I remind myself daily that I don’t know anything about geopolitics. That’s a fact. Instead, I try to make informed and educated guesses about what I see unfolding. While I am always reluctant to write about geopolitics, it is, unfortunately, necessary given the Iran war backdrop and its importance to the oil market.

So please bear with me.

On July 4, some of you may recall my memo titled “It’s Now Or Never.” The most relevant section in that memo was the following:

The Strait of Hormuz conflict is far from over. If you think about it from a game theory standpoint, it’s now or never for the Iranians.

Iran knows that if the US plays a war of attrition, it will lose 1,000 out of 1,000 times. You need the US to give up because of political pressure, and the easiest way to get that is through economic pressure.

We are now in the heart of the driving demand season. Global product inventories are low. SPR flow is running out. US commercial crude inventories are reaching levels at which US crude exports are shutting off. The rest of the world might have some barrels out of the Middle East that can last them through August or September, but what about after that?

What happens if China absorbs most of the barrels and there’s still 5 to 6 million b/d of production shut-in?

Most people seem to be paying attention only to what’s in front of them, not to what’s ahead. It’s like a man falling from a 40-story building, and you ask him if he’s ok on the 5th floor.

Yeah, he’s ok, but he’s not going to be in about 2 seconds.

We are not ok. If Iran contests the Oman route, that’s an estimated ~6 million b/d of flow that will be cut off. UAE, which saw exports surge to ~4 million b/d in June, will drop back to ~2 million b/d. The rest of the Middle East won’t be able to get the flows out in a manner that they like. Meanwhile, Iran will keep exporting its ~2 million b/d as if nothing happened.

But the US can never let that happen. The US can never let Iran control the Strait of Hormuz, because if it does, it will be able to hold the rest of the world hostage. So the only way out is through escalation, which is all but certain to make things worse before they get better.

That’s reality.

From a timing perspective and with the benefit of hindsight, early July was the pivotal all-or-nothing moment. The now or never title was meant to signify that all the stars were aligned, and coincidentally, that’s also when the escalation reached the current fevered pitch.

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Editor’s Note: This article was first published to paid subscribers on June 23. The original article is made public below.

The market is incorrectly assuming that the Strait of Hormuz will return to normal. Since the beginning of the Iran conflict, I saw this geopolitical event as all or nothing. Either Iran comes out victorious and controls the Strait of Hormuz or the US succeeds in toppling the regime and restores the Strait of Hormuz back to normal.

There was no in-between.

Now that the MOU is signed, effectively giving Iran control of the Strait of Hormuz, we are never going back to the way it was. Unless, of course, the US tries to restart the conflict and comes out victorious, but outside of this scenario, Iran is now the most powerful oil producer in the world.

It has been a week since the MOU was signed and the latest tanker traffic data is becoming obvious. Following the conflict in Lebanon over the weekend, IRGC announced that it stopped issuing permits and the current tanker activity exiting the Strait of Hormuz is related to existing permit holders.

Over the coming days, this will become obvious. But what should be even more glaringly obvious right now is the tankers coming into the Strait of Hormuz.

Since the announcement of the closure over the weekend, these are the tanker inflows for the last two days:

From a total vessel count, most analysts are looking at the bigger headline figures:

Source: Windward AI

But for the relevance of the oil market, production shut-in, we need to see sizable volumes of VLCCs going back into the Strait of Hormuz to change the math. At this moment, that is not happening.

Going forward, I will be publishing daily tanker counts, just like the table above, distinguishing between sanctioned and unsanctioned tankers and their types. That way, readers can see the emerging pattern, which is becoming obvious to me.

IRGC controls the Strait of Hormuz, and the inflow of crude-related tankers right now is dominantly going to Iran, with some leakage here and there for the others.

In my view, anyone assuming the Strait of Hormuz will return to normal is making a serious analytical mistake. This is especially true given the data that’s surfacing right now.

Variant Perception

It’s hard to believe that Brent is trading at $77/bbl, IRGC controls the Strait of Hormuz, 7 to 8 million b/d of crude oil production remains shut-in, and the market is max short Brent.

And the guy who’s long oil (me) is making a contrarian bet.

Unprecedented.

I don’t know whether I am currently stuck in the Matrix and the system is just messing with me, but this is the most surreal moment of my life so far. Either I am the stupidest person on the planet, or everyone has lost their mind. I think my view on the market is also about as binary as the setup I am seeing.

My variant perception of the oil market is simple. Everyone is in agreement on the onshore oil inventory draws.

Ex-China

Operational minimums are coming, but most people, probably because of the price, have seemingly overlooked this scenario because they are assuming the Strait of Hormuz will return to normal. And as a result, the oil market will be flooded as production surges back.

Yes, perhaps they are right, but I can tell you right now, based on the tanker inflows, this couldn’t be further from the truth.

In the last 6 days, Kpler estimates that 64.492 million bbls have exited the Strait of Hormuz. On an implied flow basis, this is 10.75 million b/d.

From the market’s perspective, this looks like the crisis is almost over, but again, it’s more nuanced than that. First, most of the exit volumes are tied to Iran. More than 35 million bbls of Iranian crude have exited the Strait.

Iran has let stranded tankers out. This is not a surprise, given that many of them have been stuck inside for over 3 months.

But the oil math was always about inbound tankers more than outbound tankers. Without a steady stream of inbound VLCCs, oil production shut-in continues, eating away at the inherent deficit in the global oil balance. It doesn’t matter whether China is reducing imports or refinery runs; the molecule isn’t replaced.

And so far, the inflow is a trickle. No surprise, because the IRGC is firmly aware of the math. During the 60-day negotiation period, they will max out this leverage and throttle the flow under the disguise of granting permits. By throttling permits, they can effectively control who comes in and who goes out. So you would be a fool if you think they don’t know that controlling the inflow of tankers will ultimately decide how much production shut-in returns.

In addition to the logic I explained above, it is now evident, based on discussions with tanker owners, that the tanker rates offered for ships transiting the Strait of Hormuz are astronomical compared with other regions. Not only is the price insanely high, but operators are having trouble assembling crews willing to take the risk of going in.

So no, the issue is far from resolved, yet everyone still thinks it will somehow be resolved because both sides signed an MOU. Just wait until Trump finds out that IRGC is throttling flows and not actually de-mining the Strait of Hormuz. Will he just ignore this reality and play along or will he have to face the inevitable choice of escalation?

I don’t know, and I don’t really care. What I do care is the number of tankers going in, and right now, the market is going to be very wrong about this because the IRGC is going to throttle flows.

This situation is worsening. The market has priced it as if it is resolved. This disconnect is why I am still bullish oil. Nothing more, nothing less.

Catalysts

In a normal oil market, every day that goes by, losing 7 to 8 million b/d should be a catalyst in itself. But clearly, we are not in a normal oil market because we have max Brent short positioning at a time when the conflict is far from resolved.

So let me go back to the first principle. What were the signals at the beginning?

• Crude timespreads

• Crack spreads

• Onshore inventory draws

We are 2 for 3. Crack spreads remain elevated. Onshore oil inventories continue to decline. But crude timespreads are weak.

Why are crude timespreads weak?

Simple.

Brazil, Russia, Venezuela, and US crude exports are up 2.2 million b/d y-o-y.

China crude imports are down 4.7 million b/d y-o-y.

Net: 6.9 million b/d delta.

OPEC crude exports are down 7.162 million b/d y-o-y.

Middle East crude exports are down 0.151 million b/d y-o-y.

Total: 7.313 million b/d.

The 6.9 million b/d delta swing, vs. the 7.313 million b/d decrease in crude exports, explains why we are not seeing panic in the oil market.

Over 68% of the delta belongs to China, so the question is simply: when will China buy crude again?

With sanctions on Iranian petroleum exports lifted, China will come in and buy all the barrels. At the start of the conflict, China banned product exports due to national security concerns. If the US comes out victorious and controls the Strait of Hormuz, it poses an existential risk to China; if Iran controls it, China gains major leverage.

Now that Iran controls the Strait, China will likely lift the product export ban and return the discrepancy between elevated crack spreads and depressed crude timespreads.

This is why it’s important, but first, let me explain what happens in a normal oil market:

Refining margins are a function of end-user demand, refinery throughput, and storage.

If refinery throughput is maxed out, and storage is low, and margins are up, that means demand is good.

In a normal market, crude timespreads go up because refineries that can increase would buy the crude and increase.

Since teapot refineries are currently operating at 50% (historically at 65%), they have significant spare refining capacity. By banning exports, you suck the marginal buyer of crude out of the market. These guys will buy crude if it means they can make $0.50 per barrel. That’s why Asian refining margins are usually depressed.

Once the product export ban is lifted, teapot refineries will pick up spot cargoes and lock in margins. This would, in theory, compress refining margins and lift crude timespreads higher. And since we have max short positioning in Brent, any reversal in timespreads will signal to CTAs to exit the market, creating a stampede.

And here is the caveat. Since refining margins continue to inch higher despite maxed-out throughput, and product storage is very low, even if Chinese teapot refineries start exporting products, crack spreads won’t necessarily crash. And like I said earlier, as long as these guys make money, they will buy the crude. So we could have a scenario where crude squeezes back up and refining margins keep pacing, creating a vicious cycle.

Now, could this happen soon?

Possibly. The market rumor is that Chinese refineries are increasing throughput in July. Now, if there were no product export ban lift coming, why would they keep producing at compressed domestic pricing margins?

I guess you can never know, but this is one of the first positive signals I’ve seen on the China front.

Outside of the China variable, the fact that inflow tankers will continue to illustrate the phenomenon I’m seeing, which is that the IRGC is firmly in control, should, in theory, be a catalyst in itself.

But again, you just never know with this market. Anything is possible and anything can happen.

Conclusion

The Strait of Hormuz is not going back to normal. All the sell-side analysts and others who are estimating normalized flow are making a big mistake. With the IRGC in control, Iran is now the most powerful oil producer in the world. They can throttle flows through the permit mechanism and you can bet money that these guys are tracking just how much implied oil flow is going through the Strait of Hormuz.

And to help clarify the math, it is very simple.

Pre-conflict flow: ~20 million b/d.

By-passes: 6.5 million b/d (conservative).

Net: 13.5 million b/d.

To achieve the desired deficit, throttle flows below ~13.5 million b/d. If the oil market is projected to be in a ~3 million b/d surplus, throttle flows to 9 million b/d, and you have a 1.5 million b/d deficit.

And if you want prices to go higher, throttle flows below ~9 million b/d.

Only time will tell who is right, but my job will be to track the daily tanker flows and report back. I will stay focused on what’s important and what’s important is the tankers going in, not the tankers going out.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of USO, UCO, BNO either through stock ownership, options, or other derivatives.

By: Wilson

I am not that smart. If you are subscribed to me thinking that I’m smart, you are shit out of luck. Thankfully, investing/trading does not require raw intelligence. It just requires someone humble enough to admit that they aren’t that smart and, more importantly, learn from their own mistakes. As Buffett always said, temperament is more important than IQ (I hope he is right).

Long-time readers will know that I have no problem admitting to my mistakes. I own up to them because my profit & loss is tied to my writing, analysis, and trading decisions. If I’m wrong, I lose money. If I’m right, I make money. Nothing more, nothing less.

With that, it’s important to write a reflection memo piece on the things that didn’t go so well on the oil trade so far.

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Geopolitically speaking, the Iran war is approaching the final escalation phase. From an oil math standpoint, the two main bypasses to the Strait of Hormuz- Fujairah and Bab al-Mandeb are now in the crosshairs. This morning, Houthis announced a blockade of all Saudi ships through the Bab al-Mandeb. We have seen them enforce the closure in the past, so it’s interesting to see the oil market completely shrug off this announcement.

In addition, tanker attacks along the Oman lane in the Strait of Hormuz continue. A 3rd vessel was attacked near Dibba, UAE, which is the closest it’s ever been to Fujairah. If my analysis is correct, Iran will force compliance in Fujairah, which will complete the final escalation of the oil math.

In this article, I will run you through some of the scenarios on the oil math. This should help inform you of the future path of where oil is headed.

Oil Math

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By: Jon Costello

Suncor Energy (SU) reports its second-quarter results on August 4, and the quarter should be exceptional. WTI averaged approximately US$95.65 per barrel from April through June, while refining margins reached levels exceeded only twice before, both in 2022.

I estimate adjusted funds from operations of approximately C$5.6 billion, compared with the C$5.345 billion Suncor generated in the second quarter of 2022. My estimate falls within a relatively wide range of C$5.2 billion to C$5.9 billion, but anything above the low end would likely represent a record.

That result will generate substantial cash for debt reduction, dividends, and share repurchases. However, a single strong quarter does not determine Suncor’s intrinsic value. The more important question is how much of the company’s current earnings power should be incorporated into a normalized estimate of cash flow.

I last valued Suncor’s TSX-listed shares at C$70 in December, when they traded near C$60. That estimate assumed US$65-per-barrel WTI over the longer-term due to the outlook for a sustained oversupply. It also assumed refining margins modestly above management’s guidance. The shares have since appreciated sharply, closing at C$87.53 on July 16.

I now believe Suncor’s normalized earnings power is higher than my December estimate. However, the change is attributable to the macro outlook and not any structural change in Suncor’s earning power.

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I am down, but I am not out. My July 17 call options went to call heaven today. May you rest in peace. I thought I gave myself enough time, I clearly didn’t.

When a trade seems too good to be true, it usually is. I don’t think I could have seen the price action even if you had told me what the future entailed. If I had only the geopolitical events handed to me, but not the price chart, I would never have expected Brent to remain below $90/bbl despite both the US and Iran returning to all-out war.

But my experience in oil trading has taught me enough humility to expect the unexpected, and while I took on a lot of risk in my personal trading account, I did practice prudence in the broader portfolio.

In this quick update, I want to share how I’m thinking about the oil trade and the portfolio.

Thoughts

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I believe the oil market is mispriced. Crude is mispriced. Products are mispriced (crazy to believe), and refining margins are masking the underlying issues.

It appears to me that because the “invisible hand” has no way of printing barrels and preventing product prices from going up, the market, the efficient part at least, has been screaming that we have a product shortage.

The 3-2-1 crack spread is sitting near $70/bbl, the highest in history.

Note: Divide it by 3.

And before people start talking about the lack of refining capacity, it’s important to preface some of this with context.

There are currently ~7.5 million b/d of refining capacity outage. Last year, we averaged ~3.5 million b/d of capacity outage.

Normally, we always lose some refining capacity because of operational issues. That’s the nature of refineries. They are fixed beast animals, and while the intent is to keep them operating near full capacity at all times, they can’t. That’s why you undergo seasonal maintenance to reduce the risk of unplanned outages.

Now, some of these refining outages are done on purpose (China), and some of them are by external factors (Middle East + Russia). In total, we have ~4 million b/d of refinery capacity offline compared to last year. Is it possible to replace this?

Absolutely.

Where?

China.

China has so much refining capacity today that if they really wanted to, they could increase throughput by ~7 million b/d (assuming they can get the crude). The issue for China is that running throughput at ~19 million b/d wouldn’t do it any good, because product exports average only ~1 million b/d per month.

For China to fully utilize its refining capacity, it would need to ramp up product exports to ~4 million b/d per month, up from 1 million b/d. That’s unlikely, given that China’s excess refining capacity was built for national security rather than economic reasons.

China learned from what happened to Japan in World War 2. In order to prevent an oil embargo, China needed vast amounts of crude oil in reserve, and since petroleum products have a shelf life, and crude doesn’t. The only solution to the product issue was to build excess refining capacity.

Now, can China save the world? Yes, absolutely, but it would have to do something it never did before, increase product export quotas.

Geopolitically speaking, does China really want to save the US from the current product shortage? Unlikely, so we are now stuck in this weird world where product prices are mispriced because crude is mispriced, but refining margins are the only real signal here.

An interesting dynamic indeed.

Where are we headed?

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I will probably get a lot of hate for this article title, but I don’t care what you think. I will tell it like it is, and there’s no basis in reality in the oil market today.

None. Zero.

The events that unfolded over the past week would have sent a normal oil market into the stratosphere. If you had told any oil trader on January 1, 2026, that:

• 2 VLCCs were attacked while transiting the Strait of Hormuz (Oman lane).

• ~7.5 million b/d of crude oil production was shut-in in the Middle East.

• US and Iran were actively bombing each other.

• And the Strait of Hormuz is closed.

But you stipulated that Brent would be trading at $85/bbl and WTI would be trading below $80/bbl; they would’ve crucified you.

No one would have believed you. No one.

Yet, here we are. The oil market is still treating the latest conflict as some transitory event that will go away with time. Some in the market have pointed out that the GCC producers are still offering barrels despite the closed Strait, never mind the fact that you actually need the tankers to come out without being bombed.

We are so far detached from reality that it is hard to explain with words. I’ve been at a loss for words for weeks now, reading sellside reports about how the Strait of Hormuz will return to normal by the end of July. Well, we are two weeks away now. Does it look like things are going back to normal?

So it’s no surprise to read another Goldman report out today, noting that the physical oil market has tightened again due to a lack of barrel flow through the Oman lane.

I mean, we all realize that the barrels flowing out were stranded floating storage, right?

Right?

I want to make a meme out of this, but I just don’t even have the energy to do that. We are so far past logic that I wish I could just awaken from this nightmare. Words cannot describe how asinine this market is.

Biggest Disconnect

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I have not had a lot of sleep lately, understandably so. Just before I closed my eyes, WTI had just dipped below $73/bbl. I just couldn’t believe it.

• The US/Iran war is back on.

• Global oil inventories are ~900 million bbls lower than where we were at the end of February.

• Global product inventories are so low that refining margins are at all-time highs.

• US commercial crude inventories are weeks away from hitting operational minimums.

• China lifted the product export ban and is starting to absorb all of the floating storage barrels.

• Meanwhile, production shut-in in the Middle East climbed back to ~7.5 million b/d and likely going back to ~11 million b/d if Fujairah is restricted and the Oman lane shuts off.

• Houthis are now involved with the latest conflict between Yemen and Saudi opening up the possibility of Bab el-Mandeb closing, ~4 million b/d of crude, and ~1 million b/d of product.

With all of this in the backdrop, Brent is at $83/bbl.

Words cannot describe what I’m seeing. Words cannot describe the fact that Brent short positioning is near an all-time high with the geopolitical risk backdrop at the highest level ever in the history of the oil market.

To say that we are breaking history is an understatement at this point. We have gone straight into the Twilight Zone.

Interestingly, the Russia/Ukraine conflict is getting so out of hand that its impact on the oil market will also be significant. Here are some facts you should know:

• Russia lost ~2 million b/d of refining capacity.

• Russia has a capacity limit on how much crude it can export (~6.3 to ~6.5 million b/d).

• Ukraine is still knocking out more refining capacity, so for every barrel of capacity it knocks off now going forward, Russia has to shut-in crude oil production.

• Russia is likely shutting in ~0.6 to ~0.8 million b/d.

Now, if you include the production shut-in from Iran and Russia, we are losing close to 9.1-9.3 million b/d.

And WTI is below $80/bbl.

Again, words cannot describe the oil market we are seeing today.

All-Or-Nothing

I know I sound like a broken clock at this point but it bears repeating: this is an all-or-nothing conflict.

Either Iran controls the Strait of Hormuz or it doesn’t.

There’s no diplomatic resolution. There’s no peace agreement. Either the US wins, or it withdraws. For Iran, this is an existential crisis. If it doesn’t win, it is a full-on regime change.

This has been clear from the start, and it will only get clearer going forward. This is why I wrote my memo last week titled “Insane Asylum.” I just couldn’t believe the reports from sell-side analysts that the Strait of Hormuz would be back to normal by the end of July.

It was pure insanity, but it is what it is.

I’m really out of words here. It has been an exhausting journey so far, and while the zen gurus all talk about how the journey is what matters, I really don’t care about this journey anymore. At some point, reality needs to hit, and we are so far away from reality that words can no longer describe the oil market I’m seeing today.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of USO, UCO, BNO either through stock ownership, options, or other derivatives.

By: Wilson

I might need to be admitted to the insane asylum soon. I went through 6 sell-side reports today, all assuming some type of return to normality within 60 days. Goldman is assuming the end of July; Morgan is assuming the end of August; HSBC is assuming sometime in August; JPM is assuming sometime in Q3; and so on.

Perhaps I’ve been reading too many OSINT accounts or following the tanker vessel counts a bit too closely. But can someone please help me understand how we are going back to normal anytime soon?

Here are some charts from Morgan Stanley:

Crude Oil Exports

Transits out of MEG

Transits into MEG

And here are some charts from Goldman:

Flows out of SOH

Production shut-in

Imbalance

So let me understand this correctly. Since June 17, we have released the floating storage that had been stuck due to the closure of the Strait of Hormuz.

Energy Aspects estimated that ~150 million bbls exited since June 17, which equates to ~8 million b/d. Most of that is due to the stranded barrels leaving, which still leaves production shut-in (optimistically) at ~6 million b/d.

Even Goldman’s own analysis assumes there’s still a ~6.6 million b/d flow difference despite the recent pickup. But the oil market is in a glut because of ~150 million bbls exiting?

What?

Every sell-side analysis I’ve read so far rhymes with something along the lines of this:

We estimate the Strait of Hormuz flow to normalize by ___. We project that the global oil market will be in a steep surplus going into 2027, which should help build global oil inventory buffers. We expect UAE to increase production higher than previous years because it has exited OPEC and will ramp production. Non-OPEC supplies have also increased versus pre-war expectations, and we expect some type of structural demand destruction that came from this conflict.

I must be insane. I just can’t believe the analysis I’m reading these days. Either I am the dumbest human being on the planet, which I am open to admitting at any time, or everyone has completely lost their minds.

There is no evidence happening in the Strait of Hormuz that leads me to believe that any semblance of normality is coming anytime soon. The US and Iran are actively bombing each other, the US is forced to escort ships through the Oman lane with AIS turned off, and sell-side analysts are assuming normality to return by the end of the month.

This is not an analysis anymore. This is wishful thinking.

In COVID, I remember sitting in my office in April and reading about how:

• Oil inventories are going to hit tanktop everywhere. Tanker rates are going to skyrocket due to floating storage demand.

• Permanent demand destruction is coming. Global oil demand will never surpass 2019 levels again.

• Oil markets will take years to recover from the inventory build-up, and we may not see $50 to $60/bbl crude for at least 3-5 years.

And as I was reading through these reports, I was simultaneously attending board meetings for Gear Energy about how we needed to drastically shut-in production because crude oil was trading below our operating breakeven. Where was the analysis about the production shut-in? Where was that analysis?

I remember thinking in 2020, I must be insane. There is no way the investment community doesn’t realize that when oil falls below operating cost per barrel, producers are forced to shut-in production. This is an inevitable outcome for producers worldwide. Even if OPEC+ producers didn’t want to shut-in barrels, they had no choice. Prices are too low, so production cuts were an inevitable outcome.

And a month later, production shut-in was all anyone talked about. I just sat there in complete disbelief. Something that was so insanely obvious was overlooked by the whole market.

Well, this time isn’t any different...

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It is close to impossible to write any in-depth piece when the information flow is overwhelmingly volatile. Following our write-up titled, “The Consensus Is Wrong About The Oil Market.” Iran fired at more ships that were trying to transit the Oman lane under US protection. And after the stock market closed, of course, the US responded by attacking Iranian targets along the Strait of Hormuz.

The latest news flow is that Trump and the Iranians are saying that the MOU is dead. Whether that’s true or not is yet to be seen, but what’s abundantly clear from all of this is that there is no diplomatic resolution to the Strait of Hormuz issue.

Since the start, I have assessed the geopolitical situation as all-or-nothing. Either Iran controls the Strait of Hormuz or it doesn’t.

But what’s more interesting for the global oil market isn’t the tit-for-tat in the Strait of Hormuz; it’s that China just lifted its product export ban.

Why is this meaningful?

In a write-up I published on June 25 titled, “We Are ‘Still’ Going Full Speed Into The Wall.” I said:

Funnily enough, China can now rescue the world again, but in reverse.

First, China saved the whole world by not buying crude (starting mid-April). The lack of crude buying allowed other Asian countries to access the barrels they needed during the pivotal summer demand months. But remember that the Persian Gulf also sent a lot of products out to Asia and Europe, so China can only help on the crude front, and not the product front since it banned petroleum product exports for the sake of national emergency.

Now that the world is running low on product inventories ahead of peak demand season, a big reason why cracks keep outperforming, China can rescue the world again by lifting the product export ban.

With teapot refineries operating at 50% utilization, China is the only country in the world with excess refining capacity right now. Teapots, in particular, can help resolve a chunk of the upcoming refined product shortages.

And since China has been willing to rescue the world so far from the crude shortage, it may very well rescue it again with its excess refining capacity.

Now does this mean that refining margins will collapse?

Unlikely given how low inventories are right now. This is especially true if the US starts to keep products at home due to the low storage.

But the only way China can actually help resolve the issues in products will be to buy crude again. So the current crude surplus is very temporary, given that inbound tankers into the Strait of Hormuz remain a trickle and the production shut-in has no timeline for restarting.

For those of you who have followed the oil math from the start, it’s very straightforward:

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I’m not going to mince words here. This article is not meant to be an in-depth write-up. I had previously planned to write up the oil math needed to get production shut-in to return, but after two tankers were attacked on the Oman route, it is clear that the Oman lane will be heavily contested in the coming days/weeks.

For those of you not familiar with the oil math from the start, I will just do a quick recap.

Following the Iran conflict, there are two bypasses:

• East-West pipeline: 7 million b/d, 4 million b/d of export capacity in Yanbu.

• Abu Dhabi pipeline: 1.8 million b/d.

During the month of May, UAE started doing shadow transits which boosted crude exports to ~4 million b/d in June. Fujairah is now exporting majority of the oil for Kuwait, Iraq, and Saudi through ship-to-ship.

The issue here is that the Oman route is estimated to handle 6-8 million b/d of crude inflow and outflow. Since June 17, Energy Aspects estimates that 150 million bbls have exited the Strait of Hormuz. This equates to a flow of ~8 million b/d. Including bypasses, this puts flow at ~13 million b/d, still ~5 million b/d short of pre-conflict levels. The other 2 million b/d is associated with Iran, which is also having difficulty getting tankers to return to load crude. It first needs to offload the crude, wait for the tankers to come back, and then gradually restart production.

Now that tensions are rising again in the Oman lane, any assumption that the Strait of Hormuz traffic flow will return to normal is just wishful thinking. As I soberingly explained in my piece on June 23 titled, “The Strait Of Hormuz Isn’t Going Back To The Way It Was.” We aren’t going back.

Either Iran controls the Strait of Hormuz or it doesn’t. There’s no in-between.

A Normal Strait? No Way

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Buying $200,000 or C$284,340 PXT.TO at C$20.75 or 13,703 shares.

Buying $200,000 GPRK at $9.28 or 21,551 shares.

Buying $50k or C$71,075 NSE.V at C$0.57 or 124,650 shares.

Please see the rationale for why (public article):

Analyst’s Disclosure: I/we have a beneficial long position in the shares of NSE.V, PXT.TO, GPRK either through stock ownership, options, or other derivatives.

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It’s now or never for the oil market. We have washed out sentiment to the point where either oil prices move violently higher, or any semblance of a normal market is thrown out the window.

On Friday, we had the most infamous signal in markets hit: The Economist.

Oh my...

To add more fuel to the fire, Brent positioning has completely washed out.

Exhibit A

Exhibit B

And on the fundamental side, these are the updated charts:

Brent vs 3-2-1 Crack Spread

Gasoline vs WTI

The gasoline vs WTI chart is so wild that I actually want to explain this.

In the history of the oil market, there’s only ever been one time where gasoline materially outperformed WTI, and the reversion ended the week after.

One week, that’s it. That was during COVID. And the outperformance was because WTI briefly went negative during April 2020.

Outside of this, there has never been a point in time when gasoline has outperformed WTI by this much.

Never.

So the week is gone. Done. And gasoline remains elevated. Gasoline spreads are saying to me that they are only going to go higher.

Gasoline isn’t going lower. It’s going higher, which means crude will have no choice but to go higher.

What about China?

Oh, China is buying. You will only see it after the fact. Positive refining margins sparked buying, but what we really need is public visibility into their buying. Sinopec needs to return in a way that shows China is back, so they need to play their game, get it over with, and show up visibly.

And you know what’s going to be funny about the Chinese buying? Similar to how no one could see the inventory draws on the way down, no one will see the inventory builds on the way up.

Black box in, black box out.

Oops, I guess that’s just how murky data works.

Real Talk

The Strait of Hormuz conflict is far from over. If you think about it from a game theory standpoint, it’s now or never for the Iranians.

Iran knows that if the US plays a war of attrition, it will lose 1,000 out of 1,000 times. You need the US to give up because of political pressure, and the easiest way to get that is through economic pressure.

We are now in the heart of the driving demand season. Global product inventories are low. SPR flow is running out. US commercial crude inventories are reaching levels at which US crude exports are shutting off. The rest of the world might have some barrels out of the Middle East that can last them through August or September, but what about after that?

What happens if China absorbs most of the barrels and there’s still 5 to 6 million b/d of production shut-in?

Most people seem to be paying attention only to what’s in front of them, not to what’s ahead. It’s like a man falling from a 40-story building, and you ask him if he’s ok on the 5th floor.

Yeah, he’s ok, but he’s not going to be in about 2 seconds.

We are not ok. If Iran contests the Oman route, that’s an estimated ~6 million b/d of flow that will be cut off. UAE, which saw exports surge to ~4 million b/d in June, will drop back to ~2 million b/d. The rest of the Middle East won’t be able to get the flows out in a manner that they like. Meanwhile, Iran will keep exporting its ~2 million b/d as if nothing happened.

But the US can never let that happen. The US can never let Iran control the Strait of Hormuz, because if it does, it will be able to hold the rest of the world hostage. So the only way out is through escalation, which is all but certain to make things worse before they get better.

That’s reality.

So yes, let sentiment reach rock bottom while the world experiences the largest production outage in history.

Let inventories decline further while Brent short positioning stays at all-time highs.

Sentiment is bombed out. It’s now or never.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of USO, UCO, BNO either through stock ownership, options, or other derivatives.

Neglect, dislike, or whatever you want to call it, investors in the energy sector are completely misreading the situation unfolding in Colombia. Following Abelardo de la Espriella’s victory on June 21, investors have seemingly responded to Colombian oil producers with a “meh”.

It doesn’t help that, since the start of Espriella’s rise in the polls, Brent has tumbled by ~35%, dampening enthusiasm for energy stocks. However, the investment community should pay closer attention to all the producers in the country, namely, the potential for more deals and exploration.

In particular, something very important came out today from Espriella’s Vice President, José Manuel Restrepo, in an interview with El Tiempo and Portafolio. This was his comment on Ecopetrol and on the state of Colombia’s oil and gas industry. I highlighted the most important part:

Regarding the issue of Ecopetrol, the vice president-elect pointed out that “it is very unfortunate. He has attacked it structurally and strategically (the current president, Petro) by preventing it from signing new gas and oil exploration contracts, by preventing unconventional exploitation in Colombia or abroad. He has attacked it operationally and financially, to the point that today, exploitation is more costly than it was 2 years ago. He has also attacked it in terms of corporate governance by intervening in decisions such as the one Ecopetrol had ready, and they threw it back after nearly 2 years of decision-making. And he has attacked it in reputational terms by keeping the current president in place.”

With that said, Restrepo stated that what needs to be done at Ecopetrol “from day 1 of our government is to call the assembly so that the assembly changes the board and the board of directors changes immediately. That is an immediate decision. I have no doubt that the assembly will be called. The assembly must change the board of directors and the board of directors must change the presidency of Ecopetrol as quickly as possible. Certain terms must be respected.”

The context is important to understand here because Colombia is the 5th largest oil producer in South America, and Ecopetrol, the national oil company, handles oil and gas contracts with independent oil producers. Every deal that gets signed needs to be vetted by Ecopetrol to some extent and by the Colombian government, which creates tedious delays and bureaucratic hurdles.

Under Petro (the left-wing current president), oil and gas exploration took a severe hit as he banned new E&P contract rounds and shortened long-term contract terms. In addition, Colombia’s gas reserves began to fall, making it more import-dependent, and its oil reserves now sit at just under 8 years at the current production of 734k boe/d.

This is not a situation you want to be in when you are an oil exporter. Colombia, under the left, was going to see oil and gas production fall in the coming years if capex didn’t increase meaningfully.

Political Godsend

It’s important to first understand the oil and gas deal structure in Colombia to give you a flavor of what to expect. Historically speaking, Ecopetrol has relied on outside capital to fund growth capex and increase total production. Deals are usually structured as follows:

• 50/50 split in production sharing, the operator partner gets 50% of the production.

• Capex is usually weighed on the operator partner first, and then split 50/50 later, or in some cases, it is just paid for by the operator partner.

• Royalty is charged on the 50% production piece of the operator, so Colombia benefits from 1) the capex spent by the operator and 2) the royalty payment made.

From Ecopetrol’s standpoint, which is majority-owned by the Colombian government (88.49%), the capex spend gives it optionality for production upside and exploration potential. The royalty payment maximizes cash flow, and the even split in production gives the operator every incentive to increase production as much as possible.

It’s a win-win deal.

But under Petro, Ecopetrol suffered because 1) he banned exploration and 2) he vilified oil and gas and pivoted the economy towards renewables.

Now that he’s gone, Ecopetrol will embark on a new era of exploration and deal-making. There are 4 years of pent-up demand for deals that have been sitting in the back office, cluttered by bureaucracy. For the sake of due diligence, we have hired on-the-ground political consultants to inform us about the labyrinth we need to navigate in such a hostile political environment, and let me just say that it is more torturous than poking your own eyes with needles.

Under Espriella, his campaign was pro-hydrocarbons. He wants to restart oil and gas exploration, something Petro banned. He wants to issue new contracts, allow responsible fracking, offshore Caribbean oil and gas, and push Ecopetrol’s reserves higher. He stated in his campaign that he wants to push Colombian oil production from ~734k boe/d to 1.35 million boe/d. That’s not possible without the support of other operators, as I explained above.

What does that mean for oil producers?

Parex Resources (PXT.TO) is now the largest independent oil producer in Colombia. It has become the behemoth primarily through deals with Ecopetrol and exploration contracts through the previous administration. Espriella’s presidency will put Parex squarely in the center as one of the key producers to take advantage of what’s to come.

Geopark (GPRK) is also extremely well-positioned to capitalize on new deals. One key issue for both Parex and Geopark was that during the Petro administration, the lack of new exploratory contracts made it very difficult to expand oil reserves. Following the production sale by Fronterra Energy, formerly known as Pacific Rubiales (more on this later), Parex emerged as the largest independent oil producer, forcing Geopark into Argentina and Venezuela.

I suspect Geopark will make an aggressive move back into Colombia now that the administration is favorable towards signing new oil and gas contracts.

What about Ecopetrol?

Well, I am reluctant to give it my blessing here, considering that the inner workings of a national oil company are inherently slow and inefficient. I suspect Ecopetrol will need to rely more on independent oil producers to execute rather than executing itself. In addition, as Jon covered in January, the valuation on Ecopetrol shares is not attractive relative to the others.

Now, for readers, you will have noticed a trade alert today that I bought more shares of New Stratus Energy (NSE.V). On paper, NSE does not have producing assets in Colombia yet, but the company announced in its year-end reports that the Colombia deal was expected to close towards the end of May. But from what I understand, political events made it difficult for a national oil company to finish deals.

From my understanding, the runoff presidential election results, which ended on May 26, saw Espriella, a right-wing candidate, surge to the top. Iván Cepeda, the candidate supported by Petro and favored going into the election, quickly fell behind. Because of this political backdrop, it is difficult for national oil companies to announce any changes to their existing operations for fear of political backlash, especially if the right-wing candidate wins.

Following the election results on June 21, where Espriella won, the president-elect immediately demanded that Ecopetrol’s board and CEO be replaced as his first decree. This meant that anything the national oil company does from now to August 7th will be heavily scrutinized, even if the existing due diligence was already in place.

But given everything I wrote here about how favorable Espriella will be to the oil and gas industry, I believe today’s sell-off presented an excellent opportunity to add to our position. The comments from the Vice President today about how the first order of business is to call for an extraordinary shareholder meeting, followed by execution of oil and gas contracts that have been months/years in the making, is the most bullish signal one needs to understand the situation that we are in.

And for NSE specifically, JF Arata, CEO of the NSE, is well-positioned to capitalize on the upcoming deal boom in Colombia. He was a co-founder of Pacific Rubiales, which was at one point the largest independent oil producer in Colombia. JF was also responsible for developing the Rubiales oil field, the largest heavy-crude deposit in Colombia. The operational team that was formerly at Pacific Rubiales joined JF when they started NSE.

This is why, from an execution standpoint, I believe the team can execute, but we just need to survive the myriad of political labyrinths required to land deals in South America.

I hope this explains my logic and my bullishness on Colombian oil producers.

Conclusion

I believe investors are still misreading the sentiment in Colombia largely due to the fact that it is 1) underfollowed, 2) unloved, and 3) in the energy sector. The recent sell-off in oil prices did not help, but I think this seismic political change will give the Colombian energy sector a major boost.

We plan to allocate to both Geopark and Parex tomorrow, in addition to our exposure in NSE. I think this is where the undervaluation is if you are looking for upstream oil producers.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of NSE.V, PXT.TO either through stock ownership, options, or other derivatives.

Bought 125,000 shares of NSE.V at C$0.56.

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The Iran conflict is a game played by giants; we (oil traders) are nothing but ants stuck in a field full of giants.

The goliath in this case is the US and China. From the start, my analysis of the Iran conflict was that the longer the conflict lasts, the lower the probability of a smooth resolution. Despite signing the MOU nearly 2 weeks ago, Strait of Hormuz traffic remains at a trickle compared with pre-conflict levels, and oil production shut-in in the Middle East continues at ~6 million b/d, excluding Iran.

But the world has found itself in an interesting predicament. It is currently short of products and has a surplus of crude.

So before we get started with the main topic today, let’s do a quick recap of the oil math.

Oil Math

Goldman’s latest update on June 29 did a good job of recapping some of the recent updates:

The first chart is the Persian Gulf flow, including bypasses from both Fujairah and the East-West pipeline. Relative to pre-conflict flow, this almost returned to normal until Kiku, the VLCC, was attacked.

Excluding the bypasses, you can see that the flows were nearly normalized, thanks largely to stranded tankers exiting before stalling again.

This can also be viewed from Windward AI, which shows a jump in traffic before falling.

Source: Windward AI

On the inbound tanker side, we have kept a tally of all visible AIS tankers entering.

What should be clear from the list of tankers is that, following the IRGC attack on Kiku, most tankers have only traversed the Oman route under US escorts. Excluding dark transits, we have averaged ~3 VLCCs per day. Including dark transits, we are perhaps closer to 5.

To further break this variable down, the current estimate for the last 7 days of inbound tankers has averaged 6.3 million b/d.

Iran - 2 million b/d

UAE - 1.4 million b/d

Saudi - 1.4 million b/d

Iraq - 1.1 million b/d

Kuwait - 0.3 million b/d

Now, in relation to the oil production shut-in math, if these variables were to continue, this is what the production shut-in would look like:

Iran - assuming normal

UAE - assuming normal

Saudi - 2 to 2.5 million b/d shut-in

Iraq - 2.2 million b/d shut-in

Kuwait - 0.65 million b/d shut-in

Bahrain - 0.17 million b/d shut-in

Qatar - 1.1 million b/d shut-in

Total: 6.12 to 6.62 million b/d

In historical terms, if this were a normal oil market, it would still be the largest oil production outage in the market’s history. But this is far from a normal market, and this brings me to the point of this article: we are but ants in a field full of giants.

China, single-handedly, eliminated the entire crude oil deficit by reducing imports.

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Buying $200,000 of SU at $53.44 or 3,742 shares.

Buying $200,000 of MNR at $12.66 or 15,797 shares.

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How so?

From the onset of the Iran conflict, these three were our signals:

• Crude timespreads: a reflection of the underlying physical market condition of the crude oil market.

• 3-2-1 crack spread: a reflection of product demand, refinery profitability, and the durability of the price strength/weakness in crude.

• Onshore oil inventories: a reflection of underlying supply & demand dynamics. If onshore oil inventories draw, balances are in deficit; if they build, balances are in surplus.

If you have been following the oil market, you will know that the current conditions are as follows:

• Crude timespreads are weak, reflecting a bloated physical market. Reason?

Chinese Crude Imports

Chinese crude imports are down 4.9 million b/d y-o-y.

Global crude exports are currently down 3.8 million b/d y-o-y.

OPEC+ crude exports are down 6.5 million b/d y-o-y.

Now if you add US, UAE, Russia, Brazil, and Venezuela, which have increased crude exports by ~1.6 million b/d y-o-y, this is what the imbalance chart looks like:

The combination of higher exports from the listed countries above, coupled with China’s crude import reduction, has offset the crude market in its entirety.

This, coupled with the recent floating storage coming out of the Strait of Hormuz, has sent Brent 1-2 timespread into steep contango.

Does this mean the oil crisis is over?

No, and far from it.

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Please read part 1 of the report.

“Dude, you must be crazy.”

I probably am, but we are still going full speed into the wall. Yes, WTI is barely hanging on to $70 for its dear life, but please remember that consumers use petroleum products like gasoline and diesel; they don’t use crude oil. Refineries do, and this is why it was always important for us to pay attention to crack spreads along with crude timespreads.

Note: Please divide it by 3.

The fever in the market today is that crude is oversupplied, but products are undersupplied. How can this be possible?

Well, China’s June crude import data so far is -4.7 million b/d y-o-y, and teapot refineries are operating at 50% utilization. Compared to US refineries operating at 95% and PADD 2 refineries operating over 100%, you can see where the disconnect is.

But here’s the thing. If end-user demand isn’t down and you still have a production shut-in of ~8 million b/d, you are losing barrels in one form or another. Yes, China might not be importing crude, but it is drawing down product inventory. No one has visibility into how much China has in products right now, but it can’t be far from very low levels.

The same could be said for product inventories across the globe. Elevated crack spreads are a sign that despite higher refinery throughput in the coming weeks/months, the world still doesn’t have enough products. You can see this in the price action in the spreads.

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