Oil Will Trade Flat To Down Until Biden Backs Down & China Re-Opens | Rory Johnston

Episode Summary

Executive Summary: Rory Johnston argues oil’s sharp selloff is driven mainly by macro risk-off and China’s demand collapse, not a simple supply story. Despite near-term oversupply and weakening calendar spreads, the physical market remains backwardated and structurally tight enough that a full crash is not yet confirmed. He also covers SPR policy, EU Russia sanctions, the price-cap proposal, refining margins, and why U.S. shale remains the main medium-term source of supply growth.

Main Topics: Oil selloff driven by macro risk-off and the dollar (Priority: 5/5): Johnston says crude is behaving like a high-beta risk asset, with prices falling alongside equities, copper, and other assets as the dollar strengthens and recession fears rise. Physical oil market vs financial price action (Priority: 5/5): He distinguishes spot market clearing from chart-driven trading, emphasizing that barrels still move in the real world while futures and macro sentiment can create violent price swings. Demand destruction led by China (Priority: 5/5): The biggest fundamental pressure is China’s lockdown-driven oil demand collapse, which he says is far larger than normal recessionary demand weakness and may mark China’s first annual oil demand contraction in decades. Backwardation, contango, and crash warning signals (Priority: 4/5): Johnston explains that the curve has weakened materially but remains backwardated; a true crash would likely be preceded by a flip into contango, as in 2008, 2014, and 2020. SPR policy and U.S. government intervention (Priority: 4/5): He discusses the Strategic Petroleum Reserve release as a major, but not sole, source of added supply, and argues the market would benefit from more flexible sell-and-rebuy policies. Russia, EU sanctions, and the price-cap debate (Priority: 4/5): He walks through how self-sanctioning, the EU embargo, and the proposed Russian oil price cap could reroute barrels while trying to avoid a global price spike, though enforcement looks weak. Shale growth remains the main medium-term supply source (Priority: 4/5): U.S. shale is still the fastest-growing supply source globally, but growth is much slower than before because of capital discipline, bottlenecks, and lower appetite for expansion.

Key Arguments: Today’s oil decline is mostly a macro liquidation: crude is acting like a “mother of all risk assets” as the dollar rises and markets de-risk. The real fundamental driver is China, where lockdowns and mobility restrictions are destroying demand far more than a normal recession would. Johnston’s models suggest the global market was in surplus by July, but the curve still being backwardated shows inventories remain low and the market is not in a fully bearish oversupply regime. A true major oil crash usually needs the futures curve to flip into contango first; current backwardation means downside may be limited unless that changes. The SPR release helped ease tightness, but China’s demand loss is about twice as large as the SPR’s added supply. EU sanctions and the Russian oil price-cap idea are designed not only to punish Russia but also to prevent a sudden supply shock and oil-price spike. U.S. shale can still provide the largest supply growth globally, but capital discipline, labor/sand/pipe shortages, and service-sector underinvestment constrain how much output can ramp. Oil prices can fall below $70 or even $60 in a recessionary selloff, but Johnston does not expect that to be a durable equilibrium if demand later recovers.

Data Points: Brent price: about $86/bbl - Johnston says Brent was near the lowest level since January at the time of the interview. WTI/Brent market condition: backwardated by a few dollars - He cites November WTI around $79 and May 2023 around $75, showing the curve still in backwardation. April 2020 supply-demand imbalance: about 9 million barrels/day surplus - He describes the pandemic period as the largest dislocation on record. Typical oversupply in major downcycles: 1.5 to 2 million barrels/day - He compares this to the 2014-2016 glut and normal surplus ranges. Normal demand imbalance range: +2 to -2 million barrels/day - He says the oil market is usually only off by 1-2% relative to total daily consumption. Global oil demand: around 100 million barrels/day - Used to frame how small changes in balance can move prices sharply. China demand loss: negative 2 to 3 million barrels/day - Estimated demand destruction from China’s lockdowns. China annual demand outcome: first contraction in 20-30 years - He warns China could post its first annual oil demand decline in decades if conditions persist. Prompt Brent spread: fell from about $1.50 to about $1.00 - He uses this as a sign that physical market tightness is easing. December 2022 vs December 2023 spread: also falling - A further sign of weakening forward demand perception. SPR drawdown magnitude historically: 30-40 million barrels - He says earlier SPR drawdowns were much smaller than this year’s release program. Crack spread normal range: $10-$20/bbl - Typical refining margin on a 3:1 gasoline/diesel basis. Crack spread during crisis: about $70/bbl - He says refining margins reached roughly 3.5x normal levels in May-June. Thermal coal vs metallurgical coal: thermal coal possibly more expensive than met coal - He notes a reversal of normal coal pricing relationships due to power demand and weak steel demand. U.S. shale capital destruction: $300 billion to $500 billion - He estimates capital destroyed over the decade before COVID. U.S. liquids growth in 2018: about 2 million barrels/day YoY - Used to show how dominant U.S. shale growth used to be. Global demand growth in 2018: about 1.4 to 1.5 million barrels/day - Used to illustrate why OPEC had to cut output. U.S. shale growth in current year: about 1.0 to 1.1 million barrels/day - Still the fastest source of supply growth, but slower than prior peaks.

Pivotal Quotes: "Today, it looks like it's the dollar." — Rory Johnston: Explaining the day’s oil price collapse as a macro-driven selloff. "The oil market always clears in the spot market." — Rory Johnston: Describing why physical supply-demand realities ultimately dominate futures pricing. "If we do see the curve on a couple different metrics... flip into contango, that's your major warning sign." — Rory Johnston: Explaining what would likely precede a deeper oil crash.

Implications: Near-term oil remains vulnerable to recession fears and China weakness, but a durable collapse likely requires contango and deeper physical deterioration. Medium term, constrained shale growth and any China reopening could sharply tighten balances again.