Russia's invasion of Ukraine has kicked off a giant mess in the world of commodities and sent prices surging. Commodities trader Pierre Andurand has made his name from navigating volatile energy markets, correctly positioning for negative prices oil in April 2020. Now, he sees tightness in the energy market staying for some time. On this episode of Odd Lots, he tells Joe Weisenthal and Tracy Alloway how we might end up getting $200 per barrel crude oil by the end of the year, and what that would mean for the world. Transcripts have been lightly edited for clarity.
Points of interest in the pod:
Joe mixing up backwardation and contango – 3.14
Andurand’s positioning before the invasion - 6.08
Potential for a squeeze higher – 9.39
Why production can’t just ramp up – 12.42
On metal prices going up and renewables — 16:14
How high could oil prices go? – 25.00
On OPEC’s role in production — 30:10
On the dollar’s reserve status — 33:22
On shale and underinvestment — 37:20
The economic cost of higher oil prices — 41:24
Tracy Alloway (00:00):
Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal: (00:10)
And I'm Joe Weisenthal.
Tracy: (00:11)
Joe, have you looked at the price of oil recently?
Joe: (00:14)
No. Is it doing something? Has oil been moving lately? I don't know. I haven't checked.
Tracy: (00:19)
You hadn't noticed? Yes, it has. I think, you know, we're recording this on March 10th, but just in the past couple of days, oil spiked almost 20% and then came down by almost 20% as well, the next day. So just incredibly volatile times for commodities across the complex.
Joe: (00:37)
Yes. In fact, I think within the last week we had both the biggest up day for the Bloomberg Commodity Spot Index since 2008 and the biggest down day. For the same index since 2008, unreal volatility, because you have the combination of an extremely tight market across the board, combined with geopolitical events that of course are inherently uncertain, nonlinear and unpredictable.
Tracy: (01:02)
Yeah. And you kind of have to wonder what it's actually like to be trading commodities at the moment, because not only do you have this massive price volatility, but you also have everything that's going on in the background with financing and exchanges, them having to deal with this intense volatility and sometimes, you know, canceling trades, which is something we saw from the London Metal Exchange. Financing has become an issue. People taking physical delivery of stuff. Is there actually going to be enough to settle some of these contracts? There are so many questions around the space right now, in addition to actually what's going on with Russia and Ukraine.
Joe: (01:41)
Yeah. The degrees of uncertainty or the vectors of uncertainty, just because there's the pure price question. Then, as you mentioned, the physical availability, the ability to move the oil, the interaction between oil and sanctions or self-sanctions, unbelievably complicated times.
Tracy: (02:00)
Yep. Well, I am very pleased to say that we are going to be talking about all of this with really -- I know we say this all the time, but really the perfect guest -- someone who has basically made a career out of trading oil and other commodities at very volatile times and has been very good at it in recent years. We're going to be speaking with Pierre Andurand, the founder of Andurand Capital Management, a big commodities hedge fund. So Pierre, thank you so much for coming on.
Pierre Andurand: (02:27)
My pleasure. Hi Joe. Hi Tracy.
Tracy: (02:29)
Hi. So I'm trying to think where to begin. But maybe we just ask you how have the past couple of weeks been for you?
Pierre: (02:36)
Well, I mean, it's been a lot of work. I mean, clearly it's a market that's driven by geopolitical events. There’s been a lot of reading trying to understand, you know, how the war will pan out and the kind of sanctions and that will happen. And that’ll keep on being added every day. So it's been, you know, lots of work and very stressful and also obviously very sad to witness that we have such a war now in the 21st century. We don't expect that, you know, we don't, clearly it's a very unnecessary war and really tragic. So there's a lot of emotions and a lot of work and a lot of stress actually.
Joe: (03:14)
So obviously we've seen this incredible, well, we've seen this huge surge in the price of oil. That goes without saying, this steep contango which signifies the market is extremely tight. Are there any historical periods, maybe let's start there. How novel does this feel in terms of the market or is does it feel like the sort of general conditions are something you've seen before? How much is everyone in new territory here?
Pierre: (03:43)
Yeah, I think it's a new territory. I can't speak of an event that was similar over the last few decades, really. So we started the year alread with very low inventories with the low spare capacity in the hands of OPEC and in general, low production capacity, spare production capacity, low expected supply goals and, high expected demand goals, thanks to, you know, the recovery from COVID. So we already started the year before the invasion with very, very strong fundamentals and the level of inventories very low, the level of backwardation. So actually, you know, the stronger the backwardation – backwardation means the front-end contracts are much higher than the back-end contracts -- and it means that the market is very tight physically. So we were already at two dollar a month backwardation before Russia invaded Ukraine and like between $4 and $5, depending on the day, for the first three months.
And gas went to crazy backwardation. At some point it was above $50 a barrel in one month, you know, between the March and April contracts. So we've never seen this type of backwardation and such a strong physical market. And it's only the start, you know, so far there haven't been massive disruptions yet. It's just the fears of how the sanctions will bite that keep the market tight. So it could be only the beginning. It could be the end, right. We don't know, it makes it difficult to make strong calls.
Joe (05:02):
Wait, Tracy, did I say, contango or backwardation in my question? I always slip and say the wrong one, even after all these years of trying to memorize it, but I do know that the front month oil is far more expensive than the oil further out.
Tracy: (05:27)
I only remember the term because of that buying a barrel of oil piece and trying to buy a barrel of oil back when it was contango, and we could all store it under our beds and wait for prices to increase. But that is not the case anymore. We are firmly in backwardation. Let me ask a very basic question, which is, I feel like your fund is often described as having bullish bets on commodities, but I actually don't have a very good grasp of what those look like. How do you actually invest? Without revealing all of your trades and your book, but how do you actually invest in commodities and what did your positions generally look like going into the recent turmoil?
Pierre: (06:08)
Sure. So actually, you know, I'm quite agnostic to, you know, over time if prices go up or down, so I'm not a producer of oil. So for me, I just, you know, study the fundamentals of the market. I study growth of demand relative to the growth of supply. And as a result, you know, have an idea if inventories are going to go up or down and what kind of price would actually balance the market so that we don't run out of inventories or we don't run out of storage to put that inventory in. So actually, I've not always been bullish. You know, there are periods of time where we had big bearish positions, such as second, half of 2008, we were short the end of 2014. We were short all of 2015. We were short when Covid started, we were short down to negative prices.
So I've not only been long, right? We had periods where we were long, periods where we were short. So for me, I'm trying to make money from the large moves in the oil market. So it means that sometimes we'll bet that price will go up for sometimes, for a few months or a few years. And sometimes we'll bet they go down over generally a few months, potentially like a year even. So to bet on oil prices going up, I mean, what we do is we’ll buy, if we think that if we have a bullish view on the market, meaning that we expect price to go up, what we do is that we buy futures. So for example, Brent futures or WTI futures, or it can be heating oil or gas oil, or gasoline futures, and we'll pick like months, for example, if we want to be long the front month contract.
So for example, at the moment it's May Brent, or if we want to be long a bit more on the curve, for example December Brent. And we also trade with options. So generally, like we don't sell options, we’re either flat options or long options. So meaning that there can be longer calls or longer puts, but I'm not going to be short the call or short the put. And so when we feel like the market's going to, you know, make a big move in a short period of time, then we'll prefer to express that view with options relative to futures. It's a way to have more leverage and have less risk.
Tracy: (08:30)
But you don't trade physical? Or presumably you would always try to avoid taking physical delivery of, you know, a tanker full of oil?
Pierre: (08:40)
Sure. We don't do physical. I've never done physical. I understand the rules and how it works, but it's mainly to understand how it can impact the pricing. But I myself never took delivery or get delivery of physical oil.
Tracy: (09:05)
It feels like the market at the moment, you know, obviously the commodity space is very financialized. There are a lot of traders such as yourselves who deal in these things, but it feels like the physical is becoming much more important. And I've seen some people talk about the potential for a squeeze in the April contract, you know, sort of the reverse of what we saw in March or April of 2020 when oil went negative. Maybe there won't actually be enough oil to deliver into these contracts this time around. So I'm just wondering how you're thinking about how the physical relates the actual trading at the moment?
Pierre: (09:39)
Well, it's really important to understand the physical because it's what's going to drive the price of oil. So for example, let's say during the Covid times when the demand suddenly collapsed 20% overnight, we built a lot of inventories over a short period of time. And, you know, the infrastructure of the market, you know, was not built to withstand those kind of events of losing 20% of the world's demand overnight. So the level of empty storage actually could only take one and a half months of this really low demand before all the tanks were full. And so in April, 2020, when all the tanks were full, basically if there’s still some production that needs to be moved. Nobody can buy that oil and that's where prices can go negative.
And as you say, when we’re in the opposite scenario where inventories are very low and there are places in the world where a delivery of certain contracts, such as Cushing in Oklahoma for WTI, where the tanks are all empty and there's no oil in those tanks anymore. If somebody is long futures and tries to take delivery of oil at that place and that point in time, well, nobody can deliver, and then you can go to any price. So generally what happens is that's where the kind of so-called speculators are in the middle to help make the price move enough so that we're never in a situation where either the tanks are full or either the tanks are empty. So it means, somehow it means, you know, that prices have not gone up fast enough and for long enough to either bring more extra supply or actually reduce demand before we run out of inventories. And that's where sometimes people wonder, you know what is the role of speculators? I mean, it's actually price discovery and also giving the right signals to producers and consumers in order not to run out of storage capacity or not to run out of inventories, because then prices can go anywhere, right? If somebody has to buy the oil at any price, you know, you could go to, you know, $500 a barrel backwardation, it can go anywhere. So that's where generally what the price should do. The price should move in order to keep the inventories within kind of in range that makes the market function.
Joe: (12:17)
Let's talk a little bit more about the fundamentals themselves. And there's a furious debate, obviously in the U.S. context in particular, why we haven't seen a more aggressive ramp up in drilling and exploration such that we get greater supply. Why haven't we in your view? Because we've had other theories, but what's your explanation for why we haven't seen a more aggressive supply response?
Pierre: (12:42)
I think there's two reasons. So the first one is that already all the, I mean, a lot of the easy oil in the U.S. has been drilled. You know, generally when you come with like a new field, a new basin, well the producers will drill where it’s easier to get the oil and over time they'll get where it's a bit more challenging. So I would say that now, U.S. shale has been producing at scale for 10 years and there's still room, you know, for another10 years of also strong supply. But I'm not sure there's room for, you know, many decades of high production and definitely high production goals. So some of it is due to the fact that the fields are getting a bit more mature.
And another reason is also because, you know, a lot of the shale oil producers in the U.S. have lost a lot of money, they’ve been focused on raising production over the years, and taking some debt against it and actually not being profitable. You know, most of them lost a lot of money at some point. The whole industry had burned through $600 billion of cash and the shareholders had taken a big hit. So producers, like production was going up in the U.S. but the firms were not profitable. Now they start start to be profitable. So now finally at current prices, they get positive cash flow and good profits. And the shareholders of those companies pressure the CEOs to not grow production too fast, because if they’re going too fast and prices crash again, then they can lose money.
And also there is some pressure, you know, for climate change, basically not to grow supply too fast in order to find a solution and replacement to fossil fuels in terms of supply actually. But the issue is, you know, there's been a lot of work on pressurizing those companies not to grow supply too fast or even to have production decline, but there hasn't been a lot of work in giving a solution for the consumers, right? To have another choice but to buy oil. So, okay. We have more electric cars every year and that will carry on going. But then the electricity that is being used for those electric cars has to be produced. And that depends where in the world, some of it, some of that electricity is still produced by coal or natural gas -- still by fossil fuel. And some of it is renewable as solar and wind, but we need basically, now the issue that we have is some shortage of electricity and oil. So it's a bit tricky, you know, I mean, in the U.S., you have a little less of the problem. I think in Europe, it's a much bigger problem where, you know, if we were to replace a normal cars, you know, gasoline or diesel cars by EVs, there’s not enough power to charge those EVs. So we have an issue, at least in Europe, in finding a solution for power supply. Yeah.
Tracy: (15:41)
Yeah, how are you actually thinking about renewables at the moment? Because I know, I think, you were quite bullish on emissions-related credits, so basically making a bet on decarbonization. But on the other hand, you know, in the past couple of weeks, we've seen a lot of people, including some people who have been on this podcast, talking about the idea that renewables are not going to be able to ramp up enough to replace lost supply from the Russia situation, and that actually we might have to, you know, stick with traditional oil and gas for longer than perhaps some people expected.
Pierre: (16:14)
Yeah. I mean, you know, this Russian situation was not expected, right? So the plan in terms of decarbonization was to grow supply of renewables every year by quite a large amount, and to have a growth in EVs. So basically you have more power supply coming from renewables and then you have more EVs and then you have the electricity to charge those EVs and it's all good. The issue... So basically the plan is for like 20 year transition. So where you have more EVs every year and more renewable power. That's something that can on long term basis, yes. But it cannot, you know, change overnight. I mean, it takes time to build solar panels and windmills and to build enough EVs and enough charging stations and all that. One issue that we've been aware of on our side for quite a few years now, is that the growth of supply in metals is not going be large enough to build as many EVs and to electrify the world as fast as we'd like, because the miners have not invested enough.
So, you know, miners also, they have been under pressure not to mine because of, you know, the ESG pressure, but then it means, okay, we're not gonna get enough metals in the medium- to long-term to build the power supply with renewables, because that takes a lot of metals. It takes a lot of metals to build renewables and then a lot of metals to build batteries. And the EVs take a lot more copper. And we won't have enough of that in the long term. So that's a long term view already. The challenge, I think metals prices will have to go up a lot in order to incentivize enough supply growth to be able to decarbonize the world over time. Now, if we lose, you know, 5 million barrels a day from Russian oil overnight, we can't have suddenly a lot more power coming from renewables overnight, and a lot more EVs overnight.
It takes time to build on that. So it's already at capacity. So there's nothing that can really change in the very short term. So I said, to replace Russian oil say over the next two years, what we can do is, so let's say if we are losing 4 million barrels a day of Russian oil for the next two years, we can replace, I guess the Saudis and Kuwait and UAE could potentially increase production by one and a half million barrels a day. They will not do it before they understand that the Russian oil is out and will not come back anytime soon. So they will do it preemptively, but I believe they will increase production once that Russian supply is out of the market. And there's visibility on how much and for how long. So I believe they can bring one and a half million barrels a day, which is not high by historical standards, but it is something.
Tracy: (19:06)
Is that your gut take? That the Russian oil that's been taken out of the market is gone for good, or at least for the foreseeable future?
Pierre: (19:13)
It'll depend, you know, if we're gonna have some kind of regime change in Russia. So for me, it's not only about the ceasefire, but I still think that the sanctions will stay on Russia until the West can feel like they can trust them and that they will not go attack another neighbor like a few months later or attack NATO countries. So I think there needs to be, once it's over, there will be a trust that will be regained. And for that trust to be regained, I don't think it can be with the current regime. I mean, you can't go from being scared of them, you know, using nuclear strikes and using chemical weapons and biological weapons to suddenly negotiate and give them money again. So I think there will need to be a regime change in some way with a regime that we feel we can trust – we as in the West -- before the sanctions are lifted or at least a big part of, of the sanctions are lifted.
So, in that way, I think, yes, we could be in a situation where we will lose Russian oil for some time until there's a regime change. But let's say if there's a regime change in one week, I mean, I think it's unlikely but you never know, then, and if we can have good relationship with that regime, then we could get the Russian oil again in a few months’ time. So it's very, it really depends on how it's going to pan out. But I don't think that suddenly they stop fighting, the oil comes back. It's not going to be the case. The oil’s going to be gone for good.
And even though only the U.S. put sanctions on Russian oil – the U.S. and UK, for now you can still buy it and the west of the world, there's a lot of self-sanctioning going on, right? So a lot of the refiners, you know, they don't want to be facing a PR disaster if they buy Russian oil. They don't want to contribute to, you know, financing a war on Ukraine and potentially Europe and the rest of the world. So there's a lot at stake here, right? It's a lot, it's about trying to avoid world war three, and we have to understand that there’s going to be cost to pay. So I think, you know, there's some issues as well with insurance. So being able to ensure the ships that go take delivery of the version oil, there's PR disasters. There's also a financing issue where no banks want to give letters of credit.
Even Chinese banks don't want to give letter of credit to for Russian oil cargo. So even though we don't have formal sanctions yet, from the EU in practice, not everybody can buy oil and there's a lot of logistical issues as well. And that will probably last for some time. So I think in the next few weeks, if that's still the case, Russia will have to stop production because they will run out of storage capacity at the ports. And so basically they will need to cut production by two, I think 2 million barrels a day, potentially 3 million barrels a day. And then it takes time to bring that supply back. You know, like, if tanks are full at the ports, they can't carry on producing and, and that's it. Then we lose it for some time until there's like peace and a better relationship with Russia.
So I think we could lose definitely Russian oil for some time. Russian gas, basically Europe is very dependent on Russian gas. Natural gas, mainly Germany and Italy, and they’re working on some kind of war plans on how they could survive in case Russia [inaudible[ or could they actually, you know, reduce their demand so that they don't pay Russia as much money. And so there will be some kind of rationing potentially in Europe, like to bring natural gas demand down and they will look at what they can do to accelerate the energy transition. But that will be require metals as well. And Russia is a big exporter of metals. So it's not gonna be easy, but it is what it is, right? Like we have to find a solution.
But to finish my point about how Russian oil could be replaced, if we lose 4 million barrels a day for some time, let's say we get one and a half million barrel a day from Gulf countries, then it's two and half, 2.5 million barrel a day that we have to find. Some of it could be supplied by the global SPR. So the strategic reserves that the IEA manages, so some of it is in the U.S., but you have also a lot of OECD countries with SPR and they could release up to 5 million barrels a day for 12 months. So let's say they could easily go to 2 million barrels a day, let's say for, you know, two and a half years. But then that means that in two and a half years there will be, you know, all the SPRs will be empty and they will have to resupply the SDR. And I think we have to accept some demand destruction, you know, like we really have to save energy as much as we can.
And if we can't find some kind of government mandate and it's not easy to bring the demand down, mandate could be something like a confinement, right? Like we saw it two years ago with Covid. We had some kind of global lockdown, global confinement, that brought oil demand down by 20%. Here, if we just need to think of bringing oil demand down by 2%, it's not going to be as drastic as a global lockdown, but there could be either some government mandates to bring demand down or it will have to be coming from price. And then the price will have to be high enough to bring that demand down by one and a half million barrels a day or so.
Joe: (25:00)
So what is, right now, as we're talking Brent oil’s at $114, WTI’s a little less, what does that mean? Are these demand destruction levels, is there driving or flying or something else that is not happening at these levels, or does it need to go higher in order to really move the needle on the demand side?
Pierre: (25:21)
Yeah. So basically when people speak about demand destruction, you know, you can think of it in many, many different ways. You don’t really generally have such things as demand destruction for oil because you can't really replace in the short term, you know, driving your car by something else. So sure, some people will decide to walk or take a bike, but that's very marginal. Generally the car is used to do like longer distance and I guess some of it, there could be at the margin a bit more public transport and these kind of things, but it stays quite marginal. Generally what brings the demand destruction is some kind of economic crisis. I mean, you also have, you know, demand destruction in the sense that if people think the prices are high, maybe they'll use their cars a bit less for one or two months, and then they they'll get used to the new price and carry on using their cars as they were before.
So that's not really demand destruction, it’s just like a slow down in demand for one or two months, and then the demand comes back. And then it’s a question of at what price do we have a large recession that then brings, you know, lower economic growth as a result, lower oil demand. And that's generally what really brings prices down is when we eventually, and what brings demand down. That's when we have large recessions, so not small recessions, but large recessions. And that price will always depend on what economic environment there will be. So, for example, for 2008, we went up to $147 a barrel, which is equivalent to around $200 a barrel in today’s dollars. And, you know, at the time, we didn't see that demand was being hit. But when Lehman went bust and then when the financial crisis started, then there was a collapse of trade, of financing, and then oil demand collapsed as a result.
In 2011 to 2013, even like first half, like summer 2014, we had Brent was averaging $110 a barrel, which is equivalent to $150 a barrel in today’s dollars. And we had the European sovereign crisis at the time. And the economy could, you know, handle $150 of today's dollars for three and a half years, and I believe the economy today before the Russian invasion, at least, because we don't understand what will be, you know, all the impact going forward, could definitely handle more than $150 oil. So for me, I was expecting already prices to go above $150 before the Russian invasion. So I was already pretty sure, I don't think that all the move up in oil is due to Russia. You know, it's the acceleration of the moveent of the last two weeks is due to it, but we would've gone to those prices anyway and higher with time. It would've been a bit more steady, but it would have gone higher. So it means to me, the fact that we're only at $114 Brent now tells me that the market doesn't believe that we will lose this oil for very long.
Tracy: (28:42)
I mean, how high do you think it could go? And what level would be worrying to you in terms of demand destruction?
Pierre: (28:49)
Well, I think, like close to $200 a barrel -- so much higher than today. I feel like there's no demand destruction at $110 a barrel and we'll have to go significantly higher before demand can go down by enough. But that's also assuming there's no government mandate and some kind of confinement, where let's say two days a month, we are not doing anything. And we are in confinement for two days a month. I mean, there could be some solutions like that to bring demand down, but if there's no government mandate, then I think that around $200 oil will be enough to bring demand to balance the market.
Joe: (29:27)
Could we see $200 oil this year?
Pierre: (29:30)
Yes, I think so. Yes.
Joe: (29:32)
Can I just ask, I want to step back. You mentioned, you know, the potential supply response from Saudi Kuwait, some of the other Gulf states. I find it striking -- and we did an oil episode a few weeks ago -- that OPEC is no longer the first thing we talk about when we talk about oil. We always talk about the shale response first, whereas several years ago, if you talked oil, the first thing everyone would talk about is, well, what's OPEC gonna do? And now it feels like they're almost playing second fiddle. What is the politics at OPEC right now? And how are the OPEC leaders thinking about it? What is your forecast generally for how that group is going to behave?
Pierre: (30:10)
Okay. So first I was, you know, really impressed by the reaction in March/April, 2020 when the collectively, you know, agreed to cap production by 10 million barrels a day. Prices were very low, so they were struggling, but they got together and agreed to cut 10 million barrel a day. Otherwise we would've had negative prices for some time, you know, that would've led to a much larger collapse in the supply today. And then they stayed quite compliant over the over time. So even when prices were recovering in the second half of 2020, and then 2021, they were really careful about bringing oil back to the market. So they did it gradually, really together, really respecting the quotas that they put, very few countries cheated, if any. And what we noticed is quite a few countries in OPEC+ could not meet the quota.
Many African countries, they could not produce as much as what they were allowed to because of under investment. So over the years there's been like under investment that brought to bought the fields to decline. There was no fields coming and that production was going down. So that's why now there's only like a little bit of spare production capacity. I think around one and a half million barrels a day. You know, when I say spare capacity, sprea capacity is production that can be bought on and kept for one or two years. I think it probably, only Saudi, Kuwait and UAE and that's pretty much it. I think most of the other countries are at maximum. So in a way, because they could not, you know, their quota has been going up every month for the last few months, but their production has not because they don't manage to. So that's why I think it's, you know, we know that they can bring one and a half million a day. We'll probably get a deal with Iran, bringing a million barrels a day back, but that's expected by the market. And then you need more supply from the U.S., but that will take, you know, 12 months or so for the U.S. to be able to bring higher levels of supply than what is expected today for next year.
Tracy: (32:35)
One of the big picture ideas that's been going around at the moment is this idea that as sanctions are imposed on Russia, and it becomes clear that, you know, the dollar and the dollar payment system can be weaponized, to some extent, against Western enemies that maybe the dollar loses its position as a reserve currency, maybe Russia has to depend on gold. And I guess we're sort of seeing a return of talk about commodity money or money that is backed by an actual thing. Is that something that you see happening? And I guess more broadly, you know, gazing into the future, do you see a world that is more tied to commodities or less tied to them given the kind of volatility that we've seen recently?
Pierre: (33:22)
Sure. So first about the currency and the potential, you know, loss of reserve currency for the dollar. I think it's overstated. I think country had a currency back to gold or something, well, the Western world could still sanction that currency, even if it's back by gold. So, you know, even now like Russia is having gold in reserves, where do they keep it? You know, maybe some of it could be frozen as well, even though it's gold. So it doesn't necessarily save you, even the same for cryptos, right? Like cryptos, some people think it's a store of value, but when things get really bad and if you have no power, what happens to your crypto and you can't really use it either. So there's always some situations that are difficult, but I would say currencies in genera, it's always gonna be countries that have a strong rule of law and trust and a strong financial market that will be able to have a strong currency.
So for now we have that in the U.S., in Europe, in Japan. And then when you look at China, there's still a lot of capital controls. And it's not a consumer economy, they export a lot. And so they hold a lot of U.S. Treasuries. So they are dependent on the U.S., right? So I think to really have a strong currency, and that's what those countries don't understand to more autocratic countries, is that if they don't have enough freedom and low enough level of corruption and, you know, enough entrepreneurship and a strong rule of law, then they will never be able to have a strong currency.
So then we go into commodities. Okay. If people are worried about the value of currency, because there's potential, you know, high inflation then, I mean to protect oneself against high inflation, you have to be long a thing that the world needs. And, you know, some people think that we need cryptocurrencies, but no, it's not something we need. It's maybe nice to have for some people, but it's not something we absolutely need. What we need is to be able to eat and move. So it's energy, it's energy, it's agricultural products. It's food, it's metal. So these are like the old school commodities that first people should be, you know, should have enough exposure to in order not to be hit by inflation too negatively. And that's, you know, despite the large move over the last couple of years, I mean, coming from a very low base, and now we are starting to be at relatively high numbers. We haven't seen a lot of investment going into commodities, right? Like most of the pension funds don't have the box thing. We have to be long to commodities, you know, like, they're generally long equities and bonds and they're looking at cryptos, but they have very little commodities. So I think there will be more interest in commodities and there should be more investment to eventually bring more supply and to be able towithstand against shocks like we’re seeing today.
Joe: (36:36)
You know, this is a theme that comes up over and over again on our episodes, which is under investment. And you mentioned that some of the OPEC+ countries, particularly in Africa, were not even able to sell as much oil as they were allotted because they didn't have the capacity. Can you talk a little bit about sort of, across commodities, how under invested are we? And then how long is this cycle? Like, are we going to see an increased investment cycle for five [years], a decade to come? What is the sort of flip side of this decade of under investment going to look like as every country wants to sort of beef up its domestic capacity.
Pierre: (37:20)
So for agricultural products, it's pretty fast. Like within a year you can change things, but for metals, it takes anywhere between seven and 15 years. So you have to build new mines. And then you have to exploit those mines, but I think that there will be a different length of the cycle of when there's a shortage and when there are no shortages. So, you know, in the past it would take quite a few years before getting the approval to build the mine. And that will probably be much faster now going forward when we'll get much higher prices. But generally, you know, it's gonna be at least five years before the decision when a company decides to bring the production of certain metals or minerals forward and when that supply will come. So there's no like short term solution in terms of getting more metals for next year or in two years, it tends to be more like five years per plus down the road.
For oil, outside of U.S. shale, it's similar. You know, for any new projects generally today would bring oil supply in seven years’ time. So there's a lot of hesitation about going to invest in those long lead time projects today because you get oil comes out in 2029, 2030, and people don't know what the demand levels will be by then. So I think that's kind of tricky in the short term to bring more production. Only the U.S. has a shorter cycle of probably 12 months before the decision to increase CapEx and getting more oil because they know where the oil is. They have all the infrastructure. There was enough kind of capacity from the service companies to actually bring that oil. So I would expect more oil coming from the U.S. in the next few years and then from the rest of the world a bit later. But I think we'll have to live with higher prices to keep demand down, for it to be treated a bit more as a luxury product and also to accelerate the energy transition.
Joe: (39:36)
Just real quickly is the shortage of metals, I mean, we hear about the sand shortage. We hear about obviously steel prices. Does that also trip up the ability to increase oil production? The fact that if you have tight commodity markets elsewhere, it makes new investment more difficult?
Pierre: (39:52)
Yeah, it does actually. You have, I mean, as we saw last year, there's a lot of bottlenecks everywhere due to Covid and then once we get less supply of any other commodities and also a very low unemployment number, you know, it's hard to find the people and then to get all the technology in enough volume, at the right time to bring supply up. So it's gonna be challenging. And I think over the next 10 years, commodities are going to cap -- the commodities supply, actually not only price, but level of supply -- will actually cap the type of economic goals we will be able to have. So I think a lot of people just assume, you know, in their economic model that we can have as much of a commodity as we want. It's just a question of demand. But no, this time it'll be supply constraint.
Tracy: (40:46)
I just want to go back to the idea of $200 per barrel oil because I'm sure some people who hear that number, and think back to the previous record, which I think was almost $150 per barrel, they're going to be shocked and worried and wondering how exactly we get to a point in the market where oil can go up over a hundred dollars in less than a year potentially. Can you maybe walk us through exactly what needs to happen in order to get to a number like that? Like what exactly is the process that is going to take place in order to get to $200 per barrel?
Pierre: (41:24)
Okay. So I think it's, you know, there's a lot of recency bias generally in people's minds. Generally we get used to recent prices. And at first we think $100 is expensive. We complain, I don’t mean we, like people in general complain. And then they get used to $100 and then they complain at $120 and then they complain at $140. But they get used to higher levels over time. So then it's a question of, is it still worth using this oil? You know, and if you look at since 2008, um, so $150 then is $220 today in today’s dollars, if as an inflation measure, you take the global GDP deflator, then it's $220. So the way I think of it is, is it more bullish today than then? Yes, it's more bullish today than then.
Then we had U.S. shale to come bail us out a few years after in 2010/2011, this time we might not have it. So I think it's just, you know, people slowly realizing that prices have to go up and accepting it and then the price goes up and, and all the usage of oil that is not really necessarily gets cut. So people will, you know, driving for, could end up taking the bus instead of taking the car or people going for some long trip while they do shorter trips and these kinda things for, you know, demand to go down and for the market to be balanced. And the thing is if prices stay too low for too long, what happens is it can be what's gonna happen soon and it’s that eventually you run out of inventories to deliver on the screen and then the price can go anywhere.
So it's very important that the price moves in line with fundamentals so that we don't run out of inventories eventually, because then it goes to, you know, anything. It can go anywhere as a price. So I think that the process is that people, you know, generally get used to it little by little, and also, you know, the economy is taking less oil per unit of GDP. So today for one unit of GDP, we are using 15% less oil than in 2008. So also that justifies, you know, the fact that maybe to have the same impact on the economy at the high price of 2008, when it was $150, might be actually closer to $250 today. So that's the way I think of it. And that's probably people get, you know, they get used to new prices and then accept it and that's why it's a a long process and demand doesn't, you know, go down right away because there's no alternative really.
Tracy: (44:01)
Yeah. It feels like this is a lesson that everyone is learning all at the same time. Pierre, thank you so much for coming on Odd Lots. Really appreciate you taking the time during this very busy moment in markets to give us your thoughts.
Pierre: (44:16)
My pleasure, thanks for the opportunity and you know, have a good rest of the day and good luck for everything.
Tracy: (44:20)
Thanks! Joe, I thought that was a very thoughtful conversation that actually wrapped up a lot of the different strands that we've been dealing with in separate episodes. But the thing that I keep coming back to is this idea that, you know, any problem that can be solved with money probably isn't that big of a problem, which is actually now that I think about it, a very MMT thing to say, but...
Joe: (44:44)
You coming over to the dark side?
Tracy: (44:46)
That's not what I mean at all, but it is true that even if you throw a lot of money at this problem, you know, you can't make the oil producers necessarily drill. It takes a while to ramp up capacity to build out alternative energy sources. And when you have a big shock, like we just saw in Russia, it just sort of destabilizes everything and it creates even more lead times that are very difficult to deal with.
Joe: (45:11)
No, I think I had the exact same thought and maybe it was like when he pointed out that, you know, we could be looking at seven-year cycles for something like ramping up metals. And of course we're talking a lot about oil, but we saw the price of nickel go absolutely wild over this past week and we're gonna need — regardless of what happens right now — we're gonna need more nickel and other specific metals for car batteries and EVs, etc. The commodity that's in short supply — this is kind of a cliche or kind of galaxy brain — is time. And that is like the one thing that no amount of money can fix. There's just a certain amount of time it takes to build and there's no immediate supply response, you know, maybe shale could ramp up at the next six months, but there all kinds of other things they can't.
Tracy: (46:00)
I mean, the other thing that was quite worrying, so obviously it's concerning whenever anyone says $200 per barrel oil is a possibility, but the other thing that struck me was this idea of maybe something happens in the actual commodities market sort of similar to what we saw in March or April of 2020, but in reverse. So, you know, someone can't ship physical delivery of oil that they owe to fulfill a futures contract. And at that point you get a very big squeeze upwards in the price. It feels like that's a possibility.
Joe: (46:37)
Yeah. I thought that was really interesting him talking about the scenario in which Russian oil could be out of the market for a long time. And so you have these companies — self-sanctioning people call it — or withdrawing maybe partly for PR reasons because they don't want to be perceived, or in fact do not want to be a part of helping fund this war. And then the oil piles up at the docks, at the ships. There's no more. And then you have to turn off production because there's literally no more place to store it. And then you automatically, regardless of what happens, get this very long lead time before that supply can come on again. And I all also thought it was interesting. And this is gonna be a big question — the other side of the sanctions, Pierre’s argument is that it will be very hard to lift them under the Putin administration, is something to think about in terms of, well, what are we looking at in terms of timeframe?
Tracy: (47:30)
Again, I was about to say, it goes back to time because even if everything was resolved tomorrow, you know, and a ceasefire was actually declared, it seems very unlikely that you're gonna get a complete rollback very quickly of everything that's just happened from a sanctions perspective.
Joe: (47:44)
Under investment rules everything around me. I feel like every story comes back to the point about OPEC, not even being able to, you know, normally we think of OPEC or OPEC+ members as cheating, always trying to sell more oil than they have. Whereas right now the problem seems to be the opposite.
Tracy: (48:01)
All right. Let's leave it there.
You can follow Pierre Andurand on Twitter at @AndurandPierre.