The Oil Market’s Billion-Barrel Problem

**Andrew Sheets** (0:00)
Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.

**Martijn Rats** (0:06)
And I'm Martijn Rats, Head of Commodity Research at Morgan Stanley.

**Andrew Sheets** (0:09)
Today, talking about the recent volatility and the direction ahead for oil. It's Wednesday, July 29th at 2 p.m. in London.
Martijn, it's great to talk to you again. We haven't talked for a little while on this program, but oil is once again back in the headlines and it's moving around. So maybe to just jump right into things, as you look at the lay of the land and global energy markets at the moment, what's been happening? What are you telling clients? Okay.

**Martijn Rats** (0:38)
Well, we've had a large amount of volatility over the last couple of weeks. If you roll the clock back to the beginning of June, in the beginning of June, it started to become clear that already some more oil was leaking out of the Strait of Hormuz than perhaps many of us anticipated at the time, that data has been confirmed since then. Then of course, in the middle of June, we got the Memorandum of Understanding.
After that, roughly 100, 150 million barrels a day or so that was behind the Strait of Hormuz got cleared.

**Andrew Sheets** (1:09)
These were tankers that were stuck there during the conflict, all came out.

**Martijn Rats** (1:12)
Absolutely. Layden tankers that were there had just basically turned into floating storage for a good couple of months. They all cleared out and that actually created a bit of a glut in the sense that all of a sudden, the refiners of this world had a lot of crude to absorb, and we saw many indication of physical looseness in the market. Physical differentials, calendar spreads, all sorts of indicators pointed that physically there was a lot of oil temporarily to be absorbed, and the spot price of Brent fell to 70 bucks.
That looked to be the new direction of travel. In principle, the world is not short of oil if you take the geopolitics out of it. For a while, it looked bearish. But then a new set of disruptions came and the military conflict restarted, and we've had 13 days of overnight bombing. With that also, the flow through the Strait of Hormuz diminished again. We are back in the last week, 10 days, to very, very low levels, the same levels we had in March. The flow through the Strait is not exactly zero, but it's two, three million barrels a day, down 80% to 90% of what it was before the conflict. With that, prices have rallied. But on top of that, last week it looked like the military activity could really scale up. For a couple of days, the market has priced that in. But then we have other choke points to take into account now. Not only Hormuz, but the Bab el-Mandab, the CPC terminal, the issues in global refining.
Altogether, it's been a tremendously volatile period. So we're on the whole leaning towards the constructive side, because there are so many disruptions in the system, but it's a very hard one to call at the moment.

**Andrew Sheets** (2:43)
Martin, let's talk about those other disruptions besides just the Strait of Hormuz, because it's not just the Strait of Hormuz anymore. We have issues in the Red Sea. You have ongoing issues with Russian energy infrastructure that's being attacked by Ukraine.
Just what are these other factors that are out there, and how much do they matter relative to how many ships are passing through the Strait of Hormuz?

**Martijn Rats** (3:07)
Yeah, they matter a lot. And you can see that expressed in the price of refined products more than the price of crude. If you look at the main global benchmark for the price of diesel, which is arguably the ice gas oil contract, which are diesel barges delivered in Rotterdam or in the wider ARA area, straining at about $1,200 a ton, which is $150, $160 per barrel. That's where you see the tightness. And so out of the total end user price, the refiners are capturing more at the moment than the crude suppliers. But what end users pay is not $85 per barrel for Brent crude oil, it's $1,200 a ton for diesel. And that is a very high price. Now that is a result effectively of four major issues that the oil market has to deal with. One of them is Hormuz, as just discussed. But then we come to these other three. And these other three are the Bab el-Mandab, which is the strait on the other side of the Arabian Peninsula that provides entry and exit to the Red Sea. That strait has gained in importance because Saudi Arabia has been redirecting about four million barrels a day of crude oil supply that was previously exported via Hormuz, now through the East-West Pipeline to a terminal near a city called Bamboo from where it is loaded and mostly sails down south through the Bab el-Mandab to refineries in Asia. The Bab el-Mandab is a strait that is effectively controlled by the Houthis, which is an Iran-aligned group that controls much of Yemen. And already in 24, earlier in 25, they've been very effective controlling tanker traffic through that strait. And in the last sort of week or so, they have said that they will no longer allow Saudi tankers to sail out, and also that group has executed drone attacks on Saudi oil infrastructure near the Jizan refinery, near the Yanbu terminal, and overnight also the Appicake facility, which is a large oil processing plant. So this whole Red Sea situation puts at risk something like an incremental 3.5 million barrels a day of crude.