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In this episode, energy market strategist Jeff Krimmel discusses the recent widening Brent-WTI price differential, the impact of geopolitical conflicts on oil markets, and the implications for energy investments and global security. Gain insights into how disruptions in the Middle East influence energy prices, supply chains, and the future of renewables. Investors and decision makers can gain a deeper understanding of the fundmental factors driving the energy industry with a view to how it will impact prices, futures, and energy equities.

 

Keywords

Energy Markets, Oil Prices, Geopolitical Risks, Renewable Energy, Oil Investment, Brent-WTI Spread, Middle East Conflict, Energy Security

 

Chapters

00:35 Understanding the Brent-WTI Price Differential

03:20 The Role of Venezuela in Current Markets

04:30 Investment Trends in the Energy Sector

06:55 Production Restructuring Amid Structural Shocks

10:10 Impact of Geopolitical Tensions on Energy Markets

12:15 Cascading Effects of Energy Scarcity on AI

14:25 Renewables as a Buffer Against Inflation

17:35 The Future of Energy Security and Renewables

 

Transcript

S. Aneeqa Aqeel

Welcome back to the HFR Podcast. Joining us today is a guest who has been here before, Jeff Krimmel, an energy market strategist with a PhD in mechanical engineering from Caltech And over a decade in market intelligence in the energy sectors. Through the Krimmel Strategy Group, he advises and trains energy and industrial executives on the economics of energy markets. Jeff, welcome back. It’s great to have you on.

 

Jeff Krimmel

Thanks so much for having me, Aneeqa

 

S. Aneeqa Aqeel

This has been such a busy few weeks for everyone, I think. And I would like to start off with talking about the widening Brent-WTI price differential. To what extent do you think that’s capturing the structural supply shock to the oil and gas markets right now? Are we seeing the full extent of the war premium in prices?

 

Jeff Krimmel

Well, I would say we’re seeing the extent to which the markets anticipate that exists right now. Clearly, the market’s understanding of the potential for this conflict to expand and extend in time has evolved. So there’s no guarantee that prices don’t go further up from here or the Brent-WTI spread doesn’t widen further. But we saw in the early stage, sort of the first week was a relatively calm price response.

I think a lot of the market had calibrated around what the US intervention in Venezuela looked like and was expecting something like that in Iran. And then as it became clear that this was a much larger scale engagement and with a longer time investment required, then prices started to step up. You got almost a panic type response with oil prices getting bid up super aggressively on the order of a week after combat operations were launched.

And that’s where you got to this Brent-WTI parity that was really interesting. It’s just not a level you often see because WTI, the way it’s priced in futures contracts is for delivery in Cushing, Oklahoma. And so in order to get WTI out to anywhere else in the world, you need to pay to bring that down to the US Gulf Coast and then load it up onto a vessel and sail that vessel somewhere. So typically there’s a sort of a structural deficit that WTI prices have relative to Brent.

But that deficit collapsed when any measure of secure supply all got bidded up simultaneously. Now we’re seeing the gap between Brent and WTI open back up and say $9, $10 type range. And that’s a truer estimate of the arbitrage that exists, whether you can secure a barrel of Brent that’s available right now, or whether you go to the US, secure a barrel of WTI, get it to the coast, load it up onto a vessel and ship it to wherever it’s going to go, that there is, as more of the world is looking to the US, given its relative security and relative abundance of production, then that spread could widen even more just because logistics get more challenged of getting that oil on the water.

 

S. Aneeqa Aqeel

So you mentioned Venezuela, and I wanted to touch on that for a second. There’s talk about this double shock scenario as markets realize the extent of the disruption from Iran continues to actually increase. And then they also begin to think about a delayed recovery from Venezuela, any help from there. But my understanding was that Venezuela was never really a big part of the picture. Is that right? What role can Venezuela play here?

 

Jeff Krimmel

That’s right. Venezuela is not a big part of the near term supply response. There’s a lot of long term potential that exists in Venezuela. If you’re able to revitalize the oil sector there, there’s just chronic underinvestment and mismanagement that’s created constraints bottlenecks that will take time and investment dollars to unlock. So that’s always more about just the promise of how many subsurface resources Venezuela has. What it might look like if you could invest aggressively into it, revitalize the sector, and get that production flowing. So it’s not that the US military intervention in Venezuela in January somehow provides material cushion for the disruption we’re seeing in Iran now. Those two domains are operating on very different timelines.

 

S. Aneeqa Aqeel

And similarly, I think one of the things that perhaps we didn’t anticipate as far as these structural investments are concerned is the influx of cash and revenue for oil companies right now is actually leading to something other than infrastructure investment, right? Where is all that going right now?

 

Jeff Krimmel

A lot of that goes back to shareholders. It goes back to owners. It’s a situation where you can trace back to the oil price collapse that began in late 2014 and ultimately bottomed out in the February of 2016. And then here in the US, you had a lot of shale bankruptcies through the 2016 to 2019, 2020 timeframe. And that was a real settling out where the investment community recognized that this thesis that these were growth vehicles and that we were going to consume a bunch of cash on the front end to ramp up these production streams and capture excess profits on the back end. There was a broader realization that that thesis just was not going to materialize. And so the incentives changed to where we needed ongoing profitability, ongoing returns on capital investment to justify investors shepherding their dollars in that direction. And that’s where this whole notion of capital discipline arose. So now management teams across the oil and gas production hard about how to frankly invest as little as possible in maintaining and growing their existing business. That requires suppressing capex to the extent that you can. And then any incremental dollars that you can get on the back end, you can transfer that back to shareholders in the form of expanding your ordinary dividends or issuing special dividends or executing share repurchase programs. And so that’s where the balance of decisions and where the inertia has steered these management teams over the past handful of years.

So now you get to a situation where oil prices are spiking. The immediate question is, the Trump administration is leaning on the industry to try to turn up production to the extent that they can. And the industry has been quite clear that a) there’s a lag involved in making that happen. And b) while they try hard not to provoke anyone around this, to acknowledge there is a real tension between what the administration would like to see and what shareholders have routinely expected over the past three to five years. And that tension creates considerable discomfort for these E &P executive teams with their capital allocation programs becoming a lot more complex than they were 90 days ago.

 

S. Aneeqa Aqeel

So let’s talk about that investment lag. Given everything you’ve just said, what do you expect from industry players across North America and the North Sea producers as well in terms of restructuring production and investment given these structural shocks at this point, both to oil and gas? What are the structural risks and opportunities that they’re looking at?

 

Jeff Krimmel

Yes, we have the notion of short cycle barrels and long cycle barrels. The short cycle barrel side, a lot of people immediately think of unconventionals. They think of shales that you can drill a well and bring production online in a matter of weeks and really ramp up your production levels in aggregate if there’s enough dollars that flow in that direction. And the challenge there is really twofold. One is a lot of these shale plays here in the U.S. are maturing. And so as you get further from the cores of these plays, it’s requiring more more effort, more more investment to get the kinds of production levels that we had seen historically. It’s just not as easy to ramp up production super aggressively in the shale space, given what the maturation profile has looked like in a lot of these unconventionals. You also have this notion of capital discipline. It is a different model now than existed 10 years ago, where it was more of a technology issue, more of almost a venture capital play of knowing, okay, we’re going to burn a lot of cash here in the beginning to stand this stuff up. But once it stood up, there’s going be a lot of expanded profitability opportunity that exists on the backside. When that calculus turned on its head, we realized that thesis wasn’t going to come to fruition.

Now, we’re in an era where ongoing profitability, ongoing returns of capital are super important. When you combine the fact that these short cycle plays require more investment, that the maturity means that you don’t get as immediate a response as you used to get from them. And then this broader hesitation to deploy a bunch of excess capital in this direction, particularly when we don’t know exactly how long these oil price spikes will remain. So before the combat operations were launched in Iran, US oil prices were trading in the mid $60 range. And that’s not a level where oil producers had much, if any, enthusiasm about trying to inflect their production levels upward from there. So if we return back to those levels in relatively short order, then it could be painful to have deployed a lot of capital and expanding your production footprint against a price structure that doesn’t remain all that favorable.

How this changes is if the war continues, if the disruption multiplies and cascades, and if it’s clear that oil prices are getting reset higher materially for some period of time, and that the world is now making an increasing call on secure available supply like what exists in the US, then I can see a scenario where oil and gas executives would want to step in and not only feel like they’re doing their national duty and meeting where the administration would like them to be, but they feel like they’re being good global citizens supplying the crude that much of rest of world depends on that they can’t get because of the conflict that’s ongoing in the Middle East. So that’s one scenario where you might see a recalibration of ENPs. I don’t think it’s something that you see three or four weeks into a conflict. That’s something that likely would take months for a full narrative to really take hold where those executive teams feel like they have the kind of confidence that they would need to stand up in front of investors and argue that we need to recalibrate our capital programs because we feel like the price structure has changed materially. These prices will be available over some period of time that would justify us deploying more capital and to engage in that conversation – that will be a difficult conversation to have with investors – may be justifiable depending on how energy markets recalibrate if the war continues on.

 

S. Aneeqa Aqeel

So in terms of the transmission of this to equity markets, would you expect that prices stay bullish for energy equities for a few months?

 

Jeff Krimmel

I would. Seeing how the war has progressed and how few off-ramps seem to exist right now. Even if the US administration decides at midnight tonight, we’re going to cease all active military operations in Iran, there is no guarantee that Israel follows suit. There is no guarantee that Iran or anyone else in the region doesn’t want to pursue the conflict further and recapture lost ground or try to introduce new leverage, you being prepared for, you know, they were just bombed a year ago, there was now this set of military operations that happened domestically. And so I could see them wanting to feel like, okay, the next round is coming at some point. And so we want to prepare for that as best we can. And that may involve some active, ongoing military hostilities that would linger past when the Americans and the Israelis pull back from all that. I just say all that not because necessarily what I’m predicting. I’m just saying there are scenarios where even if President Trump stands up and says, we’re done with all of this right now, a) there’s no guarantee the hostilities, the active hostilities themselves go away. b) you then get into timeframes, which is how long does it take for shippers to develop confidence that they can safely send ships and most importantly, crews of people through the Strait of Hormuz? Iran may decide that, even if active hostilities stop, we want to make it very clear that we control all traffic that goes through the Strait of Hormuz going forward. So it’s not necessarily blocked, but there’s an intensive vetting process that’s going to happen to determine which ships we allow at what frequencies through this. Those sorts of disruptions would be profound. And we’re already seeing the beginning of how these disruptions can cascade beyond energy systems into various supply chains, into the supply chains around agriculture, given the fertilizer piece that’s happening. And as those impacts cascade and start traveling around the world, you really get to a point where the genie going back into the bottle is just not plausible.

 

S. Aneeqa Aqeel

Let’s talk about some of those cascading effects, How will oil and gas scarcity be a constraint on power availability for these energy intensive data centers and other parts of the AI value chain that are most exposed to rising costs.

 

Jeff Krimmel

On the equity side for all of those sectors, you’re exposed in the sense that these disruptions will lead to and already have led to spiking prices for energy, for key agricultural inputs, for key industrial inputs. And as those price spikes endure and cost structures get reset, then whether we’re talking at the individual level of each consumer or whether you’re talking about the spending from business to business, there are more dollars that are getting steered toward basic necessities that are just much more expensive now than they were because supplies are so thoroughly disrupted. And those, again, many of those supplies are feedstocks or inputs to other industrial processes that then will be more burdened with costs than they otherwise would have. And so there’s more expense on the back end of that. So when you talk about the capital, that’s then available to go invest aggressively in new AI deployments, or even as an energy company, the capital is available to go now pursue new projects.

 

When you have these cost structures that getting stood up, that are getting kind of expanding in this way, that’s consuming capital that otherwise would have been available for investment. it’s just, there’s a competition for capital there that will drive up your cost of capital. But there’s also the fact that a lot of these central banks that otherwise may have been receptive to trying to nudge interest rates down from feel comfortable doing that because you have these price spikes ongoing in core goods across the economy. And if you start taking your foot off the pedal there, you risk having runaway inflation that we know creates enormous pain all on the backside. Having come through the post-pandemic recovery bout of inflation, I think central banks in general are very hesitant to under-protect their jurisdictions when it comes to the threat of inflation. Now that threat has stepped up materially as a result of the disruptions we’re seeing in the Middle East. So those interest rates stay higher. It gets harder to invest incrementally in these various capital programs and these infrastructure build out. So just these growth stories that we’ve heard a lot about face a lot of headwinds as these disruptions cascade and multiply and spread across the global economy.

 

S. Aneeqa Aqeel

Can renewables meaningfully dampen these inflation shocks, essentially act as shock absorbers? And how quickly are they scalable?

 

Jeff Krimmel

In the short term, the existing stock of renewable energies are already dampening some of the price shocks that we’re seeing. Gas prices would have gone higher in particular than what we’ve seen if we didn’t have the solar and battery deployments and wind deployments that exist around the world. Similarly, on the oil side, just because of the push toward electrification across the transportation domain. So when you are less exposed, less levered against those oil and gas, those fossil fuels than we had been historically, then there is a buffer that exists today that if the same sort of conflict had happened, even five years ago, certainly 10 years ago, we would have seen a more dramatic response than we’ve seen.

Then the question becomes exactly what you said about, well, how quickly can we marshal incremental renewable deployments to get energy to places where they otherwise would have relied on fossil fuels that are flowing through these areas of disruption? That’s where the headwinds exist here the same way that they exist around the AI deployments, as interest rates are higher, as the cost of capital increases, it becomes more expensive to deploy renewables in that way. But I have written a little bit in my own research, I showed recently that 84 % of the world’s population lives in countries that consume more oil than they produce. And of that 84 % of the world’s population, 84 % of that 84 % live in either Asia or Africa. And my point in putting together that research note is these sorts of disruptions and these sorts of price spikes, land particularly hard on those more vulnerable populations. And that creates even more incentive. When the upcoming capital deployments at the margin, I expect now those to be steered more toward renewables, more toward the solar, the wind, the batteries, if there’s hydroelectric projects out there. If there’s nuclear projects, those have longer, much longer timeframes. As these more vulnerable nations think through the cost of having an energy mix that’s levered against hydrocarbons and fossil fuels specifically, the way there is right now, these sorts of disruptions compel a rethinking of those decisions. And so again, at the margins, I do expect more investments to steer toward renewables, toward batteries, energy storage solutions more broadly. Because I think the world is also seeing not only do you just feel the pain of an immediate disruption and calibrate your response accordingly, we are seeing a true evolution in the geopolitical reality that exists globally that we’ve, know, coming out of World War II for decades had this rules based order where there was some predictivity that existed around how nation states interacted with each other, particularly when it came to points of tension, points of hostility, points of potential conflict. The roles of international organizations in trying to help mediate all that. It’s not that the system worked perfectly and it’s not that all conflict was avoided, but there’s strong evidence that the world avoided conflict and pain and military destruction that otherwise would have existed without this rules-based order.

We’re now evolving into a scenario where this rules-based order is diminishing over time and less of the world is relying on it. And so now we have great powers that feel more emboldened to act in their own self-interests at their own chosen time. We’ve seen that with Russia. We’ve seen that here with the United States. There’s possibilities where you could expect to see that in the future with China. In this world where the great powers can in real time assess their own interests and initiate hostilities that they believe are to help promote and protect those interests, the rest of the world is now more vulnerable than it otherwise would have been. With that vulnerability, I think comes a greater interest in trying to explore what energy solutions are available that allow us to protect our own security. And where you had in the past, say, a climate driven focus, say 2019, 2020, 2021, that the bulk of the conversation was much more around environmental sustainability. Then we got to a period with all that inflation, where a lot of the conversation with energy was around affordability. And I think now we get to a point where it’s the trilemma that’s always existed, but now we get to a point where energy security becomes paramount, given what’s happening in the Middle East. And when you get to energy security, that’s where each of these different energy technologies have a different security calculus, depending on what technology they are and where in the world they are. Fossil fuels do not have a uniform security calculus all over the world. Likewise, renewables do not have a uniform security calculus. each of these countries perform their own calculus. And I think on the margins that that security perspective will lean toward more renewables, basically more non-fossil fuel investments than we otherwise would have seen because you see how quickly your security can get impaired by levering too strongly against fossil fuels.

 

S. Aneeqa Aqeel

Well said. Thank you so much. I feel like we’ve covered so much ground. There’s so much more to cover and I will happily direct my listeners to your wonderful publications, your newsletter, because I think you’re a wealth of information. Thank you for sharing your insights. that’s Jeff. It’s great to have you back on the show.

 

Jeff Krimmel

Well, thank you so much for having me, and it was totally my pleasure, and I’m already looking forward to the next time we connect.

 

S. Aneeqa Aqeel

All right, take care.

 

Jeff Krimmel

Bye bye.

 

 

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