MT Explains: How global events shake oil prices – and your wallet

are getting Vanana Hari to do for us today. She's founder and CEO of Vanda Insights, which monitors the global energy markets, and she's going to help us connect the dots. Hi, welcome to the show. Oh, thank you, Andrea. My pleasure to be here. The pleasure is all ours in hosting you. So set the context for us here, Vanda. Oil is something that every single person needs more than we know, actually, whether we see it or we know it. Why is this so? OK,

great place to start. So oil is the lifeblood of the global economy. When we look at the world's primary energy mix, 82% of it is what we call fossil fuels. The remaining 18% or so is renewables and the more new energy stuff. Now oil alone is the single biggest component of that energy basket, 32%. And it has reduced. The share has reduced a little

bit over the past 678 decades, but not by that much. OK. And for the foreseeable future, the coming decades, it is expected to remain the primary source or the biggest source of energy in the world basket. So when we read about the oil market, we often hear the names OPEC, OPEC plus, OPEC spelled OPEC, which stands for the Organization of Petroleum. Exporting countries and they get mentioned a lot, right? So who are the biggest suppliers and why are they so

influential to oil prices? So OPEC and which has in recent years become OPEC plus because about 10 members that were not traditionally a part of OPEC. Now OPEC has been around for, I think, at least 6 decades now. So they were joined by these 10 other countries, the biggest Of which is Russia. So they came to be known as the non-OPEC collaborators of OPEC. Now, as a result of this collaboration, now we have this group of countries, which account for nearly 40% of global oil supply. So

that is a big deal. So whatever decisions they take with regards to their production policy is obviously critical for the supply demand. Balance of the markets for sure. As with any other trade in the world, how do the supply demand dynamics of these specific players affect us small guys, the consumers at the end of the day? So let's just go back about 5 years to 2020, when COVID happened, and we all know what life was like and how our

roads looked and transportation came virtually to a halt.Road transportation, air transportation. Our lives didn't. Stop. We were still getting air conditioning, cooling our houses, warming our houses, electricity, and what have you, but we did stop moving around, right? That led to a huge

collapse in global oil demand consumption, essentially, almost overnight. And that's when this group stepped in and said that, OK, this is not a good thing, short, medium to long term, such shocks are not good for producers. Because first of all, if you continue producing, prices will continue going down, right? Because there's no demand for that. You're going to run out of storage. Where are you

going to put that oil? And if you live with this kind of a price shock for a long time, what is it going to do to the future sustainability of your company? That's true of any company because you don't want to bleed money. No, and certainly not for this kind of an unanticipated, unforeseen shock that all company was prepared for, right? So this group played a vital role in rebalancing. So overnight they decided they're going to slash production.

By about 10 million barrels a day, which rebalanced the markets. Prices gradually came up. Of course, the world gradually getting back to normal was obviously on the demand side was a big factor. But the immediate step that was needed to save a lot of companies, oil producers essentially, from going bankrupt and perhaps never resurfacing. This group played a big role. Before that, they have continued to play a role, and after that, they've continued

to play the sort of balancing role. There's a lot of controversy around it. There are a lot of fingers routinely pointed. It gets labeled a cartel. It gets pinpointed as this is the group that is essentially trying to keep oil prices high. The very critical role they play in balancing supply with global demand and which they are able to play, especially now accounting for 40% of supply. Had it been a

smaller proportion, they may not have been as influential. So it's a very critical role they are playing, which often gets overlooked. Well, if they're trying to keep oil prices up, why aren't we at $80 today instead of 60? right? And on that note, I wanted to talk to you about that, the prices that they are at now, what's going on here? How is this group managing the situation with the oil prices vis a vis supply and demand? Sort of two themes here, right? What's happening in the

Middle East? Why is it always in the news? Why is it the biggest shock to oil when something breaks out over there? And how able or not is OPEC or OPEC plus able to manage a situation when there's a flashpoint in the Middle East. So let's zoom out. So when you look at the world's major oil producers, Saudi Arabia, Iran, Iraq, Kuwait, Oman, UAE, Qatar,

all of these are based in the Middle East. The other sort of issue that keeps the markets on edge with regards to the Middle East is there's definitely. And potentially two crucial choke points through which most of this all of the oil that I talked about a moment ago flows through. Now what happens when we talk about a choke point is essentially it's a very narrow waterways.

So should any kind of hostilities break out, any country in this case, Iran, sitting very close to the Strait of Hormuz, which accounts for about 20 million barrels per day of about 50% of the world's oil supply size. On the other side of the Arabian Peninsula you have the Bab al-Mab Strait at the mouth of the Red Sea, which is very close to Yemen and the Houthi rebels

of Yemen. The major oil producing countries for the most part other than Iran, which has been under US sanctions on and off and Western sanctions, and Iraq, which has some other internal problems. So you have this region which is the world's single biggest concentration of oil and gas production. And is geopolitically unstable and has these flash points and has this conflict between Israel and Iran, which has been going on for decades and have you found a real

solution to that conflict? I don't think so. You talked about how the Middle East concentration makes up about 40% of global supply, about a quarter, about 25% plus is about 40%, right? Who makes up the rest? OK, if you look at the big producers and the rest of the world, and thankfully relatively politically geopolitical stable places, OK. So the US today is the single biggest producer in the world. It's not Saudi Arabia, it's not Russia. So today the US pumps about 13.5 million barrels per day

of oil. Canada is also a major producer. And then you have a. In South America, Venezuela, which is a member of OPEC plus, but you have Brazil and Mexico, which are not members but also major producers. What about China? What about in Asia? Yes, Asia used to be a much bigger producer than it is now. So the main producing regions, of course, Malaysia and Indonesia, right? You mentioned China. It's interesting. So China produces, give or take about 5 million barrels per day.

The reason it doesn't get talked about much is that China consumes needs all of its oil production and more. So China pumps about 5 million barrels per day. It imports close to 11 million barrels. Oh, so not even enough for domestic consumption, nowhere and that is pretty much the story of Asia and Southeast Asia and Australia that all of these are basins that have been producing oil for a long time, for decades that haven't been any.

major new discoveries. So we are in this region sitting on big basins which are mature, which are in perennial decline. This region contributes to the biggest demand growth globally. So it is a very interesting dynamics here, declining production, no new discoveries, demand leaping ahead. So this region is actually very import dependent, going to become increasingly more so. And as a result,

Also very vulnerable to shocks in the Middle East. Yeah, and that's also what contributes ultimately to how oil prices move. So therein lies the question, why exactly are oil prices so sensitive? I mean, since it's a necessity, why can't it be fixed? A lot of commodities, very important commodities, including coal and metals until very recently have traded on

a fixed price basis. So what we mean by that is The major producers, major consumers get together and say, OK, for the next 1 year or 5 or 10 years even, we're going to trade on the basis of this number. Now what happens is if there is more demand and less supply, which needs prices to go up to incentivize more production, that wouldn't happen.

So essentially in a fixed price regime, the market is highly inefficient in that any signals of oversupply, more supply, and less demand, which should depress prices and prompt producers to cut production to restore the balance, those signals are absent in today's world, so it's actually interesting pros and cons of having so-called spot prices or prices moving. Forget day to day, minute to minute basis, right? Responding

to the demand supply balance. There are some cons, but the biggest pro is this that it is an efficient, effective channel to transmit signals to producers and consumers. So not just producers, consumers as well. So prices were, let's say crude was to jump into the 90s and 100s today. Yes, producers will produce more, but it's limited how much more they can quickly bring on in the current environment.

They will get the signal from the price, we will be getting more price, so let's invest more, let's pump more. But equally high prices also give a signal to the consumer, right? So the consumer says, OK, where can I tighten my belt? Where can I use, can I be more efficient? With my use of oil, where can I save and use less oil. So that's what happens with spot prices or prices moving on a day to day basis and

start being fixed for long periods. So there's fixed prices and there are spot prices and a good way to understand spot prices is that They're dynamic, right? They are responding. They're moving with signals that the market is picking up on supply and demand. We go back to what's happening in the Middle East and how there's a conflict there, right? Now, when there's a conflict, the first thing we tend to look at is oil prices because that's almost always the first thing

to react apart from stock prices on Wall Street. Why does this happen and when should we really worry about oil price movements being too far up or down? So I think taking Ukraine and the Gaza wars would be a good example, sort of compare and contrast them. So in the case of the Ukraine war, Ukraine is not a producer, not a major consumer, but Russia is, right, the 3rd largest oil producer, major exporter of crude and

refined products. Whenever a conflict breaks out, the first thing the oil market looks at is, is this likely to impact oil supply? Because if there is a chance, even if it hasn't directly impacted, if there is a Chance that it could interrupt or disrupt oil supplies, then we're going to have some sort of a disruption shortage all the way from some shortage to a major supply shock, which means oil prices are going to go up when that happens, typically that's a signal for producers and buyers.

The problem is that buyers and producers need time to adjust to any price signals. So the immediate response has to be what are we going to do if you're going to lose 5-7% or whatever of our supply overnight and then if we are to live with higher prices, that is a huge blow

to the global economy because oil powers everything. Now of course for the lay person you identify it as, oh, what am I paying for my taxi fare because the taxi is buying fuel, diesel or petrol or whatever or I'm putting it into my car or what am I paying for public transportation. A more sort of unseen part of oil prices percolating is all our goods are moving on public transportation, right? So it could be cargo planes, it could be trains, buses, trucks,

and so on. So high oil prices percolate into every part of the economy and cause inflation. That worries and then in turn central banks as well. Now, when inflation happens, typically the central banks tend to raise interest rates. That means you and I have to pay higher for our mortgages, for our car loans, or corporates have higher borrowing costs. They tend to then hire less, they tend to cut costs. So the corporate world suffers, the individual suffers.

So high oil prices can be a major shock, which is why the world is so sensitive to any signs of disruption in oil supply. That is quite the domino effect that I think many of us don't immediately think about. Now, while governments, they are buyers of oil as well, big time, right? What do as consumers need to worry about when prices turn volatile. Is this something that we really need to watch as closely as governments do, for example. So governments and consumers

get affected slightly differently. Both have reasons to worry unless you're the government of a major oil producing and exporting nation. A big part of your budget comes from Spending comes from oil revenues, you will probably be, OK, I don't want to say happy because governments do get worried if prices are too high for too long because then that dampens demand and nobody wants to buy. There's always a sweet spot where all consumers are happy and

producers are happy. But just going back to our original question, right? So as a consumer, your costs are going to go up unless it's a case like what happened over the past couple of weeks. It was a spike in oil prices and a quick dive, which didn't worry too many people. But had it stayed that way or continued going higher, God forbid, if there was an actual supply disruption. Then the consumers would have been quite edgy. Then they start saying, OK, now my fuel costs, my electricity costs

are probably going to go up. Where can I save? So that is also a hit for economic growth because if consumers are buying less of other products, whether it's durable or perishables, that's not good for the economy. Governments worry, especially in major oil importing countries, which is most of this. Part of the world, Asia, because the consumers buying less

is going to be bad for the economy. So what about if we are savvy investors and we happen to have oil or we're thinking about having oil in our portfolio? What would you advise there? So first and foremost, a word of caution. The thing to keep in mind with regard to oil, so you could be investing in a lot of derivative products. So there's oil. equities, oil and gas companies. But there's a lot of products which I would say are highly sophisticated for your

average layperson investor. So you have options and futures that you can trade in crude and some refined products. You have what is called exchange traded funds and exchange traded notes, ETNs which basically they don't buy or sell. On your behalf, but they are tracking the oil price. They're tracking what futures are doing, but quite often they can throw a curveball at you as well, you know.

And especially in volatile times, what we've seen over the past two weeks, you might just read maybe some social media and people are saying, oh, crude is now going to triple digits, and you say, oh this is buy

buy buy. Imagine if you were to buy it at $78 of brand futures, you would today be sitting in deep, deep in the red, OK, because simply because you followed some voices that were saying that, oh, Iran is going to close the Strait of Hormuz, and you didn't have any independent reliable research. You weren't unfortunately able to go to the people who know and who know better than to say that the strait will be closed. So there is a risk of

getting burned much more in oil. I would say investing in a more passive in mutual funds that are exposed to commodities are either mostly commodities or have some abortion funds apportioned to commodities. I think that's generally a good idea. I would suggest unless you have done a lot of research yourself, don't jump into. Being an active investor. I think those are very wise words indeed. And there you have it. We've made the connection between oil prices and what happens around the world.

Thank you for being our Money Talks explainervanda. Thank you for having me. Do you have a finance thing that you want explained? We are your people. Send us a note and if you want some answers, send an email to CNA podcasts at Mediacorp.com.sg. Thank you for listening to Money Talks. This is Money Talks Explains. I'm Andrea Hing.