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I'm your host, Zach Griffiths, head of investment grade and macro strategy at Credit Sites. It's been an exciting start to the year in markets, headlined by Donald Trump's inauguration on January 20th. We've already covered several podcasts covering tariffs from a high level, and I discussed our U.S.-China relationship outlook and what it means for markets, with Zelina Zhang last week. Today, and we're recording this episode on January 28th, we'll be discussing the oil market with a special guest from outside the firm, Rory Johnston.
He's the founder of Commodity Context, a data-centric and visualization-forward oil market research based out of Toronto. Prior to founding Commodity Context, he led commodity economics research at Scotiabank, where he was responsible for a broad swath of commodity price forecasts and sat on the bank's senior credit committee for commodity-exposed sectors. So I think today's podcast is particularly timely as we continue to consider adjustments to our tariff policy with Canada and Mexico over the weekend, what it means for oil markets broadly. So without further ado, Rory, thank you so much for coming on the podcast today.
Thanks for having me, Zach. All right, so before we get into the topics du jour, why don't you take us through your high-level assessment of what we saw in the oil markets in 2024 and how that's shaping your thinking about 2025? The story of 2024 in many ways for the oil market was one of slowing down. Demand slowed down, supply slowed down, news flow and volatility slowed down.
We had the lowest volatility and range of trading since before COVID. Everything just the polar opposite of 2022 when we had COVID, then you had the recovery, then you had Russia-Ukraine, then you had an entire year in 2023 of surprise after surprise after surprise from OPEC. And then 2024 was about OPEC in particular trying to hold that entire deal structure together while the market just kind of slowed down. As an example, the pace of both supply growth and demand growth eased considerably, well under historical average levels for both supply and demand growth.
So I would say heading into the year, I still see markets in, I see markets average last year, a moderate supply deficit. I think this year we'll have another minor to moderate deficit. I think given that we have inventory levels at extremely low levels, particularly in onshore crude stocks, very, very low inventory levels with persistent durable deficits means even lower inventories come a year from now. If that holds, I see prices likely grinding higher from here, at least on a kind of a pure barrel counting balance outlook view.
I see that complicated by, I'm sure what we're going to talk about, which is Trump tariffs, U.S. policy, et cetera, et cetera. But I think we'll leave that for a second. And I think we'll just deal with kind of these like big, chunky supply and demand balance model line items for a second.
And on that, I think that the outlook looks reasonably good. Demand growth has begun re-accelerating more quickly than supply growth has. Most sources of supply right now are generally kind of underperforming expectations. You had Brazil last year that some expectations had it growing, like yeah, you had it almost growing by like 400,000 barrels a day or more.
It came in flat on the year, basically, which is a huge disappointment. I think Canadian growth, which was a huge outperformer last year, one of the strongest years of supply growth, you know, one of the strongest years of supply growth in, you know, a decade, you know, rivaling some of the heydays of oil fans building in the first place, that I think had the opportunity to be growing this year, but now likely because of some of those tariffs and everything else, we'll also likely have a period of, you know, slightly slower growth. U.S. crude production as well is an area that, you know, year after year after year right now, the expectation is that we're also going to see continuing slowing in that pace of growth, which again, all of this, you know, and you know, I see Zach right now smiling.
All of this is naturally going to dovetail back to Trump and Trump's objective orders and tariffs, whether that's, you know, this element of Canada or, you know, energy dominance and U.S. shale growth or whatever else, all of this is going to kind of get wrapped up in a bow as we go on. And on the demand side, I think, like last year, Chinese demand by my numbers actually contracted on an annual average basis for the second time in about 25 years. The only other year that actually contracted outright was 2023 during the kind of peak of COVID zero shocks.
So all of this together, like for me, it's difficult for things to get immediately worse in China on the demand side. Again, China tariffs could make it worse. I'm not saying it can't, but I'm saying base case, if we don't see all of this stuff ramp up, I think that, you know, the most likely pace, the most likely trajectory of Chinese demand growth is a modest reacceleration. But I think it's also important that given the size of China's base effects in the crude demand and in the oil demand space, even a modest reacceleration moves a huge amount of headline level, even a modest pickup will be the equivalent of all of India's planned demand growth for the year.
But like all that together is, you know, it's pointing towards a system that at least begins to tighten up again. And combine this with the fact that OPEC also now has, in its latest iteration of its supply deal, has, it's now planning on beginning to ease its production cuts or increase production in other way, putting up like normal human beings. And, and that, you know, the plan is to begin lifting production in April, but rather than, you know, lagging it back into the market over the course of 12 months, so 2.2 million barrels over 12 months, now it's 2.2 million barrels over 18 months. And I actually think that slower pace of increase is actually probably the most important aspect of the new deal.
It means it's much easier to picture a world in which those barrels, those volumes can be fit back into the market without inevitably tanking it. Whereas prior, you know, 2.2 million barrels of additional supply in any year is almost always going to put you into an oversupply because that's more than demand to pick the person in a year. So unless you assume a massive collapse in non-OPEC supply, there just wasn't any plausible way to get those barrels back in. Now that they're looking at a way of doing that more realistically in a slightly slower, more methodical manner, I think that's bullish on one level because it means that, wow, they can actually do this and they won't tank the market in the process.
But on the other side, I think there's also a bearish read on it, which is they kept delaying it. So this actually means all is equal. If it's less likely to be disruptive, it's more likely to finally do it. And if the oil market had been built again, been baking in this assumption of perpetual delays, which had been my assumption until this latest iteration and the elongated timeline, I think this new deal makes it less disruptive, but it actually begins to show off my base case more and more rather than being this kind of bearish tail risk in the market.
So there's a ton to unpack there. And before we do, can you just give our listeners, and I'm not as familiar with this as I'd like to be, some high level numbers around global supply and demand. You just alluded to the fact that 2.2 million barrels over 12 months is certainly typically going to be far more than we expect demand to rise in a single year. Can you just give us some of those high level figures that you kind of keep in mind when thinking about the supply and demand picture?
Yeah. I mean, we're slightly off these numbers now, but it's been 100 million barrels a day producing consumed. I think right now, my latest trailing 12 months is about 102 million barrels of production consumption, give or take. Now, these numbers are estimates, best estimates in many cases.
When you build these models yourself, you know how many light items there are that can really go awry. So it's best to only look at them in terms of an overarching directional story rather than a true accounting balance. But I do think that in terms of parameterizing what 2.2 million barrels a day is, it's about 2.2% of the market, give or take. Let's take 2% of the market.
And I think for a lot of people that aren't familiar with commodity markets or particularly commodity markets, it's like, oh, that doesn't sound like that much. But the important thing to remember here is that these markets trade on the marginal barrel. So the last barrel sold is really the barrel that's the price of the entire industry, more or less. And that kind of supply-demand balance is really how this market trades.
Basically, you go from production and consumption gives you a supply-demand balance. The cumulative accumulation of that supply-demand balance over time shifts your inventory, your realized inventory position. And as I see it, inventory position drives both level prices of crude and term structure in the crude futures curve. So when 2.2 million barrels a day might not sound like a lot, but that's more, that's about the oversupply we faced in 2016 when the market collapsed to like $25 a barrel.
So it doesn't take a lot to push this market into a tailspin or into a surge on the other side. All I'm saying is 2.2 million barrels is actually a lot of crude. And OPEC actually, they talk about it casually sometimes, but I think it's a heavy lift. And I think that they're going to need a combination of kind of policy savvy and luck to get these barrels back in anywhere near their kind of hoped-for timeline.
All right. I think that's really helpful. Also convenient that it centers around 100. That's certainly an easy number to stick in your head.
Yes, that is quite convenient. And it's interesting you make the point about the oil market slowing down in 2024 compared to a couple of crazy years leading up to that. I feel like it was somewhat similar in the credit markets for us with spreads tight, yields remained fairly elevated. The Fed was finally delivering some cuts, but we've actually had yields back up a ton.
So I think you're already seeing the unfolding of what kind of felt like a status quo year or a slowing down year as you put it in 2024, yielding to many more forces at play that are likely to make 2025 perhaps a bit more interesting, the first of which is certainly the Trump administration, what they plan to do with tariffs, certainly for this discussion, immigration here in the U.S., taxes and deregulation. So now that we sort of set the stage in terms of global supply and demand, I'm sure we're going to come back to it a little bit more. What are the key things sticking out to you with respect to the policies that Trump administration are considering? I alluded to the potential for 25% tariffs on Canadian goods going into effect this weekend.
How likely do you think that is? Is there any way to handicap that? And how is it fitting into your overall view of the markets in 2025? I'm going to say one quick thing before answering this question, which overall, I think, you know, the handicapping is a particularly important question right now.
The other thing I will just note about 2024 is while it was slower on the balance math, it obviously on a bunch of levels was still quite busy and headline focused. You know, we started off with, you know, Houthis closing the Red Sea. We had Israel and Iran launching missiles at one another, like an active open brazenness. And I think the other thing, and I'm framing this now because I think it's going to dovetail into, I think, how the market is trying to handicap Trump is over the five years kind of around COVID, call it, let's say, 2019 to present, we had just an accumulation of crazy things that happened from the killing of Soleimani to the Iranian attacks on the Saudi Abkhic facilities, to COVID itself, to Russia's invasion of Ukraine, to, you know, Houthis in the Red Sea, to Israel and Iran launching missiles at one another.
And all of it basically had no lasting impact on the oil market fundamentals. I'm so glad you brought that up because when you put it in that context, slowing down feels like you can't say that holistically, even though, to your point, market prices, market volatility ultimately somehow wasn't terribly crazy, but the headlines certainly were. Absolutely. And I keep chalking this up to markets have become numb to this risk.
I think you've seen more and more algorithmic based trading into the mix that just empirically sees that these kind of headline shocks are almost never followed up by true tightness in the market that's durable. And so like the whole, like the whole classic refrain of like, you know, sell the news, that's like becoming hard baked into how these markets work. I think that's going to become very interesting now in the era of Trump's second term, which is what we've seen even already. And we're like, we're literally like basically a weekend and the level, the frenetic pace of governing that is occurring of, and I mean like, and by governing, I mean, governing by decree, largely governing by executive order is something that's very different than what we saw in Trump's first term.
And I think it's also very different from, you know, there's this, you know, like the classic, like a, like internet meme, which is like, you know, hashtag nothing ever happens. Well, all of a sudden, a lot of stuff is happening in Washington. And I don't actually know if the oil market, I don't know any markets, I don't know if the oil market in particular is ready to properly incorporate that yet. Because, and I think very reasonably, the market is kind of at this stage kind of saying like, show me, show me the barrels and then we'll, then we'll deal with it.
But when we're talking, and like just to very quickly go through some stuff, we've already seen Trump do on oil. We've seen him, you know, from a virtual podium at like World Economic Forum in Davos, basically urge OPEC to increase production and reduce the price of oil. We've seen him threaten tariffs on Canada, which accounts for about 60% of U.S. crude imports and Mexico, which is the second largest source of U.S.
crude imports. Also, basically those two countries, almost all of U.S. heavy crude imports. You've seen the, you know, very, call it aggressive language around, you know, U.S.
energy dominance and re-accelerating the pace of U.S. production growth. All of this stuff. I mean, we are not even getting to the fact that he withdrew from the Paris deal.
He withdrew, you know, all this other stuff. He eliminated E.D. subsidies. He, all these things that help, theoretically help oil prices in the long term, but we're not going to see a media effect.
But this other stuff, like we did see a pretty quick sell-off when he urged OPEC to increase production. But we also saw that time and time again last year. So I think it'd be helpful to kind of go through each of those a little, a little more slowly. Do you have any kind of, do you know what you want to start with?
So I think as you were mentioning the aggressive increase in U.S. energy production, we were going through that. Ticking through them and how they would mechanically result in higher production, he basically said none of them are likely to meaningfully increase U.S. production.
And I was like, is it really that simple? None of these, and I guess you could probably tick through them better than I could, will incentivize more production in the U.S. And he's like, it's that simple. None of these policies being proposed will meaningfully increase production.
What's your take on that? Well, I would say that anyone speaking with the last name Johnson on this, I think is, I hold him very high esteem. But I agree. I think that, and we don't need to go through all of the nitty gritty here, but generally what they're doing is they are looking to ease the regulatory burden and that will allow, because it's, you know, Trump and the federal government can reduce the cost of production to a degree because there's an element of the cost of production that is just regulatory burden.
Like if, if Trump wanted to, and you know, we're seeing him again, do things pretty rapidly, he could eliminate the environmental protection agency. That would, yeah, if you eliminate the EPA, that would probably reduce the price of producing oil and gas, like just like, you know, baseline, right? Yeah, not going out on a limb there. I'm not saying it's a good idea to eliminate the EPA, but I think that like when we're talking about what he can do, there's a bunch he can do.
He can allow more leases, you know, all of this stuff. But what he can't do is he can't force these drillers to drill. That's the key, right? That's the key.
And I think what you've, what you've seen is like, so us production last hit its recent high growth in 2023 and that was about and that was a surprise when it doubled initial expectations initial expectations were about 750 000 a day of growth expectation uh for 2023 it came in about 1.5 million then 2024 that would have and then this year the expectations have again coming around 300 000 that's going to be an awkward narrative line for the trump administration if the first year of their energy dominant strategy comes in at you know one of the weakest paces of u.s production growth exclusively you know excluding covid basically excluding 2020 that doesn't jive narrative doesn't be awkward um but like to your point um you can't force them to drill and the reason they're not drilling is because the price isn't high enough i think and we're going to see time and time again in this trump paradox of his stated goals is that he wants more u.s production and lower prices which the only way you're going to get more production is with higher prices there are ways that trump can incentivize more u.s crude production you know sanction iran into oblivion he can zero out venezuelan exports again all of this will tighten the oil market more than our base case and that would increase prices and increase the incentive to drill and even if let's say you would you know so that would help drillers just more sure even if we say none of that happens and let's say trump wants to reduce it managed to reduce the regulatory burden equivalent of let's say five dollars a barrel of production costs i think that's probably ballpark what we're talking about in the near term i think first of all it's going to take a year or two minimum for that to kind of percolate through and then second you know i don't think like if we're sitting at let's say kind of low mid 70s right now for wti do i think that u.s production would be gangbusters different if it was five dollars a barrel higher no i think i think we need 10 15 20 dollars a barrel higher like if i think that u.s production growth right now will continue to slow or remain at this kind of much lower pace unless we go back up to 90 100 110 dollars a barrel crude if those higher levels are reached i think absolutely u.s u.s production will be accelerated again i think there's a lot of people in this industry that they frame their pessimism on u.s production growth as like as geological fate where i see it as more of just an economic reflection of reality and these and for those that don't follow this market super closely their reason like the core underpinning of why exactly these companies have begun to become so you know gun shy on investment when is that you know they for the decade prior to covid were known for the profilacy i think the you know they collectively incinerated roughly half a trillion dollars of investor capital with unproductive uh unprofitable production and the market doesn't like that anymore that and that i mean that is mind-blowing so 500 billion of capital destroyed can you like and what was that just and i recall the crash in mid 2010s you know i guess real quick touch on that and maybe how that maybe has shifted i think that's kind of what you were alluding to this hesitancy to embrace the potential for more production i guess almost regardless of price just take us to those dynamics really quick you can't say half a trillion without uh without giving a little more detail right yeah i mean so a lot of you have always argued that you know a common argument in the industry has been that cheap u.s credit looking at people like yourself of course you know has facilitated the rise of u.s shale by subsidizing subsidizing kind of non-profitable production it's the same way like i have you heard the argument of like um the millennial subsidy how like the idea of like how tech investors subsidized uber and lyft and all these companies that they basically made no money on their early processes they were in this market share accumulation phase so that we as millennials all got that i'm millennial anyway yes i am i assume but we all kind of got this massive subsidy paid for by silicon valley for i mean i remember taking ubers around toronto like seven bucks like that doesn't have to be so much cheaper yeah totally um and i think the shale boom was in many ways like the ultimate millennial subsidy of it subsidized the entire global economy that you know we had this cheap credit that facilitated this and i should say it was cheap credit combined with legitimate breakthroughs in technology and kind of technique and familiarity and process all that together is what brought us you know the revolution but again the pace of growth was just something that the industry had never seen before we had never seen a million to two million barrels a day of growth year after year after year from one country it just never happened now the challenge is is that it was happening amongst dozens of independent smaller u.s producers so there's no real collective strategy for huh does this make sense for us all to be producing so much all at once it was a classic kind of collective action problem and what's happened over the interim is first the industry got punished by investors you know we talked we like to talk about them you know finding uh the religion of cash flow finally that they were like let's actually produce some money before investing in a new well um and the other thing you saw was a lot of consolidation particularly through covid and the kind of bust but you so now more and more and more of u.s shale operations for instance are under the umbrella of like majors like exxon and chevron and conno phillips etc whereas before it was much more of these like you know u.s independents like um sheffield's pioneer or occidental or other things like this that were kind of the core pillars of that previous pace of growth now it's entering much more of i think a mature basin phase which is you have these companies like exxon etc they're looking at producing this for like decades and decades and decades now um and figuring out how best to kind of optimize that production over a very very long period of time rather than like a literal dash for cash which was kind of the entire kind of tone and tenor of what was happening before i think that's that's what changed and i think we kept hearing i should say we kept hearing that they had found cash you know found the original cash flow we found it nope we learned this time we learned this time year after year it wasn't it took covid and it took that sudden snap of the market to actually you know really begin to be like we know this out and even then there was some initial questions because like again everyone got really spooked about u.s production growth in 21 and 22 because u.s production growth was not re-accelerating as quickly as expected uh despite very very high prices especially in 22 and the the issue at the time wasn't that the prices weren't high enough it's that all the rest of supply chains underpinning that segment of the market were also all you know completely shot through let's say by all the other things like the kind of ever-present covid era supply chain now i will just very very quickly dovetail one of the things that became very very expensive and hard to get during this period was what we call oil country tubular goods which is a very very fun word to say because i love saying tubular but this is essentially a complicated way of saying pipe like steel pipe uh you know you've ever seen it like these really really long steel pipes that you know basically go down the well um and kind of create the basis for how you drill this you know you drill for oil uh kind of an important piece of the entire puzzle that in particular got exceptionally expensive take your hands on and one of the things i just had someone like this morning mentioned this to me that the tariffs on china that have been threatened china is increasingly a critical source of u.s oil country tubular goods imports so they were saying they basically they basically said my firm will not survive if we see a repeat and i'm taking from their context they are a u.s thriller their firm will not survive if you if we see a repeat of 2022 level oil country tubular good prices and i think it's an interesting aspect of this when we talk about things even like u.s energy dominance u.s energy dominance is like all aspects of u.s economic and political strength a function of the u.s's core underpinning kind of strength itself but also it's interrelations with the rest of the world and the rest of the country supply things with things with assets that doesn't really supply itself so if china wants to let's say fight back and stymie uh the u.s over trade policy well maybe it just decides to say well we're not going to ship you you know tubular goods anymore well that's all of a sudden a big problem because you can't produce all that you need in the the United States so all of this is interconnected and i've deviated a little bit from from this kind of uh walk back from 2022 but all this to say u.s firms have got u.s oil and gas producers have become more disciplined they have become more sensitive to price costs have risen through that inflationary period a lot of those supply chain bottlenecks well it did finally let up prices didn't get back for for instance for or tubular goods didn't get back down to pre-covid levels all that together it's just it means you need a higher cost a higher price in order to incentivize the same level of production i think that's extremely helpful bringing this all together and thinking about the recent context and also kind of bringing in what a tit-for-tat trade war part two could look like and how it could have vast knock-on effects for various industries and so sticking with that maybe setting china aside for a second what do you think about the likelihood of these tariffs on canada and as i understand it that would create a big issue at least in terms of costs for our midwest refiners that get the heavy crude from canada and can't really get it from anywhere else so maybe take us through how you're thinking about the likelihood of that and then ultimately who that cost gets passed on to or who ultimately bears the bear the burden of the tariff cost of those particular tariffs the tariffs these 25 tariffs against canada mexico they've always been kind of paired but occasionally he'll focus more on one than the other depending on what kind of story today is but they've always kind of been combined at least uh narratively they've been really in place since late last year in terms of threat when this first started coming out i actually started flagging a risk because i saw even a change in the tone of how people were talking about canada uh from the kind of you know american right circles that often show up in my replies um i would say there was a week i remember where it was like one day people were like trump is going to pass he's going to re-approve keystone xl and then canada and states are going to be uh you know energy superpowers and we'll be able to take on the world like ah that sounds great and then like literally the next day it was like actually we don't need your crap canadian oil and like that was really fast um and i'd say that was the moment and i started flagging this and people thought it was crazy people thought like there is zero chance that trump will put tariffs on canadian oil rory you're being melodramatic that was kind of the tone i was getting both from people and the largest people you know in western canada but even people states like it's not going to happen you have to understand i understand the role of canadian oil you have to understand what i'm seeing and so i will say that when this all started i saw it as a tail risk but it's a distinct one and i would put the probability like five or ten percent which is i should say disconcertingly high given that can united states are arguably the two strongest longest lasting kind of democratic allies in modern history longest on basically effectively unguarded border like etc etc etc um best probably increasingly part of the problem anyways but the then you know steady drumbeat of more and more and more threats week after week after week you know you know the good daisy and in you has to kind of keep ramping that probability higher over time gradually gradually like your prior is to your anchor but it's slowly creeping higher and i would say the biggest break for me um the moment where i it went from like a tail risk to this might not be the base case but this is the second most likely case and i'm starting to be very concerned was um so alberta premier daniel smith um for those that aren't aware of canadian politics premieres are like our governors of provinces um so alberta premier daniel smith alberta obviously the major oil province she had been the most optimistic and kind of um sanguine about the prospects of both u.s terrace and kind of broadly and specifically on on canadian i think i should also say that there was always this debate of like okay well maybe he'll do it on manufactured goods in ontario quebec but he's not going to do it on oil right and then so she went down to mar-a-lago uh to the weekend before inauguration so that would have been whatever like the weekend and like the monday was a 13th so i guess that would have been like the 11th and 12th of january and she went down and the conversation at least by the pictures was brokered by of course kevin o'leary um and i don't even know what's happening in holly's anymore um but the uh i think the her comments were really interesting and concerning so the next morning she had kind of a press uh a press event where she spoke to a bunch of largely canadian journalists about what had happened what sense she got out of that and i think i and many others were expecting more of that same optimism right we're heading into moderation i just had a great conversation with president trump you know we're looking forward to a you know bright partnership that's kind of the that's not all we got we got canada needs to prepare tariffs are coming uh i i heard no indication of any exemptions so all of a sudden we went we had probably the single most optimistic premier becoming the one that was arguably either pragmatically or pessimistically kind of most alert and concerned about this and it was on that day on that monday where markets really began all of a sudden pricing this in very distinctly in a very notable way um you saw that both in a fairly notable widening in the futures curve for wcs differentials so for those that aren't aware canada major oil major oil exporter largely exports heavy sour crude our primary heavy sour export blend of crude is called western canadian selector wcs um so and that trades on a differential or you know basis or spread versus wti so right now that wcs differential is about before that about 11 or 12 and i briefly wind out to more than 14 that was kind of the beginning of reflection of that you also saw notable moves in equity markets fairly weird moves for canadian oil names in that you saw a couple names get really hit really hard while other majors were not some companies like canadian natural resources and meg energy two very very large oil sands producers that are export oriented were hit hardest whereas companies like suncor and imperial oil which are the other two majors or other two other majors as well but imperial and suncor weren't hit nearly as hard because they have large extensive canadian refining distribution marketing and marketing arms of the businesses so theoretically they could be insulating some of the tariff shock to their own businesses but i think it was that moment that you saw basically smith's comments hit and then within about an hour you saw this absolute route and we saw it was like a five percent collapse on the day of both you know both cnq and meg so that was that was bad and that's what i got very very worried i'd say that probably peaked that probably shot my my probability up to 40 or higher that was gonna happen soon well yeah then inauguration day came we got first thing in the morning we got news no tariffs at all at all on day one no tariffs at all on week one fantastic news we're home free i can do other things with my life again uh and then later that night a journalist is asking him has he's speed signing executive orders what's happening with the tariffs and then ben trump's like oh actually yeah those are definitely still happening probably on february 1st and it's like oh so close back to the driver we're so close this close to greatness and unfortunately that we're back now i would say that even with that firmer date in place i would say i'm still only at about a 35 probability i think part of that is because as we'll explain in a second why it would be so disruptive and so problematic in the states to tear up the soil but we already saw trump what was initially worried to be a day one or week one priority he had no shortage of things he was signing on day on the day one and first week so plenty of things he could have had ample space to do if he wanted to and at the same time once you delay something once i think it's much more likely that you're then going to delay it again i use the same rough philosophy for following opac where it's like no we're gonna do this and they delay like no no they were really gonna do it this time it's like oh we've seen this play before so i'd say i'd probably go to 35 right now but i would say it's beginning to retire again because again this steady drumbeat is, you know, it's impossible to ignore. It's every sign that we're hearing set is pointing towards this happening. Now, I would say, I would say it's probably a lower probability I see that this happens on February 1st. Now, by the time that this episode airs, I could be proven wrong.
So fingers crossed. But yeah, but that's, that's how I say the probability is. Do you want me to kind of walk through what it would mean for US, US crude flows and refining? Yeah, I think it'd be great if you could touch on that quickly.
And then we bring it into kind of, I'm just kind of going through and looking at, you know, balancing the tariffs, you kind of make the comment that thinking about supply and demand growth, probably another moderate supply deficit this year already have low inventory levels. There's a lot of cross currents to consider in the market, even outside of these tariff situations, how that kind of fits into your price target for year-end 25. In terms of, there are two things that make Canadian crude really important to US refineries. One of which is physical and fixed in place, which is physical pipeline infrastructure that brings the stuff to market.
And the second is the quality of the crude, which is heavy, sour crude versus what the US produces, which is largely light sweet crude. So on the, let's start on the latter one, let's start on the quality. So the US produces a whole bunch of oil. It's the largest oil produced in the world, but the vast majority of that has come from the shale plays, a type of oil that has broadly become to known LTO or light type oil.
It's oil is generally graded on an API gravity, which is basically the density of the oil, the higher number of the lighter it is. US crudes in the shales, often anywhere from like 35, 40, upwards to like 45, 50. WCS, a candidate for grade is 22. It's like way, way, way, way lower.
And it's also the largest of the heavy crude flows in the world. There's no other heavy crude flow in the world that is as large as WCS in terms of a globally traded basis. So not only is it, it's very complimentary to US production because the US refinery base was designed and largely built up before anyone knew that the US shale was going to explode. So this was all built during the time, kind of like how the US had built a bunch of LNG import terminals before realizing they actually needed export terminals instead.
So refineries were all built to us, all built to process, kind of a medium, medium, heavy grade of crude. So you want to be able to consume some of your domestic light sweet stuff in house. So the best way to do that is by blending it with a bunch of this heavy sour stuff that comes from Canada. So that is essentially the easiest way to think about it.
And that is why that's really helpful for those refineries. If you change up the balance of that, it starts to throw off one, your ability to like operate at peak operating capacity. And on the other end, it also affects, if you tweak that too much, it throws off your balances of products that you're producing, which throws off your marketing and the market and the kind of market balances, et cetera, et cetera. So that's not great.
So on the one hand, it's important to have this heavy crude, even if you could, to try and get it from other places, you know, the next best sources of heavy crude, Mexican Maya crude. Well, that's also going to be tariffed. How about Venezuelan Mary? That's going to be sanctioned.
How about Colombian crude? Well, we almost got tariffs on that over the weekend too. So there's lots of, you know, all of this is all, you know, it's a little bit tongue in cheek here, but it's just like the craziness of it. But at the end of the day, even if you were able to find the replacement barrels, you can't, but even if you could, you couldn't get them to where they need to go because of the second piece of the pipelines.
Right now, all of the pipelines in Canada basically point straight south, not all of them, but virtually all of them. We have a new, very fancy one that we love, especially now that goes to the West Coast and still only gets around the US, but all the rest of them from the original Keystone to virtually all of our crude goes through the Enbridge mainline, which goes down to the Midwest into Pad 2. But Canada accounts for 100% of imported crude now into Pad 2, 100% into Pad 4, which is the mountain region. All of that, you can't replicate it.
There's no way to get those barrels going the other direction because you have to import them into the US Gulf and there aren't the pipelines going from the Gulf north into the Midwest. In fact, there used to be. That's the direction that crude used to flow into the US because typically before the growth in Canada, before the growth in North Dakota Bakken, you actually had, it was quite common to import stuff into the US Gulf Coast and ship it north, which is why Cushing is actually where it is. Cushing, Oklahoma, the pipeline the US Gulf Coast.
And the answer is that quite frequently, quite often, those barrels have flown north through Cushing to get into the Midwest. But all of those pipelines have actually now been reversed. So they now head south to allow Canadian and Bakken and other crews to head down into the Gulf Coast to be re-exported or exported at the other end. So because of those two reasons, it's really, really hard to kind of get around that structural requirement for Canadian crude, which is why in terms of we were talking about who bears the burden or kind of, as we talk about like who bears the largest incidence of the tariff, it'll depend on the degree of un-tariffed competition that Canadian barrels are exposed to.
If those barrels are forced to compete with like un-tariffed Iraqi Basra, because I should say, if we've moved on from Venezuelan and Mexican crude and maybe even Colombian crude, then we're just talking about buying Saudi, Iraqi, and other OPEC crudes, which, again, seems like a very strange political choice. But anyways, if we're forced to keep up those barrels, it can end up facing and bearing brunt of it. Because you would, like I was saying, crude and all commodities price at the margin. And if our marginal barrel was clearing, if we had to discount the marginal barrel to compete with that final clearance, then we'd end up in a situation where we bear the brunt.
But if we can either re-export those barrels, which is a big question right now, and get around that competition, I see your question itching there. And basically, the answer is that, as trade lawyers told me anyways, you have a very large, you had a very large re-export industry where Canadian crude gets shipped all the way south and not get consumed by U.S. refinery, but will get re-exported at the U.S. Gulf Coast.
And those barrels were treated as bonded or never having landed in the United States through that entire journey. They're treated as foreign crude in transit rather than a landed barrel. And that landed barrel is the one that gets tariffed. So if you could re-export those barrels, you don't need to face that competition, and therefore you don't need to do that discounting at the margin.
So that could theoretically get us around that aspect. Yeah, so I'm trying to think if I even know how to ask it. So if the barrels get re-exported out of the U.S. somewhere else, that's still Canadian oil.
And therefore, depending on, therefore, wherever it goes, it's not the U.S. and not subject to whatever increased tariff we potentially ultimately implement. That's the idea. I'm not even going to point out that many of the pipelines we're traveling are also owned by Canadian companies.
Small wrinkle there. Small wrinkle there. But I think, but then let's say we don't face that unfair competition either because of re-exports, or as I've argued, if we do face the unfair competition, we also curtail production in Alberta. So reduce the amount of production so that we basically limit that unfair competition.
In that kind of normal situation, we're not facing the competition. I think that if we're just dealing with the Midwest kind of, you know, monoway mono, then I think we basically have a situation where we kind of go three ways between Canadian exporters, U.S. refineries, and U.S. consumers.
So let's say there's six, let's say roughly $65 a barrel for WCA, for a barrel of WCA, now give or take, about 15, 16 bucks a barrel, you know, 25%, that's 15, 16 bucks a barrel. Let's say five bucks a barrel, you know, wider WCA differential, $5 a barrel, worse U.S. refining margin, and $5 a barrel, or about 13 cents a gallon, increased U.S. pump prices.
But I think the important thing that I was trying to stress here is it has to still start with the refiner because a tariff is still, by definition, an import tax that starts being paid for by the importer. Right. And because of the import, because those refineries are also subject to U.S. antitrust law, they can't collaborate or conspire to say, wow, we know that these Canadians are all facing a tariff now, or, you know, are there barrels of tariff?
So we should all push, we should agree to push this tariff up the pipe towards them. And because of that, they can only affect, they can only shift the incidents to consumers and exporters from the refiners by essentially changing their own behavior, which in this case likely means seeing their margins destroyed and then reducing run rates so that such that it decreases product supply and, you know, in pad two, which increases prices and decreases demand for Canadian crude, which decreases prices for Canadian crude. I think that's how it begins to even out. And markets will obviously front run this, what would be an iterative cycle.
But I think it's still important to remember what the actual like causal chain would have to be. I think a lot of people think, a lot of people just casually say, oh, well, they'll try and push the cost off. But these are still commodity markets and these refiners are competing for feedstock and they're competing for customers. They can't really just decide to push on costs like it would be, let's say, a technology or a kind of consumer company.
So yeah, I think there's a lot of oversimplification of these very complicated matters, which is why it's great to have you on to take us through all of this. And I think it comes back to this idea that the Trump administration has all these policies. It's considering with a stated set of goals, but various policies pulling in opposite directions. We want cheaper oil, lower prices here in the U.S., but we're considering tariffing everything, which as you know, is a tax essentially on imports.
And so it's borne by the importer, but they're going to have to pass on a certain amount of that or see their margins crush. And so there's a lot to consider here. And I think it's very easy to try and paint it all with a broad brushstroke, but that's obviously oversimplification and misses some important details on how it's going to affect the global economy and global financial markets. And speaking of all that, let's bring this all back to your base case call for oil.
Is it WTI that you forecast, WCS, Brent? I'm usually a good globalist and I usually go with Brent. Okay, Brent, yeah. So bring us back to that.
I want to hear your base case. And for me, in my seat, obviously, I'm always thinking about inflation, what it means for the Fed, what it means for interest rates and all of those things. And so I think getting an idea of what such a key input cost to so much of global everything is important and that kind of can help us think about where things could be headed in 2025 and maybe quickly just compare what your base case looks like relative to perhaps what's implied by futures or the shape of the futures curve and how that fits into your forecast as well. So very, very roughly, I think that Brent will probably average low 80s for Brent, which is like not that different from where we're at like $77.50 a dollar a barrel right now.
We got up to about $81, $82 a barrel before we pulled back. I think that this pullback itself was largely driven by kind of a pullback in some degree of speculative positioning, which has gotten kind of overstretched, as noted in kind of both the CFTCs and ISA's commitments of traders data. So managed money, specular hedge funds had gotten very, very overstretched long in crude contracts, pretty strong relationship between how you see these levels peaking out, kind of associated with like a $5 to $7 a barrel pullback over the next month. I think we probably, I think we still probably have a couple more bucks to the downside to go here until that cycles out.
But I think we, then I think we start grinding higher again from there. Because I still think those underlying fundamentals do remain strong, but I just think that we rallied too far too fast. And like in all things, too much of a good thing has to kind of work itself out. So I do think that I do think that we will probably at least end the year kind of in that low 80s Brent range.
But there's the degree of possible, you know, choose your own adventure paths for the year, depending on what exactly happens with these Trump EOs is flabbergasting. We didn't, I mean, we didn't really touch on, I mean, China is obviously a very important aspect of this global demand picture. And if Trump throws up, you know, massive tariffs on China, that changes the picture very quickly. If Trump does pull the trigger on tariffs on Canada and US, Canada and Mexican crude, that probably has a big impact because yeah, that starts to take away, I mean, I think it will probably cost some supply from Canada at least temporarily as we try and kind of rebalance the slate.
All that gets, you know, taken from global balances as well. So I think some of these things could pull us a little higher, some of these things could pull us, you know, a little lower. And then, you know, all of this as well, I should also note crude, while it remains a fundamentally driven commodity, is also still the most financialized, you know, commodity class asset there is. Used a lot of inflation hedging trades and everything else.
So when you have that many connections with the broader market, and then you have, let's say, like, say yesterday, the largest one day pullback in equity market valuations in human history off of this DC stuff, I think that yeah, if we have a broader equity markets, if there becomes, you know, if we start to spiral in some way, crude will obviously take it on the chin. I do think that it's always, it will always have rebalanced fundamentals though. And any, any additional weakness we see, let's say, in the first half of the year, will probably make the rebound that much stronger in the latter half. I think that's a great point on the financialization.
And it's interesting, it's interesting for me to learn how certain commodities really are only, not only, but very primarily fundamentally driven, then you get to something like oil that has perhaps a little bit more exposure to broader financial market sentiment, drawdowns in equity markets, perhaps more extreme moves in the macro world is obviously going to have at least a short-term influence on oil prices separate from what fundamentals might otherwise suggest. So, Rory, this has been an incredible discussion. I've learned a ton. I really appreciate you coming on our podcast, taking us through your views.
I feel like we probably could go another several hours. So hopefully we can have you on again, maybe once we have some more concrete policies to consider and factor into our outlooks. But Rory, thank you so much for coming on the podcast. Thanks for having me, Zach.
And I'm absolutely happy to come back. Anytime. Great. Well, I will certainly be taking you up on that.
And I want to thank all of our listeners for tuning in. And we will catch you next time on No More Risk Better. We'll see you next time on No More Risk.