Episode 46

Brian Linde on oil markets

Brian Linde, Managing Director, Portfolio Manager, Insurance at SLC Management, discusses complexity in global oil markets and the potential knock on effects in the U.S.

Steve Peacher: Hi everybody thanks for dialing in to this episode of “Three in Five,” this is Steve Peacher at SLC Management. And I’m with Brian Linde today, who is a portfolio manager in our insurance asset manager business he's based out in outside of Seattle and today we're going to talk about oil prices which are obviously a hot topic given everything that's going on in the world, so Brian thanks for taking a moment.

Brian Linde: Hey thank you very much for having me on Steve looking forward to it.

Steve Peacher: So obviously the situation in Ukraine has led to sanctions on Russian oil output by the U.S. and then you know varying responses around the world, so what has that meant for global energy prices?

Brian Linde: So fundamentally speaking the sanctions on Russian oil means oil prices are likely to remain elevated for a prolonged period of time, with significant risk that we see markedly higher oil prices. Russia produces 10 and a half million barrels of oil per day, which is effectively 10% of the world's oil and it makes it the third largest producer behind the U.S. and Saudi Arabia: to note, they actually export six and a half million barrels of oil and oil products per day and making it the second largest exporter trailing only Saudi Arabia, so the really the importance can’t be underscored enough. U.S. and Europe account for about 4.3 million barrels and if you were to look at that and try to take out 4 million barrels per day, if you were to see outright ban it just the orders of magnitude that would drive oil prices higher are just remarkable. You know the IEA noted current sanctions and the reluctance of some shipping companies to load Russian oil could cut more than 3 million barrels per day from output or effectively 3% of global demand. This would be the fifth largest one-month disruption since World War Two, however it's quite challenging to track how much Russian oil is actually making it into the market currently because certain vessels have turned off their navigation beacons to avoid sanctions. The logical question then becomes you know where do we find 3 million barrels of spare capacity globally in an energy market that is near universally under invested in production projects over the course of the covid pandemic? If were to step back and look at spare capacity, you know, broadly speaking you're going to focus on the OPEC nations. You have Saudi Arabia, which has about 1.3 million barrels a day in spare capacity, UAE has 1.2 and Iraq has about 500,000 barrels. So the problem being is that the current OPEC Plus agreement those terms don't enable them to compensate for other members. In the past, the Saudis would have been the swing producer, however they're very comfortable standing pat in this elevated oil price environment. Additionally, production capacity is likely to be significantly lower than it was when the pandemic began because we've seen dramatic reduction in drilling activity over the course of the last year. This is likely underscored by the fact that OPEC Plus has been missing their monthly production targets of 400,000 barrels per day to the downside for eight straight months. Other potential sources of supply would be Iran, you know any easing of sanctions against Iran could bring back about 1.3 million barrels a day. And this looked like a much more likely scenario a few weeks ago, but just last week, we have the U.S. enact additional sanctions against key actors in Iran's ballistic missile program which makes a nuclear deal much less likely in the near term. You know another potential avenue would be Venezuela, we could see them potentially bring back another 400,000 barrels per day to raise their production to 1.2 million, but again, this is another nation that has current U.S. sanctions placed against them, which looked back to 2019. And then, lastly, if we were look domestically, you know U.S. shale had prolific production throughout the 2010s. However, it's not a viable solution as we currently stand, given the lag and capex and then the time and months necessary to drill and bring new wells online. Additionally, the oil services sector is already running very tight and that's limiting the ability to ramp up production meaningfully anytime soon. So taking a step back you know the ability to pick up the last production from Russia would take material effort from a number of nations that aren't exactly aligned, whether it be the Saudis and Iran, UAE, Iraq, Venezuela, or the U.S. Interestingly, even if Russian sanctions were to fall away completely I wouldn't expect to see western energy companies jumping back into the country that's the brain drain and technological drain will manifest itself in likely lower Russian production in the future as well. Ultimately, in order to balance oil supply and demand you'll need to see meaningful demand disruption via elevated prices.

Steve Peacher: You know I it's hard for those who are listening who don't follow the oil market closely these numbers are hard to conceive of you know, a million barrels here a million barrels there per day and you're talking to a lot of barrels. And the US just made a major announcement that they were going to be releasing 1 million barrels per day I think 108 days, and you know that's I think the largest release ever. You know those sound like big numbers but maybe they're not that big in the context of all the numbers you just threw out, so what do you think that move means for the oil market and oil prices?

Brian Linde: Yeah, absolutely Steve, I mean you nailed it on the head, this is truly a historic release. You know 180 barrels in total is four times the previous largest release. And if you look in total across the last five months the Biden administration has announced the release of 260 million barrels. So it's really important to highlight here that at this point in time, after this announcement, the U.S. will be tapped out, they will not be able to release any additional barrels from the strategic petroleum reserve without first building back that reserve. And this effectively drains a third of that. Historically speaking SPR releases aren't really effective at controlling prices, once again you're not fixing the structural problem of supply and demand. Ultimately, the SPR release could cause some downward pressure near term and prevent some of the worst-case price spikes that have been feared. However, it doesn't change the longer-term structural deficit in the oil market from years of underinvestment. Essentially, the recent release has the effect of elongating the higher for a longer period. Lower prices in 2022 actually support oil demand while slowing the acceleration and shale production, leaving a deficit moving into 2023 with an eventual need to refill that SPR. And the SPR has been talked about you know the refill level would be about $80 per barrels is what the whisper was, so again you're underscoring you know, a higher for longer period. And what has been noted by some on the street is that the ultimate winners are likely to be China and India, as they are currently buying Russian crude at steep discounts, you know to 30% plus discounts and some are even noting that this could be viewed as a transfer of resources and energy security from the U.S. to China as China's likely the net beneficiary here.

Steve Peacher: You know it's well you highlight these knock-on effects that just speak to the fact that the world is complicated. So here's the money question Brian you put all that together, and what's your outlook for oil prices? So we're gonna monitor this and whatever you say we're going to come back we're going to check on this, be careful over here, so I would suggest that you give a price, but not a time frame.

Brian Linde: Anyway, I don't get to do the sell side and just continue to revise the higher every month or so? Yeah so, I guess you know everything that I’ve underscored thus far as speaks to an elevated price environment moving forward. I would say that for this year, you know your base level is going to be $100 per barrel, but I would note that the skew is definitely the risk is definitely to the upside and I would think that you know $120 per barrel, you know average throughout the balance of the year, it wouldn't be a surprise. You know if we really do need to see demand disruption to balance, the market prices are going to need to be an excess of $150 per barrel. That's not what anyone wants to hear but fundamentally that's what it would take so I put me down for $120 barrel and hope I’m wrong to the lower side for gas prices but that's where I targeted $100 to $120.

Steve Peacher: Okay, and then does that mean you go out to buy and buy a new Tesla I guess too?

Brian Linde: Yes, exactly.

Steve Peacher: So completely unrelated to oil prices, I like to ask a personal question. So you are, as I mentioned earlier, you live in the Seattle area, a big Seattle sports fan, so I want to know what you think of the recent blockbuster trade of Russell Wilson. So what's your take?

Brian Linde: Yeah, you know you hit really close to home, I mean I think if I’m being honest, I have no less than six Russell Wilson jerseys in my household. Those aren't all mine, I have two young kids who are big fans as well. So yeah, it's tough to see. Russell’s been a great you know person in the community, been a great quarterback for a decade and I certainly didn't think he would ever be wearing any other jersey, let alone an orange Broncos Jersey. So that one's been tough to swallow I think it's gonna be a couple reset years if I’m honest. But really, he's been such a good guy for the community, I definitely, I’ll continue to root for him, but it's going to be a bit more painful if this next Super Bowl is for the Broncos.

Steve Peacher: So it's, so those are now those jersey’s are now collector's item so that's the silver lining.

Brian Linde: I have a friend in the neighborhood who is from Denver, and is a huge Broncos fan, so there was the comment that I might need to start dying some of my white Russell Wilson jerseys orange and giving them away.

Steve Peacher: Well, listen thanks a lot for making some of this, you know the recent developments in the oil market a little clearer. And thanks everybody for listening in on this segment of “Three in Five.” Thank you, Brian.

Brian Linde: Thank you, Steve.


Source: https://www.dallasfed.org/research/economics/2022/0322


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