Listen: Geopolitical strife, politics set to take oil market on ‘wild ride’

Phil Flynn:

What we're seeing is that Russia's able to avoid the price caps, they're able to sell it to other countries that eventually sell it back to the countries that are trying to give Russia pain. As you can see, it's convoluted. It doesn't really work. Really I think that the price cap is going to be proven over time to be an exercise in futility.

Jasmin Melvin:

Welcome to the Capitol Crude Podcast. I'm Jasmin Melvin. Turmoil in the US and European banking sectors dragged oil prices to their lowest level in over a year. Though concerns on that front appear to be easy, sentiment suggesting continued bearishness in the crude complex is being challenged by the potential for a tightening market in the second half of the year. Russia continues to be a wild card as the country works to maneuver around sanctions and could retaliate further against price caps on its crude and oil products. Tensions with Iran and China also pose upside risks to the oil market. Just as Chinese demand looks to shoot back, OPEC seems intent on supply cuts and the US aims to refill the strategic petroleum reserve. Phil Flynn, senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor, join the podcast to share how events taking place around the world are playing into oil prices and gave his take on how geopolitics are impacting oil industry investment decisions. Stick around after the interview for Jeff Mower with the Market Minute, a near term look at oil market drivers. Now, here's my conversation with Phil Flynn.

Phil, a lot is going on around the world right now that is having ramifications for the oil market. I wanted to touch on a couple of those with you. First, we have the continued and what's looking like is going to be long-lasting war in Ukraine. What should we be on the watch for in terms of sanctions, implications, and actions Russia could take that could roil the oil market?

Phil Flynn:

I think the biggest threat is the EU price cap, because right now what we've seen is that Russian oil is still being supplied to the global market. And to be honest with you, that's what Europe wants, right? They really want Russian oil. They just don't want Russia to make a lot of money with it. Well, my concern is that we're going to challenge that price cap. Let's assume in the new year we see a big surge in demand, which I'm expecting. We see supplies tighten a little bit, and all of a sudden, the price of oil spikes up. European buyers who have agreed to the price cap might not be able to get their hands on Russian oil. If that's the case, we could see a scramble in the global energy market and a lot of people trying to find crude oil at what would be much higher prices than the original price cap that they put in on Russian oil.

Jasmin Melvin:

That'll definitely be something to watch for, especially this month with the plan to review the $60 per barrel cap. Do you think in terms of how that review goes, in terms of whether keep the cap the same or if it goes higher or lower, what kind of impact do you see that having?

Phil Flynn:

First, let me give you my definition of a price cap. You show me a price cap, I'll show you a shortage. Very simply that. Maybe not today, maybe not tomorrow, but eventually that will lead to shortages. It's going to be very interesting to see where they set this price cap. There's a lot of people that are hawkish on Russia. They think we need to be harder on Russia. They want that price cap set at a lower level. The problem is a lot of oil consuming countries and the United States don't want to see that happen, because they're afraid if the price cap goes into effect, Russia will cut off supplies and lead to a global shortage. You really are in a situation where it's going to be very fascinating to see how they adjust this price cap. I think they're going to have a hard time moving it. For example, India's already said, "Hey, guys, we might not like what Russia's doing, but we haven't agreed to a price cap." In other words, we know that India, regardless of where prices are, if they need the oil, they're going to buy it from Russia. Crazy enough, we're seeing signs that when India buys that oil, they refine it and the excess supply goes to Europe. Maybe we ought to quit playing this game about the price cap because ultimately what we're seeing is that Russia's able to avoid the price caps, they're able to sell it to other countries that eventually sell it back to the countries that are trying to give Russia pain. As you can see, it's convoluted. It doesn't really work. Really I think that the price cap is going to be proven over time to be an exercise in futility.

Jasmin Melvin:

There's been heightened concern over Iran's nuclear program. There was a deal on the table that would've seen some lifting of oil sanctions on Iran in exchange for restrictions on that program. But that didn't happen. And though the State Department is saying they're still looking for a diplomatic solution, relief from oil sanctions no longer looks to be an option in those talks. What impact is that having on the oil market and potentially on prices?

Phil Flynn:

I think because we've dragged this situation out for a long period of time, in the short-term, it's not having a lot of impact. One would assume because of the way that Iran is thumbing its nose at the world community at this point, that we would see oil prices go up on the increased risk of attack. Now, the funny thing is, if you talk about the oil sanctions on Iran, the problem is they haven't really enforced the oil sanctions on Iran. The reason why they haven't done that, I think, is because they wanted to try to entice Iran to come back to a nuclear power deal. But for Iran, they have the best of both worlds. Right now they're able to sell their oil pretty much unimpeded in the global market. They find willing buyers in places like China. For them, there's no incentive from an oil sanctions viewpoint to change their habits at all. Now, a lot of people blamed President Trump for pulling out of the Iran nuclear deal for this situation where we're at today. But if you look at that, honestly, we knew that Iran was not really adhering to the spirit of that agreement anyway. They were looking at ballistic missile technology. They were doing things that made the world very uncomfortable that they made a bad deal, because they realized that this country, based on the old program, would eventually get nuclear weapons. This is a country that has threatened to wipe countries off the face of the earth if they get them. Really I think that there was a real need for a reset on these negotiations in the way that they have found to bring Iran back to the table probably means that we are headed to some type of conflict unless Iran changes its way. Now, there's a lot of talk about Israel maybe going in and taking out their nuclear program, so we could see a limited strike on that as well. But look at the way the world dominoes are changing right now. Iran at the end of the Trump administration was really isolated to a large extent. But it appears that under President Biden, that isolation has lifted a little bit. I think because of Iran's really strong desire to become a regional power probably will continue on its quest to get a nuclear weapon, unless there's somebody who can dramatically change their mind. I'm afraid that probably means some type of military intervention.

Jasmin Melvin:

All right, so that's definitely something we'll be keeping a close watch on. Now, I want to turn to another supply-demand issue. With the COVID lockdowns in China coming to an end, the oil market is also bracing for the return of demand from that country. While there've also been increasing tensions between China and the US over competition and trade and other issues, what is that doing to the outlook for oil prices?

Phil Flynn:

I think it is wildly bullish. I think that the reopening of China is going to be looked back upon as a major game changer as far as oil prices. We just had a report from the recent OPEC monthly outlook. They said in their report that they expected that China's oil demand with the reopen would rise by about 710,000 barrels a day, and that was a substantial increase from their previous forecast, which was 590,000 barrels a day. What we're seeing here is that OPEC is acknowledging that the China reopening is going to have a major impact on oil. To be honest with you, I think OPEC is underestimating the increase that we're going to see from China's oil demand. I think it could be a lot more than 710,000 barrels a day. I wouldn't be surprised to see another upward revision. The reason why I say that is that we're seeing signs in recent months that instead of exporting oil and products out of China like they were when the economy was basically shut down, now they're back to more of an import situation. Their exports have seen the lowest levels that they've seen in seven or eight months. That's a sign to me that things are happening in China, demand is going up, and I wouldn't underestimate the impact of Chinese demand. If you go back over the last 20 years or 30 years in the global oil market, one of the biggest mistakes policy makers and energy traders have made is to underestimate the growth of China demand. I mean, that's what we saw in the 1990s. We had a whole decade where people were ignoring what was going down in China, much to their chagrin. That's why we saw one of the biggest oil price spikes in history. Now, while I'm not predicting anything on that scale, I think the naysayers on China are going to be surprised because I think their demand's going to come back in a big way. On the flip side of that, Jasmin, I don't see where we're going to find the extra production to make up for that. To be honest with you, global spare production capacity is at the lowest level almost in history. With more demand coming from China, it's going to really severely challenge the ability of the global market to meet demand.

Jasmin Melvin:

You mentioned OPEC, and OPEC production decisions have always been watched closely by the market. What's the latest going on there? What are your expectations for how the production block responds to both this expectation of increased demand from China and these other geopolitical issues going on?

Phil Flynn:

Well, right now, I think they're going to stay the course with their current quotas. A lot of people had hopes or thought that when there would be new sanctions imposed on Russian oil, that somehow Saudi Arabia or other OPEC countries would rise to the occasion and try to fill the void that we might have seen from a reduction in US oil supplies. It's funny because historically, if you look at the relationship between the United States and you look at the relationship between Saudi Arabia, in the past when we've had supply outages due to geopolitical events, a lot of times Saudi would rise to the occasion. How about the United States and pump more barrels of oil? But I think under the Biden administration, we've developed a more adversarial relationship with Saudi Arabia. In these times of market stress, they are going to be less likely to respond to US calls for increased production. And that means that more than likely we're going to have a hard time meeting demand in periods of global oil market shortages. Now, in OPEC's defense and Saudi Arabia's defense, they're arguing that to raise production prematurely is a mistake because they realized the value of having some extra barrels held back so they could bring them on to calm the market. This goes back to a problem I have with the releases from the Strategic Petroleum Reserve. Now, a lot of people argue it was okay to release oil from the SPR when they had a war in Ukraine, but really the releases from the Strategic Reserve started well before the war in Ukraine. And because of that, OPEC feels like that their markets have been manipulated by the government and they're going to be less likely to respond because they would expect that if prices go up and they raise production, if a government releases oil from the reserves, it's only going to counteract and hurt them by making prices go much lower.

Jasmin Melvin:

How do all of these and other geopolitical concerns play into oil industry investment decisions?

Phil Flynn:

Well, I think one of the problems that we've had with oil industry investment decisions is the lack of clarity coming from governments around the world. On one hand, you have governments around the world saying, "We want to put you out of business. We want to reduce our reliance on oil and natural gas, and we want to penalize a lot of the people who invest in oil and gas and hold them responsible somehow for the sins of the oil industry since the beginning of time," whether it be climate change, what they call environmental justice and social justice, and things that make it much more treacherous to invest in oil and gas. You had our US Energy Secretary on the world stage a few years back basically telling the world, "Stop investing in fossil fuels. Put your money into ESG. Put your money into green energy. Quit investing in fossil fuels." Well, because of that type of mantra, we are seeing a dramatic drop in fossil fuels. We've seen much more of an increase in green energy, and we've actually seen a drop in traditional fossil fuels. And while that may sound good on the surface, if you're an environmentalist, the reality is is that the money spent on the fossil fuels versus the green energy is that the green energy hasn't returned the type of energy power compared to what we would've seen had that same dollar been invested in fossil fuels. What we are doing is because of this investment in technologies that are less proven, less reliable, more expensive, and less efficient, we're going to see growing lack of security when it comes to energy supplies. This is part of the problem that I have when the government starts getting involved in these decisions, demonizing one investment over the other and making decisions based really on politics, but not on science. I mean, things like the Paris Climate Accord, let's make sure that the United States stops making coal plants, but allows places like China to build 20 of them, things that don't really impact the environment, but make us feel better. The problem is, is that all this price increase because of these policies are falling on the backs of the poor and the middle class. The increase in energy prices by these silly policies are hurting the people that we need to help the most. I think we have to get off this misguided energy policies back off some of these real militant green energy and let the markets work. Listen, I believe in the markets. The markets know we have a problem. They know we want to get more green. Quit having governments throw a bunch of money at projects willy-nilly. Let's let the free market get in there and work a little bit. I think it'll be better for the environment. I think it'll be better for the economy, and I think it'll be better for the poor and the middle class.

Jasmin Melvin:

Phil, well, thank you for joining me on the podcast. It'll be interesting to see how things play out.

Phil Flynn:

Yeah, it's going to be very interesting. Make sure you buckle your seatbelt because I think it's going to be a wild ride.

Jasmin Melvin:

Now, here's the Market Minute with Jeff Mower.

Jeff Mower:

Market watchers this week will be looking for direction from the US Federal Reserve, which is on a crossroads on its battle to lower inflation. Inflation remains sticky in the US. The consumer price index fell to 6% in February from 9% last June. However, CPI remains below the Fed's 2% target rate, which suggests the Fed might boost interest rates by another 25 or 50 basis points. But the Fed is also facing a banking crisis. Bank shares were falling late last week despite attempts to inject billions of dollars into failing lenders. A rise in interest rates would tighten liquidity for the banking system risking further damage. A rise in interest rates would also likely be bearish for crude oil prices, as petroleum futures complexes largely followed the broader decline in equities over the past week. The CME's FedWatch Tool midday March 17th was showing a roughly 71% probability that the Fed would boost rates to 4.75 to 5%, and a 29% chance that rates would remain unchanged at 4.5 to 4.75%. Crude prices have fallen over $10 in one week on the banking crisis. It's worth pointing out that refined products prices while lower have held up relative to crude. This suggests that the market is not as concerned about a drop in end user demand, at least not yet. Diesel, in particular, remains tight with refinery strikes in France limiting supplies. That's something else the market watchers will be keeping a close eye on.

Jasmin Melvin:

Thanks, Jeff. Well, that's it for today, but don't be shy about letting us know what topics you want to know more about. Get in touch. I'm on Twitter. Drop me a line at @jasminmelvin. If you like what you hear, please consider leaving a review on your favorite podcast app. Capitol Crude is produced by Jasmin Melvin in Washington, DC and Jennifer Pedrick in Houston. Thanks for listening, and we'll see you next time.