If you've been gauging the severity of the war in Iran by
just looking at the S&P 500, you'd be forgiven for thinking
that the whole thing is just a minor administrative hurdle, the
kind that clears up after a weekend of strongly worded
tweets. Equity investors, it would
appear, have decided that a regional conflict might just be
a by the dip opportunity. dot com finally broke on Thursday
when stocks had their worst day since the conflict began with
the S&P 500 sliding to a six month low and the tech heavy
NASDAQ officially crossing into a technical correction, meaning
that it's more than 10% below it's high.
The mood on the bond and commodity desks remains grim.
Analysts there are staring at their screens in a state of what
1 commentator called alarming cognitive dissonance.
In the bond market, the term premium, effectively the
insurance premium investors charge for holding long term
debt, is surging. Robert Armstrong noted this week
that while 10 year interest rates have gone up, break even
inflation has stayed relatively flat.
This suggests that investors aren't just worried about
inflation, they're worried that in a world of supply shocks,
bonds no longer act as a good hedge for stocks.
They simply both fall at the same time.
In the UK, 30 year gilt yields have climbed to 5 1/2% as the
Bank of England faces a central bankers nightmare, an energy
shock that raises inflation while killing growth.
This divergent is being driven by a new Wall Street obsession,
the Trump Pressure Index. Developed by Deutsche Bank's
head of Cross Asset Strategy, the index is made-up of the one
month change in Trump's approval ratings, one year inflation
expectations, the performance of the S&P 500 and U.S.
Treasury yields. The idea is that these are the
things that Trump cares the most about.
Sorry Eric, but you just didn't make the list.
The higher the index goes, the more pressure Trump is under to
make a change to his strategy. In Iran, traders are using this
to predict when the administration will experience
what Robert Armstrong calls a Taco moment.
The acronym, coined about a year ago, stands for Trump Always
Chickens Out. We saw this play out in real
time on Thursday. Just 11 minutes after the
closing bell, the president posted a 10 day extension to his
peace deadline, pausing his threats to destroy Iranian
energy plants until April 6th. Now we have to ask ourselves, do
stock traders actually believe these announcements?
A few weeks ago, the president announced that the war was very
complete, pretty much causing stocks to rise and oil to fall.
Those moves reverse themselves later as events in the Middle
East dragged on. Earlier this week, Trump
announced that the US and Iran had held very good and
productive conversations about ending war, once again causing
stocks to rise and oil to fall, even though Iranian leaders
quickly came out and denied having any talks.
I'm not sure the traders actually believe these peace
announcements, but they possibly see the announcements as a
signal that the president's resolve is weakening.
They aren't buying the peace so much as they're buying the
capitulation. But possible problem with that
is that you can't necessarily tackle out of an actual war as
easily as you can a trade war. Unlike a trade dispute, which is
a matter of administrative ink, the Strait of Homeowners is
currently governed by mines and broken infrastructure.
Even if a ceasefire was signed tomorrow, oil wells can't just
be turned back on like a kitchen tap.
It takes weeks to bring them back online without causing
permanent damage. But even if Trump does blink,
negotiating a deal assumes that there's a credible leader on the
other side of the table, and the war has left Iran's command and
control in total disarray. As the saying goes, it takes 2
to tackle. Or at least I think that is what
the saying is. Senior officials in Iran are
reportedly underground and avoiding all electronic
communications for fear of targeted assassinations.
It's not clear if any single diplomat in Tehran actually
speaks for the Revolutionary Guards, the people who actually
have their fingers on the buttons.
A formal agreement signed in a safe house may have little
effect on a field commander at a remote missile side who's either
unable to receive orders or probably doesn't respect the
authority of the person who sent them.
Today we're going to look at why this crisis is about much more
than just the price of Brent crude and how the global economy
may be approaching a supply Cliff that no true social post
can fix. We'll look at the single points
of failure for global industry commodities like helium, LNG,
aluminium and fertilizer that have no easy alternative routes.
We'll also discuss the winners and losers of this new reality,
and why the physical damage to the region's infrastructure
means that we'll likely be living with the fallout of this
war long after the shooting stops.
Now, while much of the general news coverage is quite rightly
focused on the military conflict and the human cost of the war,
the financial headlines have focused almost exclusively on
the price of oil. And this is understandable
because it's the source of the region's immense wealth.
But if you're only watching the price price of a barrel of Brent
crude, which hit $110 this morning, you're likely missing
the real story. Oil, for all of its importance,
is a relatively fungible commodity.
If a shipment is blocked in the Gulf, you can eventually find
another barrel in West TX, Guyana, or the North Sea,
provided you're willing to pay up for it.
The real crisis is to be found in commodities that are much
harder to replace. According to ship tracking data,
we're currently approaching a Cliff edge as the final LNG
tankers that loaded in the Gulf before the blockade began are
due to reach their destinations in the next few days.
When snow ships are unloaded, the flow of these commodities
essentially stops. Qatar produces 1/5 of the
world's liquefied natural gas and nearly all of its exports
have been halted by the closure of the Strait of Hormuz.
Unlike oil, LNG requires massive specialized liquification plans
to turn gas into liquid for transport.
The Raz Lafan facility in Qatar has already suffered enormous
damage from Iranian missile strikes.
The Qatari energy minister has warned that 17% of their
capacity will be out of service for three to five years, forcing
them to declare force majeure on long term contracts.
This is a hole in the the global energy supply that no amount of
diplomatic pressure can fail. Then there's helium.
Around 33% of global seaborne helium passes through the Strait
of Hormuz. Helium is a non renewable
byproduct of natural gas, and it's essential for cooling the
Super magnets used in manufacturing semiconductor
chips. There's no synthetic substitute,
and for high tech manufacturing hubs in Asia and the US, there's
no easy way to reroute the supply.
We also have to consider fertilizer and aluminium. 1/3 of
the world's seaborne fertilizer trade passes through the
straight, along with 1/4 of the world's seaborne aluminium.
Since the US and Israel launched their strikes, including a fresh
wave of strikes on Tehran this morning, the price of nitrogen
based fertilizer has skyrocketed.
This happened right as farmers in the Northern Hemisphere are
heading into springtime when they fertilize their fields.
This is a lurking threat to food security.
As UAE Minister Sultan Al Jabaar put it this week, Iran holds
Hormuz hostage and every nation pays the ransom at the grocery
store. If farmers in Asia and Africa
can't fertilize their crops this spring, the World Food Program
warns that we could see record levels of acute hunger by 2027.
These are the single points of failure in our modern supply
chain. The optimism that we see in the
stock market relies on the idea that these are temporary
hitches. But with Iran now asserting
sovereignty over the straight and reportedly demanding a
$2,000,000 fee for every vessel that wants to pass, the physical
reality suggests that we're moving into an era of scarcity
that a simple ceasefire won't fix.
Even if a breakthrough is reached by Trump's new April 6
deadline, the immediate relief rally will likely see in the
stock market will be at odds with the reality on the water.
To understand why, we have to look at 3 specific bottlenecks
that a peace treaty cannot simply wish away.
First, there's the problem of the shut in wells.
Because the Strait of Homers has essentially been blocked for a
month, Gulf producers were forced to stop as their storage
tanks hit their limits. This is a much bigger problem
than just pausing a production line.
When you stop the flow of an oil well, the environment inside
that well changes immediately. Without the constant heat and
the movement of flowing oil, the crude starts to settle and
separate. It can become waxy and thick,
physically clogging the tiny pores in the rock that the oil
needs to travel through. In some cases, the surrounding
groundwater can even seep into the oil layers, which can
permanently drown a well's productivity.
To make matters worse, many of these wells will have been
closed using heavy mud or cement plugs, which are needed to keep
them safe during the fighting. Those plugs will have to be
painstakingly drilled out before any oil can move again.
If you try and force the pressure back too quickly, you
risk cracking the underground formation and ruining the field
forever. It's a delegate multi month
restart process that doesn't just happen overnight.
The second hurdle is the naval gauntlet.
While the US and Israel have spent a month bombing Iran,
they've achieved almost no substantive gains in loosening
Iran's chokehold on the straight.
This is why the Pentagon is currently sending in 10,000
additional troops, including units trained to seize and hold
land. Their mission appears to be
prying the straight open by force, physically taking the
islands and coastal slivers where Iran hides the drones and
missiles that are keeping the American Navy at a distance.
Even after those launch sites are secured, the waterway
remains, at the very least, a suspected minefield.
Whether or not Iran has actually laid thousands of mines, the
mere risk of them creates what experts call a psychological
blockade, which is just as effective as a physical one.
Reopening the straits safely requires a careful naval
operation, first hunting down any remaining threats like speed
boats and drones that have been harassing shipping, followed by
the slow, painstaking process of sweeping the water for mines.
Only then can the final phase, providing continuous naval
escorts for commercial tankers, actually begin.
Finally, there's the logistical logjam.
Traffic through the Strait has dropped 97% this month.
The few ships that are moving are often dark fleet vessels.
Are those willing to pay the $2,000,000 safe passage fee that
Iran is currently demanding? Insurance premiums for the
region haven't just spiked. In many cases, policies have
been cancelled entirely. Ship captains and their crews
are not going to steam back into a recently cleared war zone the
moment a true social tweet goes out.
They'll wait for a sustained all clear from naval authorities and
for the insurance markets to normalize.
When you combine all of these issues, the Oxford Economics
timeline of the Strayed remaining largely impossible
until May starts to look very realistic.
Whenever a crisis like this breaks out, economists are quick
to point out one comforting statistic Our oil intensity has
collapsed. In the 1970s, it took roughly
one full barrel of oil to produce $1000 of global GDP.
Today, that number is less than half.
We need only about .4 barrels to generate the same amount of
economic output. The argument is that because
we're more efficient, we're no longer the hostages to the
Middle East that we were 50 years ago.
But this is a dangerous distraction.
While we've moved away from oil as a primary fuel for factories
and home heating, we haven't actually reduced our energy
vulnerability. We've simply transferred it to
the power grid in much of the world.
Electricity prices are set at the margin by natural gas fired
power plants. So when the Strait closes and
20% of the world's LNG vanishes, the shock doesn't just hit the
gas pump, it hits electrical sockets too.
And this is where the modern U.S. economy has a weakness that
didn't exist in the 1970's, the AI revolution.
Right now we're near the start of what's being described as the
largest infrastructure build out in human history.
Centred entirely on hyperscale data centres, these facilities
are essentially giant energy things that require massive
steady state power to function. To understand the scale,
analysts look at these facilities in terms of
gigawatts. One GW is enough power to run a
mid sized city, or about 750,000 homes.
The International Energy Agency predicts that by 20-30 the
global demand from these data centers will grow by an
additional 50 gigawatts. To put that in perspective, the
electricity needed just to keep the world's AI chips running in
four years time is expected to be equivalent to the total power
consumption of Germany and France combined, or roughly 3
1/2 times the total power consumption of the UK.
These projects represent hundreds of billions of dollars
in capital investment, and the United States appears to be
pinning it's expected growth in the coming years on AI build
out. An energy shock today would
likely be very different to the 1970s, where there were long
lines of gas stations. But it's not reasonable to claim
that energy scarcity won't impact growth.
In the world of geopolitics, winning doesn't always involve
having the best military. Sometimes it just means being
the last person to run out of somebody else's money.
The terms winner and loser often have very little to do with
whose cities are being bombed and everything to do with
relative strategic advantage. If we look at the scorecard for
this conflict, the results are surprising and deeply
counterintuitive. It's difficult to call a country
a winner when it's air defenses are in pieces and its leadership
is hiding in bunkers to avoid assassination.
So the best we can say for Iran is that it's a survivor.
But as The Economist argues, for the Islamic Republic, mere
survival against the combined might of the US and Israel
counts as a victory of sorts. Iran has successfully
demonstrated that it can hold the global economy hostage using
nothing more than asymmetric tools, cheap drones, missiles,
and the credible threat of underwater mines.
Most strikingly, in a move that highlights just how desperate
the global energy situation has become, the US appears to have
quietly retreated on its own sanctions.
Despite being in an active shooting war with Tehran, the
Trump administration has temporarily waved sanctions on
140 million barrels of Iranian oil currently at sea because the
supply stock from the Straits closure is so painful that the
White House cannot afford to keep those one and a half
million barrels a day off the market while Gulf allies watch
their own tankers sit idle. Iran is currently getting its
crew to China and is now attempting to institutionalized
a $2,000,000 safe passage fee for non hostile vessels.
If they can make this stick, they could generate up to $80
billion a year, effectively replacing their lost oil revenue
with a global transit tax. Russia is perhaps the most
unambiguous winner of the crisis.
Not only are soaring oil and gas prices relieving its previously
strained budget, but it has now received its own sanctions
holiday. On March 13th, the US Treasury
lifted restrictions on Russian oil tankers currently at sea to
prevent a global supply shock. This move has achieved 2 of
Moscow's primary strategic goals, it provides an immediate
cash infusion to its war effort in Ukraine, and it has triggered
A bipartisan revolt in the US Congress, with lawmakers like
Chuck Schumer labeling the policy asinine.
By forcing the US to choose between between energy security
and its foreign policy goals, Russia has successfully exposed
the limits of American economic warfare.
China occupies A fascinating and arguably enviable position.
While it's the world's largest oil importer, it's now roughly
85% energy self-sufficient thanks to its massive domestic
coal reserves and an aggressive multi year pivot to renewables.
The upside for Beijing is that this oil shock is the best
possible advert for Chinese technology, as the world may
speed up its transition to solar panels, batteries, and EVs,
industries that China absolutely dominates.
While Netanyahu may be thrilled with the tactical success of the
strikes, the strategic reality for Israel is much bleaker.
Despite the bombardment of their enemy, Israel is not really any
safer than before. Iranian missiles have still
penetrated Israeli airspace, and the nuclear threat remains
buried under rubble. Furthermore, the war is severely
straining Israel's relationship with its most important patron.
As US gasoline prices soar and markets slide, American voters
are increasingly pointing the finger at the cost of supporting
the conflict. Europe is currently facing what
analysts call its second major energy crisis.
With Qatari LNG completely cut off and domestic gas storage at
a dangerously low 30% capacity, electricity surcharges of up to
30% are hitting heavy industry, leading to fears of permanent
deindustrialization. The real shock to Europe isn't
just economic. On March 20th, Iran fired 2
ballistic missiles at. The USUK base at Diego Garcia.
This strike demonstrated a range of 4000 kilometres, twice Iran's
previously known capability. This means that every major
European capital is within direct reach of Iranian
missiles. If you want to find the G 20s
biggest loser, you don't have to look much further than the
United Kingdom. Because of its extreme
dependence on imported natural gas, the UK is facing what
Kenneth Rogoff calls the biggest stagflationary shock in five
decades. The damage is appearing in real
time. The route in the gilt market has
pushed 10 year borrowing costs to their highest level since
2008, forcing lenders to withdraw over 1500 mortgage
products from the market in a single month.
Finally, there's the United States.
On paper, the US is a winner. It's energy independence and
status as a major LNG exporter have provided a massive windfall
for domestic producers. But according to the FT, this
insulation is something of a mirage, and the reason comes
down to what economists call embedded energy.
The US runs massive trade deficit in manufactured goods,
and it takes an enormous amount of energy to produce those goods
in factories across Asia and Europe.
When energy costs for those global manufacturers skyrocket,
those costs are eventually exported to the US in the form
of higher prices for everything from electronics to clothing.
The American grocery bill is also directly in the crosshairs.
Because the US agricultural system is so heavily dependent
on fossil fuels for both fuel and nitrogen based fertilizers,
the energy shock in the Gulf translates almost immediately
into higher prices for bread, meat, and dairy.
This imported inflation has forced a radical shift at the
Federal Reserve. This brings us back to the Trump
Pressure Index. The president's political
survival is tethered to the returns of the S&P 500,
inflation, and the price at the pump.
By making a big threat and then backing down the moment markets
panicked, the administration has signalled to every adversary on
earth that the fastest way to defeat a superpower is to strike
it's retirement portfolios. I'm recording this video right
before the market opens on Friday and S&P futures are down
almost half a percent in the overnight market.
And it's possible that markets are no longer giving the
president the benefit of the doubt that his strategy in Iran
is working beyond the major powers.
The conflict is triggering a form of energy triage that's
fundamentally reshaping daily life around the world.
We have to start with the United Arab Emirates and the potential
end of what we might call the Dubai dream.
For decades, Dubai has branded itself as a neutral high luxury
Oasis, a Singapore of the sands where you could do global
business while the rest of the Middle East was in turmoil.
But that brand is currently being battered.
Since Iran began its retaliation on February 28th, the city has
transformed from a billionaires playground into a ghost town in
just three weeks. The problem is demographic.
Over 90% of Dubai's population is foreign born.
When you don't have deep roots in a location, stability isn't a
luxury, it's the entire product. The mobile elite have already
hit the exit. We've seen reports that the
hedge fund Millennium Management is exploring a relocation of its
Dubai based staff to Jersey after drone debris reportedly
damaged the building housing their offices.
Which leaves us wondering if Andrew Tate will soon be the
only person left on the Palm Jumeirah.
While wealthy expats might fleet tax neutral islands in the
English Channel, the rest of the world is entering a period of
energy rationing. Governments almost entirely
dependent on Middle Eastern energy are racing to save what
little they have left. In Thailand, the Prime Minister
has ordered civil servants to take the stairs instead of
elevators to save power. In the Philippines, the
government has shifted to a four day work week and ordered
officers to switch off computers during lunch breaks.
This rationing highlights a brutal divide.
While wealthy nations like the US and the UK can use massive
subsidies to shield their citizens from the worst of the
price hikes, they are inadvertently suffocating
everyone else. But by artificially keeping
domestic demand high, rich countries block the price signal
that would normally force a drop in consumption.
This leaves the world's poorest nations to bear the full brunt
of the scarcity. In Bangladesh, universities have
been closed, and in Pakistan and India the gas shortage is so
acute that families are being issued half filled cylinders of
cooking gas. Shortages aren't just happening
in poor countries either. A Japanese potato chip company
had to halt production this week due to a shortage of oil, which
is a relatively minor inconvenience in Japan.
But if deep fries went dark somewhere like Scotland, where
people have evolved to subsist entirely on deep fried food, it
could cause a genuine famine. As we approach the next deadline
on April 6th, the temptation is to believe that a deal will
return everything to the status quo, but the logistics of oil
and gas may not be so easily appeased.
Even if a deal is signed tomorrow, the economic fallout
from this conflict will likely be felt well into next winter
and possibly for years beyond. This crisis has highlighted
something that we've also been seeing in Ukraine, that you
don't need a peer level military to defeat a superpower.
By holding the global economy hostile, Iran has shown that
asymmetric disruption is just as effective as traditional warfare
in achieving your goals. The fact that the US has been
forced to ease sanctions on its enemies is the ultimate proof
that in the modern world, the market is a more sensitive
target than any military base. The 2nd shift is the end of the
idea of security by distance. For decades, Europe viewed
Middle Eastern volatility as a tragic but distant problem.
The breakthrough of the 4000 kilometre missile has ended that
luxury. Every European capital is now
within reach of a power that has proven it's willing to strike
whomever it needs to to get its way.
Ultimately, a negotiated de escalation might provide a sigh
of relief, but it can't Weld the turbines back together at Ras
Lafan. And it can't erase the new
reality of fragmented alliances, where energy security has
replaced ideology as the ultimate geopolitical currency.
The stock market might be buying the peace trade today, but the
physical world moves at its own pace, dictated by ships, pipes,
and turbines rather than sentiment.
Thanks again for tuning into this week's podcast, with
special thanks to my supporters on Patreon whose financial
support makes this whole thing happen.
If you'd like to sign up on Patreon, I'll leave a link in
the show notes. Have a great week and talk to
you again soon. Bye.