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Robinson Meyer:
Hello, it is Wednesday, June 24, and the Iran war has entered a new phase. The United States and Iran are reportedly conducting talks in Switzerland. We’re now in this period of so-called technical negotiations that are supposed to resolve the permanent status of the Strait of Hormuz and Iran’s nuclear program. So that’s, you know, small stuff, and I’m sure we’ll work it out. I want to talk in this episode, though, about what just happened. The past 110 days, give or take, of war between the U.S. and Iran, and the most important thing that I think we learned during that war. This show is about a phenomenon that I think has not gotten enough play compared to its enormous importance. And that is that China helped save the world from economic calamity. China, as you’ll hear in this episode, primarily buffeted the world from the economic impacts of Trump’s war of choice in Iran.
Robinson Meyer:
And the implications of that are really massive. So you’ll remember at the beginning of the war, a lot of energy experts, including those we had here on Shift Key, talked about how oil was going to hit $150 or $200 a barrel. Iran had just closed the Strait of Hormuz. It was the biggest supply shock to the oil market in history, and everyone expected the biggest price shock in the oil market in history to follow. But then it didn’t happen. Brent, the global oil benchmark, peaked around $115 a barrel on May 4. And of course, it shot up right after Iran closed the Strait of Hormuz, but it was very volatile. And it never hit $140 or $150 or $160 a barrel, which people were predicting. Gas prices obviously went up here in the U.S., but we never got $7 or $8 gas in most of the country. Europe was at one point forecast to run out of jet fuel. It never actually did that. So why? Why did we have this huge supply crisis in the oil market, but no comparative price crisis? Well, we know it has something to do with China. We know that starting around the same time that Iran closed the Strait of Hormuz, China significantly cut down its oil imports by something like 3 million to 5 million barrels a day. That is, for context, a huge amount of oil. It’s about three to five percent of global oil demand.
Robinson Meyer:
But we also know during this period, China didn’t seem to use less oil. And that means China was releasing oil. It was making 3 million to 5 million barrels a day of oil appear from somewhere. Where? How did it do that? Well, you’ll hear in this show, at least you’ll hear as best as we can figure it out. But the results mean a lot for the future of everything, actually. They mean a lot for the future of climate change and climate policy, for the future of the energy industry and oil in particular, for the future of the global economy and the modern geopolitical order. The ramifications of what China did are so massive that they’re mind-boggling to think about.
Robinson Meyer:
And luckily, we have a great guest to think about them with. Rory Johnston is an oil market researcher in Canada and the author of the Commodity Context newsletter. He’s someone who, as you know, we often have on the show to talk about changes in the oil market. And today on this show, we’re going to talk about what might have just happened, why it may have happened and what it means for the future. I’m going to ask you to stick with us because the beginning of this show is a little wonky. We talk about satellite data, we count some barrels, we talk about like, why we know how anything that’s happening in the global economy is actually happening. But at the end, we get somewhere really interesting and really important, I think, if you’re someone who works in the energy industry or cares about the energy industry or thinks about the future of climate policy and decarbonization and carbon emissions. So I’m Robinson Meyer, the founding executive editor of Heatmap News, and all that and more, it’s all coming up on Shift Key.
Robinson Meyer:
Roy Johnston, welcome to Shift Key.
Rory Johnston:
Thanks for having me back.
Robinson Meyer:
It’s great to have you back. I feel like you’re becoming our, I don’t know, is resident barrel counter like a flattering or offensive thing to say? Is that what you?
Rory Johnston:
So a lot of people say it pejoratively. I take barrel counter as like a mark of honor. Yeah, I can be actually the resident fossil guy on Shift Key.
Robinson Meyer:
I just appreciate, you know, always with the quantitative data, which speaking of which. So the Iran war began. Iran closed the Strait of Hormuz. We had you on the show back then, I believe. And you, like many energy analysts and us, we’re freaking out. Yep. Because the world lost access to, what, 10%, 30%?
Rory Johnston:
So to the barrel counter name, let’s count the barrels. So of the total initial hit of 20 million barrels a day, which is roughly 20% of global supply, we knew at the gate that we weren’t going to lose all of it. And I think as we talked about the podcast at the time, we had known offset capability. or a rerouting capability, the Saudi East-West pipeline, this Emirati pipeline to the Gulf of Oman that terminates at the port of Fujairah. And over that period, for much of it, we still had Iranian exports kind of chugging through the strait given the recent sanctions relief. But overall, the net impact that had durably impacted the market for the duration of this crisis was a 13 million barrel a day production shut up. So this is all the barrels that weren’t able to get rerouted, and they weren’t able to get exported out of the Gulf, so they were basically forcibly shut in. So the gross hit to the global supply was roughly 13 million barrels a day, give or take, which is by far the largest single shock on supply in the history of the market.
Robinson Meyer:
And so we all expected oil to go to approximately a bajillion dollars, give or take a bajillion dollars. And it didn’t. It peaked, what, in the $130s? And one of the big reasons for this is that China significantly cut its imports. In fact, I think the sense is the primary reason that oil was able, the oil, global oil market was able to weather such a huge supply shock is a number of countries tapped their strategic oil reserves, including the United States. It was the largest synchronized release of oil from IEA.
Rory Johnston:
Yeah, from the IEA member states, roughly 400 million barrels.
Robinson Meyer:
Yes, exactly. So there was this huge release of oil from the IEA kind of combined member states oil reserves. But China, which is not an IEA member state, also significantly reduced its oil imports and specifically reduced them from 11 million barrels a day as a kind of antebellum status quo ante to 7.8 million barrels a day in May. And so China was able to vaporize 3 million barrels a day of oil demand. I want to hear your take. But insofar as I understand it, this is the primary reason that oil never went to $200 or $300 or a bajillion dollars, was that China was able to go in and release not only crude, but presumably some refined fuels, too, from its strategic petroleum reserve and also do some magic on demand destruction. China was able to destroy a huge amount of its demand for oil. And this act of economic policymaking from China basically saved the world. And I would add Donald Trump from the biggest oil price shock ever, given that we were dealing with the biggest oil supply shock ever. And my question to you, Rory, is how did they do this?
Rory Johnston:
Yeah. And let’s just back up one second and kind of say, like, the reason we thought we were going to get the bajillion dollars, the $150 or I said, $200 a barrel we could get through this if it was sustained.
Robinson Meyer:
And I was at Sierra Week and I remember someone saying to me, gas in the U.S. could hit $7 a gallon, $8 a gallon. And once that happens, anything is possible politically.
Rory Johnston:
Exactly. And I think the reason we were worried about those levels and I thought we could get there is that if we’re drawing down by that, say, 13 million barrels, even netting for the fact that we had a surplus going into this, you were going to so rapidly approach tank bottoms of inventory that you’re going to need to forcibly destroy demand. What China did, and this is where we get to China, China was by far the single largest swing in that global balance. So, you know, of the IEA release of that 400 million barrels, really only what we’re counting is the actual pace of releases between the United States and Japan and a few others. Those only really ever reached, say, three-ish million barrels a day of total outflow at their peak. China’s implied swing is upwards of five million barrels a day. And just to give you a sense, so the numbers that you quote were from the official from the national, basically Chinese Customs Bureau. We’re watching more of the kind of satellite and tanker tracking data, which for the three months prior to the war, they were importing roughly 11.5 million barrels a day of crude.
Rory Johnston:
Via seaborne means. So doesn’t count the pipelines and everything else. So that could be a little wishy-washy there as well. But just to what we can see there, and that has fallen to, on average through June, 6 million barrels a day. So over 5 million barrels a day of delta there. Massive, massive, massive swing. And by far larger than any of the other, basically the equivalent of the entire shift of the Saudi East-West pipeline, China did through import demand destruction alone. I want to stress here, import demand destruction, because demand destruction, I think when people think about it, they think people aren’t driving, people aren’t flying, etc. And the strange thing about this is that as far as we can see, Chinese consumers are still driving. Trucks are still on the roads. Airplanes are still in the sky. All of these things that we would have normally associated with a demand contraction of the scale aren’t occurring. So let’s kind of go through the various steps here, because we’ve seen this kind of, let’s just say for round numbers, five million barrel a day contraction in from pre-war levels. We’ve seen refining run rates fall by, let’s say, three to three and a half million.
Robinson Meyer:
Is this in China?
Rory Johnston:
We’ve seen this in China. Yeah, everything. What we’ll talk about the next little while is just China. Refining run rates in China fell by 3 million, 3.5 million barrels a day. Over this period, right now, Chinese visible crude inventories continue to build for the first half of the crisis and have only now started coming down a little bit. The ones we can see, and this is an important distinction, the ones we can see, are roughly today standing where they were at the beginning of March. But the implied difference between the run rate change and the implied change in the imports is 1.5 million to 2 million barrels a day. So where did those other barrels come from?
Robinson Meyer:
In other words, the visible Chinese supply is where it was in March today.
Rory Johnston:
Yeah, the visible Chinese stocks. So these are the inventories. And I think let’s just dwell for a second what we mean by visible and why that’s important in this context. So China, unlike the United States, unlike Canada, and like most other kind of advanced Western countries, does not publish official data on, importantly in this context, either inventories or domestic demand.
Rory Johnston:
So with both of those, we are left to kind of infer from shadows and estimates to what’s actually going on inside China. So when we talk about visible crude stocks, what we’re talking about is the stockpiles of oil that are held in above ground storage tanks with floating roofs. And the floating roofs are important because we can use satellite imagery to infer how full those tanks are. Whether optically via like the size of the shadow, the lower they are, the bigger the shadow cast across the top of the tank, which is very cool stuff. And even more cool recently, you have like SAR satellites that can measure very specifically the difference in the kind of radar pinging off the top of the roof and the radar pinging off the top of basically the catwalk that goes around the top of the roof. So you can measure the distance between that. So of a total Chinese crude storage that we know of of say 1.1 billion barrels, give or take, those held in strategic underground stocks that we know of, very important here, are roughly 131 million barrels across six underground sites. Now, by definition, we cannot see these underground sites. They do not have floating roofs. The implication here is that if we know that supply is coming from somewhere else in the system, but we’re not drawing, or by we, I mean, China here is not drawing down visible commercial crude stocks, the kind of Occam’s Razor is that they’re drawing down by stocks we can’t see. These are the underground stocks.
Rory Johnston:
But the draws don’t end there. I mentioned China also doesn’t have official demand data.
Rory Johnston:
So what we are left with is deriving apparent demand data for China, which is essentially a domestic disappearance calculation. They do report, for instance, refining production. They report refining runs. They report refining production of, say, gasoline, diesel, jet fuel, etc. And you can net those refinery outputs with trade to get basically how much there should be in the economy that’s disappearing. Net it, of course, for those inventories we can’t see. Now, those run rates and those outputs, the biggest factor by far in the calculation of these apparent demand, those are down 3 million to 3.5 million barrels a day.
Rory Johnston:
That implies a demand-destructive event in China at the scale of what we saw at the beginning of 2020 during COVID Zero. That’s the scale of what we’re seeing. It would be equivalent to the largest contraction in Chinese history, at least modern history that we’re aware of. But strangely, if you, you know, obviously we knew about COVID Zero. There, you know, there were endless stories about COVID Zero at the time. We knew that they were like literally spraying bleach on the roads and like no one was going anywhere. And they’re like robots that tracked you and kept you in your house. Like, this isn’t happening now. So the assumption is that it’s just price alone that’s driving this kind of demand destruction. But here again is where it gets weird because Chinese domestic policy and regulations for fuel prices have capped or basically throttled the rate at which domestic petrol prices can rise. So while global gasoline diesel prices effectively doubled through this crisis.
Rory Johnston:
Prices of petrol in Beijing are only up by, at their peak, 30%. So it would be very strange to get a COVID Zero demand destructive event driven by only a 30% increase in prices. It doesn’t make sense. What it does make sense of those domestic product prices do drive the reduction in refining runs because all of a sudden your crude feedstock’s really expensive and your domestic market is really, really cheap. So your effective refining margin, your profitability has collapsed into deeply negative territory. Now, it’s important before I get too kind of heavy hand on the numbers to kind of say that there are little bits that we can theorize that they could actually destroy demand from a kind of a top-down approach. You know, a lot of Chinese oil demand is in the petrochemical sector.
Rory Johnston:
And you’ve seen some degree of capacity to either say, let’s throttle down Petchem run rates and just run off of inventories of intermediates, It’s still an inventory draw, but it’s not a strictly oil inventory draw. So sure, maybe you can also have feedstock diversification that you’ve seen natural gas feedstocks filling in potentially for oil feedstock.
Robinson Meyer:
So the whole story here is that they could take instead of taking oil or crude oil and turning it into plastics or other forms of chemicals, pharmaceuticals, they could be, first of all, just throttling the amount of chemicals they’re making, period. Or they could be taking natural gas or they could be taking, maybe this is where you’re going. But we also know that they’ve built up a really big coal to chemical sector. And they’ve been using that too.
Rory Johnston:
Exactly. And really at the end of the day, whether it’s oil, gas, coal, all fundamentally the same chemistry, just in different kind of physical forms. It’s all hydrocarbons all the way, you know, it’s all hydrocarbons all the way down, right? And I think that that does allow some flux, particularly in the chemical space where it’s like, it’s really, it’s trickier to say, make diesel out of coal. But various chemical precursors, yeah, I think that’s very, very plausible. Again, though, I think it’s unlikely that it’s five million barrels a day worth like that. We’re talking like that’s that’s more demand than Canada and Mexico combined as like a red off the top. Like we’re talking huge volumes.
Robinson Meyer:
Is it five or three that we’re trying to explain?
Rory Johnston:
I would say five because I would say from again, this the data we have in China so far only goes through May. And again, I tend to prefer independent references. So that’s where I go. I’m using Kpler data. It’s a tanker tracking company. They show that crude imports have fallen. Again, average of December, January, February was about 11.5 million barrels a day. And as of June, month date average, we’re down to 6.07. So almost halved. Yeah, there’s some wiggle room here. Maybe they were building some stocks prior. Like, again, there’s so much that we don’t know about China. There’s wiggle room around here. But I think the important thing is the scale cannot be explained. So something has to be releasing somewhere along the way. And people are like, well, Rory, haven’t you been following, and I’m sure you guys on Shift Key have been following this, that China has more than 50% sales penetration in new energy vehicles? Or we’ve seen EVs and natural gas-powered vehicles penetrating deeper into the truck fleet.
Robinson Meyer:
We talk about demand destruction, But there’s really two kinds of demand destruction, right? There’s at least I think of it this way in my head. Maybe these are not industry terms, but there’s like temporary demand destruction, which are all the things people do when gas gets expensive, which is you fly less, you carpool, you, you know, put different trips together on one time when you leave the house, right? There’s like temporary demand destruction where you are as consumers or as a country or as a government trying to reduce your short term purchases of liquid fuels. And then there’s permanent demand destruction, which is like you get really tired of having to think about all of that and manage it in your head. So you buy a Prius or a Tesla or an Ioniq and you switch to an EV or you as a Chinese consumer decide that instead of flying home to see your parents, you are going to take a slightly longer set of high-speed rail trips, right? And so anyway, this is just to say that there is this temporary versus permanent demand destruction dynamic. And indeed, one of the questions here, which I think you’re just about to answer for us, is like China has this incredibly successful electrified vehicle sector. How much of that can explain this 5 million barrel a day discrepancy?
Rory Johnston:
And the answer is maybe a little bit, but by far not all of it. Because the implication is, right, sales penetration doesn’t consume fuel. Vehicle stocks, the fleet composition consumes fuel. So yes, we have seen a massive penetration of EVs in China leading the world. But in terms of the overall total fleet on the ground, you’re still something in the realm of 10 to 1 internal combustion engines to new energy vehicles. So unless Beijing was hiding 400 million EVs in a warehouse somewhere, and they just were like, oh, Hormuz is closed. Release the EVs. Said in the Oprah release the bees voice for all that are curious.
Robinson Meyer:
Yes, everyone reached under there.
Rory Johnston:
But I think that unless that happened, and again, no one reported on it. I would expect Heatmap would have been reporting on the massive fleet of secret Chinese EVs that entered the system all of a sudden.
Robinson Meyer:
And I think one of the dynamics here, right, is that it’s not even like it was during COVID. During COVID, this was feasible, too. Like, we can talk to people in China. We know what the consumer gasoline price is in Beijing. We know how much people are on the roads. And so we know from talking to people in China, from the fact that you can fly to China, enter China, and leave China during the past 107, 108 days that the war happened. We know from all of that, that like there is not a COVID Zero level demand destruction event happening, nor has there been some massive demand change to the daily rhythms of life or some massive release of EVs, for instance, that would affect oil demand on the scale of 5 million barrels a day.
Rory Johnston:
Exactly. And again, I think so much of this is plausible over years, but not in two months. Right. I think that’s it’s a scale in the pace of change that would have absolutely been apparent in so many ways. Now, we do see some signs of what you’re talking about. We have seen, And for instance, through May, we did see a decrease from, you know, a year ago and particularly earlier this year, levels of flights in China. And we knew this was going to come because even outside of just spending and elasticity of demand, we saw that through April and early, you know, March and April, there was the concern about the actual shortage of jet fuel, and Chinese carriers canceled various routes and various flights. So that is just a kind of a wholesale kind of reduction there. And you did see a commensurate increase in, say, rail transit. So some of what you’re talking about did happen. But again, that’s only like a tiny piece of a tiny sector of the overall kind of base we’re talking about here.
Robinson Meyer:
Do we have any numerical estimates of how much behavioral change could have shaved off oil demand? In China?
Rory Johnston:
You know, it’s hard. I mean, it’s like, we can guess, but maybe the behavioral change was 25%, maybe. But I think that might even be too charitable. Because again, if you’re thinking about behavioral change, what drives behavioral change? Prices. And prices, as we were saying earlier, weren’t that much higher. Like there was a comment for a while that like maybe some Chinese households have an EV and internal combustion engine and higher prices mean they drive the EV more than the internal combustion engine. Okay, plausible. But again, is it enough of a price incentive to vastly kind of see a sea change in that relative usage, it just doesn’t seem likely. You have to assume a much higher demand of price elasticity in China than we’ve seen ever demonstrated before. So I think all of this is just, you know, there’s just a huge amount of oil here we’re talking about. I mean, just to give you a sense, running this estimate earlier just today before I jump from the call to give you a nice round number in terms of we’re using that 11 and a half million barrels a day and the three months pre-war as our average baseline, The reduction across months was 1.3 million barrels a day reduced in March, 3.3 million barrels a day reduced in April, then 4.7 million in May, and then 5.4 in June. And again, this is all based on Seabourn tanker imports.
Rory Johnston:
In total over that period, the cumulative total is somewhere in the ballpark of like 400 to 500 million barrels. That’s a lot of oil that you have to kind of make up for through this system. And that’s where we kind of come back to this assumption that like the Occam’s Razor here is that inventories have been drawn down, particularly on the product side.
Robinson Meyer:
So just to make sure I understand it, China, from very early March when the Strait of Hormuz is closed to sometime last week, eliminates in total an implied 400 million to 500 million barrels of oil demand. That is actually on the same order of magnitude as the IEA-organized release of... Oil from strategic petroleum reserves across 32 countries, including the U.S. So it’s very, very, very big. It’s like the same size as the largest supply intervention from Western governments ever in the oil market.
Rory Johnston:
And I should also say it’s actually larger than what we’ve seen released by the IA countries and collective because that was the total announced release. And that included some really weird stuff like Canada had a contribution to that. Canada does not have a strategic petroleum reserve. We have the oil sands. So what they ought to pledge was like, Oh, there will be some like heavier maintenance in the oil sands. I haven’t seen it. So like all of these numbers, it’s a little bit of like hand waviness. We’ve definitely seen a massive drawdown from the U.S. And we’ve definitely seen the largest ever drawdown from Japan. But European as well, we’ve seen maybe some, but like European SPRs are not, like the big pool of government out of oil that you’d expect stateside. They’re more like commercial stocks where the government tells you, you have to hold a certain amount in reserve for strategic purposes. And when they release it, they just say, you don’t need to hold that oil anymore. But theoretically, it’s many industry participants. They’re going to want to hold it in a period of scarcity. They just don’t have to hold it anymore. So it’s this weirdness where so I would actually say net net China has contributed more of a demand solve or more of a supply solve in this sense. If we assume it’s all SPR, more of a supply solve in the entirety of the Western nations combined.
Robinson Meyer:
And I want to add one more piece of context here, which is U.S. Authorized capacity for the American Strategic Petroleum Reserve. And this means as big as it could possibly, as big as Congress has said it could go. Who knows if, you know, the DOD or DOE has kind of some extra salt caves we haven’t heard about. But as big as the publicly disclosed authorized capacity for the U.S. Strategic Petroleum Reserve is 714 million barrels. And so the Chinese release, it’s basically if they had, it’s on the scale of if the U.S. released its entire Strategic Petroleum Reserve, more or less, you know, give or take a hundred or two million barrels. So what this means, right, is that China had a — and I want to talk about in a second whether we knew this was here, whether we knew they could do this. But first, I just want to make sure we actually put a button on this. China has strategic petroleum reserves, undisclosed, on the scale of at least half a billion barrels, or 400 million to 500 million barrels. These reserves presumably encompass both unrefined crude and products, and it has an ability to release them without, you know, kind of public fanfare, let’s say. It can tap these without making them visible.
Rory Johnston:
Bragging about it. I mean, they’re not bragging about it. Yes.
Robinson Meyer:
Yes. It could just quietly tap its half a billion barrel strategic petroleum reserve, which encompasses both refined products and crude, we guess, right? Because it has to, because otherwise, how can you explain the fact that refinery activity has gone down?
Rory Johnston:
Yep.
Robinson Meyer:
And it just quietly started doing this, and then it continued to do it for the past 107 days, 110 days. Is that the right lesson to draw from this?
Rory Johnston:
Yes. Okay. And I think there’s a couple things, right? Everything mechanically is exactly how it went down. One big question. So we’ve talked about how. And we’ll talk about in a second what it means. We haven’t really talked about why yet. And I think this is another massive question. Because when we talked months ago, and you would ask, did we know China had all this oil? The answer is generally yes. We didn’t know the exact composition. We didn’t know exactly where it was. We didn’t know the breakdown or whatever. But for instance, we knew that China had over a billion barrels of visible crude inventories?
Robinson Meyer:
Well, I was going to ask this because basically one of the plot lines in the oil market over the past like two years has been that China, but basically there was some quantum of oil on the global market that was clearly being purchased in China that was not in the Chinese public data that sure looked like a strategic petroleum ramp up, right, that they were stockpiling oil. And you could see this in like the global supply and demand data, it actually kind of kept global oil prices a little elevated. It was good for producers, so to speak. But there were two assumptions here. I mean, I think the two assumptions were like, either one, they are building up fuel so that they have enough domestic fuel reserves so that they could invade Taiwan. Number two, that if they did invade Taiwan or if there was some crisis over Taiwan in the future, number two would be the less bellicose assumption or the less hawkish assumption. If China, there was some crisis over Taiwan status with the United States and the U.S. navy basically cut China off from seaborne fuel imports, then China was stockpiling these liquid fuels so that if that eventuality were to occur, it would have some strategic options and would be able to sustain its economy for some period of time with its domestic reserves. We knew that there was this buildup. Did we know the buildup was this big?
Rory Johnston:
No, not really. So we knew that there was a buildup in crude. We suspected there was a buildup in products. And back in 2023, I wrote a piece called “Chinese Oil Demand Doubts.” And in 2023, coming out of COVID Zero in the prior year in 2022, China posted the strongest year on year demand growth of any country in the oil market’s history. I believe it was about 1.7 million barrels a day year on year growth in Chinese demand, again, from a weak base. But that was 2022 was the first annual average demand contraction on record in China, basically in 30-plus years, modern China. And the following year was the largest growth ever. At the time, the rest of the Chinese economy didn’t look that hot. I mean, the same way that we’re tracking mobility now, like it just didn’t seem that good coming out of COVID Zero at the beginning. So not good enough to post all time high demand. But what I said at the time was when we were talking about how we create, how we estimate apparent demand, a big assumption there is that net-net, there is no material kind of bias in terms of stock building or stock drawing. That net-net, because we can’t see them, those net out. But given that we can’t see it, strategic stock building of gasoline, diesel, jet fuel would show up in these calculations as demand.
Rory Johnston:
Now, in 2023, I wrote exactly what you said, which is the assumption here is, one, China loves stockpiling raw commodities, period, end of sentence. Prior to oil, I covered a lot of metals markets. And you have the Strategic Metals Bureau in China that basically, you know, the State Metals Bureau, they do the same thing. They will just go in and swing copper or zinc or nickel supply by like multiple percentage points in the global market. This is the first time we’ve seen that level of swing in oil. And I think that’s a big conclusion that we can take from this. But yeah, so that basically the assumption was that it would be some, you know, either that kind of propensity towards stock building, and trying to secure up and shore up domestic supplies or explicitly as a kind of build up hedge for an invasion of Taiwan and the more hawkish interpretation. And at that time as well, it’s important to remember that that was when we saw Beijing increasingly saber rattling towards Taiwan. We saw, you know, them buzzing Taiwanese airspace. We saw, you know, Chinese naval drills off the coast of Taiwan. There was a lot of people talking about like, is this the moment? Is it actually going to happen? And I mean, there was even I think there was an Economist article at the time talking about how China was stockpiling all this stuff. What are they doing with it?
Robinson Meyer:
Around when Nancy Pelosi visited Taiwan. Yes, it was. And there was a sense that, you know, if the U.S. mishandled this moment, that the two countries were as close to war over Taiwan status as they’ve been in a long time.
Rory Johnston:
Yeah, exactly. So I think that that was the initial thought. Now, why are they doing it now? Because obviously they’re not harassing Taiwan at the moment. The world has much bigger problems. So I think that with the Strait of Hormuz closed, the assumption was that, Okay, I thought that Beijing would not help. I thought that particularly coming out of that fairly, you know, cold, let’s call it, visit between the Trump administration and China a couple months ago, it did not seem especially successful. It did not seem like Beijing was going to help actively resolve what was going on in the Strait of Hormuz. So we kind of thought that they were not going to do this because doing this helps the Trump administration. It released massive pressure on the Trump administration.
Robinson Meyer:
Basically, right. What it means is that China absorbed with its strategic stock. In some ways, it’s the biggest what it means of all. China absorbed with its strategic stockpiles the primary hit to the global economy caused by Trump’s war of choice on Iran.
Rory Johnston:
Correct. And if we go back a couple of minutes ago to where we’re talking about the reason they built this up in the first place, because they are paranoid about energy security. So the question is, why would they single handedly take the bullet for all of Asia, Europe, everywhere else in the world?
Rory Johnston:
While diminishing and eroding that energy security blanket that they had so dutifully built up over years.
Rory Johnston:
It doesn’t make a lot of sense. So I think there’s two explanations that I’m working with. There’s three explanations. There’s the completely, you know, innocuous, like kind of like business as usual. So let’s go for that one first. Let’s assume that everything we’ve talked about, I’m wrong on the specifics and that you actually did have that much potential flexibility in the Chinese petrochemical space, that there were, you know, every one of those things I mentioned as potential offsets did happen and were about double as large as like, as I kind of bank them to be. Maybe, maybe. But I think the more likely is one of these more active choices I’ll mention. Now, the one is like, kind of, call it kind of like Beijing altruism. And then there’s like a very hawkish one. So the Beijing altruism one is.
Rory Johnston:
Okay, we know that Beijing is looking to diversify away from the United States, to pivot away from the U.S.-China relationship, to try and buttress economic trade linkages with everywhere else. The two other areas that are most obvious, East Asia and Europe, but the two areas that are going to hit hardest by the Hormuz shock. So in one telling, there’s an argument that China, it was not in Beijing’s interests to let, all the rest of the global economy falter so acutely at a moment when, as we’ve discussed, North America was going to be the most secure region given, shale production, given Canadian oil sands, given all this stuff. We were going to feel prices, but we were not going to feel the shortages in the same way. So again, the altruistic argument is that Beijing looks around the world and says.
Rory Johnston:
Trump has abandoned you. You know, Big Brother Beijing is here to help. So we’re going to backstop it all. The challenge with this argument is going back to they haven’t said anything about it. So you would, again, if they were doing this, if they were trying to make a point of offsetting, you know, the consequences of reckless American, you know, adventurism in the strait, they’d probably say something pretty sassily at that. But they didn’t. So then let’s move to the kind of more like, I’ll put my tinfoil hat on for a second And this is like the hawkish, like more concerning one, which is I mentioned this trip that the Trump administration took to Beijing. All external signs, all reporting indicate that it was not a particularly successful trip. Nothing blockbuster. Maybe it was like, you know, smiles and like waves, you know, waves at the crowd, but nothing, no trade breakthroughs, no breakthroughs on, you know, Beijing sending the Navy in to help reopen Hormuz. But maybe on the sidelines, they agreed to something else. They agreed to some kind of arrangement where Beijing stepped in to help the Trump administration with its gargantuan oil reserves. And again, we know that they theoretically have in stock, but this is the way we knew they were going to work or not. We knew that they had a lot of oil and they weren’t, releasing it immediately.
Rory Johnston:
So why would they do that? Why would Beijing help America in this case? And then we go back to kind of our interpretations of like the Donroe Doctrine, which is the idea that Trump was looking to withdraw from global kind of hegemonic, you know, oversight. And it was going to seed the world into these basically tranches controlled by regional powers that the United States had the Americas, Russia had Eurasia and Europe, and China had all of Asia. So what else was happening during this time? Well, there was a lot of military equipment destroyed in the Middle East during this period by Iranian attacks. And what we saw was that the U.S. military was pulling out a lot of heavy military kit that has historically resided in Asia to, say, buttress Taiwanese defenses. And they’re pulling them back over to the Middle East. I think the most concerning interpretation is that they basically trade Hormuz for, you know, Asian oversight and kind of attempted influence. I think that’s a very concerning potential.
Robinson Meyer:
Wouldn’t we see more signs of that publicly other than this kind of quiet, unheralded strategic petroleum release? Like, wouldn’t China be in this moment kind of notifying the other governments in Asia that they were now under its hegemonic authority as opposed to the United States?
Rory Johnston:
Out of the three options I discussed, the one where you would be least likely to talk about it publicly, I think, is this more clandestine. Because, again, the crisis is still ongoing. We still don’t know how long Beijing is going to keep this up. And I think this is this question of like, again, I don’t think any of these perfectly fit, which is why I think it remains a mystery as to why China did this. I’m mostly in kind of camp, you know, two or three that this it’s either trying to save the regional market or it’s something more nefarious. Because, again, I think that all the other explanations just don’t account for the scale and pace of the change we saw. It feels more discretionary policy than it feels like a natural market reaction.
Robinson Meyer:
Do we know how long they could have done this? Because crucially, as part of this dynamic, you know, if China was drawing down unseen strategic product reserves, Those reserves physically exist somewhere on the earth. They cannot be drawn down forever. And although we experience their being brought onto the global market as this kind of lack of price action, that has a duration. So, like, do we know how long they could have done this? Because looking at other global petroleum reserves, indeed, what seems to have driven part of the Trump administration’s decision making is that everyone’s stockpiles were getting drawn down, including like visible commercial, public data, non-strategic, just corporate stockpiles were like at very low levels. Everyone was kind of about to hit the bottom of their tank. If that had happened, maybe oil would have gone haywire globally or in certain regions. Was China like also close and we don’t know?
Rory Johnston:
It could have been, I think. And just to kind of reflect on the specific comment you’re talking about. So at the G7 and all of these speeches as Trump was kind of like.
Rory Johnston:
You know, championing this MOU, he’s like, well, there would have been bedlam. You don’t understand. Like we were four weeks away from hitting like tank bottoms. That would have been really bad. So one in the current system, yeah, four more weeks would have brought us even lower on commercial stocks. The U.S. SPR could have gone for 40 more weeks at that current pace. Like, I mean, this reference to reserves, I think a lot of people were thinking strategic. Those could have kept going. What was absolutely going to happen had this gone, as this continues to go longer, is we continue to draw down commercial stocks, you know, by the fastest pace on record. And we started this at very, very high levels. And now we are at very, very low levels and we’re still drawing at record pace. So yeah, I think the kind, the charitable interpretation is that the Trump administration actually has decent advisors in the space. And they were like, enough’s enough. Don’t pay attention to the price. We’re literally about to run out of oil. Maybe the other, I know going into the kind of tinfoil hatty thing here, and again, it’s the best we have, is like maybe Beijing gave him a bit of a timer on how long they would do this. I was surprised. I wasn’t surprised that this is how we got to an MOU. This is basically the MOU I thought he would sign. But this is the MOU I thought he would sign with crude at $150, not with crude at 80. It felt much more forced. He felt like he was under much more duress than markets were putting him in, much more pressure than they were putting on him. So there has to be something else that drove him because over the last two and a half weeks.
Rory Johnston:
The pace of the abrupt change in the way he was talking about it was like palpable. Like there was a very, very stark shift. It went from we’re fine, we’re fine, don’t worry, just trust us, to if we didn’t stop this, there would have been economic cataclysm. That’s a pretty, you know, wild swing in the span of like two weeks. It’s hard to make sense of any of the principal’s behavior in this crisis because, again, he was talking, the tone was like it was $150 crude. But we were we were sub 90 at that stage.
Robinson Meyer:
Right. I mean, what’s hard here is that the decision to go to war hasn’t made sense. The decision to end the war hasn’t made sense. We’re ending a dumb war of choice, basically on Iran’s terms. I mean, the whole thing is with none of the main issues that allegedly began the war resolved. In fact, all of them, you know, kick to this 60-day technical negotiation, technical, quote unquote. But let me ask an interpretive question here, which is like, isn’t there a non-nefarious, non-altruistic answer here for this kind of behavior, which is that we know the Chinese economy is doing fine. It’s not doing great. It’s consumer sentiment is pretty weak. Many households are still basically climbing their way out of having to write down their real estate investments from a few years ago. And we know that Chinese policymakers at this point have internalized that the problems with their economy are around this question of consumer demand versus investment. And isn’t it possible that Chinese policymakers just saw this massive energy supply shock coming down the turnpike and said, Our economy is not strong enough to deal with this. We know that they value energy security. They also value economic stability. And we don’t know, but it does seem like maybe they’ve shifted.
Robinson Meyer:
They feel like they can cut some kind of deal with the Trump administration. They like the way the Trump administration is referring to them as a peer. It does seem like their strategy on Taiwan has shifted a little bit from extremely bellicose to continue salami slicing Taiwan status and get some concessions out of the Trump administration about what the U.S. would do. Like, which to be clear, Donald Trump has partially already given them by referring to Taiwan status in ways that I think previous American presidents haven’t. Isn’t it possible that they just said, we simply don’t want this economic bomb to hit our economy and we’re going to do what we can to preserve our own economic stability. We don’t really care about what this signaled the sense of the rest of the world. We care about our consumers and preserving the strength of our economy. The feeling internally is that we’re not going to, there’s probably not going to be a war, inshallah, in the next year. And so we can just twist the knobs on this thing and prevent our own country from, you know, getting fed into the economic chipper, so to speak.
Rory Johnston:
Potentially. But let me problematize that in a couple of different ways. Because I think, while that could have been true when prices were skyrocketing through March and April, It certainly didn’t feel true as prices were collapsing into May and June. And during that period, Chinese imports continued to fall deeper at the period when it wasn’t happening. And I also think that you had this moment again of if that was the case. So here’s something that’s interesting. So the import collapse that I mentioned and the refining run collapse that I mentioned was... China seems to be holding refining runs higher than they would otherwise economically be otherwise, because if refining runs were deeply negative because of this policy change, why are Chinese imports not down 80 percent? Why aren’t they down more? Like, there’s also this question of, like, something’s telling these refiners to keep operating at some level because they have to keep going, maybe because they can’t draw down that entire pace of products on the other side. And again, we come back to one of pace of if that was the case, I think we would have seen more signs that you saw a kind of a heavy top down change because you would have seen more behavior change in that case. I think you would have seen way less, you know, transit. You’ve seen that China is very capable of locking down the economy.
Robinson Meyer:
Is China’s control over its tools of economic policy making like that fine tuned? Because I think like during COVID, right, there’s one story where it’s like we know China can shut down. You know, the country in COVID, we saw it. But the other story of COVID is that China basically has this market economy that operates on through this combination of provincial competition and top-down signals. And the top-down signals tend to get interpreted in this like very absolute way. So it’s like, we know that the economic policymakers can twist from two to 11, but they can’t really, they don’t like always know where seven is. I guess I’m trying to extend some faith here but like is it possible that they just like meant to twist to 7 and it got stuck in 11 and the signal is like damn the torpedoes full speed ahead, and they just start holding it there?
Rory Johnston:
Maybe. And I should say, this is a mystery to me. So I’m very open to other interpretations. I think, though, if that was the case, I think we would have seen buying return faster. I think that we’ve seen China building stocks at prices higher than they are right now. And they’re not even going back to pre-war norms of runways. We’ve also seen very, very early signs that Chinese import buying is picking up now that we’re starting to see more ships going through Hormuz. Now particularly seeing more Iranian ships going through Hormuz, which again speaks to a level of kind of waiting for the moment, which feels more, fine-tuned and discretionary than like a big kind of heavy mallet of, you know, that it’s stuck at 11.
Rory Johnston:
One thing I think we should talk about is what it means for the future.
Rory Johnston:
Because there are pretty massive consequences inherent in what we’re talking about. Bears the fact that, one, likely the implications that Chinese oil demand was weaker going into this than we had appreciated. So that means the glut surplus supply going into this was larger than we had appreciated. That’s point one. Point two is that we now see that China can swing massively and in rapid fashion, in the case of a massive spike. So it has the capacity and much more apparent willingness and execution ability than the West to stave off crises of fossil fuel prices. if, say, this happens again or it doesn’t end or whatever. And I think in anyone’s view of the oil market, part of your distribution is like a fat tail of like a $150, $200 oil price spike. And if all of a sudden that’s been like tamped down, That changes the kind of, you know, average of that distribution pretty notably.
Robinson Meyer:
We have this concept in oil of swing producers, right? The reason that OPEC Plus and Saudi and the UAE to a lesser extent can shift the global price of oil is because they have these very swingy production apparatuses, right? Very swingy reserves where they can rapidly scale up or rapidly scale down the amount of oil they’re sending into global markets. And because they have such power over the margin, they have a lot of control over the global price of oil. One thing we see in mineral markets, though, is that swing consumption really matters, is that China for the past 20 years has been able to set global commodity prices by the fact that it’s buying a lot or not buying a lot of a mineral. Do we need to start thinking in the global oil market in terms of China has an ability to set oil demand at the margin, perhaps already has been setting oil demand at the margin and therefore has a degree of market power that is? I don’t know, maybe isn’t equivalent to Saudi or the Permian, if we ever wanted to use the Permian in that way, but is like a very potent force in global economic policymaking.
Rory Johnston:
I’d go even further than that. I would say in terms of like the type of swing we’re talking about, we’re talking like even like five million barrels a day. That’s the collective cut of OPEC plus that it was unwinding over the course of the past couple of years. We’re talking not just Saudi, we’re talking like it can have the same swing demand impulse as all of OPEC together, which is like staggering and certainly more than has been demonstrated the capacity of the Western nations. So then we start talking about, yes, the state mails bureau was doing this with various commodities before there. It seems like they’re now doing that with oil as well. I am sure you guys talk all the time on this podcast about how China has worked to dominate critical minerals, you know, energy transition industries, et cetera, et cetera. In some ways, you know, people were like, well, at least they don’t control the fossil fuel sector. And I was like, well, maybe they actually do have a lot more influence in this sector than we had appreciated. And again, even comparing to the Permian or whatever, what makes OPEC so powerful is that it’s not necessarily a market driven thing. It’s discretionary. It’s a policy choice.
Rory Johnston:
Trump, as we have clearly seen, cannot make the Permian drill baby drill. Only economics and market incentives are going to do that. This, again, as far as we can see, the Occam’s razor is that this was a policy choice, to decrease import demand rather than a purely market one. And I think that, again, is like a very, very powerful thing if taken to its like logical extreme.
Robinson Meyer:
Is this the most important thing we learned in the Iran war?
Rory Johnston:
Yes, by far. I think that I think there’s other things like, for instance, I think that we’ve proven that the Trump administration and Trump himself can have a call it a soft manipulative capacity with jawboning, with spiking volatility and pushing people out of the market. China alone wouldn’t have stopped, I don’t think, the melt up that we saw through or rested the melt up we saw through March and April. But I don’t think the jawboning alone would have worked to do that without the slack that China injected. I think together it proved to be an extraordinarily potent combination. And then all of a sudden, just to tack this on to the end, we also have the fact that the IEA is now forecasting that once this thing ends, we’re going back to the world of mega glut. So maybe our historical references for how the market interprets low stocks or low inventories is also different in this moment because of that upcoming glut.
Robinson Meyer:
If Chinese, let’s say, real demand, I don’t know what the terms to use here are, but let’s say that real Chinese demand was even lower over the past few years than we thought it was because China was building up these massive strategic stockpiles. Does that mean that the real peak of liquid fuel consumption in the global economy has already happened?
Rory Johnston:
I don’t know if it’s already happened because I think that China is not the only source of demand growth we’ve seen over the past couple of years. It’s obviously a massive piece of that. But you’ve actually seen through COVID, Chinese demand has been really flattish since this period. So maybe Chinese liquid demand has peaked earlier, but I don’t know if yet. I think it might be too hard to say overall demand has peaked yet. But I do think, you know, absolutely, this is proof that you have a lot more swing in Chinese demand. And I would differentiate by demand is consumption plus strategic stock building. But to your point, I think consumption is almost certainly lower than we had thought going into this. So overall, we now know that Chinese consumption was likely lower and China’s swing demand is much higher. Or the capacity for swing demand is much higher than we would have appreciated.
Robinson Meyer:
It’s so interesting because it basically means that under a flat demand signal, consumption has risen and fallen. And we don’t know exactly when it happened, but we know it happened under there, which would be very good news to bring it back to the topic of shift key for the climate. The issue is if the other big lesson of this crisis for China, and by the way, for India, for the rest of Asia, is that it’s really good to be able to switch fuels in your petrochemical sector and you want to build out a lot of coal to chemical plants, that would be very, very bad for the climate because while you can change whether you make chemicals from oil or natural gas or coal and it doesn’t really matter for the end product, it actually does matter a lot for the climate whether you’re making chemicals with oil or gas or coal. And so anyway, lots to think about. Rory Johnson, it’s so great to have you here. This was a great conversation. Thanks so much for joining us as always. I learned so much.
Rory Johnston:
Thanks for having me, Rob.
Robinson Meyer:
And that will do it for us today. Thank you so much for sticking around till the end. Before we get to the credits, I just want to say, I don’t know if you subscribe to Heatmap Daily. It’s Heatmap’s newsletter. It goes out every afternoon or evening, Eastern U.S. time. But lately, we’ve been having some fun with it. I have been writing that newsletter every day. And it really is me, by the way. I’ve added a lot of writing to my weekly workload. And in that newsletter, I share an observation or a piece of analysis or some recent reporting that I’ve been thinking about. It’s like an email from me to you every evening. I really enjoy writing it. It’s frankly been a blast and it’s kind of the peer to Heatmap’s morning newsletter, Heatmap AM, which is written by my colleague Alexander Kaufman. So what I want you to do is if you don’t subscribe to Heatmap Daily, but you do listen to this show, and in particular, if you’ve listened to this show all the way to the end, you should go subscribe to Heatmap Daily. Like I am writing this thing for people like you and I would like you to subscribe to this newsletter. We will stick the link in the show notes. You can also find it at heatmap.news. But please, please do come and subscribe. It’s really fun. It’s free, by the way. You don’t have to be a Heatmap paid subscriber to read the newsletter. But I think you’ll enjoy it. I encourage you. In fact, I ask you to subscribe.
Robinson Meyer:
We will be back next week. I’m relatively sure with a new episode of Shift Key. We might, might have something on Friday, but I think it’s going to be next week. Until then, Shift Key is a production of Heatmap News. Our editors are Jillian Goodman and Nico Lauricella. Multimedia editing and audio engineering is by Jacob Lambert and by Nick Woodbury. Our music is by Adam Kromelow. Thanks so much for listening, we will see you next week.
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