Geopolitics and the economy: How war-triggered oil price shock was largely avoided

Talking Heads podcast with Thijs Van de Graaf

Daniel Morris: Hello, and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing the outlook for oil markets. I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Thijs Van de Graaf, Professor of International Energy Politics at Ghent University.

Welcome, Thijs, and thanks for joining me.

Thijs Van de Graaf: Thank you. Thrilled to be here.

DM: Needless to say, an opportune time to be recording this podcast. The US and the Iranians agreeing to talk, which I think we all appreciate is better than agreeing to fight. But no near-term certitude. Let’s go back to the markets’ or the world’s reaction to the outbreak of the war at the end of February. We saw a lot of predictions for a quite catastrophic impact on oil prices and therefore on the global economy.

We saw figures – oil going to $150 or $200 per barrel, global recession, and so on. Happily, that didn’t happen. Maybe, Thijs, you can take us through some of the reasons those dire predictions turned out to be mistaken.

TVdG: I think it has to do with a different set of factors. One is that we went into this crisis with ample buffers because oil was at $60 a barrel. Gas prices were also low. There was actually an oversupply, which meant that commercial inventories were very high. And markets have proven also quite resilient.

And then there are also countries in the Gulf that were able to still ship oil to export markets through pipelines that bypass the Strait of Hormuz.

Saudi Arabia, for instance, maximized the capacity of its pipeline that goes to the Red Sea. Also, the UAE has a pipeline bypassing Hormuz. All of that helped.

And there was a massive release of strategic oil stocks by Western governments. Four hundred million barrels were released. Needless to say, this also helped to calm the markets.

The US relaxed sanctions on Russian and Iranian oil for some time so that this could also be sold into the market.

And we need to talk about China, because China did an amazing thing. It reduced its oil imports by almost three million barrels per day. It was a big shock absorber, and was probably able to do so because it itself has massive strategic oil stocks. It doesn’t disclose information about the pace at which they drew from this, but we can imagine that they did so in large quantities, and that also helped to calm the markets.

DM: So these dire predictions didn’t come to pass. Here we are in the midst of the negotiations. Oil prices have fallen sharply, but haven’t gone back to the level they were before the war. We seem to be around sub-eighty [dollars a barrel]. We appreciate there’s going to be a lot of volatility around that. The question is, what comes next? So, if you peer into your crystal ball and estimate how long you anticipate it’s going to take for oil supply out of the Middle East to get back to normal?

TVdG: Well, the International Energy Agency expects oil markets to physically balance again by the fourth quarter of this year because it takes time to make sure that the supply chain is back in order. There has been a massive disruption, and even if Hormuz completely opens and doesn’t get closed again, it takes time for tankers, which are now on their way everywhere around the continents, to get back to Hormuz to get a cargo and then deliver it to their destination markets.

We also know there are still sea mines in the Strait of Hormuz that need to be removed. [It is] still very unclear how many [or] who will take the responsibility to remove them, but they need to be removed for normal shipping to return.

And then two important questions: A lot of Gulf countries had to curtail their oil production during the crisis. How fast can they rebound? How fast can they scale their production up to pre-war levels?

Some countries, like Saudi Arabia, which was able to export via those pipelines, they are in a good position. But a country like Kuwait, which didn’t have a [Hormuz] bypass, is in a worse position, and it will probably take a bit longer, up to two months perhaps, in Kuwait for oil fields to be back to pre-war production levels.

To conclude, there have been a lot of missiles and drones fired across the region, also targeting energy infrastructure. We know for some infrastructure – like the critical Ras Laffan liquefaction plant in the UAE – that it will take up to five years to repair the damages.

But we don’t have a full picture of the damage at other sites and how long it will take to repair. So I think, to look at the physical supply of oil coming back to pre-war levels, we need to calculate not in weeks, but in months.

DM: If we think a little bit more long-term, though, this isn’t the first time you’ve had an energy crisis in the Middle East. I think we appreciate, if you go back even to the ’70s, something like this has longer-term implications.

TVdG: Absolutely. Longer term there are going to be consequences of this episode both on the supply side, but more crucially on the demand side as well.

If you look at the supply side, one of the things that has happened over the past few weeks is that the UAE has announced it would leave the OPEC cartel, which means the UAE will not be bound anymore by a production ceiling. It’s already had long-time plans to ramp up its production capacity to five million barrels per day by 2027, 2028.

So, they will be producing more and this can, in the mid-term, say from mid-2027onwards, again create that prospect of an oil glut, which was the prospect we had when we entered this year when oil was at $60 a barrel.

But the most interesting things, I think, are happening on the demand side. Looking back at previous energy shocks – the oil shocks of the 1970s – they set in motion a complete transformation of our energy system – the rapid uptake of nuclear power, the introduction of efficiency standards for vehicles, looking for alternative oil fields outside of the Middle East. That was the long-term legacy.

Here, I think the Hormuz crisis will probably accelerate two things, mainly: Electrification of end-use demand – heat pumps, electric vehicles – and renewables plus batteries, which are a cheap, scalable set of technologies that we haven’t had even four years ago during the 2022 energy shock.

Battery prices and solar panel prices were higher than they are today. Today, they are lower, and they can be scaled really fast. This means that the demand for imported oil and gas is going to be pushed away by rapid uptake of all of these technologies, including nuclear.

So, electrification is now the talk of the town and is going to be very high on the agenda of governments who want to prioritise energy security above anything else.

DM: Thank you, Thijs.

If I could summarise some of the key points you shared with us in answer to the question, why didn’t we get those worst-case scenarios?

Oil prices thankfully didn’t go to $150 or $200 per barrel. You pointed out we entered the crisis with ample buffers. There was oversupply, arguably, at the time. We were able to find alternative routes for oil exports, so that helped, also drew down oil reserves. And importantly, China reduced its own demand.

 If we think about the future and the question of how long is it going to take for oil supply to normalise, we have to remove mines from the Strait of Hormuz, repair the damage to the infrastructure in the region, getting the ships back to bring out the oil, and therefore you think it’ll be in the fourth quarter at the soonest that we see things get back to whatever the new normal is going to be.

And finally, we think about the future. What are the longer-term consequences of all of this? You pointed out it’ll have impacts both on supply and demand. In terms of supply, the UAE has left OPEC, and interestingly, that could lead to the prospects of an oil glut by 2027. Perhaps more importantly, on the demand side, this is likely to encourage countries and consumers to want to reduce their dependency on oil and therefore increase the demand for renewables, batteries, nuclear, and overall give another push to a broad adoption of electrification.

Thijs, thank you very much for joining me.

TVdG: My pleasure. Thank you.

DM: That’s it for this week’s episode of Talking Heads. If you would like more information about our capabilities in this space, please reach out to your asset management contact or check out Viewpoint, our website for investment insights at viewpoint.bnpparibas-am.com.

Just before we go, I’d like to mention that the Talking Heads podcast is available on Spotify and on YouTube. For YouTube, visit youtube.com/bnppam/playlist and tap or click on Talking Heads.

You’ve been listening to the BNP Paribas Asset Management Talking Heads podcast with me, Daniel Morris, and Thijs Van de Graaf, Professor of International Energy Politics at Ghent University.

Please do join me next week. Until then, take care.