn helps keep prices at the pump in check. But, you know, when we came into this thing, there was the expectation you can't close the Strait of Hormuz for two, three weeks, it will cause like Armageddon. Yet here we are four and a half months in, and so it's really realistic to try and consider the scenario. Could this still be closed in November and December? Yes, there are workarounds. There's medium-term plans here to reroute crude, but we really could be just continuing to scramble over the next four or five months here. And that's a reality. If that happens, you're not going to be in an environment where prices at the pump and diesel prices are moving lower.
What kind of price do you think that would result in if we find ourselves in the same situation that we're in today? And to be clear, I mean, it seems like a couple ships are making their way through the Strait of Hormuz. Is that right? Or is it just zero?
Well, there was like a week or so ago, or even just before the weekend, where you were seeing some getting through there, but the Iranians have turned their focus to targeting those because they were going through the Omani route. They were getting like a US naval escort. And so they're trying to deter any kind of traffic. So the only traffic that we're seeing going through right now is related to Iranian or Iranian, and it's just empty tankers. And so, but to your point, we were seeing over the last month this increase in traffic going through, increased confidence, increased risk-taking, and that really helped the oil market, not necessarily on the oil price, but in the differentials you really saw the air being let out of the tires there, the pressure taken out as we saw the stranded cargoes in the Middle East Gulf getting out of there. But then again, it's one step forward, two steps back here, where we're back to essentially the doors being shut again.
So I'll return to my question, which is, if we find ourselves in the same position that we are in today four or five months from now, what would you estimate the price of oil will look like?
Yeah, sure. It's got to be higher. You know, I'll hold up my hands here, and you know, in March, if you'd asked me that question, or you may have done actually, I'd have been like, you know, oil prices should be $120, $130, $140 if you close the strait for months and months. And so perhaps I've been burned by saying that, right? But maybe if we're going to be pushing above 100 here, that doesn't seem unrealistic at all if we're in the same scenario that we're in now in four or five months' time.
If we are in the same scenario that we're in now and it isn't above $100 a barrel, what would have had to have happened to get it lower than that? What truths would need to exist in the world for oil to not be more than 100?
