Why the Fuel Market Is Still Tight | Andrew Lipow

The Middle East war is now in a new phase with Houthis getting involved and hitting infrastructure, oil and gas and refining infrastructure. At the same time on the Ukraine and Russia fronts some Russian refining infrastructure got hit. Today we sit down with Andrew Lipow to find out what's going to happen with diesel prices amidst all of this. They attacked this pumping station on the east-west pipeline This pipeline prior to the conflict was actually supplying five Saudi Arabian refineries along the Red Sea coast. Well, guess what? Those refineries were making gasoline, jet fuel and diesel fuel. When we look at our distillate inventories along the east coast, they're for all intents and purposes at the lowest level that the Department of Energy has ever reported since 1982. We're at really low inventory levels. We're going into the home heating oil season in the Northeast United States. I'm Siamak. Welcome to Market Insider. Andy, it's great to have you on. Welcome. Well, thanks very much for having me. I appreciate being able to come here. You're an expert in refining and the oil and gas space and there's a lot happening in this space, especially in the refining. We really want to talk to you about that. But before we get into that, can you tell us what you're seeing out there with the conflict? Because when the conflict started, the prices went up significantly of oil and gas and diesel. Well, I'm sure as you know, the oil market has been tremendously volatile over the last six or seven months trying to figure out number one, what is the impact on crude oil and refined product supplies? And number two is how long is this conflict going to last? And will we ever return to some semblance of normal being the pre-conflict levels? So if we kind of look back when this conflict started, crude oil supplies continue to transit out of the Middle East to the various markets around the world. But then Iran decided they would play the Strait of Hormuz closure card, which of course then impacted on supplies out of that region of the world. And prior to the conflict, 20 million barrels a day of crude oil and refined products would transit that waterway. And that represented 20% of the world's demand. So you can see when the missiles started flying between Iran and its neighbors and actually hitting a number of tankers, the shipping industry said, you know, this is simply not safe to transit through the Strait of Hormuz. And as a result, we saw oil prices increase. And they increased pretty substantially from less than $70 a barrel to over $110 a barrel and even more in parts of Asia. And now this conflict is taken towards the Bab el-Mendez and also there's some pipelines that they were diverting oil from the Strait of Hormuz, and they're getting hit too, right? So the Middle Eastern countries, Iraq, Kuwait, Bahrain, Saudi Arabia, the Emirates, they found themselves in the position that if we couldn't export our oil because the Strait was closed and no tankers are coming into the Strait and the Persian Gulf to allow us to load oil, that means we had to cut production. And they cut significant amounts of production. Now, some of them had the opportunity to divert oil in pipelines that got it away from the Strait of Hormuz. And of course, best known is the Saudi Arabian East-West Pipeline that runs from the Persian Gulf to the Red Sea. But in addition, the Emirates had a pipeline that ran from the Persian Gulf to the Gulf of Oman. And finally, we had Iraq through their pipeline system was able to divert a certain amount of oil into Turkey and into the Mediterranean load ports. So these countries were able to mitigate some of the supply disruption by diverting about 6 million barrels a day of crude oil. Well, of course, the Houthis, who are an Iranian proxy, certainly they were already having a civil war in Yemen and they've been fighting with the Saudis. Well, recently what they've seen is them or their proxies have begun attacking energy infrastructure in Saudi Arabia. And over the last week, they attacked this pumping station on the East-West Pipeline, which had a capacity of 7 million barrels a day. So it's a significant supply source to divert oil out of the Persian Gulf to other markets around the world. And when they did that missile attack on this pumping station, the pipeline shut down. And over the last few days, the market has been trying to assess what does that mean as far as crude oil supplies? Well, there's actually two choices. One is it could be down for several months as the pump station gets repaired. But two, it appears that Saudi Arabia will be able to bypass this pipeline station, start up the pipeline, but at a 50% reduced rate. So there's a little bit of relief in the oil market that some of that oil transiting the East-West Pipeline will be able to get out and make it to market. But the other piece of the puzzle is that this pipeline, prior to the conflict, was actually supplying five Saudi Arabian refineries along the Red Sea coast. Well, guess what? Those refineries were making gasoline, jet fuel, and diesel fuel. Some, of course, was used inside Saudi Arabia, but much of it was going to be exported. And if those refineries were unable to access crude through this pipeline, then we would lose nearly 2 million barrels a day of refining capacity. And in a world that is already scrambling for gasoline, jet fuel, and diesel fuel supplies, the consumer would be on the short end and they would be paying even higher prices than they're seeing today. There is another phenomena that we have been told by some of our guests that China cut back buying of oil during this conflict. Have they come back into the market? Are you seeing anything with them? Well, that is absolutely true. Prior to the conflict, China had increased their strategic petroleum reserves to about 1.4 billion barrels. Now, keep in mind, China actually has to import over 10 million barrels a day. Here in the United States, our strategic petroleum reserves, when this conflict started, were about 450 million barrels. But the U.S. is only a net importer of 2 million barrels a day. So we had less exposure to the events in the Middle East than did China. Now, because China has so many state-run refining companies, you know, they're able to control how much crude they process and how many refined product exports are given back into the market. Well, of course, China did not want to see higher prices. So number one, they cut back on their imports. And at the same time, they did reduce their refining utilization to the point that the state-owned oil companies were operating below 70% utilization and the independent teapots were operating at around 50% utilization. Now, over the last two months, the utilization has ticked up a little bit. The state-owned oil companies are operating at just under 80% utilization in August, while the independent teapots over in Shandong province, they've increased their utilization to about 58%. But they're still running well below capacity because they're always looking at what the refining margin is, especially in Asia, where they have to pay not $100 a barrel for oil, not 110, but the current market is somewhere between 130 and $140 a barrel because they've been so reliant on Middle East crude oil supplies. Now, Andy, when we see the prices of oil and we see these numbers and its futures, when we're seeing like, is there a big difference between the prices we're seeing and the real market when people are actually buying the product? Well, it certainly is. When we look at rent prices and say rent prices are $100 today, well, you're looking at the futures price for delivery in November. Well, that price does not do me any good if I need my oil to run in my refineries on October 1st. So because the oil market is so tight, I have to pay a premium to those futures. Now, those future prices are lower than they are today because they're hopeful that there'll be some resolution between the US and Iran that would allow tanker traffic to return to some semblance of normal, allowing more crude oil supplies to leave the Persian Gulf and make their way to market. But let's face it, that has certainly not been the case for the last six or seven months where the Trump administration first thought that this conflict would be over in a matter of weeks, if not one or two months. Well, now we're getting ready to go on month eight and what we're seeing is a significant product supply disruption. There has been some additional transits through the strait as the United States has moved naval assets in the area to escort tankers out. But over the last six or seven months, the world has been relying on the release of strategic petroleum reserves as well as the drawdown of our commercial inventories in order to mitigate this supply disruption that we've been seeing. And can we continue relying on these strategic reserves? Is there enough? Well, we cannot continue on this trajectory. It is simply unsustainable. Since the conflict began, the United States has released about 130 million barrels of strategic petroleum reserves and currently we have 285 million barrels left in our SPR, which is the lowest level it's been since we were filling it in the 1982-1983 time frame. So we can continue to pull down probably another 40, maybe another 80 million barrels. So that's for the strategic petroleum reserve. Now, if we were to look at commercial inventories of gasoline, jet fuel and diesel fuel in the United States, the biggest concern is diesel fuel. Diesel fuel inventories have been drawing. The U.S. has been a major exporter of diesel fuel to everywhere else around the world, including South America, Northwest Europe, the Mediterranean, even as far away as Australia. And currently, when we look at our distillate inventories along the East Coast, they're for all intents and purposes at the lowest level that the Department of Energy has ever reported since 1982. So let me kind of, you know, put that in perspective. We're at really low inventory levels. We're going into the home heating oil season in the Northeast United States. And this is all happening at the same time that in the agricultural community, they're getting ready to go into the peak harvest in the Midwest, consuming more diesel fuel to power their tractors, their grain harvesters and whatever other farm equipment they have out in the field. We have record low reserves right now when it comes to diesel, right? And you mentioned that some of this refining capacity, you're not sure about part of it in Saudi Arabia. And it seems like some refining capacity is gone or is it damaged Can you tell us about the refining capacity globally? Well, we certainly do know that refineries in the Middle East have been damaged due to missile or drone strikes. So, you know, of course, in Saudi Arabia, several months ago, the large Ras Tanura refinery was struck. And over in the Red Sea, the Jizan refinery, which is close to the Yemen border, was also struck in late July. And it's 400,000 barrel a day capacity has been offline since the end of July. And just to put that in context, that refinery, 60% of its output is diesel fuel. But these are not the only refineries that have been damaged. There's been refineries in Kuwait, Bahrain, Qatar, as well as Iran that have all been damaged along the way. Now, while we've spoken about the Mideast, there's another area of the world that has seen a lot of refinery damage, and that's mainly Russia. Because over the last several months, Ukraine has been very good with their drone attacks on taking out and damaging Russian refineries to the point that 30 to 50% of Russian refineries are now either shut down or at reduced capacity. And what that's done is it has turned Russia from a fuel exporter to a fuel importer. And that has further exacerbated the diesel fuel situation all around the world. Now, Andy, do you have any numbers on how much do you estimate is the diesel production of the whole world? And how much of it has it been cut? Like, is there any thoughts on that? Are there numbers out there to estimate? There actually are numbers out there, and I do have them. So to give you an idea, the world consumes about 28 million barrels a day of distillate fuel. So that can be diesel fuel, home heating oil. It can be diesel fuel used to run generators. So 28 million barrels a day. And to put that in context, the U.S. consumes about 4 million barrels a day. Europe consumes about 6 million barrels a day. Now, how much diesel supplies have we lost with all of these events around the world? Well, we've lost about 2 million barrels a day, or 8% of the world's diesel supply. And of course, that loss of diesel supply is coming from about 6 to 7 million barrels a day of refinery capacity that's been damaged. Diesel prices are going up, and at the same time, what we are seeing is the margins for refineries are going up too, right? Is this good for the refining business right now? Well, this is fantastic for the refining business because when you lose about 7% of the world's refining capacity, at the same time, refineries in the United States over the years have been shut down so that the remaining facilities are now operating near full capacity. And if we're operating at full capacity and the world is in search of more gasoline, jet fuel, and diesel fuel, we're simply unable to meet that demand. So while there's some additional capacity available in China to increase their crude oil processing rates, we haven't seen it return to full capacity yet to make up for any deficiencies around the world. So if you're a refinery and a refining company, you're making out because the market is paying you for the capacity that you have and it's incentivizing you to do anything you can to increase the capacity or, unfortunately, to build new capacity, which is many years into the future. And has China banned the exports of diesel? Is that something they've done? Well, I don't want to use the word ban, but the way China handles it by limiting their export licenses. So they won't grant export licenses, and that's a way of limiting exports without calling it a ban. I think what I would say is, you know, China looks at the markets every single month. And if the refining margins are there for the state-owned oil companies and the independent teapots to increase runs, I think you will see in the future China refinery utilization go up. Now, Andy, going back to oil and also diesel, how does it look like to you going forward? Do we have, is it after this conflict is over, is this going to go back to normal and prices will drop significantly? Is it going to be fast? How do you see this situation moving forward, looking forward? Well, I certainly believe that after the conflict ends, you'll begin to see the Strait of Hormuz reopen, tanker traffic increase, and that will lead to increased production of oil out of the Middle East. Now, there will be an immediate impact on price because the market will breathe a sigh of relief and a lot of the geopolitical risks that we've seen in the market will come out. But that doesn't mean that things will return to normal like the day after. In fact, it will take several months to get oil production to return to about 80 or 90% of pre-conflict levels. In addition, these refineries that have been damaged, it can take months, if not years, for them to repair their facilities. In fact, a good example is in Qatar where their LNG facility, which also supplies the world with 20% of the LNG demand, was completely shut down. And these LNG facilities have multiple numbers of what they call trains. So each of these trains can operate independently of the others. Well, two of those trains were significantly damaged and it's going to take three to five years to make repairs and bring them back online. So it gives you an idea, production might be able to come back rather quickly, but refining assets, not so quickly. And that's where the restriction is in order to produce more gasoline, jet fuel, and diesel that the consumer wants to buy. There's also another phenomenon we're seeing. The shipping costs are going up for these tankers. The daily rates have gone up significantly. Do you see that having much of an impact in the cost? Or is that marginal? Well, no, it has been a significant impact on the cost of the oil that's delivered to the refineries. And if we think about how the trade routes have changed when the Strait of Hormuz was closed, you could go from the Persian Gulf to the west coast of India. That would take you three days. You could go from the Persian Gulf to China. That would take you three weeks. And if you wanted to go to Northwest Europe, it was about 18 days. But now if India and China and other countries in North Asia, such as Japan, Korea, and Taiwan, are looking to replace those MIDI supplies with supplies out of the United States Gulf Coast, it's now a 45-day trip from the Gulf Coast to North Asia. So to move the same amount of oil, you need a lot more tankers to do it because the voyage times are double what they had been. Now, in terms of the lessons learned from this conflict, do you think this industry will change from here? Do you think things will change going forward? Or was this such a short-term issue that it may not have a long-lasting impact? Or do you think there will be long-lasting impact in this space? Well, I think there are long-lasting impacts, and we are going to see them going forward, starting with the countries in the Middle East looking for alternative ways to move their oil out of the Persian Gulf. If Iran was able to shut down the Strait of Hormuz once, there's nothing to prevent that happening in the future. And as a result, we're already seeing the United Arab Emirates build another pipeline to divert oil around the Strait of Hormuz, and that should come online next year, in 2027. Saudi Arabia is talking about expanding their east-west pipeline from 7 to 9 million barrels a day. But there are more significant projects that are being looked at. There used to be, actually, a pipeline that ran from Iraq to the Syrian Mediterranean coast, but it hasn't been used for decades and, in fact, is in such disrepair that people are looking at building a brand-new line. Well, that's still 3 to 5 years into the future. So we're seeing that type of alternative logistics coming into play, and that will happen. The next thing that people are going to look at is if you're a refiner and you're a consumer of crude oil, you're going to look at saying, where should my supply be coming from to mitigate the risk out of the Middle East? And, of course, now we're going to see a lot more interest in the United States, Canada, Mexico, and all of South America. In fact, if you look at North and South America, you would see record amounts of oil production in Canada, the United States, Guyana, Brazil, Argentina. So the market is going to look for where the risk is minimized in order to get oil out of the ground and to market. So that's going to be another fundamental change. A third fundamental change is the risk to just energy infrastructure. Where do people want to invest their money in the future? If we're seeing that a lot of facilities, Kuwait, Iraq, Saudi Arabia, Qatar can easily come under attack, then maybe the next tranche of investments, whether it's refineries, chemical plants, or even natural gas facilities, maybe they should be built outside of that region. What about the investment into the oil and gas space? Because we've been hearing that there's not enough investment in this space. And many companies and even countries that have sovereign companies in this field, they haven't really invested in the infrastructure in the oil and gas space. Do you think there will be more? Or what are your thoughts on that? Well, timing is everything. So if we were to go back into the past, about a year or so ago, we saw oil prices in the low $60 a barrel range. And people were also talking about a very big glut occurring in 2027 as more oil production was coming online and countries like the United Arab Emirates left OPEC and they were seeking to produce as much as they can. At the same time, Iraq wanted higher production quotas. So a year ago, one could argue that there wasn't enough investment because people looked into the future and said, you know, with inflation going up, higher cost of production, higher cost of investment, it just doesn't make sense to invest. Well, now if you look and you say we're at $100 oil, you see lots of companies are now interested in investing in the oil industry, especially as the Venezuelan oil market has opened up. But once again, Venezuela is a country that hadn't seen investment really for 30 years, and their infrastructure is so decrepit that it means tens of billions of dollars just to get the electrical grid into some semblance of reliability so that you can actually run drilling rigs. And then you've got to replace so much of the pipeline infrastructure to get the oil to the coast. And at the coast, you've got to repair the storage tanks and the docks, which in many instances are about to fall into the sea. So this is a very slow process and that's why it takes the industry so long to make a decision because not only are they looking at today's price, they need to make an assessment of what the price is going to be in three or five years when that investment finally comes online. Do you have any thoughts where we're going price-wise? Will we see those $60, $70 a barrel in the near future, in your opinion? Well, I don't think we're going back to $60 and $70 a barrel because of all the geopolitical risk and the amount of time that it's going to take for the industry to return to some fashion of normal. So we're going to have a higher risk premium come in. Now, could you see lower prices? Sure, because these really high prices are stoking inflation. It's stressing the consumer. And as a result, you could see consumer spending go down and economies around the world slow down more than people would like. And as a result, oil prices could really tumble. But as I look going forward, I think we're going to remain at elevated levels. That doesn't mean it's going to be as high as they are now, especially if the conflict were to end. I think they would return to the mid $80 a barrel range. But the one thing that we don't know is when is this conflict going to end? And the longer that it goes on, I fear the higher you're going to see gasoline and diesel prices go. Obviously, this industry, from the refineries to the oil and gas companies, to even the tankers, they all have had a major run in their stocks. Do you see this space being a good investment right now? Or do you think people should be more cautious at this level of prices? Well, you've seen some of these major refining companies, their equity prices have doubled, you know, rather quickly. I think that, you know, people still want to go in. You know, I would say, if you think the conflict is going to continue to last for an extended period of time, even at these high prices, you know, it's a good investment. If you think there's some question as to, well, maybe things will get resolved sooner rather than later, then I think, you know, you might want to be interested in it as a very short term investment. There is a major refinery facility that's getting proposed to be built in Texas, right? Is it a $300 billion facility? So there's a project down in Brownsville, Texas, to build a new refinery with about 168,000 barrels a day capacity. And it would be the first greenfield refinery built in the United States since the 1970s. Now, the cost of building integrated refineries, you know, that do more than just process crude, you of course have to make gasoline, jet fuel and diesel, which means you have a huge investment, probably in excess of $10 billion. And so we're kind of waiting to see, you know, how that project progresses. Project announcements are really cheap to make, but actually getting the financing to build refineries is much more difficult. And where we've seen some success and where I would expect refinery construction to continue in the future, number one is by a firm called Dangote, who just built a 650,000 barrel a day refinery in Nigeria and is looking to double its size. And meanwhile, in East Africa, they're looking to build a similar sized refinery because Africa is a continent that is growing in its energy demands. The other place that we're expecting to see increases in refining capacity, of course, is in India. Indian oil demand is in excess of 5 million barrels a day. And we do expect it to grow over the next couple of years as the society is becoming more affluent and you're simply getting more cars on the road. Andy, we are based in California and we have seen a couple of our refineries shut down here. Do you think those could come back in this scenario, in the situation we're in with so much demand and so much profitability for refineries? Well, I think it's very difficult. I think the probability of these refineries coming back online is pretty low. In fact, one of the refineries is already being dismantled up in the Bay and another one in Los Angeles. They're redeveloping the site for light industrial warehousing. And once the refinery is shut down, you have to ask yourself, well, now I have to get all the employees back, many of which may have retired. They may be moving out of the area. And I would say California is simply a very difficult business environment for the refining industry. And had it not been for the conflict between the United States and Iran, we might have seen another refinery shut down in California. And keep in mind, California is a state that really is promoting a lot of electric vehicle use. So the demand for gasoline is going down at the same time. We have talked about diesel and you mentioned there was an 8% of shortage that we lost of supply and the prices have shut up significantly. We are at record prices now. What's the impact of the diesel cost being this high? Well, diesel prices are up about 70% from this time last year. So let's suppose you're a homeowner in the Northeast and you're burning home heating oil during the winter. Now, usually those trucks come to your house when your heating oil tank is about a quarter full, which means you have room to take a delivery of about 150 gallons. Well, 150 gallons at $6.5 a gallon, you're going to be handed a bill of $1,000. So those consumers are going to see sticker shock. Meanwhile, if we look at California, those ports of Los Angeles and Long Beach are handling 40% of the container traffic imports into the United States. And once those container ships are unloaded, those containers are going on trucks and rail and delivered to their destination using diesel fuel. Well, in California, diesel fuel prices are approaching $8.5 a gallon, and those higher prices are going to be passed on to the consumer, whether it be fuel surcharges, higher delivery costs, or in the price of the goods that the consumer is buying. So the prices will go up from here and it might escalate for a while. So I'm expecting consumer prices to go up. This is not good news for inflation. And of course, that makes it difficult for the Federal Reserve to lower interest rates at the same time that they're trying to keep inflation under control. So you can see over the last three or four months, the higher oil prices have been a real driver of higher inflation. And that's put the Fed in a quandary of what to do because they'd like to reduce the interest rates on the one hand, but they can't because they're trying to tamp down on inflation. Andy Liepau, it was great to have you on Market Insider. Please come back and share with us your insights in the near future. Well, thanks very much for having me. I appreciate being here. Tell us what you think about the diesel and gas prices. Are you seeing the prices skyrocketing in your community? And do you think they will come down soon? I'm Siamak. This is Market Insider. We'll see you next time.