Speaker 1:
From the library of the New York Stock Exchange at the corner of Wall and Broad streets in New York City, you're Inside the ICE House, our podcast from Intercontinental Exchange on markets, leadership, and vision in global business, the dream drivers that have made the NYSE an indispensable institution for global growth for more than 225 years. Each week, we feature stories of those who hatch plans, create jobs, and harness the engine of capitalism right here, right now, at the NYSE and at ICE's 12 exchanges and seven clearing houses around the world. Now, here's your host, Josh King, Head of Communications at Intercontinental Exchange.
Josh King:
According to the International Energy Agency, nearly 96 million barrels of crude oil were produced each day in 2016 globally, and that number is expected to cross 100 million in 2021. Oil and refined products are still one of the most highly imported products for the United States, and laws were recently changed to allow the US to export more of its rapidly growing shale oil production to refineries around the world. Because of its extensive use, the price of crude oil, and the fundamentals that drive the global oil market, are critically important to businesses and consumers around the globe. Our guest today, Ed Morse, an energy market economist and currently Global Head of Commodities Research at Citigroup in New York. He's responsible for advising investors and companies around the world on fundamentals effecting the global energy markets. Our conversation with Ed, right after this.
Speaker 3:
Inside the ICE House was brought to you this week by Norwegian Cruise Line, NYSE listed, NCLH. Norwegian Cruise Line's 16th ship, Norwegian Bliss, will begin cruising Alaska and the Caribbean seasonally in June, 2018. For more information, visit www.ncl.com.
Josh King:
With over 45 years of experience in energy markets and international affairs, Ed Morse is one of the most highly respected energy analysts, and an expert in the fundamentals driving global energy markets. In 2007 and 2008, when oil prices reached near record-high levels, Ed was a leading voice arguing that prices were at an unsustainable level. Looking back, history proved him right. He's taught international relations at Princeton University, served as the Deputy Assistant Secretary of State for International Energy Policy, worked for oil companies, and built world-class teams of analysts covering the constantly evolving energy markets. Ed Morse, welcome to the ICE House.
Ed Morse:
Nice to be with you.
Josh King:
How does someone become an energy market economist, and why does a bank like Citibank need one?
Ed Morse:
Well, how one becomes one is different from how I became one.
Josh King:
Tell us.
Ed Morse:
I was a kind of geeky guy, and I decided to get a PhD, and then I decided to teach. I luckily was teaching at a time when oil markets, among other commodity markets, were in turmoil. This was in the middle of the 1970s. It was during, in fact, the period in which there was an OPEC oil embargo on the US and the Netherlands. Oil prices shot up fourfold in a very short period of time.
Josh King:
Gas lines, Jimmy Carter's Oval Office addresses.
Ed Morse:
I was on gas lines, so I remember them well. All of that was happen. It was before Jimmy Carter was elected. So, I got involved in it indirectly. And then, eventually worked for the state department as kind of the top-level person whose full-time job was looking at energy markets, representing the US. When I started negotiating oil and gas issues with other countries, I saw theory and practice kind of merging together, I saw reality changing in front of me, and that was it. So, I've done it ever since.
Josh King:
State department of what administration?
Ed Morse:
I was actually a political appointee in both the Carter and the Reagan administrations. It was a little continuity, for a bunch of reasons that would not likely happen these days.
Josh King:
Your political leanings must have meant a lot less than your expertise?
Ed Morse:
Yeah, and I think that was it. I was involved in the transition to a new Secretary of State, it was Al Haig. He and his people appreciated...
Josh King:
Ed Muskie and Al Haig, right? Was Muskie Carter's last secretary?
Ed Morse:
Yeah, he was. Yeah.
Josh King:
Yeah.
Ed Morse:
Those briefings were something that he appreciated. He had the White House trying to replace me with some political appointee. He didn't want somebody who he might be uncomfortable with sitting on that desk, so I stayed there for a while.
Josh King:
What were the pivotal moments either at that desk or after leaving the department that imbued this level of passion for this area of the energy industry, of which you are such a leader now?
Ed Morse:
I think what I felt most compelling was change. You remarked earlier about a call that I had in 2008 on the unsustainability of $100 plus oil prices. That was partly because I had lived through change, and partly because I went from the state department at a time when the US was just beginning to fill the Strategic Petroleum Reserve, was a reserve at the capacity of 730 million barrels of oil. We've had almost no oil in it at all, and nobody who was sensible thought the US would ever be able to buy oil to put in the strategic stock pile. I left the state department having been involved in the first negotiations to put oil in the strategic stock pile, it was deal done between the US Government and the Mexican Government. The reason this happened was that all of the assumptions that everyone had in the market then, that prices were going to go up continuously, started to break down. We saw really emerging the first of a wave, a tidal wave, of new oil coming into the market.
Ed Morse:
Although I had thought about cyclicality, nobody was thinking about cycles. And, all of a sudden it dawned on me that commodities were cyclical business, and a viciously cyclical business. All of sudden, when you were worried about, whether from a policy perspective, or then working in an oil company responsible for telling the people in the oil company where prices were going, that this was a rollercoaster. It required preparation for the rollercoaster. As I live through many rollercoaster rides, I learn that the structure of the business changed with each rollercoaster ride. That led me to... And, I think it's the edge that either I have or that others who work for me have had, namely that I look for discontinuities. I don't think about momentum as something that's permanent. I think about yesterday as being different from tomorrow, not as a precursor or a predictor of what tomorrow will be like.
Josh King:
What have been the various stages that you've seen from the '90s, and then into the aughts, and then into the teens, that talk about the different ways in which we should think about the oil marketplace?
Ed Morse:
Sure. So, my interest in this business came as OPEC became something important, and I was teaching too. I had a student who wrote a thesis, and the thesis was about when the US was the big guy in the oil sector, and when the US was the swing producer having shut-in capacity to produce. That was a function of low prices, and a function of the Texas Railroad Commission, and the fact that places in Texas, like the Permian Basin, which is very much in the news today, were the largest source of supply in the world market. There was rationing that took place in order for prices to stay at a higher level than the market would clear at. And then, OPEC kind of followed that.
Ed Morse:
Going from 1980 to 1985, there were two really remarkable aspects of the oil industry that I lived through as I was either in the government or in an oil company. One of them was that OPEC really changes in its complexion over time. So, if we look at 1981, to pick a date, OPEC's production capacity was about 35 million barrels a day. Incidentally, it's about 35 million barrels a day today. Saudi Arabia, 1981, produced the highest level that it had ever produced, around 10.7 million barrels a day in the summer of 1981. Then, you fast forward, it's actually a very fast ride, from 1981 to 1985, oil demand actually fell by five million barrels a day. Unheard of. Nobody thought oil demand was going to fall.
Josh King:
Why was that?
Ed Morse:
So, there were two things going on. One, was in the markets where demand was growing in the world as a whole at around 7.5% per annum, which means it doubled every 10 years. So, you get to a point in the middle of the 1970s when oil production in the world was about 33 million a day, and you project forward, it's going to be 66 million a day. It hit 66 million a day, actually, or 65.5 in 1981, and then it fell. Why did it fall? People thought it was because of recession at the time, but in hindsight it was because, what I call, frenetic fixed asset investment was taking place before 1973, was taking place in the US, partly because of the build out of continental-wide road network. And, we had this kind of continental-wide system feeding into gasoline demand. But, Europe and Japan, in the industrial world, were seeing 10% per annum demand growth. That is all related to infrastructure development in Europe and Japan, like we had infrastructure development in the US. Except, in Europe and Japan it was reconstruction from World War II. And guess what? 1973, '74, when the Arab oil embargo took place and oil prices went up, frenetic fixed asset investment came to a halt, because it was all done, and you didn't need 20 plus percent fixed asset investment.
Ed Morse:
So, you can ratchet a little bit forward on this. China, 20 years between 1990 and 2010, saw oil demand growth of more than 10% per year. You try to think about what caused it, it was frenetic fixed asset investment. Chinese side was not into state highway system or reconstruction, it was urbanization, "Let's build at least 10 cities a year of a million people or more, and do it for 20 plus years. And then, say all of a sudden, like that, 'Hey, we're not going to do it anymore.'"
Josh King:
Lets stop.
Ed Morse:
So, when that happens, demand comes to a roaring stop. In Europe and in Japan, in the middle of the 1970s, when fixed asset investment came to an end, demand growth came to an end. So, you take the original six members of the European Economic Community, and their oil demand now is what it was in the middle of the 1970s.
Josh King:
Are there other places on the planet that will experience what happened in North America, Europe, and Asia during the periods that you talked about? Do you see new spikes, or is it going to be a long, gradual decline?
Ed Morse:
I think it's going to be a long, gradual slow growth. It'll decline eventually, but we're not seeing dramatic growth. We're seeing a dramatic increase in the efficiency of the world to use energy, and with that a decline, whether in an emerging market or in an advanced economy, a decline in the energy intensity of GDP growth. So, just to put a number out, for the world as a whole, when I first got involved in this, there was more than a one-to-one relationship between GDP growth and oil demand growth. Now, there's less than a half of percent relationship between the two.
Josh King:
Take us through your day, what are the first tools, screens, and pieces of information you use to assess where the oil market is and where it's going?
Ed Morse:
So, the first thing I do is I have a Reuter screen and a Bloomberg screen, and I got to see what the headlines are. That's where the day starts. So, you have to assess headlines. Sometimes the headlines relate to Iran or geopolitical issues, and you've got to think through them. Sometimes they relate to a deal between Russia and Saudi Arabia that may be extended or not. What is it that is driving momentum? And, what is it that's driving change? The change really can be abrupt and big. The change that we focus on most of the time now is on the supply side, not the demand side. You have to be cynical on the demand side, and I think the lesson learned there is that when you see a sharp drop in prices, you can't get all bawled up and say, "My God, oil demand growth is going to return and it's going to be twice what it was last year, because of lower prices."
Ed Morse:
I think the big change is kind of summed up in that we are now in an age of energy abundance. There is likely to be not much on the horizon that's going to change that energy abundance. And, that energy abundance really has changed the way the energy sector works. It's a highly politicized sector. There's politics and economics at work at the same time. On the political side, I'd say the big lesson is that there are always winners and losers in the geopolitics of oil and the geopolitics of energy more broadly. But, the winners and losers change a bit over time, and the structure of them changes. So, you need to look at the market to figure out where the winners and losers are.
Ed Morse:
What happened in the last decade, not the current decade, but the one before this, was that prices went up, they went up very high, capital spending went up because people thought the peak oil was here, and there was investment and technology that was changing. The investment was obviously in shale, because we think about that given the headlines in the country we live in, but it also was in deepwater, and it also was in oil sands. It challenged somebody's way of life, namely OPEC's way of life. It did so for a structural reason that's kind of neat when you think about it. If we had a map of the world and made it flat, the way a map is, and we had in the middle of that flat map the Middle East, and Central Asia, and Russia, and to the left side was the Atlantic Basin, to the right side the Pacific Basin. You really had to basins that were in supply deficit. So, if you were in surplus area, the Middle East, and Central Asia, and Russia, you were the supplier to the world. But, all of this new supply, whether it was shale, or whether it was deepwater, or whether it was oil sands, came out of the Western Hemisphere. Non of it fed into the Pacific Basin. It all fed into the Atlantic Basin.
Ed Morse:
All of a sudden, the world did not have two deficit areas, because the Atlantic Basin became surplus. It had one. That meant a battle for market share in the Pacific Basin. The first part of that battle was Saudi Arabia saying, "We lost market share," which they did dramatically, both in the two largest oil importing countries in the world, the US and China. And, they decided they couldn't fight back for market share in the US, except they could destroy US production, they thought, by bringing prices down by overproducing. Turning to the Pacific Basin in China, they thought that they could get their market share back, particularly because they thought, like the US, the Russian energy industry was high-cost, and was going to crumble like the US energy industry would under a low-price environment. That turned out to be a lesson that they were burned by, because the ruble is really not anything other than an oil currency, and it is tied dramatically closely to the price of oil.
Ed Morse:
The price of oil goes up, the ruble goes up. The price of oil go down, the ruble goes down. And, when the ruble goes down, the Russians earn more money at a lower price than almost anyone else, and the cost of their production, which is mostly ruble denominated, plunges, so they can invest more. And, rather than their production disappearing, it grew, and meant that the Saudis looking at the market looked at a fact that historically becomes obvious, their production capacity in 1981, for OPEC as a whole, was the same as it is today. The world's demand for oil, as I said, fell to 60 million barrels a day, and is now closer to 100 than it was to the 96 that it was in 2016. So, OPEC hasn't grown. In order to market intervene, they need assistance, because the role of OPEC is now less than half of the market, rather than more than half of the market. So, they had to form an alliance with Russia that had a government with an interest in trying to stem the tide of these new sources of supply.
Ed Morse:
But, higher prices have really made these robust. An interesting aspect of that robustness is 2014 was when the Saudis increased production, brought the price of oil down. But shale, and oil sands, and deepwater had a role to play, because that was a year where demand grew by about a million and a half barrels a day. These three countries that had deepwater, shale, and oil sands, Canada, Brazil, and the US, added 2.3 million barrels a day to the market, also helping the market to soften and made the Atlantic Basin a surplus basin. Saudi Arabia and Russia got prices back up. But, as we look at this year, 2018, we expect about 2.5 million barrels a day of liquids coming out of the US, Canada, and Brazil. So, they're now in a very different position of winning and losing, and trying to push the burden of adjustment onto consuming countries that are now also producing countries. It's a very different world as a result of that.
Josh King:
So, sorting through the winners and the losers, Ed Morse, you were talking about the beginning of your day, looking at the Bloomberg screen, the Reuters screen, if you have another corner of your eye that you can go to that TV in your study and you can see the Saudi Crown Prince, Mohammed bin Salman on his tour of the United States, New York, Washington D.C., Silicon Valley, what do the moves that he has made, since being made the Crown Prince last year through the present, tell you about what the Saudis are thinking about the future of energy production, their opportunities in oil, and where they need to expand their economy?
Ed Morse:
Sure. Most obviously was the plan for 2030, to get off of the morphine of living on a oil economy, and finding ways to get it to grow. If we look at winners and losers, potentially, the Saudis have to be way up there on the winning column, because of all the petrostates in the world, in an era where I'd say we're in the era of the failure of the petrostate, of all the petrostates in the world, the Saudis are the ones that have self-consciously tried to find a roadmap to find new sources of employment, find new sources for the private sector, which has been crowded out by the public sector. To do that, at the same time that they find more value in the resource base that they had.
Ed Morse:
So, when NBS articulated the plans for both 2020 and 2030 at first, he looked into the future and clearly came to the decision, the conclusion that the net present value of oil in the ground is no longer higher than taking it out of the ground. I'd say that puts them closer to the winning column of a set of tasks that's very difficult to achieve. But, unless you have a roadmap, and unless you have it as an objective, you won't be able to achieve it. I think the really big difference between the Saudis and the Russians as petrostates, is however much Russia may be better endowed in human capital and in technology, they've done nothing to move away from being an economy and a government dependent on oil and gas revenue, and the other one has done a lot.
Josh King:
Let's turn a little bit to US energy policy. We started our conversation mentioning that you worked in both the Ed Muskie state department and the Al Haig state department. There have been many state departments and many administrations since then. If you think about the beginning of 2009, President Obama comes into the office, one of the first trips he makes is to a solar energy manufacturer and stands in front of the solar panels and declares, "Green energy is going to be our future." If you think about one of the major points of contention in the 2016 campaign, Hilary Clinton, Donald Trump, the question of whether big coal can ever be revived, how would you gauge the difference in rhetoric from one administration to the other, and in actual fact?
Ed Morse:
Yeah. So, they're both really stark in the differences between them, and the differences between rhetoric and reality. So, here we have the former president, Obama, who certainly was sensitive on the green side, and many of the main supporters that he had before he was first elected were what we call green energy people. So, he started and ended with that objective in mind, namely to accelerate the reduction and dependence on dirty resources, and accelerate the increase of dependence on cleaner resources. At the same time, no matter what the rhetoric was, the market was at work. The market turned out to be pretty powerful, because it was in the Obama Administration that the shale revolution really unfolded, and unfolded because of the compelling combination of entrepreneurial independent companies in the US oil and gas patch, combined with the financial services sector that could provide capital to these poorly-capitalized companies, given the risk-reward for that capital to make through greater production. And, we had one other thing in this country, namely almost uniquely on the planet, an ability of private parties to own resources under the ground. So, that combination, and the high prices that were there, relatively speaking, at the beginning of the Obama Administration, really is what created the shale revolution. He might not have liked it, and he might not have appreciated what was going on. He did, however, sign a bill to end all of the obstructions against US oil exports.
Josh King:
Thus raising all the incentives for these types of extraction processes.
Ed Morse:
Significantly raising them, and actually changing the US from being a declining oil and gas producing country, to be the fastest growing one in the world. And, once the export restrictions were removed, the fastest growing exporting country in the world. It is kind of factual that the increase in US exports of crude oil, petroleum products, natural gas liquids last year, was bigger than global demand growth. Like 1.7 million barrels a day, a stunning number. So, we have this contrast between the objectives of the government and what the market is doing. Similarly, I think with the Trump Administration, yes, there is a rhetoric of US energy dominance, but what does that mean when the US has no state levers to use oil or gas as an instrument of public policy? So, I don't know how you articulate a meaning for policy from the concept of energy dominance. Although, the US has become a bigger player in the market than it otherwise had been.
Ed Morse:
Just to give you a notion of that, by the end of this year, if we look at all liquids produced by the US sector, natural gas liquids turning into things like propane and ethane, oil, crude oil, biofuels, by the end of this year the US will be producing 50% more liquids than both Russia and Saudi Arabia. So, it's not something that we normally think about, but it's been a dramatic change. President Trump started by liking dirty energy, and particularly liking coal, but the fact of the matter is that it will be hard to find the board of directors of a utility anywhere in the United States that will take on the potential liabilities of building a new coal fire generating power plant. There is every incentive, when these 50 or 60-year-old plants come to the end of the useful life, not to put capital into them to lengthen their days, but rather to replace them with something else.
Ed Morse:
So, no matter what public policy says about coal usage in the US, which has fallen by over 30% from the beginning of this decade to now, and is going to continue to fall at a fairly rapid rate, particularly because the US is not consuming grid energy at a faster rate. We're consuming grid energy at a lower level than we used to, as renewables that are in the distributed energy business that provide an ability for a university or a big retail chain to fuel themselves with solar panels and wind turbines, doing it off grid, maybe selling some of it onto the grid. Even in a...
Josh King:
Residential, commercial power generation just for the purposes in a very localized area.
Ed Morse:
Yeah. And yes, we'll have a big spurt of power demand again with electric vehicles when and if they come of age, but it's not going to happen between now and 2020.
Josh King:
Are there things that investors, that you listen to, read, follow, and then also provide guidance to? What would they say the Trump Administration and government should turn their sights on? The most effective things that they should do for national energy policy that they're not doing now?
Ed Morse:
I think that there has been a growing popularity within corporate America, and within governments within America, to take seriously climate change, take seriously the need for cleaner energy. Companies have their own behavior. It's hard to find a bank that'll lend anything to a new coal mining venture. There are multiple reasons for that, and maybe it's self-defense, in some cases, against share holder preferences. But, the government can't do anything to change what companies want to do. Sustainability has become a theme of the public and of companies. I think it's not reversible. I think that's the underlying trend line. And, it's such that it's really hard, whether you look at pushing coal again to have more employment in coal mining, or whether you're pushing to keep fuel efficiency standards at a lower level than a higher level, it's hard to stop the momentum, whether it's in the US or any other country.
Josh King:
We're with Ed Morse, he's the Global Head of Commodities Research at Citigroup. After the break, we'll continue our conversation with Ed, talking about the mechanisms that set global oil prices.
Speaker 3:
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Josh King:
Back now with Ed Morse, Global Head of Commodities Research for Citigroup. Ed, what is your frequency of output? You've mentioned your rhythm as you get into the office. How often are you communicating to investors, and in what form? Are you passionate about writing and sharing information about where the industry's headed?
Ed Morse:
Yes, I'd say there's not enough time to write the things we want to write. My team and I are fairly prolox in what we put out. Some of it is because we regularly have to do it, so we regularly have to think. We follow financial flows in and out of commodity markets. Financial flows in and out of energy markets and oil markets, in particular, are near and dear to the ICE, near and dear to the markets. I'd say it's the most fascinating part of the market, in terms of price setting as well. So, if we look at financial flows, they're very fickle. You can't follow momentum in them a lot. If you look at the net length of managed money on both of the big exchanges, you can see that at the moment we're at, a combination the two exchanges, at about the record ever. There is a tight correlation between the net length of managed money and the price of oil. Unless you have your eyes fixed on that, you can get burned as an investor in the market. So, we spend a significant amount of time trying to think of the drivers of short positions and long positions in the market, and who is putting them on.
Ed Morse:
The one thing that's really clear is that when you're in a record level of length, it's not going to last forever. This is a real rollercoaster, and the turning points happen just like that. Market sentiment can change on a dime. Market sentiment, at the moment, is very bullish for geopolitical risk purposes. May is a month of phenomenal geopolitical risk in the markets in general, but the oil markets in particular, the month of May sees a deadline on the JCPOA agreement with Iran. It has elections in Venezuela. It has elections in Iraq. May is also the month when the presidents or the heads of state of both North Korea and the United States have decided to get together. There's a lot of geopolitical risk in the consequences of the month of May.
Ed Morse:
If we get through the month of May with a sigh of relief, there's bound to be a selloff. How the selloff materializes is hard to know. The financial market, and the financial market, which is something we have to think about every day, and particularly every weekend, because we put out a report on this every Monday. We put out the report because there is reporting both from the ICE itself and from the CFTC on position of people in the market from the week before. But, we also look at the stats. Stats are high-frequency. We have both high-frequency and low-frequently statistics coming into the market every week. Typically, we have weekly data from the United States, from Japan, from observers of independent storage in Northwestern Europe and the Caribbean, and in Singapore. The market is fixated on the issue of whether Saudi Arabia, and Russia, and the rest of OPEC, are bringing inventories down, or whether inventories are rising. We kind of project out, as I said earlier, there's 2.5 million barrels a day, potentially, of production growth from the US, from Canada, and Brazil, which will be, at some point in time, adding to inventory.
Ed Morse:
We suspect when the market sees US drilling rates continuing to rise, and inventory starting to rise, there's going to be a big selloff from this managed money at its record level of net length, combined with less geopolitical risk. We think that's going to bring prices down. So, we have to watch this weekly, bearing in mind that we're looking at turning points. We expect that the turning points are going to be what they are directionally, but we just don't get the timing exactly right in advance, so we have to monitor it all the time.
Josh King:
Bringing prices down. Let's talk about benchmarking for a minute. You're known for your extensive research into crude oil benchmarks. For the uninitiated, we are talking about bringing prices down, what is a benchmark, and how does it effect the pricing of oil?
Ed Morse:
So, a benchmark is a crude stream, normally traded on an exchange, that is used to set the value of other crude streams. So, we have two major benchmarks, the largest of which is the ICE benchmark. What's critical to the market is the spread between Brent and something else, whether it's urals, whether it's another benchmark. The benchmark is the price setter. It's the price setter that you'll look at it in two different regards. One is, in the exchange market itself, what's the difference between today's price and tomorrow's price? And therefore, what is the structure of the forward curve? So, the benchmark is pretty critical to that when the benchmark is higher price than the nearby contracts. That shows you that the world market is pretty tight. If the benchmark is lower priced than the next month and the month after that, that's an indication of softness in the market. When the two big benchmarks, WTI and Brent, which are mostly lookalike crudes differ from one another, both the nature of that differential and the nature of the change in the structure of both of them, which I suspect is going to be very different at some point this year where we think Brent will stay backward data, and we think WTI will be in contango. You need to, for investment purposes, have a critical eye on what those benchmarks are, and their relationship over time to one another and themselves.
Josh King:
So, thinking about ICE Brent and gas oil as global benchmarks, are there any recent or future changes that you've seen dat-to-day, week-to-week, month-to-month that should drive our thinking around those products?
Ed Morse:
We have, in recent days, seen a new benchmark being tried on an international exchange. It's a new Shanghai exchange, where liquidity seems to be growing in leaps and bounds, where the Chinese government is very much behind the exchange. Unlike the exchanges on which oil is otherwise traded, which were evolutions of a market, not government diktat. The irony is that the world thought, the market thought that the two benchmarks, particularly Brent which is used more than WTI is, in contract terms, by sellers of crude oil, they thought that these were anomalies, they were light sweet crude in a world dominated by heavier crude. Every heavier, more sour crude benchmark that's been tried has failed for one or another reason. The market is evolving, where the incremental barrel these days is light and sweet. So, it's probably going to prolong the existing benchmark, and will likely make it even more difficult for the sour crude benchmarks that China is trying to float, or that Russia is trying to float, to be able to succeed.
Ed Morse:
The other one, gas oil, is really interesting these days. In that, for most of the last 20 years, particularly up until 2011, the product line that saw the major growth was gas oil. It was thought that it was going to be the critical product in the product markets, then, for five years after this decade turned, gas oil demand stopped growing. It was supposed to be the leader in growth. But now, it's growing again at a very fast rate, for reasons that you've got to keep your eye on, hard to think through, and are happening at a time when in less than two years, on January 1st 2020, marine gas oil standards change to a low sulphur gas oil standard. It's not clear that the refining system of the world can make enough of that. I suspect that that benchmark is going to become, again, more critical and have more market eyes on it.
Josh King:
So, Ed, just taking a quick trip back in history, in 1920, the US enacted the Jones Act, also known as the Merchant Marine Act of 1920. It required good ship between the US ports to be transported on ships that are built, owned, and operated by US citizens or permanent residents. Can you talk about the way that the Jones Act has affected US oil market dynamics?
Ed Morse:
Sure. It's been another distortion in the market. A massive distortion when you think about what the objective of the Jones Act was. It was post-World War I. And, it was designed to preserve the dominance of the US Merchant Marine Fleet, which was the dominant fleet in the world. What it did was accelerate the decline of the US position in the world of shipping. So, we have a law that was designed, partly for national security purposes, and partly for intervening in the market purposes, and it didn't really play as big a role in either, and has this distorting effect. The distorting effect was also, for a while, in the grain markets as well as the oil markets, because shipments of grain under the PL-480 program, US aim to subsidize farmers, effectively, had to be shipped on these vessels also, which are more expensive to own and operate than non-Jones Act vessels and non-US flag vessels.
Ed Morse:
What this has meant is that it is often cheaper for a refiner on the East Coast, or the West Coast, to bring in crude from afar, from another country, than it is to bring crude in from the US, unless there's a pipeline that at times when, for emergency reasons like a hurricane, you can't get enough product through a pipeline from where the product is produced on the US Gulf Coast to the deficit markets.
Josh King:
This was huge issue in Puerto Rico.
Ed Morse:
It's a very big issue in Puerto Rico, but it was a big issue in Hurricane Sandy. It just has a distortionary impact. The interest groups where the shipyards are, having an alliance here between Rhode Island, Mississippi, and California, to put three odd couples together, is... Or, maybe it's more a ménage à trois than an odd couple, but strange bedfellows fellows are made by politics. And, the desire to keep, for defense purposes, this industry, means keeping the Jones Act going. Just like the renewable fuel standards, which has winners and losers, winners in Iowa in the Corn Belt, losers in the independent refiners, just as that is hard to overturn and make it more rational, so too this is hard to overturn.
Josh King:
Can you talk about some of the trends that you're seeing in Asian oil markets and in refined production that we didn't touch on earlier? You've got ongoing communication between Xi Jinping and President Trump, and how that will play out over the next 12 to 24 months?
Ed Morse:
Yeah, I don't know how that plays out. There's brinksmanship going on in the trade part of the world, and that brinksmanship can be very dangerous. We don't know what happens if one or another party doesn't blink, and where the party waging the trade war goes if the trade war can't be won. But, the underlying trend in China is diversification of sources and supply, and the market is working there too. I noted earlier in our conversation that US exports grew by 1.7 million barrels a day in 2017. The largest growth of that came in the Chinese market. Where the US, a month and a half ago, was exporting about a half a million barrels a day of crude oil to China. The demand among the refiners in China for light sweet crude is quite high. And, where earlier conversations between President Trump and Xi led to a view that there was going to be a Chinese welcoming of US LNG exports. Ad indeed, next to Mexico, which is the largest recipient of US LNG, China's number two, in terms of buyers of LNG. Maybe that had to do with dramatic shortages over the winter of gas in the Chinese market. But, the US is incrementally, on the precipice, becoming the largest incremental supplier of LNG to the world. That will go to China as well.
Ed Morse:
Ironically, the US is taking a lot of the market share of the producers that have cut back, and that changes the dynamics of the market and price determination in the market. So, the US is becoming much more of a price maker in the market, by virtue of the supply growth, than it has been any time since maybe the early 1970s.
Josh King:
So, whether crude oil production ever gets to 100 million barrels a day by 2021, or grows at a more gradual pace, we're going to continue to depend on analysis of experts like Ed Morse and his team to help us to continue to sift through the political, economic, and even production and transportation issues that drive the cost of what we pay for a barrel of oil or a gallon of gas, now or in the future. Thanks, Ed, for joining us in the ICE House.
Ed Morse:
Thanks for having me here.
Josh King:
That's our conversation for this week. Our guest was Ed Morse, Global Head of Commodities Research at Citigroup. If you like what you heard, please rate us on iTunes so other folks know where to find us. If you've got a comment or a question you'd like one of our experts to tackle on a future show, email us at [email protected], or tweet at us, @NYSE. Our show is produced by Damon Leavell, Pete Asch, and Ian Wolff, with production assistance from Ken Abel. I'm Josh king, your host, signing off from the library of the New York Stock Exchange. Thanks for listening, see you next week.
Speaker 1:
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