What's Holding Back Oil Prices Now? | Matt Smith

Many experts are wondering why oil prices didn't go up as much because China stopped buying significant amount of oil. Today we sit down with Matt Smith who's been studying the supply and demand of oil globally. He's here to tell us what's happening in the markets right now and what are the impacts on gasoline and diesel going forward. China simply coming out of the market has meant that five million barrels a day that was going to be absorbed by them has simply been freely available for other buyers. The absence of Chinese buying can really draw oil prices down inconsiderably. You've also had President Trump to be honest who simply can tweet a message out and send oil prices down 10-15 percent and we've seen that happen a number of times and so the big concern is that the Strait of Hormuz remains closed for a large part until next year. What that means is that just extends the product shortages that we're going to feel into 2027 here. I'm Siamak and this is Market Insider. Matt, it's great to have you on. Welcome. Thanks for having me. The conflict in Middle East is escalating now and it is starting to have an impact on the oil markets and some people said that the oil prices are not really justifying what's happening in the real world. They should be higher. What are your thoughts? What do you think is happening now? Yes, well immediately once the conflict started in early March here we saw prices running higher which made sense but then we have seen them dial back, you know, drop back from getting $110, $120. Right now we're back in the 80s. We did drop into the 60s for WTI, that US benchmark, and the reason for that, there's a with China. China has really dialed back on its demand big time and the market didn't really expect that. So what that meant by China not buying about 5 million barrels a day of oil, it meant those barrels were in the market when the global market was not expecting them to be so. So that has helped keep prices in check. You've also had President Trump, to be honest, who simply can tweet a message out and send oil prices down 10-15% and we've seen that happen a number of times and so you've got a certain amount of hesitation in terms of trading in the market right now. So the oil price is that kind of lower than you perhaps expect it to be from a logical perspective here. But what that means is we're seeing product prices increasing. So what I mean by products is refined products, so gasoline, diesel, and that's where the pain has really been because we've lost maybe 10 million barrels a day on average over the last four and a half months, something like that, from the Middle East because they're not able to produce, because they're not able to export. But a large amount of that offset has been done because we've seen refinery runs, refining capacity, dialed back to offset the loss of all that supply. The ultimate result of that means you're not getting all of these products being produced over the last four and a half months and so that's why we've been seeing product prices increasing. So before we get into products, which is gasoline, diesel, and all the other things that we actually use, do you think the state of Hormuz is as important as it used to be strategically? Absolutely, absolutely. We have 15 million barrels a day of oil being passed through there. We have about 5 million barrels a day of clean products, of LPGs. As global demand increases, which it continues to do so, about a million barrels per day, year on year on year on year, we're seeing higher flows coming out of the state of Hormuz out of the Middle East. And so yes, we've seen some rerouting of that crude, about 4 million barrels a day of that 15 million, which has been sent into the Red Sea by Saudi Arabia. There's a rerouting pipeline from the UAE, which goes from Abu Dhabi to Fujairah. But the state of Hormuz, it continues to be the biggest choke point in the world by far here. What about Iran's conflict? Well, even just in the last few weeks here, as we've seen a re-escalation by President Trump here, our potential is that we see the state of Hormuz being closed for many more months to go here. And so it seems that with the ramp up in military action, President Trump here is trying to really degrade Iran from being able to attack these vessels and tankers that are passing through the state of Hormuz. The trouble is, if you up the ante, as the US is doing here in terms of those military attacks, there is a natural response that will come from Iran. And so we've been seeing that in the last few days. But what we should expect that if the US escalates to the point of hitting Iranian energy infrastructure bridges, then there will be the response to close the Red Sea. So they're getting the Houthis, a proxy for the Iranians to fire at tankers and basically close off Bab al-Mandeb, which has a lot of the crude flows that have been, a lot of those have been rerouted from Saudi Arabia. So we expect at this point, there isn't an end in sight and escalation seems the way forward here rather than diplomacy. What about the supply? Because the US has been supplying more oil. And then there is other countries that have more supply has come online. Can you tell us more about that? Has the supply gone much higher? So that has helped incrementally. From a US perspective, we've not seen production ramp up like crazy. But what we've seen is exports have increased because not only has the US been able to help substitute or backfill the loss of that Middle Eastern crude, then we've had President Trump who has been talking down US oil prices. What that does is basically mean that they become relatively more attractive versus global benchmarks. And that has just greased the wheels for record exports out of the US. So we have seen a supply response in that way. But we're talking about the 15 million barrels a day that have been ground to a halt almost from the Middle East. US exports have increased by about maybe one and a half million barrels a day when they're at maximum in terms of that increase. And so it's an incremental piece, 10% of what has been halted from the Middle East. So we've had the US been able to step up a bit there. We're also seeing increasing production coming through from elsewhere, which was happening already. And so we've got Brazil, which is pushing to a record in terms of its production, that is resulting in higher exports. Then we have other countries too, such as Venezuela. So again, we saw the capturing of Maduro at the beginning of this year. What that has meant is the production in Venezuela has increased. And so we've seen that push to about maybe 1.2 million barrels a day. Those flows have halted from going to China. They were sanctioned barrels, 2025 and going back in history. Suddenly they are unsanctioned. Suddenly they're at market price. The US is pulling in a lot of those barrels. Some are going to India as well. So we have the US, we have Venezuela, we have Brazil. But there's these longer term stories too. So in terms of Canada, we've seen production increasing from then. Guyana is going to be adding more crude at the end of this year. But that's more of a long term picture. So it's been this gradual increase we've been seeing hitting the market. But by no means has it been able to offset the flows out of the Middle East because inevitably a third of the world's waterborne crude exports leave via the Strait of Hormuz. So you mentioned there's a cut of 5 million barrels from China in terms of consumption. And then there is the 15 million barrels that are stuck in the Strait of Hormuz. And maybe there is less of it because there's some ships going through here and there. And then there is an increase in the supply. But there seems to be still a shortage based on the numbers that you're seeing. Is there a shortage right now or is the market balanced? If you'd have asked me two weeks ago, we're in much better shape than we are right now just because that traffic going through the Strait of Hormuz is grinding to a halt again. But previously, we're talking about 15 million barrels a day lost in terms of those exports. Four of those were being able to be rerouted via Saudi Arabia and UAE. And then we're seeing maybe three, four, five million barrels a day being able to get out in terms of through the Strait of Hormuz. That's including Iranian crude too. The US blockade is lifted, but also UAE getting some out. Saudi Arabia starting to load tankers at the end of last month. And so that differential was perhaps only five, six million barrels per day, which is the plug essentially of the flow that would go to China but has stopped. So from that perspective, the market was fairly well balanced. It just means that now that the Strait is closing shut again, it means that we're suddenly being pushed back into a deficit here. And what about China? So you've cut back five million barrels a day. Was there a point that you realized that? And also, how long can they go? Sure. So yeah, it was amazing when we started to see those slowing flows coming through in sort of March, April time, and they have just continued to drop here. And so the realization has happened over a good number of months here. There was the immediate assumption, oh, they're drawing from their onshore storage, because China has been stock building in a very big way over a good number of years here. But it wasn't that per se sort of in March, April time. It was the dialing back of their refinery runs. And that is still the case we believe right now. So a large part of the drop to offset the loss of that crude being imported has simply been lower activity from their refineries. That's not something that can continue ad infinitum. And so we expect them to gradually return to the market here as we see flows through the Strait of Hormuz and Middle East production gradually returning as well. But by all means, we have seen China drawing down its storage in the last couple of months. It's been about 40 million barrels over May and June, which equates to about 650,000, 700,000 barrels per day there. So that's a bit of an offset to that 5 million barrels a day. Some has been the drop in refinery runs. Some has been a drop in domestic end user demand there. And then finally, it's been a ban that they've had come through on exports of products, which has slowed things. So we could see China staying out of the market here for a good few months going forward. If that is the case, they're going to have to be drawing from onshore inventories. From what it looks like, they're not doing the refining. Correct. They're not really drawing from the storage to do their refining. They just stop refining. Do you know where those products would go? Would they stay domestic in China or would they get exported to the rest of the world? So most of them would stay domestically. And so we believe that we're seeing product inventories being drawn down there as well. So they've got these stockpiles that they're happening into rather than refining those barrels and consuming them. So when you talk about product exports out of China, they're less than a million barrels per day. And so we're seeing refinery runs down maybe 3.5 million barrels a day, something like that. And so it's really just the application of the breaks there in a temporary way to basically offset the loss of the lack of that crude coming in. You mentioned products and it seems like you mentioned that we haven't been doing a lot of the refining in the last four months because we have had a level of shortage, right? Can you tell us more about that? How does the refining work and are there potential shortages or challenges with products? Yeah, sure. So we can take it region by region because the main region that has been hit because of the Strait of Hormuz being essentially closed has been Asia because they took 90% of the crude that was coming out of the Strait of Hormuz. So immediately in the aftermath, we have seen countries like South Korea, India, et cetera, that have had less crude to come in. And so they've been able to refine less. They've been able to export less products. And then you've had a situation like with China where they have just dialed back on those purchases outright. And so we have seen a certain amount of replacement that has happened in Asia. So for example, India has been able to put in a lot of Russian crude to offset the loss from the Middle East. South Korea has pivoted and pulled in from the US, has pulled in from that Red Sea crude redirected from Saudi Arabia. But you have had a lot of countries in Asia that have been running less. Their refinery runs have been less simply because they haven't had access to the crude over the last four months. The flip side of that is you have countries such as, well, you have regions such as Europe. Again, they were getting like nearly 50% of their jet fuel from the Middle East. They have pivoted to pull from a new refinery in Nigeria, the Dangote refinery. They have pulled from the US as well. And then finally, if we just look at the US, the US is so important because it's about 20% of global demand. It's about 20 million barrels per day, something like that. We have refining capacity in the US. Refinery runs right now 17 million barrels a day. So the US has a lot of production. It has a lot of refining capacity. And so a lot of countries have been turning to the US for diesel, for gasoline, for jet fuel. And what this has meant is we've seen diesel inventories in the US being drawn down dramatically at the same side on the gasoline. We know this because US data is so frequent and so transparent where we have less transparency into elsewhere in the world. But even just numbers came out just earlier today for Europe shows that Europe seeing its stocks depleted for gasoline, for jet fuel, for diesel as well. So it's a theme that you're seeing these stocks being drawn down on a global basis from a product perspective. You mentioned that we lost some of this refining. And from what it seems like, if the refiners didn't do the work, they didn't have the starting material, they didn't have the crude oil, they lost the time and we're not going to make up for it. Now we're using the reserves to actually compensate for them. How long do you think this will last for these kinds of products like gasoline and diesel? And then what are the impacts on the prices going forward? Yeah, sure. So one thing that's happened over the last few months, we've had strategic petroleum reserves being released. And so that has helped as a cushion. So for example, Japan has got 80 million barrels of oil that it's able to release. It has drawn down its inventories, but that has helped keep its refinery runs up. Same for the US, we have seen 100 million barrels been drawn down in the US from its SPR. And so that has helped buffer these inventories dropping even lower here. And so that has sort of delayed things. But right now, seasonally, you are having refineries running as hard as they can because we're in the peak of demand from a summer driving season perspective in the Western world. And so you have these refineries that are encouraged to run as hard as they can because there is the profits available there. But we're simply still not producing enough products on a global basis here. If you just think with China, if we're seeing Chinese refinery runs down three and a half million barrels a day, we're seeing, you know, the Middle East is also a large producer of products too. It has refining capacity over 10 million barrels a day. We're seeing them down perhaps two and a half million barrels a day. So they export, you know, 800,000 barrels a day of diesel. We're not seeing that much hitting the market. It's the same for the gasoline across the various different commodities. And so in terms of when this impacts, I think we're really starting to see this now when you look at the price of diesel just in the US here is just continuing to climb every single day, it feels like. And even when we see oil prices moving higher, diesel prices are outpacing that. And so now on a retail basis, we're back above $5 a gallon, which is painful from an inflation perspective, because the vast majority of US goods basically are moved around. So everything that we get at the grocery stores is moved around on an 18 wheeler. And so that's going to be reflected through into inflation. But simply just on the tightness that we're seeing in the market here and the inability for refinery runs to be keeping up, that's why we're seeing product prices pushing higher and higher here. So you think as the price, even if the price of oil goes down in the long run, it won't impact the product prices that much, the product prices will stay up for a while? They will move. So they kind of move in tandem, you will just see a more exacerbated move to the downside on oil and on the products if you move higher. So they're just less insulated. And so that's really where the pain is right now is on the product side, rather than on the crude side of the picture. And is there a difference between gasoline and diesel? Sure. Oh, so yeah, yeah, absolutely. So if you think about gasoline, that's for your cars, for diesel, you're using that in manufacturing and also for driving these trucks around. But when we talk about the Strait of Hormuz being closed, a lot of the crude that comes out of the Middle East is a medium sour type of crude. And from a medium sour crude, that's where you get the most diesel when you refine that barrel. And so those refiners in Asia not being able to get that medium sour barrel means they are producing less diesel. They're perhaps replacing as we're talking about South Korea with US crude, but US crude is light sweet. So what that means is more high quality, it has less sulfur in it, and you get more gasoline and less diesel from a barrel of light sweet. And so you can run that, but you're still producing less diesel. And so that's where the diesel issue is arising from. Another thing to bear in mind is that a couple of months ago, we were hugely concerned about jet fuel for the same reason you get a lot of jet fuel from a medium sour barrel. But we've had refineries, particularly in the Atlantic Basin, that have tweaked their refining activity to produce as much jet fuel as they can. And that has helped address the jet fuel issues. So there's not shortages anymore. We're not hearing about widespread flight cancellations. But addressing the jet fuel issue has been to the detriment of other parts of the barrel, such as diesel and gasoline. So that's where you're seeing the inventory weakness showing up instead. And so it's just all of a product story. And it's almost a game of whack-a-mole. If you address one issue, another issue rises up. Now, in terms of the refining capacity and capabilities across the globe, was it too tight already? Or was it kind of an equilibrium? It was fairly close to equilibrium. The challenge that we've had is that the capacity additions we were expecting to come through from this year have been delayed because of the conflict. A lot of those were expected to be in the Middle East, also India and China. And so some of those have been delayed. So that's one piece of it. The second piece is that as we've had these product shortages, refineries have been encouraged to run as hard as they possibly can because the profitability, those refining margins are so strong. And that puts these refineries at risk. And so we've started to see some issues even in the US in refineries just because they've been running too hard. And then just the other piece of this is that you typically run your refineries as hard as you can, mostly on a global basis here. There is seasonality in terms of you take maintenance in the spring and in the fall, but you run hard in the summer. But then the only country really that has spare refining capacity is China. And China not only is not running at a normal level, is dialed back big time here. And so China does have the ability, if it wishes to, to ramp up refinery runs, ramp up crude purchases and push out these products to make a profit on those on the global market. But it appears that it is choosing instead to take security of supply and continue to try and look after those stockpiles as much as possible rather than make a profit and produce products instead. In terms of the profitability, how are these refineries doing? They're making a lot of money right now, right? Yeah, absolutely. So if we just consider diesel, so price of oil is about $80. A price of diesel is double that, more than double that. And so typically you see a refining margin, say on the three, two, one cracks. So basically what that means is you take three barrels of oil to produce as the profit versus two barrels of gasoline and one barrel of diesel. And so typically you may see that about $30 a barrel, something like that. It's pretty decent for refiners. It's in the sixties right now. So if you own a refinery, you are encouraged to run as hard as you possibly can because there's huge profits to be made here. How long do you think it will last for the refineries, this type of trend? So just because inventories have been depleted so much and because there is still this demand in the global market, because prices are high, but they haven't skyrocketed to the point where we're seeing demand destruction. So even if we just look in the U.S., now prices at the pump on the national average is still below $4 a gallon, at least for now. And so it's probably not to the point to where you get to $5 a gallon on the national average, where you really start to get sticker shock and you see demand destruction. And it's the same on the diesel side. I mentioned earlier, diesel is at $5 a gallon, but we have seen as high as $5.80. So there's still room for it to go much higher before we see demand destruction. So with demand holding up and with inventories depleted, it looks like this is going to carry through until the end of this year in terms of these shortages, even if the Strait of Hormuz does open back up in the next week or two. The problem is, or the big concern, is that the Strait of Hormuz remains closed for a large part until next year. What that means is that just extends the product shortages that we're going to feel into 2027 here. Did you get surprised by the fact that the demand destruction hasn't happened? Were you thinking if in a scenario like this, we'll have demand destruction or did you think it's okay, it's normal? No, it's that price of crude that you have to come back to though, where, you know, logically, if you're going to close off the Strait of Hormuz and not have 10 million barrels a day of production over months and months and months here, then prices should be well into the triple digits. But we have seen market mechanisms take hold here, whether it is China completely dropping out of the market, strategic petroleum reserve releases, various different cushions to try and balance or offset the impact of these events. But this cannot continue forever. And so these have been short term fixes that have happened. But really, I think what we're seeing right now is the realisation of these shortages and the fact that they're not being addressed. And these cushions are running out, right, in that China cannot stay out of the market forever. We've already depleted the SPR releases. And so it's going to start to cause more pain going forward here. But it has just been remarkable over the last four months seeing the market adapt, but also just the power of even President Trump being able to drop prices by 10, 15 dollars, 10 percent a barrel, right, just by simply getting on his phone and tweeting. What about the oil companies? Do you think they, after this conflict, do you think they have become more important, better investment, or do you think they might not be? So I think there's kind of two pieces to that. So the first piece is that over the next few years here, oil demand growth is going to be very strong. The reason I say that is because not only do we need to replenish the oil inventories that have been drawn down, the product inventories that have been drawn down, the strategic reserves as well, but also you're going to have certain countries in Asia and perhaps the Middle East producers as well building more storage so that they don't get into this situation again. Going into this, the likes of Australia, India, etc. have not got that much storage at all to draw from. They've just been expected or relied upon imports, and they're not going to sustain or accept that situation again. So we will see inventories built up. So that will support demand going forward over the next few years. But as we get into 2030 and beyond, I think that's when you start to see the real impact of what has happened over the last four and a half months, because policy changes are being put in place so that we are less reliant upon fossil fuels, so that if a situation like this does happen again, that there is the ability to pivot, whether it is to more electric vehicles or to other sources of energy, rather than being so reliant upon such a choke point that can get stopped on any given day. So you have basically this group of producers that have been relied upon for 40% of the world's oil production, but just in recent months, we've had UAE, which is one of the largest producers in OPEC, essentially removing itself from the group. Now, there have been tensions over the last few years here, so it's not completely unexpected that they would leave, but just the timing of it really shocked the region and shocked other producers. But what this means for UAE, and we're already seeing it now, is that because they are not dictated or held by OPEC production quotas, they have started ramping up that production and ramping up their exports already. And so they were previously about 3.4 million barrels a day at the beginning of this year, now they're up to about 4 million barrels a day. And so the reason for them leaving is so they can do this, and this oil will obviously be very gladly accepted and bought up on the market, because we're in a tight situation here. But what the last four and a half months has shown us is that there are fractures in the OPEC group, and if we do see some of the other large producers leaving the group, you could have a dissolving of the entire pact there. That said, that's not our base case expectation, but the leaving of UAE definitely has weakened their hand. You mentioned dissolving of the OPEC. What's the impact of that if something like that happens? If OPEC were to be dissolved, that means they wouldn't be beholden to production quotas anymore, which means they could increase supply, which means that that would have a bearish impact on prices. It would weigh on prices because we'd have more barrels coming to the market. But that's perhaps the whole reason why we may not see OPEC dissolve, simply because they are able to control prices somewhat right now by managing how much they are putting onto the market. And so, yes, by UAE leaving, it does weaken their hand because they are one of the key producers. But ultimately, there's enough members of the group to try and keep this cohesive message going forward here and try and keep prices perhaps higher than perhaps they would be if they weren't in the group. Is there a level where these countries might be losing money if the price of oil goes below? Well, I think a lot of these countries are already losing money compared to their budgets. And so they've set their budgets, oil prices much higher than where they are now. And so they're just essentially trying to muddle through at least for now and then benefit from higher prices later as we move along. But that may never actually happen if we continue to see non-OPEC producers increasing supplies onto the market. And so, yes, some of them are feeling pain. So that's why after certain announcements, you do have the likes of Saudi Arabia dialing back on some of their future ambitions because they're perhaps not going to have the revenue that they were hoping to have. When we looked at 2008, the oil prices went up significantly, right? And a lot of people were wondering, despite all the inflation we've had, how could the oil prices not reach even to the level at 2008 with us having this much supply? Is it all because of China in your estimates? It's a good part to do with China, yes. China simply coming out of the market has meant that 5 million barrels a day that was going to be absorbed by them has simply been freely available for other buyers to come in and snap up. And so that has played a huge part in keeping oil prices down. So when you look to the Chinese, they have played this exceptionally well here because rather than going into the market in March, April and buying oil at $110 a barrel, now we've moved much lower than that and they're still kind of starting to perhaps creep back in. And so that then China is such a large buyer, it essentially makes the weather, we like to say, you know, in that when they come in and they buy a lot, it can drive prices higher. But what we have seen over the past few months, the absence of Chinese buying can really draw oil prices down considerably. Matt Smith, it was great to have you on Market Insider. Tell us what you think about this conversation with Matt. And are you still worried about gas prices and diesel prices going up? And have you seen them going up significantly and not decline as much with the oil prices going down? Tell us in the comments. I'm Siamak, this is Market Insider, we'll see you next time.