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The Asset Class with Paul Gooden · Strictly Business

• 0:00
  You're listening to Strictly Business Podcast with Lindsay Williams.
• 0:05
  Here's a headline for you.
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  China to buy US oil to feed its insatiable appetite.
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  Those were the words of Donald Trump on a television programme on his return from
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  China,
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  on a trip which many people think was more business than diplomacy.
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  But that's an aside.
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  With me is Paul Gooden, Portfolio Manager at 91 in London.
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  That headline that I just read, could you...
• 0:27
  Put some more flesh on the bone, as they say, please, Paul.
• 0:31
  Yeah, sure.
• 0:31
  So, look, I mean, the context here, of course, is that China gets much of its oil
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  from Iran.
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  There is currently a double blockade in the Strait of Hormuz that is kind of sort
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  of blocking in
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  most of the Middle East production.
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  The US, of course, produces a lot of oil itself.
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  And, yeah, there's a headline emanating from the recent meeting between Trump and
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  Xi suggesting that
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  China might buy more US oil.
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  The reality is, you know, flows of oil are dictated by commodity prices.
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  And look, China has an awful lot of oil in storage at the moment as well.
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  So the reality is, is I think, you know,
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  China is basically going to sort of continue to run down its inventories as a
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  way to kind of balance the global oil market.
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  My naive reflections before Trump went to China were these, I thought,
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  He's going to go there and he's going to talk about Iran.
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  He's going to say, please stop buying so much
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  Iranian oil and funding their war effort and funding their economy and funding
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  their regime.
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  And you can buy American oil, if you like, President Xi. And I thought to myself,
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  well,
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  that will marginalize Iranian supply because it can't sell as much to anybody
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  else.
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  It's very difficult, especially with the Strait being patrolled by the U.S.
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  Navy.
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  And on the demand side, then they'd buy American oil and the price would go up.
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  What's the reality of that rather fanciful idea?
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  Yeah, look, the reality is, is that
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  Iran is not going to let other Middle Eastern oil through Hamas if it can't get
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  its own oil out.
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  And so, you know, thus, you know,
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  I understand the US puts pressure on China and India not to buy Iranian oil.
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  But, you know, those requests are kind of pretty much ignored.
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  And to be honest with you, even.
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  Ahead of this war, the U.S.
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  was quite weak in terms of enforcing sanctions on Iranian oil, because the
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  reality is,
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  is that if the Iranian oil doesn't flow, then the oil market is going to tighten.
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  U.S.
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  gasoline prices go up, and that's bad for incumbent U.S.
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  presidents.
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  So look, clearly there's a different dynamic now.
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  And yeah, we have this double blockade.
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  And ultimately, there has to be a diplomatic or military solution because is
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  You know,
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  the longer the straits remain closed, you know, every day the oil market tightens.
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  And we're kind of at some point approaching kind of D-Day when, you know,
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  we kind of run out of inventories.
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  But I think that's still a few months away.
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  You've answered my next question.
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  I was going to say, I think oil stocks are globally at their lowest level for 10
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  years.
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  How much longer can stocks be drawn down without, A, having to be replaced or B,
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  running out completely and people having to go to the market, which is incredibly
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  tight?
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  for all the reasons that you've just mentioned.
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  And what does oil do?
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  I mean, it's hovering, Brent is currently about $107 a barrel.
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  I mean, if the worst comes to the worst, and this goes on for a few more weeks or
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  months,
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  then perhaps it's going to pop much higher, Paul.
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  Yes, look, so there's a few questions there.
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  Let me unpack that.
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  And forgive me, I'm going to have to give some maths here as well to kind of give
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  some context to what I'm saying.
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  So look, the basic maths is...
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  You've got roughly 100 million barrel a day oil market.
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  20 million barrels a day of that production is kind of stuck in sort of
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  behind the streets of Hummer's.
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  Now, there's about 5 million barrels a day of rerouting that's going on.
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  And there's probably 3 million barrels a day that's getting through.
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  So that still leaves us with about a 12 million barrel a day short foil in terms
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  of oil hitting global markets.
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  Now, I reckon there's probably 2 million barrels a day of demand destruction going
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  on due to high oil prices.
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  And that means there's 10 million barrels a day left over, which is kind of running
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  down inventory.
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  So 10 million barrels a day, or about 300 million barrels per month.
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  Now, where's that destocking happening?
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  It's happening, a lot of it is in the US.
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  Recent data suggests the US is exporting an incremental 4 million barrels a day of
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  oil.
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  Data also suggests that China imports of oil are down by about 4 million barrels a
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  day, and that's mostly de-stocking.
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  And then there's a little bit of other de-stocking that's going on.
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  with SPR releases, places like Japan.
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  So that's it in terms of the flows of oil.
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  Now let's look at the stocks or the inventories.
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  So we started the year with about 8.5 billion barrels of inventories,
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  and that is the broadest definition of inventory that there is.
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  It includes oil, it includes products, it includes SPRs,
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  it includes oil kind of in pipelines and in refineries, so a very broad definition.
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  We've already forfeited about a billion barrels of production,
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  and that includes the time to ramp up production when there's reopening.
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  So we're locked into inventories falling to about seven and a half billion barrels.
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  Now, my guess is that the operational floor of the system, i.e.
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  tank bottoms, is about six and a half billion, because you need kind of work in
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  progress in the system.
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  You need oil in pipelines, in tankers, in refineries.
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  Now, if we continue drawing at this 10 million barrels a day or 300 million
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  barrels a month over May, June, July,
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  that means that you hit tank bottoms globally in kind of like early August.
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  Now, this is the global picture I'm painting, okay?
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  You will hit shortages before then in certain geographies and in certain
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  countries, i.e.
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  over June and July.
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  And then your question was kind of like, look, what oil price do you need to kind
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  of balance the market?
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  So When you hit tank bottom, so to speak, you need to live within your means.
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  You can no longer draw down inventories, so supply needs to equal demand.
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  I mentioned earlier, we've got about 2 million barrels a day of demand
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  destruction at the moment with oil in the low
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  100s. So to truly balance the market in terms of supply and demand, you need to
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  curtail 12 million barrels a day.
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  So you need to have an oil price that's materially higher.
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  And something to bear in mind is that...
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  This is going to be driven by economics, right?
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  So, you know, wealthy consumers in the US and Europe are less likely to struggle to
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  pay the price.
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  But in emerging markets, that's where the demand destruction is going to really hit.
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  And look, you know, we can pick any number we want, right?
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  It's going to be somewhere, I imagine, between like $130 and $150 a barrel.
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  So look, a very long answer, but I wanted to give you a a fulsome account.
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  It was a great answer.
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  Thank you very much.
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  And it makes an awful lot of sense.
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  And right at the end is if you want to pick something out from that answer is 130
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  to 150.
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  If you're looking for a good headline for this podcast, it's very scary.
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  130 to 150 for all sorts of different reasons.
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  How are portfolio managers and traders behaving?
• 7:35
  Yes.
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  Well, that is a great question.
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  OK, because there's two things to remember.
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  The first thing to remember is that when we look at...
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  Brent oil price on our screen, what we're looking at is the closest month,
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  the prompt month in a financial futures curve.
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  So it's not a physical barrel.
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  And the financial flows in these contracts is about 100 times the physical barrel of
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  oil.
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  And so these forward curves are very dictated by tweets, by news flow,
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  by PR.
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  And I think one of the reasons why Trump has been posting so much about oil is
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  because he's trying to
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  get down that financial futures price.
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  Also, bear in mind that the typical futures contract is kind of like four to
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  six weeks away.
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  And, you know, the market's view is that this is going to be sorted in the next few
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  weeks.
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  So arguably, the real impact of the war is not really been seen yet in the full the
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  full kind of.
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  futures price.
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  So that's just a word on sort of the contracts that we see on the screen.
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  In terms of equity investors, I would say equity investors are quite wary.
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  The reason they're wary is of the headline risk,
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  because we know one day you're going to come into work and there's going to be an
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  announcement, a proper announcement that's correct,
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  as opposed to kind of the fake announcements we've had, that basically
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  says, look, there's a diplomatic solution.
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  There's now unfettered access to the...
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  Strait of Hormuz.
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  Now, when that happens, there's about 120 million barrels of oil that are in tankers
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  behind the Strait of Hormuz.
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  So that can kind of hit the global market quite quickly.
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  So there will be some sticker shock and the oil price will come down, which will
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  impact energy equity.
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  So people are just concerned about that day, that headline, that day one impact on
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  equity prices.
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  And investors are also kind of, quite frankly, just confused by the psychodrama.
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  of all the news flow that's going on in this space.
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  And it's very difficult to analyze.
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  So in general, equity investors, I would say, are quite reticent and quite
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  concerned.
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  And that's one of the reasons why energy equity is actually since the war started.
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  have not kicked on that aggressively.
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  So, you know, that's my general sense is there are quite a lot of investors on the
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  sidelines who,
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  once we get this announcement, once we get that day one shock,
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  might be adding to energy equities because you've got that shock behind you and you
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  can now invest in energy
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  equities that are pricing in, let's say, $70 a barrel when I think the mid-cycle
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  oil price.
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  that's needed to balance the market over the next three, four, five years is
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  probably $80 a barrel.
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  Very interesting.
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  Now, this leads me to my last question.
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  How are you behaving?
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  How am I behaving?
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  Well, look, I mean, in terms of the Global Natural Resources Fund, last year,
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  we were overweight, precious metals and copper.
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  And that was exactly the right positioning for last year.
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  What we did through the first few months of the year, January and February,
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  was we basically trimmed base metals and added to energy.
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  So we kind of eliminated that underweighted energy.
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  And then since the war has kind of started,
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  we've added to energy and we've added to other commodities that are impacted by
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  this.
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  So we've added to aluminium and fertilisers because in the Middle East,
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  there's not only a lot of oil and gas produced,
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  but there are kind of industries there that produce energy intensive products
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  like aluminium and fertilisers.
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  So yeah, we've been kind of leaning into this.
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  We kind of think the market is quite complacent about some of the risks that
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  exist.
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  Paul, great chat.
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  Thank you very much for your time.
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  Paul Gooden is a portfolio manager at 91 in London.
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  The views and opinions expressed in these podcasts are those of Lindsay Williams and
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  various contributors and do not reflect the policy,
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  position or opinion of any other agency, organisation, employer or company
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  associated I'm David.
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  with StrictlyBusinessPodcast.com.
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  Assumptions made on the analyses are not reflective of the position of any other
• 11:58
  entity other than the speaker or the author
• 12:00
  and since we are critically thinking human beings these views are always subject to
• 12:04
  change,
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  revision and rethinking at any time.
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  Please do not hold us to them in perpetuity.