If you look at the stock market today, you might naturally
conclude that the global energy crisis has been permanently
resolved. The S&P 500 recently hit another
record high, climbing past where it was before the fighting began
in late February. Equity traders seem to have
decided that a war in the Middle East, one that has closed the
world's most critical energy choke point, is simply a great
opportunity to buy the dip. But if you talk to the people
who actually move physical barrels of oil, the mood is
considerably darker. Futures markets are pricing in a
swift diplomatic resolution, while physical commodity traders
are staring at a completely different reality.
There's a massive gap between the optimistic news flow that
drives stock prices and the actual cost of a physical barrel
of oil sitting on a ship in northwest Europe.
For weeks, we've seen a bizarre cycle play out.
A ceasefire or diplomatic breakthrough is announced, the
stock market spikes and the price of crude plunges by 10%.
Then almost immediately, the Iranians announced that they've
not agreed to anything and prices reverse.
Just this week, despite the announcement of a three-week
ceasefire extension between Israel and Lebanon, Iranian
forces boarded and seized 2 MSC container ships.
President Trump responded by ordering the US Navy to shoot
and kill any boat caught laying mines in the water.
This is not what a functioning trade route looks like.
Investors seem to be suffering from a bad case of muscle
memory. They're sitting at comfortable
desks in New York and London, assuming that the administration
will eventually experience what investors have been calling a
Taco moment. Where Taco stands for Trump
always chickens out. They expect the president to
look at the upcoming midterm elections, look at the rising
price of gasoline, and simply walk away from the conflict much
like he did when he retreated on his liberation, say tariffs,
last year. The fatal flaw in this
assumption is that a trade war is fought with Administrative
Inc. You can cancel a tariff with a
weekend post on True Social. A shooting war in the Strait of
Hormuz is fought with drones, naval barricades and anti ship
missiles. You cannot unilaterally back
down from a conflict where the other side has their own agenda.
The Iranian regime has survived the initial strikes and
discovered covered that holding the global economy hostage is an
incredibly powerful piece of leverage, and unlike a nuclear
weapon, it's one that they can actually use.
As I've said before, it takes 2 to Taco, and right now the other
side of the table is busy seizing container ships.
For the commercial ships currently trapped in the Persian
Gulf, the situation is devolved into something resembling a high
stakes maritime prison break. Captains are turning off their
tracking equipment and sneaking through the water in the dead of
night just to get their crews out safely.
About 45 ships have entered or exited the straits since a
temporary ceasefire was first agreed on April 8th.
Yesterday, over a 24 hour period, only 5 through at least
22 other ships have been attacked and several others
seized by the Iranian Revolutionary Guard since the
conflict began. The situation is now being
described as a dual blockade. Iran has restricted passage to
hostile vessels from unfriendly countries, while the US Navy
began its own counter blockade on April 13th, specifically
targeting ships bound for are departing from Iranian ports.
The reality of trying to navigate the Strait of Hormuz
right now sounds less like global logistics and more like a
heist movie. Just this past weekend, a Greek
owned tanker called the Acta carrying 300,000 barrels of
diesel managed to make a run for it in the dark.
It lined up at the head of a snake of ships and slipped out
just hours before the Islamic Revolutionary Guard sent
gunboats back into the channel that are being actively
targeted, like those tied to the MSC group are attempting to
sneak through with their GPS transponders completely turned
off. Some are hiding behind Omani
flags. Others are navigating demands
from the Iranian regime to pay safe passage tolls in
cryptocurrency, which major trading houses vehemently deny
paying as doing so would breach U.S. sanctions.
The resulting backlog has created what 1 Executive
described as a car park of 3 to 400 ships desperately waiting to
get out. It's not just oil tankers that
were trapped. 6 cruise ships were stuck in the Gulf but
managed to make it out with skeleton crews and no passengers
on board in late February. One of these was owned by MSC
Group, which has business partnerships with Israel.
What's perhaps most striking about the whole situation is the
complete abandonment of these merchant vessels by Western
governments. Larry Johnson, the global head
of freight at Mercuria, expressed his frustration this
week, saying that politicians are simply burying their heads
in the sand. State owned vessels might have
access to naval escorts or back channel communications with the
Iranian regime, but pure merchant traders are entirely on
their own. the US Navy's barricading the coastline and
has turned around dozens of ships.
Iran is firing on the ones that try to squeeze through.
There's no concerted effort to formalize a safe transit
mechanism. Instead, the people tasked with
moving 1/4 of the world's seaborne oil are essentially
being told to turn off their headlights and hope for the
best. While investors might assume
that this blockade is just a temporary glitch in the supply
chain, the physical reality is that the world has now run out
of its safety cushion. In the early weeks of the
conflict, the market was insulated by the fact that a
near record amount of oil was already at sea when the war
started. But by April 20th, the last few
tankers that managed to cross Hormuz before the fighting began
finally reached their destinations in places like
Malaysia and California. That seaborne buffer is now
completely exhausted. Physical commodity traders are
warning that a lot of long term damage has already been done.
Saad Raheem of Traffic Eura told The Economist earlier this week
that a cumulative loss of 1 1/2 billion barrels of Gulf crude,
roughly 5% of annual global output, is almost unavoidable at
this point. Traders are noting that even if
a ceasefire holds today, the market might not return to
equilibrium until 2030 due to this permanent loss of supply.
Normally, an American president might expect the domestic oil
industry to simply drill the country out of an energy shock
like this. After all, the US is now energy
self-sufficient. The administration has strongly
urged oil executives to increase production to bring gasoline
prices down, but US shale bosses are actively resisting those
calls. According to a recent Dallas Fed
survey, energy executives are refusing to significantly
increase production, pointing to the absolute chaos of the
current market. While this may not make the
president happy, it's a perfectly rational capital
allocation decision made by executives who've been burned by
over drilling before. The extreme volatility between
physical prices and futures prices sends conflicting signals
to operators. They can't responsibly plan long
term capital budgets or rigged deployments when the price of
their products swings wildly. Based on presidential tweets,
most companies are taking a do nothing approach to their 2026
budgets. They know perfectly well that if
they spent billions to over produce now and Trump secures a
sudden peace deal tomorrow, they'll be left holding the bag
in a crashed market. If you want to understand how a
geopolitical energy shock actually trickles down to the
real economy, you'll have to look beyond the headline price
of crude oil and examine the specific refined products that
keep the world moving. Take jet fuel.
Europe does not produce enough enough of it to meet its own
demand. According to Politico, it's
refining capacity can cover at most 70% of what airlines need.
Any prolonged disruption to tanker traffic through the
Strait will leave carriers scrambling for supply.
Europe is currently sitting on about 50 days of jet fuel
reserves, which is their typical operating level.
But according to modelling by the data firm Kepler in
association with The Economist, those stocks are going to fall
precipitously if flows through Hormuz don't normalize by June.
the United States could theoretically help by exporting
refined products, but if the administration decides to
prioritize domestic prices and bans refined fuel exports,
Europe's aviation sector will be staring at a brick wall.
Then there are the esoteric commodities that most people
don't think about until they run out.
Qatar is not just a dominant player in liquefied natural gas,
it's also one of the world's largest producers of helium,
accounting for roughly 1/3 of global supply.
Helium is a byproduct of natural gas extraction, and you can't
safely ship it on a plane. It has to move by sea.
When the Strait of Hormuz is barricaded by gunboats, the
global supply of helium is effectively choked off.
This isn't just about party balloons.
Helium has the lowest boiling point of any element, along with
an extremely high thermal conductivity, which makes it
irreplaceable as a coolant for sensitive equipment.
It's used to cool the superconducting magnets in MRI
machines, as a carrier gas in the chemical vapour deposition
process, is used to manufacture semiconductor chips, and as a
purge gas in clean rooms. There is no synthetic substitute
for helium. If you're running a chip
fabrication plant or a hospital radiology department, you cannot
swap it out for something else. The logistical nightmare of this
blockade doesn't stay confined to the Middle East, either.
The global shipping industry operates as a closed loop.
Because ships can no longer safely pass through the region,
they're being forced to take a massive detour around the Cape
of Good Hope. This significantly extends
journey times, which effectively removes a huge chunk of shipping
capacity from the global market. Congestion at the Panama Canal
has intensified too, as Asian buyers have turned to purchasing
crude oil from the Gulf of Mexico to replace their Middle
Eastern supplies. The canal was already dealing
with severe transit restrictions due to historic drought.
Now, with oil tankers outbidding bulk carriers for scarce transit
slots, the knock on delays are rippling through supply chains
that have nothing to do with energy, according to the FT.
Ships carrying lower value cargoes like grain are being
pushed to the back of the queue as oil tanker operators pay
millions of dollars to skip to the front.
Wait times at the canal have stretched to around 40 days, and
some grain routes have already seen shipping rates increase by
50 to 60%. Grain is now moving slower and
costing significantly more to transport.
Which brings us to perhaps the most alarming knock on effect of
this crisis, the threat to global food security.
People tend to think of the energy market and the food
market as two separate things, but modern agriculture is
essentially a very efficient system for converting
hydrocarbons into edible calories.
Natural gas is the primary feedstock for nitrogen based
fertilizers like ammonia, and the Strait of Hormuz handles
roughly 1/3 of the world's seaborne fertilizer trade.
When the Strait closes and gas prices spike, agricultural input
costs explode. Before the hostilities broke out
in late February and hydrous ammonia cost US farmers around
$800 a tonne. Today it's sitting at $1050 a
tonne. But fertilizer is only one part
of the equation. To run a modern farm, you need
massive amounts of diesel to operate the tractors, the
combines and the trucks that transport the harvest.
The agricultural sector was already operating on razor thin
margins, and this dual spike in both fertilizer and diesel costs
represents a massive unbudgeted expense.
A recent survey by the American Farm Bureau Federation found
that around 70% of farmers report being unable to afford
all of the fertilizer they need for this crop cycle.
And even if they could afford it, the supply chain is working
against them. The chief risk officer of Louis
Dreyfus pointed out this week that there's growing competition
for other critical agricultural inputs like sulphur, the fourth
major nutrient after nitrogen, phosphorus, potassium.
Because of the crisis, sulphur is being diverted to higher
value industrial uses like copper smelting, leaving
fertilizer producers waiting at the back of the queue.
Zippy Duvall, the president of the American Farm Bureau
Federation and the man with the most American sounding name I've
ever come across, told the FT that the farm outlook is bleak
right now and farm country needs help.
Look, it's not necessarily the best quote ever, but I included
it just because I wanted to say Zippy Duvall.
Pablo Escobar, yes, that's his real name too.
The head of LNG at Vital warned this week that we're living on
borrowed time, saying that if this continues, the energy
crisis will rapidly become a global food crisis.
But of course, the term global catastrophe means different
things to different people. While agricultural traders are
worried about crop failures and food security, Bernard Arnault,
the billionaire head of LVMH, has his own concerns.
He warned his shareholders this week that the war could spiral
into a global catastrophe with extremely negative economic
developments if it isn't resolved quickly.
His definition of catastrophe, however, appears to be that
sales of Louis Vuitton and Dior handbags in Middle Eastern
shopping malls have fallen by as much as 70% since the war began.
1 sector is preparing for famine and the other is lamenting a
drop in high end spirits, clothing and luxury leather
goods. While the US deals with
expensive diesel and unsold handbags, Europe is facing a
much more structural squeeze. Right as the Hormuz crisis
reached its peak, Russia decided it was the perfect time to turn
the screws on Germany. Moscow has announced that it
will suspend the flow of Kazakh oil through the Soviet era
pipeline that supplies the PCK refinery, the facility that
provides 90% of the petrol, kerosene and heating fuel to the
German capital. By cutting off this alternative
supply line right as seaborne imports are choked off in the
Middle East, Russia is ensuring that Europe feels the maximum
possible pain from this conflict.
Whenever an energy crisis breaks out in the Middle East,
financial commentators inevitably start drawing
comparisons to the 1970s. We're immediately bombarded with
black and white footage of cars lining up at gas stations and
warnings about a return to the stagflate that defined the era
of the 1973 Arab oil embargo and the 1978 Iranian oil workers
strike. In certain ways, the current
situation is a lot worse than what we saw in the 1970s.
As Daniel Juergen pointed out recently on the Odd Lots
podcast, the absolute volume of the disruption we're seeing
today is the largest in history. Global oil production and
consumption are roughly twice what they were 50 years ago.
However, major economies are structurally much more resilient
to oil shocks today than they were back then.
The metric economists used to measure this is called the oil
intensity of GD P. It measures how many barrels of
oil it takes to produce a single inflation adjusted dollar of
economic output. Since the 1970's, the oil
intensity of the global economy has declined by more than 70%.
Our factories are more efficient, our cars get better
mileage, and our power grids rely much more heavily on other
sources of energy than they do on petroleum.
But while the physical economy might be less vulnerable, the
financial economy is standing on much shakier ground.
Paul Krugman noted recently that in 1978, the price to earnings
ratio of the S&P 500 was sitting at historic lows.
Today, equity valuations are stretched to near record highs,
supported by a highly complex, interconnected private credit
market that didn't exist in the 70s.
We have an economy that requires less oil, but a financial system
with a much lower margin of safety for a prolonged inflation
shock. This crisis is also
fundamentally rewiring how governments think about energy
infrastructure. For the last two decades, the
push towards wind, solar and electric vehicles has been
driven primarily by climate policy.
The closure of the Strait of Hormuz has rebranded the entire
green energy transition into a matter of national security.
You can't fix a 20% drop in global hydrocarbon supply with
wind turbines in the short term, but the realization that an
entire continent can be held hostage by cheap Iranian drones
is rapidly changing capital allocation decisions.
In Asia, where countries are heavily dependent on imported
seaborne oil, the transition is accelerating.
Electric vehicles now make up over 50% of new car sales.
In China and 40% in Southeast Asia.
While the US tries to drill it's way out of the crisis, Asia is
looking to nuclear power and electric vehicles as tools for
long term energy sovereignty. All of this structural shifting
will take time. In the immediate present, the
western world is dealing with the harsh reality that inflation
is back and it's going to be sticky.
The economic fallout from this war has already started showing
up in the data. Both the United States and the
United Kingdom saw inflation accelerate to 3.3% in March.
In the UK, the Bank of England is now facing a central bankers
worst nightmare, an external energy shock that raises the
cost of living while simultaneously killing economic
growth. In the US, the political panic
is becoming palpable. President Trump has dispatched
his top lieutenants, including Interior Secretary Doug Burgum,
to beg oil executives to increase production.
Meanwhile, Treasury Secretary Scott Percent has resorted to
threatening retail gas station owners, warning them that the
administration is watching to ensure they slash prices at the
pump the moment crude oil drops. If that rhetoric sounds
familiar, it should. It's almost a word for word copy
of the Biden administration's complaints about the price
gouging at the pump. Back in the summer of 2022,
President Biden tweeted at gas stations.
Bring down the price you're charging at the pump to reflect
the cost you are paying for the product and do it now.
It turns out that yelling at gas station owners is a bipartisan
tradition. Regardless of who's in in the
Oval Office. The political response to an
energy supply shock is exactly the same panic ignore the
underlying market dynamics and threaten the guy who owns your
local gas station. The problem is that you can't
yell at inflation until it goes away.
The IMF warned earlier this week that short term inflation
expectations in the United States have already moved up and
that the economic fallout from this conflict will not evaporate
overnight, even if a ceasefire is signed tomorrow.
The increased costs of fertilizer, diesel and rerouted
shipping have already been baked into the supply chain.
Those costs will inevitably be passed on to the consumer at the
grocery store and at the hardware store over the coming
months. While politicians focus on the
price at the pump, macroeconomic analysts are looking at how this
crisis is fundamentally rewiring the flow of global capital.
When the price of energy spikes, the balance of global trade
shifts. Brad Setzer, an economist at the
Council on Foreign Relations, pointed out on the FT Economics
podcast last week that you would be wrong to expect an energy
shock of this magnitude to wipe out the massive trade surplus.
Surplus is held by countries in Asia.
China's surplus in manufactured goods is so structurally
enormous that even paying record prices to import seaborne oil
barely makes a dent. While this energy shock is a big
deal, it won't magically rebalance the global economy.
It simply redirects a portion of the dollars that were
accumulating in Beijing towards alternative oil and gas
exporters. Some of that money will go to
Saudi Arabia, which has an East West pipeline and can still get
some oil out. But most of it will flow to the
world's other exporters, Kazakhstan, Tajikistan, Norway,
Russia and some South American producers.
The US and Canada collectively export about 5 million barrels
of oil a day, So what Setzer expects to see is a general
shrinking of the big Asian and European surpluses, with the
money flowing instead to certain oil producing economies, a
reshuffling of who holds the world's dollars rather than a
fundamental rebalancing. Because the United States is now
the world's largest oil producer, a position it's held
since 2018, you might assume that this shock would ultimately
be a net positive for the American economy.
But the windfall at the wellhead doesn't necessarily reach the
kitchen table. American oil and gas exporters
are benefiting from higher prices, but the American
consumer is absorbing the pain on the other side, paying a
geopolitical tax on everything from agricultural products to
transportation, leaving them with less money to spend on the
rest of their needs. the US trade deficit isn't shrinking.
Life is just getting more expensive.
This brings us to the ultimate lesson of the crisis.
As I mentioned in my video on Europe's financial nuclear
option back in January, the financial markets have spent the
last 30 years operating under the Great Illusion, the belief
that economic interdependence naturally prevents conflict.
We assumed that because an open Strait of Hormuz was essential
for the survival of the global economy, no rational actor would
ever try to close it. But the interdependence that was
supposed to be our safety net is framed from both ends.
On one side, Iran has discovered that holding the global economy
hostage with a fleet of cheap drones is a highly effective
negotiating tactic. On the other, the world's major
economies have spent the last two years actively reducing
their dependence on each other through tariffs, export
controls, and onshoring, dismantling the very web of
trade relationships that was supposed to make a crisis like
this irrational. When you control a vital
geographical choke point, you don't need a trillion dollar
military to exert massive geopolitical leverage.
And when your adversaries are already pulling apart the system
that was supposed to deter you, you have even less reason not to
try. For decades, the global supply
chain has relied on the unwritten assumption that the
United States Navy would act as the ultimate guarantor of free
trade, safely escorting merchant vessels from one side of the
globe to the other. That assumption is now obsolete.
The Navy is no longer acting as a neutral guardian of open sea
lanes. It's an active combatant running
its own blockade. The merchant marine is on its
own. We've moved from a world of
global cooperation to a highly transactional era where historic
alliances are significantly less meaningful and negotiated.
Diplomatic de escalation might eventually provide a sigh of
relief, but it cannot undo the realization that the plumbing of
the global economy is incredibly vulnerable in this new
transactional era. The stock market might be buying
the peace trade today, assuming that a weekend of strongly
worded Truth Social posts can fix the supply chain.
But the physical world moves at its own pace, directed by ships,
pipes, and turbines rather than market sentiment.
Thanks for tuning into this week's podcast.
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If you'd like to support it, I'll leave a link in the show
notes. Have a great week and talk to
you again soon. Bye.