A Concrete Plan to Bring the Price of Oil Down Right Now

way implicitly, right, I I totally agree. It feels like the FED has really raised the steaks on oil because obviously, look, high oil creates all kinds of problems, it's very difficult for consumers, creates all kinds of challenges. But at the recent FED meeting, you know you heard Sherman J. Powell say, look, consumers, don't think about core vers headline plation. Just think about headline inflation. And if inflation stays high or gasoline prices

stay high, then that could lead to increased expectations. The FED does not want inflation expectations to get out of hand, and so the FED will tighten in response to high oil prices, Defended implicitly said, I think it is willing to pay the price of recession to get the price of oil down. Yeah, and I've been thinking about this a lot. But it's also like gas prices just loom large in the American consciousness and I guess politically as well.

And I got to say, I was at my dad's house over the weekend and all I heard was grumbling about gas prices and the Biden administration for three days. Well there, So anyway, it is, it is permeated the public. It is everything Defend has made at everything. On our recent episode, the one that we out released on Monday with Peter to Second, we talked about the challenges of eliciting a supply response and getting more oil out of

the ground rapidly. But the stakes are very high. Clearly the White House is extremely stressed about that is having recently sent a letter to oil companies basically, you know,

encouraging them to do more. So the question we have to ask is what if anything can be done in the short term, right, And I think this is the crux of the matter, because we've had many discussions about this at this point, but this is a problem that was many, many years in the making, so structural under investment in certain types of energy i e. Fossil fuels, and now everyone seems to be trying to figure out short term ways to alleviate that bottleneck or that choke point.

Absolutely huge economic and of course political stakes. All right, let's jump right into it. We're gonna be speaking with two guests who we've had in the past who know a lot about this space, both of the terms of oil specifically, as well as various tools that the government might have to improve the supply, uh, the supply. So I had a little bit. We're going to be speaking with Rory Johnson. He is the editor of the Commodity Context newsletter of Fantastic read. He's also market economists and

managing director at Price Street in Toronto. And we're also gonna be speaking with Sconda Amardath. He has the direct executive director at Employee America, a think tank which promotes tight labor markets. So Rory and Scanda, thank you so much for coming on odd lots, thanks for having us back on, thanks for having me on. Absolutely all right. Sconda, I actually just want to immediately started with you because

you've been writing for several months. Now that you think the White House has tools at his disposal right now to increase oil production, they haven't been used. We'll get into the details, but why don't you just give us the very high level idea here of how the White House can use the Strategic Petroleum Way Reserve strategically to

ease oil markets right now. The tools we've laid out are really about addressing what i'd call the most proximate binding constraint on u S domestic industry, and that's one of a high propensity for low investment capital discipline um for some pretty understandable and rational reasons that have to do with what i'd call uncertainty on in terms of price risk, demand uncertainty, and it's called to something and also financing uncertainty depending on where you are in the industry.

And so there are tools available within the federal government that can if you work with industry, you can actually provide that kind of certainty because the government has a lot of long term storage capacity to the Strategic Controlling Reserve, which is not trivial by the way, right they have physical storage capacity in commodities is important if you're actually going to be able to fund more production but also

to provide the kind of price insurance. And so the Department of Energy has the authorities to replenish their reserve they're currently releasing, which is good, but just don't be under any illusion about how much it's really helping. It helps a little bit of the margin, but it's not going to be uh, sort of the all powerful solution. But what would be valuable is actually to signal to producers who have been burnt by cycle after cycle in the last eight years or so by price crashes that

have effectively led to really poor shareholder returns. And now the response has been let's invest really slowly, let's be pretty in elastic in our investment response to high prices, unlike what we saw in previous episodes of oil prices running up. And so what we're trying to get at is through what's called an insurance mechanism. It's it's a sale of physical put options and through financing mechanisms offering

leverage changing that shareholder proposition. And those tools have been on the table that the administration has had notice and knowledge of these tools, they've thus far been much more reluctant to really latch onto them. They've done some marginal things that have been helpful around strategic patrolling reserve regarding the willingness to maybe explore forward contracts to replenish the reserve.

But the kind of insurance plus financing pairing those two things together would be very I think helpful and powerful. It doesn't solve every issue in the industry, but capital discipline is a big reason why we're not seeing the big capex ramp up in US industry. And look, US is the biggest producer, so it's not as if US is some small fi producer relative to the global economy. It is the biggest country. So Rory, maybe I could

bring you in here. You know, when Sconda talks about the need for price insurance for the oil industry, what exactly is the problem that we're trying to solve here, Because I'm sure a lot of people will look at oil above a hundred dollars a barrel. A lot of the big oil majors or energy majors are posting record profits and they're going to see that and think, well,

why in the world would you need to underpin it further? Yeah, And I think one thing that's really interesting is to think about the way in which the SPR can be used to to really kind of ameliorate this challenge we're facing. And one of the things we've often heard as a reason for lackluster interest in investment is, sure, the price of oil is very high, but backwardation is extreme, right, So the you know, full word price of oil you know,

twelve eighteen months out is considerably lower. Uh, And that's where they would effectively be hedging in their production. So that's really, in some ways the price that matters more than the spot price. So it's interesting here, particularly when relating it to you know, discussions of you know, Chairman

Powell's worries about an unmooring of inflation expectations. Consumers care about the spot price, whereas producers probably care about a price you know, twelve to eighteen months down the line. So the question is how can the SPR be used to kind of you know, achieve some of that goal. Um. A lot of the criticisms of the SPR I think are warranted in that, you know, for instance, the release at the end of one by the by administration was very much just a oil prices are high, so let's

open the taps. Let the oil out and you know, hopefully bring down the price of oil. That's a bad use of the s PR because it's you know, using a finite resource. It's you know, it's it's a stock of oil. To bring down the prompt price without really anything else and all was equal, that should you know, reduce the investment incentive or investment signal to the patch.

But what if you you know, for every barrel you sold today, you bought another barrel like Sconda was saying in the in the in the futures market, you know, twelve to eighteen months down the line. So then what you're doing is you're both bringing down the spot price and you're lifting up the back of the curves. You're flattening the curve, which both reduces that kind of inflationary pressure on consumers well also increasing the signal to producers

to produce more. So I think that is that is the way the SPR should be used, and it hasn't been used historically cause it's a bit more you know, you know, technical, a bit more kind of uh, you know, seems very Wall Street, and I know that Washington doesn't always like to go down that road, but I think it's a much more effective way of using that capacity resource effectively as a buffer battery, rather than just as

viewing it as like an emergency stock. So oil might be at a hundred and fifteen dollars per barrel or whatever right now, but if you look at the futures curve or the curve of all the various oil prices out in time, you'll see that it's in backwardation, which means that people expect prices to come down over the long term, which is exactly the kind of thing that doesn't incentivize people to ramp up production because they're thinking they can't forward sell future barrels at a higher price.

Is that right, Yeah, exactly. And I would just quibble a little bit about the expectation comment, and I think it's not necessarily the market's expecting the price to fall. It's that right now the market is willing to pay X amount for a for a barrel of w T I in eighteen months um, which is slightly different than

like let's say a market forecast. But just as an example, so w T I right now is trading you know, above a hundred and ten, around a hundred and twenty or whatever, whereas eighteen months out it's it's it's decently below a hundred. So I think that's the price signal that I think producers are really looking at. And so the question is how can you kind of achieve both

those goals? And I think the spr and again Employe America has a tremendous amount of I think, really creative policy work around this space to kind of change up the playbook a little bit, because it's not you know, this is a new kind of crisis we're facing, uh, and I think it's going to take new ways of trying to solve it. So the idea here, the core idea, is to really bring markets into balance and elicit an

increase supplayer response, so they're just more gallant. So far, the idea we know this is creating a tremendous amount of political pressure and stress for the White House, and I assume in Canada for Trudeau's administration as well, although I haven't followed the politics as closely. So far, most of the ideas they get bandied about don't actually seem to address this. So let's talk about some of the other ideas and their drawbacks. So what's wrong Scanda with

cutting the gas tax? So again, cutting the gas tax. Right, when we think about gasoline, it is scarce in the sense that, um, you can look the inventory at it to say it's scarce. You can say that the supply picture for crude oil and the terms of global refining capacity, there's a clear crunch that is tied to the Russian invasion of Ukraine. So we're dealing with real scarcity here.

And if we think about what the gas X as a prop for making it easier to consume gasoline, and when it's scarce, when it's a subsidy for demand at a time when it's scarce, that typically doesn't check out. It may sort of cross subsidize in some through a bunch of intermediating mechanisms the supply side, but it's pretty inefficient if it's going to do that, and it actually it creates a disincentive for actually adjusting your consumption for

those people who can adjust their consumption. I think obviously in the United States especially, there are a lot of people who just can't adjust their consumption very easily because there are dependent on an internal combustion vehicle for their livelihood. Um, there are people probably in Westchester County. He could probably take the train a little more. Um So there are

Western County in New York. So there's clearly um ability to adjust consumption that you're taking off the table when you sort of take these sort of blunt measures too. All the all alse equal, it's a subsidy for consumption and subsidy for demand when the root cause that we really want to attack is on the supply side. If you want to raise um to the said, you want to bring supply and demand into balance. You don't want some adjustment on the demand side and some increase in

terms of on the supply side. So all right, here's another one that people talk about. What about and Rory or Scanderble what happened? What about banning exports of energy? You hear that too. It's like, Okay, the world demands a lot, but we have plenty here, and we have plenty of capacity. Why not just keep it all here so that US consumers aren't fighting with global consumers. I

think there's two ways you could think about it. One, the US had a crude oil export band for a very very long time and and repealed that about a

half decade ago. Um that actually in some ways has actually been pointed to that repeal, ironically is actually appointed to as one of the reasons that the US refining sector has had its kind of waned a little bit over the past you know, five to seven years, because the band had actually artificially kept the price of western you know, West Texas intermediate or domestic US feedstock at a lower price than global So it's actually effectively a

subsidies to two refiners. Now, now, what they're discussing and what's been kind of floated around from some of the you know leaks out of the out of the White House and elsewhere, is a potential ban or at least um limiting and cap on the export of refined products. Because while the US you know, does you know, have all of these kind of you know, imports and exports,

it is actually a net exporter of gasoline, diesel, etcetera. Uh, and that is you know, and a lot of that goes to Latin America in particular and elsewhere, and banning that in particular would be you know, rescipe for a diplomatic crisis. Um, A lot of allies depend on that, and it would just kind of, you know, it would further punish US refiners because right now, sure now they don't have a dis kind of feast stock, but now they actually have really you know, high value export markets

that they're exporting to. If you take that away, then it's really going to be you know, you know, a one to punch for for domestic US refining. So could you talk a little bit more about the mechanism for making this happen. So if someone says e s F for the Exchange Stabilization Fund, I mean I have a very very vague memory of it during the financial crisis, But what exactly is it and what has it been used for before? So the Exchange Stabilization Fund exists within

the Treasury Department. It has been used for a variety of crises. But the statutory purposes around UM sort of the commitments of the U S S of the I m F that promote UM stable exchange rates. So it could be in some cases very direct UM and even still with some controversy, say the Mexican Paso crisis, of the Treasury got involved made some short term loans through

the Exchange to Abalization Fund. It kind of got the moniker of being some uh a high discretion um instrument, but to support stable exchange rates In two thousand and eight, Hank Paulson, than Treasury secretary, used it to guarantee money market funds under the guys that stable money market funds would be better for exchange rates stability. I think that's

a pretty legitimate argument, but it is attenuated, right. You have to acknowledge that, like you're trying to like keep money markets and keep what was a brewing and actually spiraling financial crisis at the time um in place. Keep that in check. Yes, that did create exchange rate volatility.

Something between the two is what we're calling for in terms of it's well, it may not be uh directly in exchange rate intervention, the exchange rate and balance of payments struggles that are again right now brewing and growing. In terms of developing and underdeveloped countries, and in terms of sources for exchange rate volatility, commodities played a pretty big role, specifically oil and food. That's what really matters for import bills for a number of countries, and it's

where oil price spikes especially. We haven't really seen the big declines yet, but in terms of the supply risk from Russia and what the implications are like if you want to attack those root causes. There's a pretty strong case. It's a stronger case than the money Market Fund usage.

And I should also mention Steve Minuchen did pretty much the same thing, probably through slightly through sort of FED facilities using the Exchange Tabilization Fund before the CARES Act passed two to effectively backstop money markets through FED facilities using the Exchange Stabilization Fund. So we've used it for those three purposes. This is a little yeah, I said, less attenuated than that. It's within the discretion of the statute.

And I would say you can make a very strong case that supporting stability and supply demand balances and reduced likelihood of price bikes in key commodities can be very justified and legitimate. And at this point the Treasury has two or twenty one billion in that account with the

ability to actually use it pretty flexibly. I think there are a lot of people who will shutter at the notion of using it for this purpose, but I think it's also time when we really need to think seriously about what the supply implications of supply risks are on

exchange rates and financial stability. Let me ask you another technical question about your plans so the implicit is you how do you de risk production now, because as Rory pointed out, the shape of the futures curve can tell investors where they can hedge in or what what the market is paying for eighteen months out, and it's not as attractive as spots. So the price that we see on the screen hundred and ten West Texas isn't necessarily the price that investors could get. And so, okay, you

want to raise that. You want to lower the short end, which is what retail pays the pump, and you want to put some put a floor under the long end so that investors so that companies will produce more. And that creates that sort of like you get that supply response, Where do you price that long end? So you're talking about the idea of like you're the government can give a put and so de risk production. How do you

price that? And what kind of like what is guaranteed If I'm an oil company and I'm looking at this plan, what is like the sort of like exact economics that the government is potentially offering me here in order to drill more and produce more. There are advantages to sort of doing a forward contract that are made in terms of simplicity, right, it's just look at the forward curve

and try to use that to price. And I think that's that's a pretty helpful and legitimate way, as Rory laid out, and we laid that under an original proposal that this is something that it comes with at a you take a smaller profit margin effectively right when you lock in as a producer forward prices, but it's certainty and if you can leverage that up, that's still pretty valuable.

But as you've see, if you've seen the oil and the number of EMPs that have talked about lifting their hedges specifically they don't want the burden of locking in lower forward prices when they could ride high right now on current spot prices. And so for those that are have free cash flow and um are not capital constrained, so they don't really have a need for financing and they have enough for pain earnings to accelerate investment as they so wish, they may not be as interested in that.

I think they would still be interested in sort of downside price protections that they have the option, Like, optionality is valuable even if you are so let's say we actually don't know how long oil crude oil markets are gonna stay tight, if they're gonna get tighter for how long they're gonna get tighter like it maybe a year and maybe a few months, Maybe it's um it's multiple years. And in that environment, if spot prices are high, you

can still sell at high prices. But if prices crash, and that could happen because of recession, that could happened because of OPEC, that could happen because of maybe an electric vehicle adoption. Right, there's all those certainties that are very real, and I think all the major CEOs are getting those questions from their shareholders and internal management of

what do we do in those environments. Well, if you have if you have actual um downside price protection and price risk is my farther the biggest risk to really think about in this industry, then I think it's it's a pretty valuable thing to have and say, Okay, we can actually accelerate some investment in exchange for having the side assurance that you need so to me to actually

make that financially viable. So the optionality is kind of critical, and I think I've talked at least a few people who work at MPs and kind of understand called the financial map here to a degree that's suggest Yeah, the optionality is valuable, even if I'm not someone who hedges in terms of forward contracts. Um it doesn't solve every problem in the industry. There's obviously other things that matter, but I think this is getting out a pretty key

source of uncertainty and risk. I have a non technical question. I guess it's a question about optics, which I've increasingly come to realize are very, very important for the way

policy is actually made. But when we talk about the Biden administration essentially providing a backstop or a way of incentivizing further oil production, that just seems to be such a massively different position to the way Biden came in, where he was basically saying we're going to really crack down on the fossil fuel industry, We're going to encourage renewable energy, UH, turned down emissions and all of that.

How do you how how do you manage the optics of moving from a clean energy policy to a policy where you're essentially incentivizing or trying to incentivize more production of fossil fuels, like the principle of resilience is an important one to keep in mind that actually we need to walk into gum here because we did have a huge geopolitical shock. Um. I think there are certain stances that were likely taken because it was politically convenient during

sort of primary election season. But the world has changed, and their stances should be willing to adapt to the current moment. Especially Uh, it probably was too far to begin with to say that, Okay, we're going to sort of block leasing and block sort of need certain try to keep investment down in the oil industry in the US. And at the same time, it's also what it's saying, like you can just say the world has changed. I

think that's that's okay, and that's like, why is it okay? Well, one, this kind of oil price futility is not actually very helpful for a lot of reasons. But it's social stability, whether it's even stability for the energy transition, because in the end, metrochemical products are also relevant for that purpose. And so if oil prices spike because Russian supply rapidly comes offline, that's gonna have a lot more economical locations

and just about the price at the pump. So stability is good, and in stability in a way that's actually preventing price crashes is actually i'd say more in the spirit of trying to adjust consumption patterns for the better.

So if you're providing the kind of price insurance I'm talking about that prevents the sort of price crash scenario in which we see gratuitous oil consumption and also one in which industry kind of gets financially cleaned out, So we should those are the kinds of things that I think admission should see clearer eyes and try to be

able to bridge that gap. But it does like we have to walk into gun here, and I think that's something that if we don't, we're gonna have these really messy handoffs between oil and gas to whatever the future of sort of clean energy ends up being. And you can make those investments just but those latter investments in clean energy do take time. The technology is still in certain and certain dimensions, and so those things we should not expect those things to come online and somehow displace

oil and gas instantaneously. The technology and the production structure is just not there yet compared to the timeline it takes to be able to ramp up and ramp down US oil production, which is like uniquely, it's such a unique phenomenon in terms of geology and technology coming together to turn what was once long dated investments that had

to happen. Are now on a much shorter cycle in terms of it takes about i'd say nine to twelve months before when you see the rig counts going up to when you see production going up um up, And if you think about the decline rates itself also are lower, higher in shale as opposed to the past. So these are sort of unique opportunities to really thread that needle. I unfortunately don't think that there's really been a lot

of serious movement administration towards making threading me needle. Let's bring in another dimension, rory of some of the condistrants that's getting a lot of attention. And you already hinted at this refining capacity. What's the problem? What where did it go? And can you just sort of give us the sketch stress of like why the refining aspect is

difficult right now? Yeah, So I've been in the industry over a decade now, and the entire time prior to this year, refining has more or less been a boring kind of backwater of the overall oil industry in that it has been chronically oversupplied, over capacity and margins have been kind of generally bad. Um. Mix that with the fact that you know, having a refinery is it's a very highly polluting, emitting facility. A lot of communities don't

want them around there, you know, typically very old. You know, the classic refrain is that is that there hasn't been a new, major green field refinery built in the United States since nineteen seven, which is a very very long time to go without kind of new facilities. All all of the capacity growth we've seen has basically been bolted onto existing facilities. So and just to put in perspective

the extent of the crisis we're currently facing. Normally, crack spreads or what we'd or refining margins the difference between the price of crude oil and the value of the

refined products themselves. Normally that's you know, gy rates between you know, ten and twenty dollars a barrel, So on top of the price of oil, consumers are paying that ten to twenty dollars a barrel of refining cost essentially at the pump that is currently at you know, in the United States between five dan seventy dollars a barrel, so you know, three three and a half times normal. Uh. And that's why while oil prices are are very high,

consumer pump prices are exceptionally high. Uh, you know, highest by a long shot through history. And that's a big part of the reason why. So there was this It was it was generally undesirable to invest in new refining capacity for a whole bunch of reasons, particularly in the West, uh, North America, Western Europe, et cetera. At the same time, you you had this capacity pressure from a lot of

particularly emerging markets. Um. You know, areas in Africa. There's a major refinery that's been coming online for a while now in Nigeria. And the other areas that you have a lot of capacity coming online are China and India, where you know, a lot of the incremental demand growth is expected and they're gonna be very new, highly sophisticated refineries. So they have been putting this pressure, and you saw

this kind of tidal wave of capacity coming online. So everyone was slowly winding down or at least you know,

disinvesting from the refining assets in the West. Um, and then that you know, uh, that trend was pushed into overdrive during the initial bout of COVID, when obviously demand completely collapsed and everyone was like, Okay, well maybe we're planning on, you know, retiring this facility in a year or two, let's just do it now, because this seems like a terrible time to kind of try and hold

on when we're so close to the end. So I think what's really happened, unfortunately, is we have this capacity coming down the line globally, and then we had this bridge of these kind of old facilities that we're going to kind of get us across the finish line, and that bridge is more or less been collapsed by COVID, And now we're in this period of exceptionally high and exceptionally volatile refining capacity constraints that have been pushed into

further overdrive by things like the Russia shock, because in addition to being a major export of crude oil, Russia is also a major exporter of refined products, mostly kind of um, you know, partially refined feedstock, but also diesel.

And finally, the other thing that's kind of come all together at the same time here is that China is also normally a fairly large export or refined products, but for a variety of domestic reasons, one of the most notable ones being a stated intention to reduce the emissions in China, they've actually been running their refineries less hot and basically banning exports, not not fully banning, but drastically restricting exports. So I think we're looking at what can

be done. One of the easiest things is to try or one of the simplest things, theoretically would be to try and press Beijing to loosen those refined product export restrictions. Alternatively, the other thing, and we've been talking about policy options here. One of the policy options that has been generally been kind of derided, I think by the industry, but I think is actually pretty interesting is this idea floated normally associated with with Secretary Yellen um of a buyer's cartel

or a price cap on Russian exports. And this would be effective a way of saying, okay, instead of having full blown kind of Iran style secondary sanctions on anyone purchasing Russian exports, you will only sanction barrels that are purchased above a certain price threshold so that you can still reduce pressure, or you can kind of reduce pressure on the overall global price system, will also still depriving

mos Cow of you know, war revenue. So I think this is this, you know, we're trying to find all these different ways to address this situation. I think the same general philosophy could be applied to refined exports from Russia as well. So one of the criticisms of government intervention in the market has always been that it might inadvertently end up exacerbating booms and bus versus actually smoothing them.

And we've seen this dynamic a number of times um in places where there is a lot of government intervention, and I'm thinking mostly of China, and one of my favorite examples there is the government trying to smooth out the pig price cycle post African swine fee verse. So, you know, prices went up because there was a shortage of pigs, and then the government tried to ramp up pig production and prices collapsed, and everyone who had decided they were going to become a pig farmer and expand

their pig production facilities suddenly was losing money. So I guess my question is, how do you actually how do you ensure that these types of support measures smooth the cycle rather than exacerbate them on the way up as well as on the way down. I think there's a

way that you can. I mean, the issue here is that we're in an acute crisis today, So I think there's this question, Like there's an example, for instance, of a over a hundred year old refinery in Texas that is slated for retirement next year, and the kind of estimates I've seen or that it would cost three billion dollars to get it up to kind of get it back to some kind of you know, reasonable state for operation.

And while three billion dollars is obviously a tremendous amount of money, when the overall kind of consumption base globally and particularly the United States is paying like I was saying, kind of three to five, you know, three to four times the refining margins, it's very easy to cover, you know, the economic impact of of three billion dollars on that

scale very quickly. So I think I think the hope is that you can you can kind of get a short term stop gap solution that then you can kind of let the market take back over, because again we're mostly trying to uh combat the effects of this you know, exholginous shock of COVID that pushed all of and this is a classic theme on your podcast, especially of accelerating these pre existing trends and that had happened for you know, in the bad ways of kind of a wind down

in the industry. So I think the hope would be to kind of do something temporary as a stop gap.

And then also I think when we can start to think about things like a Sconda's proposal around the SPR, I think that is a way that you can kind of change the kind of operational concept of an asset like the SPR to be more flexible and more useful in all of these instances, because you're not if you're just shifting the shape of the curve, that's by definition not going to exacerbate booms and bus you are flattening

that booming bus. Just to be clear, Scanda, or is there anything the government could do right now to expand domestic refining capacity? Is other facilities that were recently closed that could be reopened? Uh? Is there are other facilities that could be expanded? Like is that what? What can be done there. So I think that because of the or finding as an industry, is very hard to sort of make a buck over time, even though and you typically have one or two years in which the bulk

of the payout really materializes. And so when you think about like the amount of duration in your capital structure, you need to be able to actually manage that. It's sort of you do need to I don't know, it's not gonna be something that's solved through uh sort of any kind of short term financing or anything like that. It's something that you do need to sort of directly

fund that. Some people may not like that, but that is something that if it costs three billion dollars, like, that's something that's, uh, that's got to be considered if you really want to kind of keep existing capacity online. There's there were a number of refineries that were closed in the last five years. So this has been a sort of secular phenomenon and not nothing really related to the political cycle to the extent you can. It's it's not easy to be able to turn on an existing refinery.

You should really have an engineer on to talk about what it would take. I've talked to a couple of them who have talked about effectively restarting a refinery in certain countries, and it does take time, it's not impossible.

It could be on a timeline that's stills relevant for sort of bridging the gap between where refining capacity is now and where it likely will be in a few years when, especially in emerging markets, we see refining capacity emerge, and so in that time there's probably something useful to be done. It's just important to be a little bit humble about it, and that there is a refining bottleneck,

there's only so much you can do. There is uh you can try to fund um some of the existing capacity and make sure it doesn't get shelved too quickly.

And probably there's stuff on the trades side where if China is sort of I don't know, I don't want to go too much into the motivations, but the fact that we're finding in a global refining capacity crunch and they've kind of intentionally decided to not run their refineries at quite the same pace that we're seeing in the US, it may be something to do there in terms of diplomatic and trade channels. So Joe and I were talking about this a little bit in the intro. But the

FED is raising rates until inflation comes down. Energy and gas prices seem to be a big part of rising inflation. What exactly is the impact of raising interest rates on oil and gas prices? Because on the one hand, you would expect raising interest rates to bring down consumption and reduce prices that way, and at the same time you would expect lower prices via demand destruction not to be

necessarily a good thing for encouraging future production increases. So how do you square the sort of the overall impact active rate increases on on prices here? Well, what's it really interesting here in particular is you know, even in years where we've had very serious recessions, like back in the you know, two eight nine financial crisis, you didn't actually see that much of an outright contraction in global oil demand. It's it's really more of a flattening typically.

Obviously in the beginning of COVID you did, but that was a very particular kind of recession and crisis. So I think theoretically what you would do is you would more or less buy time for supply to catch up, rather than bringing outright demand back down to the supply level. So it would help, but it would help in a very disruptive and kind of economic and socially deliterious way. The other irony here, like you were saying, not only are it would you theoretically, by bringing prices down, reduce

the incentive to invest more in new supply. But I think one of the things I was saying last time I was on the podcast was one of one of the things I think will drive eventual E n P reinvestment will be the performance of their of their equities. Um And what we've seen by this aggressive move by the FED has obviously taken a tremendous amount of air out of the overall market, but that includes oil and gas equities, which, while still performing very well, have actually

fallen back considerably over the past week or so. Um So that again, I think, pulls back in the wrong way. UM So, yeah, you could. It's one of the things that you could theoretically get to that goal, but in a in the kind of a roundabout and kind of deeply ineffective or inefficient manner. Yeah. I'll just talk on two key mechanisms to I think about here. One is, even though the price of oil in the US has

obviously gone up quite considerably. It's actually much higher for countries they're not going to back to the dollar, right so that they actually the dollar effect, so we dollar appreciation that is effective. The oil is much more expensive, has actually increased even more in a number of developed and developing countries. And so that's one part of demand destruction where it's actually the burden for other countries and not the US through some of the fed's actions and

the FEDS forcefulness right now. And so that's that's one part of it. The other part that I would just highlight is, yes, maybe the FED tightening at the margin leads to lower inflation and lower prices through some sort of demand channels, but it is going to cram the supply side to in the process. Because every single E n P is probably getting the question, now, are you sure that your capital plans can withstand recession, especially since

like the return performance has been so poor. And I think that's a very rational question, and it's one that I always say. The Fed's pretty much encouraging them to ask this question, which it's I guess maybe it's solved some sort of big macroeconomic inflation challenge if you push it hard enough, like Vulker, but it's actually not good for the supply side responses that they claim to be hoping for because at least to greater reluctance to invest.

So this is where I was gonna go, Scander, I mean, big picture, You've been really sounding the alarm pretty intensely on this topic for a while. Why the urgency? And I just wanted like, like, how big of a deal is it? What are the stakes that we're talking about if this sort of if there isn't a way either through industry or public private relations to get the oil price down, like just sort of lay it out. Why this is so urgent in your view? I think it's

so urgent. And obviously we are a think tank focus on full employment and yet we're start of talking about oil and policy. It's that oil price shocks are macro economically relevant. Commodity price shocks are macroeconomically relevant, and they can actually lead to greater business cycle in stability and over time, if that instability is not managed, leads to recession,

higher unemployment, slack labor markets that are bad for everyone. Look, there's a lot of there's there's two channels I think are really important to think about. They're both very highly salient to this current moment. One is even like, let's leave aside the FED for a second, oil prices going up if oil prices spike further from here, which I think there's clearly a scenario with second materialized. That is one in which you will see more consumer spending be

dedicated towards price at the pump food. These are the areas where we've seen like if you say commodity price pikes in general, but I'd say the elastic sectors and

so nondiscretionary that takes away demand from discretionary sectors. All else equal, consumer discretionary sectors is where there's actually a lot of labor that's also tied to it, so we'll see employment demand at risk of attorney the other way where we actually see that um there are layoffs potentially in those sectors, and that itself is important and it's something that I think a lot of people say, well, the U S is a net oil exporter now or a net were energy independent, and yet it kind of

misses the fact that the elasticity of investment in the

energy sector has really changed. Again. I remember in sixteen everyone was very bullish on There are a lot of people who are in the economic space who are very bullish about the economies, like low oil prices is good for the consumer, while missing the fact that actually it was fixed investment that was um rapidly declining because of oil prices declining, and there's a high elasticity at that time, so the elasticity of capit capital spendatures to the price

of oil was exceptionally high sixteen and those macro implications almost led to a recession. The FED ultimately backed off their sort of hiking plans, and I think that was actually pretty critical to keeping the expansion alive, but it was largely missed by the FED by most I would call it. I'd say the Bomb administration and most of sort of the main economists at the time who are

focused on this. I thought it was going to be actually a big consumer benefit and a big win, but it really acquired the FED to back off their hiking plans for business cycle stability to materialize. Now you're seeing the opposite where actually the elastic city has gone down.

So expecting a big capex boom in the energy sector to offset whatever is happening in the consumer discussionary sector may not happen, especially because yeah, we've seen that rig counts have not increased at the same pace as you would expect an oil prices, You're not going to see the same fixed investment boom that you might have otherwise expected or seen in prior oil price increases, and so

that is a self resource of instability. The second part is what the Jaypal effectively admitted, which was that oil prices do wait on their thinking now that they are thinking about energy inflation and whether that actually takes them away from their target for longer. And that kind of plays out through just oil prices going up and then the FED just responds, but also like there are going to be growing pass through issues that we need to

take seriously. Passed through from the price of diesel to the price of retailed goods is a tricky thing to model. It's sort of sometimes it shows up and sometimes it doesn't. But typically the bigger the price pike, the more non linear the response um, and the more likely you see passed through materialized. So we're kind of flirting with a lot of risks in this direction, and the FED re responding to those risks with tighter policy is more likely

to translate into sort of recessionary financial conditions. Rory and Sconda, so great to have you both, huge topic, great conversation. Thank you for coming on odline. Thanks so much. Thanks for traving that great Tracy. I thought Scanda's answer there, you know, setting aside how you elicit the price, the supply response, the steaks are really hot, totally. You know what.

I had an epiphany over the weekend which was basically that everything everything comes down to cycles, right, and booms and bus and we always overshoot going down and then undershoot going up. And it just feels like people especially have a tendency of internalizing whatever their last experiences, which means that everyone reacts very slowly to a changing environment, which is why I think it's hard to incentivize more production than things like oil and gas or lumber, which

we've spoken about before, infrastructure everything like that. Well, I was thinking about this after our last episode with Peter church Second, which is like, okay, like we had this sort of like if you think about like a game theory matrix in we had this like really like good one for consumers where there was a lot of incentive, especially after to pump more even though it wasn't that profitable.

And you know, I was thinking also like that was like you could say that was the state of housing pre Great Financial Crisis, Like that's what we had like two thousand three to two thousand seven hre just like this massive increase in like home building, etcetera. And we've never been able to get that back. We've never had like a big home building boom outside of those years.

And so you know, we had this like huge costly oil and gas boom from through It's gonna be really hard to get that back with respect to oil and gasoline. But in the meantime, the costs are very high, the risks are very high owing to the effect on monetary policy or you know, just consumer buying power. Right, So you could see why you might want the government to come in and try to smooth these boom bus cycles a little bit. But on the other her hand, you know,

I asked that question about optics. You know, it comes down to that, and I think it's going to be very very hard for the administration to sell something that's basically you know, we're going to subsidize or incentivize oil and gas versus something like a tax holiday on gas, which is much more i think politically pleasing because you're aiming that at consumers, right, I mean, it's that's still unclear to me whether there is a significant force within

the administration that actually like wants increased production. It's I think at this point there is, but it's tricky. I think there are other things that maybe don't move the needle as much that are more politically popular, like the idea of a gas holiday, but in terms of like will we use public money to subsidize in backstop energy producers, still seems like politically a tough sell. But again, steaks seem pretty high. Yeah, alright, shall we leave it there.

Let's leave it there. This has been another episode of the All Thoughts Podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Hallaway and I'm Joe wi Isn't All. You could follow me on Twitter at the Stalwart.

Follow our guests on Twitter. Rory Johnston, He's at Rory Underscore Johnston, Sconda, Amerdath at Irving Swisher, follow our producer Carmen Rodriguez at Carmen armand followed the Bloomberg head of podcast Francesca Levy at Francesco Today and check out all of our podcasts at Bloomberg under the handle at podcast Thanks for listening.