Rick Rule And Mike Rothman Say The Oil Market Is About To Break Wide Open

0:00 What you notice is an incredible difference in price between the so-called reference price and the delivered price, as much as $40 a barrel delivered into some markets. The price forecasts that he talks about in the out months reflect something very different, non-anticipatory pricing and pricing where you're actually rationing oil by price. which is something that if the floating inventory north of the Straits of Hormuz doesn't get released very quickly, I think you'll see occur. Welcome to In It to Win It. This is Steve Barton, and thank you for

0:45 tuning in. Today, I have two guests who look at the resource world from different but highly complementary angles. First is Mike Rothman, founder and president of Cornerstone Analytics. Mike has spent more than four decades studying global energy markets, attending OPEC meetings since 1986, and helping serious investors understand oil, natural gas, supply, demand, inventories, and geopolitics. Also joining us is Rick Rule, one of the most respected natural resource investors in the last 50 years, with a deep experience across mining, uranium, oil and gas, and other cyclical resource sectors. Today, we're going to connect the dots between energy fundamentals and investment opportunities. The big question is simple. Are we entering into another major energy bull market? And how should intelligent investors and speculators think about it?

1:34 Gentlemen, thank you for coming on the show. I'm grateful that you guys are both on here. This is going to be a lot of fun. But you two have probably forgotten more about oil than I know. So if there's some dot I'm not connecting or, you know, some question I should be asking, then by all means, please let me know. Well, I have a presentation prepared for us to go through kind of pre and post Epic Fury and the way the world looked. And then what does it actually point to? Why should anybody even care about this, much less just the investment implications? So. Okay, awesome. Yeah, what I'm hoping is that you can kind of lay out the macro view for us, Mike, and then we can get Rick's opinion on the investor angle and go from there. So if you could share

2:21 your screen, that'd be great. All right, so hopefully you can see that. And yes, sir. Okay, so in terms of my comments and where this is going to lead us to, this is a disclaimer of sorts. Most times, a lot of what is going on with the oil market and what it points to is very comfortable for a lot of people. Most people want to hear that the price of oil is going to actually just keep getting lower and lower and lower. For investors, it's not the 5%, 10%, 30% of their portfolio that might be energy. It's the rest of the portfolio that might suffer as a result. So again, treat this as a disclaimer that what we're going to talk about is not gonna be what most people are generally hearing. And before

3:11 Epic Fury started, before February 28th, we were already pretty much steeped in controversy. There was a number of assertions that had been in place for six to nine months that there was a glut, which was gonna turn into a super glut in 2026, that there was a billion extra barrels of oil in tankers ready to pounce on the market. And part of why that glut to super glut story was taking place relates to the analysis on the right, which is the demand series published by the International Energy for Global Oil Demand versus our own series, which is a reconciled oil balance model number. Meaning we're looking at how many barrels are actually disappearing to the system, not something that's more econometric based.

3:58 For anybody who's watching this, even for both you and Rick, you're not a stranger to this. You've been told that the market this year was going to be oversupplied by four and a half million barrels a day. And that's what the flotilla of crude, you know, ready to come to market. That was one aspect. The second, which is really something we put right on the doorstep of the IAEA was this idea that oil demand was going to go away. The idea of death of oil, electric cars, or any kind of emerging technology somehow portended the end of oil demand growth. And we'd have non-OPEC supply, essentially not become an issue. The market would be comfortable. Prices would be steady to low, et cetera. Two major issues with that. First is the idea that global oil demand was going to stop growing anytime soon was really

4:45 pretty much fantasy. If you look at commodities and you go back to when you were in college or graduate level course, you were told that if the price of something goes up, the demand for it goes down. Oil is the exception to the rule. If you look at the middle analysis there, for so far this year, century oil prices are up this is even prior to the recent run-up by the way but oil prices are up a little over 300 oil demand has grown 40 percent you're taught that it's supposed to be the opposite and this has to do with the nature of oil consumption most of it is tied to transportation and petrochemicals there really isn't a substitute in mass that could dislodge growth in oil demand for what i call the forecastable future On the right, however, is kind of where things get spicy for people, which is that if you looked at what was being purported to

5:34 be the demand growth scenario through 2030, the idea of no growth was fine because the amount of supply coming out of the 79 non-OPEC countries is gonna be pretty limited. That part is actually in line with our forecast. The issue is what you see is that gap there. So again, prior to Epic Fury, there was a pretty wide range of people's opinions about what the oil market was going to look like over the next several years. We were obviously very, very bullish. And the forecast that you see on the left there is updated, but it was published basically almost identical to that back in 2020, which is when we made this very controversial call that we were going into what was going to be a structurally bullish oil balance situation, that demand would get back to growing normally post-COVID, about half the rate

6:24 of global GDP. However, non-OPEC supply was not going to keep pace. And what this was going to result in was a whittling away or paring down of OPEC's spare production capacity and draws on inventories. Now, this analysis on the right is updated with our month-to-date figure for April, but we're at 945% million barrels. There was nothing like this in the history of the oil markets. Even that draw that you see there was counter to what people were being told as inventories were being drawn down. And obviously, completely opposite to the idea that there's this billion extra barrels floating around on ships. So this is the way the market looked. It was structurally bullish. And then, of course, we made a call a number of

7:11 years ago about the twilight of shale. Yeah, it's a play on a Matt Simmons book about Twilight in the Desert. But It was the idea that U.S. oil production growth, which had been dominated by shale, was experiencing, or at least what we saw, as a negative second derivative, meaning it would grow, but at a slower and slower and slower and slower rate, which has been playing out. The problem is, if you look at the last 15 years, almost all of your supply for those 79 non-OPEC countries was from the U.S. So the story was changing. So this is already telling you that things are changing. controversial. And of course, where are we coming up with this non-OPEC supply assertion? Well, just have to look at spending. We forfeited about $3.6

7:56 trillion in upstream spending since the 2014 high watermark. So the industry was not putting enough investment into the idea of growing oil supply. That is a structural problem, which a lot of people simply did not want to hear. They wanted to believe that there was going to be this overhang of production. So as we're getting closer now to the start of Epic Fury, the other key point that was extremely controversial, aside from the idea that we're going to have a superglut, which was basically a lie, was the fact that spare oil production capacity was essentially less than a million barrels a day. Now, this is extremely controversial. Why? Because every month, the IEA publishes a table you see on the right there, And basically, they told everybody

8:43 that there was four and a half million barrels a day of spare capacity. So if the market's oversupplied by four and a half million barrels a day and we have four and a half million barrels a day of spare capacity, nine million barrels of supply extra day, no problem. Whatever happens to Iran shouldn't really matter a whole lot, which was really not correct at all. So this situation you're looking at, this idea of spare capacity having been whittled down so sharply, was why... Late last year, we talked about 2026 as the year of crossing the Rubicon. The idea was, if we were in the ballpark on our oil balance forecast, and we had good reason to think we would be, the back half of the year was going to see the oil market get extremely tight because most all of OPEC's spare capacity would

9:33 be exhausted. Now, this was an extremely out of consensus call. It remains an extremely out of consensus view, but you can see where it's coming from. And Saudi Arabia figures pretty prominently in the discussion because most times you'll see that they can produce 12 or 12 and a half million barrels a day when in fact their wellhead maxes out at around 10.7, 10.8. So then we have Epic Fury. And when this started, we told our clients there are four main issues you're going to have to worry about here with regards to effects on supply. One is you get interrupted tanker traffic. Second is you have countries that can't ship out oil. They have to start now shutting in production, meaning if Saudi Arabia can't load

10:18 ships at Rastanar and Jumaayah sufficiently, they can't get it out on the Red Sea. They're going to have to shut in production. Kuwait will have to shut in production. Iraq will have to shut in production, you know, right down the Gulf, Bahrain, Qatar, Oman, UAE. Then you have to worry about Iran- trying to now negatively affect production in the neighboring countries, which is where this graphic we produced comes from. These are the attacks as of a few weeks ago. And then you have to worry about oil production operations in Iran being affected. So those were the four main supply risks. It was inevitable that we were going to lose some supply, but within a fairly short period of time, all four of these happened. All four of these happened. And if you think about the Iran-Iraq war, if you think

11:08 about when Iraq invaded Kuwait, if you think about anything that's happened, go back to the Arab oil embargo, this is really unprecedented. We have never had this much physical supply disrupted and dislocated from any set of events. And then, of course, we have the other war, which has been all but forgotten, Ukraine and Russia, and Ukraine overtly targeting production capacity at this point and export capacity. And the bigger story with Russia is actually less about the effects of Ukraine's attacks on its infrastructure and more about this erosion in capacity. So we talked about the US, which basically was almost all of your supply growth in non-OPEC. And then you're talking about Russia, at least we were talking about Russia, as seeing an erosion in its

11:54 production capacity. Again, a pretty bullish construct in the scheme of how we were looking at the oil balance. The attacks... If you look at production data, that trend is the focus. There's really been very little data to back up the idea that 40% of their export capacity is offline because we saw production actually in March go up a little bit, not down. But the big story is that downtrend and this erosion in capacity. So you say, okay, can we get to some punchlines, please? It's like, yes. So everything we do when it comes to the oil balance is is always about the effect it's going to have on inventories. All supply and demand factors intersect that storage. We're talking about inventories in the OECD group of

12:40 countries. This is essentially the proxy for global storage. You can see the very strong inverse correlation between inventories and oil prices for this reason. So 25 years ago, I built a model called MICR. Yes, it's a play on my initials. But it's essentially a proprietary oil price model that looks at inventories and kicks out average monthly Brent prices. You are square to this for people who are econometrically oriented is 82%, which is kind of gold when you think about a one variable explanatory model, but it does a great job in terms of taking geopolitics, what's gonna happen to the oil balance, and then what does it mean for oil prices? And the link immediately now becomes the dislocated, really

13:25 disrupted production from Epic Fury, and they call it the Iran War. So on the left, you should see a pretty clear chart about production from the Gulf producers. And if we look at the data for March, we look at crude and natural gas liquids, you lost basically 12 million barrels a day, 11.91 million barrels a day. This is just crude and natural gas liquids. We're not including gutters, liquefied natural gas. that basically was halted, which is the equivalent of about 1.7 million barrels a day of diesel. It was something we keyed in on the day it happened because this is gonna be a problem for diesel because that's gonna be the competing fuel. And if you look at the duration, which was kind of the issue here, and we're in week nine, and you look at this 12 million a day and you offset

14:14 it by the full volume of the OECD emergency stock release, it was announced as 400, it's really 308. And just assume all of it's released. You get a net inventory effect. That's the fifth column there. And then you can use our micro model and you see what the price of oil looks like at the end of the year. Now, Brent's at 111 as we speak. We're barely above the five-week loss line. We're already in week nine. I mean, the market has not discounted what's going on in the physical balance, which is obviously why there's still, in our opinion, significant upside down potential oil prices as opposed to downside risks. In other words, the risks are disproportionately skewed to the upside, even at $111 a barrel.

15:03 And of course you say, well, you know, this SPR release, big number was announced. Yeah, they announced 400. It was a little goofy that you have some countries like the UK says, hey, we'll, you know, we'll make a release of oil except they don't have any, they don't have any SPR. So I'm not sure what they're releasing it from, but the real number is 308. We're past that. We're already in the hole in terms of assuming this is all out. And less than a third of this has actually been released at this point in time. In fact, I'm not even sure if it's quite a quarter yet has been released at this time. So the rub is every time there has been stock releases from strategic reserves, the price of oil rallies through it. And this is kind of a curious phenomenon. I'm not entirely sure if it's because The release of that means there

15:52 is some sort of bona fide issue. But in a couple of cases where oil is released without an issue, the price of oil is still a rally through it. The analysis on the right there is from 2022. We had up until now the biggest SPR release, meaning the OECDs, not just the U.S. SPRs. Prices doubled. In fact, we had no shortage of oil and the price went from 70 to 140. That's with zero shortage of oil. We're still trying to tell people, You don't actually need a shortage to get price to spike. In this case, we have a bona fide storage. And then, of course, you say, well, what's going on right now? And this is an analysis or three analyses we published last week for our clients that looks at the inventory change for April with strategic reserves, just commercial stocks, and then the year to date. But you're dealing with a

16:41 situation where the consensus believed that inventories were going to build four to four and a half, really four and a half million barrels a week. That's 32 million barrels. We start doing that. What does that mean? So 32 a week times four weeks times, you know, five months, you start realizing we should have been building, you know, literally hundreds of millions of barrels when we are down. And this is a rub. And for people who are trying to look at this data, they're saying, you know, the price of oil is still way too low. And obviously we agree with that. And then, of course, at the end of the day, everything comes down to the energy equities. The bulk of our clients are money managers. They have fiduciary responsibilities. The energy equities trade as a proxy for the commodity. We made our big call

17:30 in October 20 that we were going to be in this multi-year secular bullish story for energy, meaning oil prices and then the equities. We have vastly outperformed the broad market. This is the U.S. and Canada. Canada's has been stronger than the US, which is not a surprise because people are a little more receptive to what's going on with the energy space. And you don't have the level of virtue signaling you have in the US. But this is something that we still feel we are in middle innings. This is not, we're at the end of that bull cycle. This is to me just in the middle. And an analysis that we developed a couple of months ago, which really was pretty, even for me to say fascinating, when you've been doing this for so long and you find something new, it's kind of fascinating. And it came out of an examination of what happens when energy equities, this is

18:19 the S&P Energy Index, are vastly outperforming the price of oil. Because typically they move together, but at times, and there's been three, this is the fourth time in the last 20 years, where the energy names advance greatly relative to the price of oil. Each time it has coincided with a major bottom in crude prices. We felt 2026 would be the fourth bottom. Obviously, we didn't know that Epic Fury was going to start, but the fact is it happened again. The secondary analysis that we made our clients aware of is when that occurs and you're thinking about oil prices rallying, it's lasted a minimum of about three years. In other words, we made the bottom and then we rallied for about three years. Not a straight line, but

19:06 generally you're going to rally for about three years. This is perfectly consistent with the way we see the oil balance forecast. So this idea that we're just getting a rally because of this war and that's all we did, no, we were crossing the Rubicon. Epic Fury basically just put a 300 horsepower outboard on the back of that boat and got us kind of across the river much sooner than we had talked about, meaning a couple of quarters, three quarters sooner than we talked about. But there is still a secular bullish story here for oil prices and for the energy names. Now, that's my last slide. This is the legal mumbo jumbo. I will stop sharing my screen and close this down and you guys can have at it. Rick, you want to go first? No,

19:54 you go ahead, Steve. You're better at charts. Other than the great presentation, I broadly concur. Okay. All right. So basically, you were saying that there's been an underinvestment of $3.4 trillion, basically a lack of spending since, I think you said, 2014. Correct. And that coincides, Rick, with what you've been saying of oil companies have been underinvesting by $1 to $2 billion a day, right? And that cumulative effect, is that what you're getting at, Mike? In mind, it is. If you look at the number, I think it's $3.6 trillion. Yep. That's consistent with my numbers, Steve, because what I described was a lack of investment in sustaining capital investment rather than sustaining capital and new project investment. I suspect if

20:44 you add my two numbers, you get awful close to Michael's numbers. Okay. Okay. So you're both in agreement that they've been vastly underestimating. And basically the concern with that is if they haven't been going out and looking for new oil, Is this kind of where you're getting those missing barrels, Mike, or am I not connecting something? That's a different discussion. Missing barrels has to do with demand underestimation by the IEA, which I can talk about. What I'm referring to about the spending is oil. It's not a wasting asset, but when you punch it into the ground, you pierce a reservoir, oil comes up, there's changes in the actual reservoir. You start losing pressure and you have to do secondary recovery and tertiary recovery. And eventually

21:30 you are gonna get maybe best case is about 35% of that oil out of the ground and you need to find something to replace it. So the idea of an erosion and production from a structure is probably easy to think about with regards to shale. Shale oil, a natural well only has a life of about five years. It's not like shale natural gas where you can get 25 or 30 years out of a well it's done after five. So you're trying to bring on new structures to raise your production, to offset declines from your existing output. Globally, if you remove shale from the equation, because it's such a high erosion of underlying decay, the world loses like four to 6%

22:17 of its production capacity every year. In other words, if nobody spent money on doing work on the reservoirs, If you were producing 100 million barrels a day, you did no work. Next year, you'd be somewhere between 94, 96 million a day. And then it would keep declining like that. So if you look at the actual amount of spending that goes into just maintaining existing reserves, it's almost like 90%, 85% of CapEx. That's just to keep the treadmill from not getting steeper and harder to run on. So that's the CapEx side of it. And that's the issue with NonoPEX supply and this whole idea of Non-OPEC will grow, but not nearly as much as global demand. That's where the pressure on inventories and OPEC capacity comes in. Missing barrels,

23:02 and I don't want to turn this into Professor Mike, but missing barrels is a very old issue. You have to remember when the IEA was formed in the aftermath of the Arab oil embargo, their directive was to collect and disseminate member country data. What was the OECD? So, The Organization for Economic Cooperation and Development was the Oil Importers Club, and OPEC was the Oil Exporter Club. So the idea is to collect and disseminate this data. They did not care about the emerging markets. They didn't care about China or India or Brazil or name your country. They didn't care. It wasn't a big deal. At the time, in the 70s, early 70s, oil demand growth was dominated by Western Europe, Japan, and the US, so the countries that

23:47 were members. The problem, and we saw it in the 90s, and then it became kind of full-blown post-2000, is that in this century, 100% of all your oil demand growth is out of the emerging markets. And we have very poor data for country-level consumption. So what the IEA does, and this is not a condemnation, I've talked about this with them in Paris in 1987 after an OPEC meeting, is they said, you know, we have a number for pick a country. Mozambique, it's five years old, six years old. We have estimated GDP from five years ago to now. We have an assumed rate of oil demand growth to GDP growth each year. And that's the number you see from Mozambique, which in Italian side

24:36 language is FGASI. It's a fake number, all right? Because you're assuming your GDP number is good and you're assuming that ratio of oil demand growth is actually correct. And even where you have great and timely data like the U.S., that oil demand to GDP growth ratio can swing around from 0.3 to 0.7. And that's in a country pretty well established. So the issue of missing barrels boils down to something very simply. You're trying to look at how much oil is disappearing into the global system. If your production numbers, which are generally regarded as good, are, say, 100 million barrels a day over two quarters in a row, we'll just spread it out to make this a little easier. And inventories... In the OECD, commercial and government controlled are flat. No change in inventories. You'd say demands 100

25:26 million barrels a day. 100 million came out of the ground. Inventories are unchanged. Demand's 100. IA says, well, no, demand was 97.5. And you're like, whoa, whoa, whoa. Where's the other two and a half million a day? And they'll tell you it's on the water, which is kind of like the checks in the mail. You know, it's, it's, It's an old, I mean, we were hearing this for 40 years. It's on the water. And the first time missing oil was like a pretty big issue was 1987. The IEA was saying that there was 300 million barrels of oil on the water, which in 1987 was five days of total world demand. So I was at the OPEC meeting. I was with Sheikh Ali Khalifa al-Sabah, the Kuwaiti oil minister. And I said, Sheikh Ali, IEA is saying there's 300 million barrels of

26:15 oil on the water, which is like, a meteor in that movie Armageddon, like this is a planet destroying size volume of oil. And we were in this suite, it was at the Marriott and he looks at me and he had a voice like Barry White and he goes, Michael, that oil's in the Bermuda Triangle and you'll never find it. And everybody just started laughing and I'm kind of standing there like the designated idiot. And of course the oil never showed up. And eventually they had to revise their demand numbers up. And that's like a recurring story. And this has become epic at times. Like, Again, I sound like it's a professor thing, it's not. In 1999, the IA was sued by somebody saying that they caused economic damage to their company because they put out this bad data saying there

27:03 was, at that time, 800 million barrels of oil on the water, which was a record level at that time. I ended up having to testify to the Office of Management and Budget because my research at Merrill Lynch was considered the evidentiary matter that the IEA was bogus. And it ended badly for the IEA. The head of the group was fired. They were publicly censored. Of course, the oil never showed up. And that's a recurring story. 2022, I think it was, February, they made 10 years of demand revisions. The missing oil number was up at like 2.3 billion barrels, which is right now like 85% of the size of the whole commercial stockpile. This is a recurring problem. You say, well, why would I give a crap? This sounds

27:49 like statistical. It's not mumbo jumbo. The problem is back in the 80s when Merrill hired me, I was the last petroleum economist they hired. There were people with all kinds of experience working at a lot of, there were a lot more banks and there were people who were like reservoir engineers and they did actual real supply demand work. They knew what an assay was of crude. They knew how refineries worked. And of course, we were going into a 20-year bear cycle and people just stopped caring about oil. So what became the norm was just use the IEA. It's good enough. So most of the banks that you will know, all the main banks, basically just have someone who takes the IEA model and they regurgitate it, which means the IEA supply-demand outlook is actually the consensus outlook. So

28:37 most of the people who are watching this that are investors are are basically seeing some version of what the IEA is publishing, and they take it as gospel, like the billion-barrel flotilla. Everyone knew there was a billion-barrel flotilla. So that's where it becomes an issue. There's very little really independent research that you're putting out reconciled oil balances. And there's not one instance, I'm doing this 42 years, there's not a single instance where missing oil actually showed up. The issue is only resolved when the IA revises up their demand series. There's not one exception to that rule. Okay, so they're basically saying that they're misforecasting how much we're actually consuming, and they're saying, well, there's this plethora of

29:26 floating inventory on cargo tankers, and that's where it is. And that number is up over a billion right now, but you're saying- Don't worry about it. Don't worry about it. Okay. Okay. Going back to your slide, I think it was slide 12. You were basically forecasting that every week that this conflict goes on, your projected price towards the end of the year is getting kind of nuts. I think the last one I saw was almost $200 a barrel. Is that right? I don't want to misquote you. I'm pretty sure it's north of 180. And yeah, I do the slides myself, so I should be able to recall it. But You're in the ballpark, which is probably the only thing that matters. And so it's almost like a parabola, right? Like the longer this goes on, the worse

30:15 it gets. So there's two things that you have to keep in mind here. Two things. One is we have only one month of data. So that 12 million barrels a day lost, that's March only. We don't know what happened in April. For instance, you heard about the blockade on Iranian ports. Well, Iran was... producing and exporting almost normal amounts in March. Their production was only down 200,000 a day in March. Their oil income went up sharply because prices went up as much as they did. So there was no negative effect. Like the rest of OPEC in the Gulf or the rest of the Persian Gulf producers, if you do the math, their total income was down something like 34%, whereas Iran was higher. So the question is, do we know how much effectiveness to blockade really imparted? No. There's no

31:06 timely data for production like that. There's also no real good data outside the U.S. for inventories. That is a separate problem. And in fact, countries that were reporting inventories stopped reporting product inventories like Japan. Because I think they were trying to prevent a panic and a run on people hoarding. So today is the 28th. In another period 10 days, 12 days, we'll get another tranche of data and we'll update our analyses and then look at the effects. We just took that 12 million as constant. We assumed it wasn't worse than the first month. And part of the first month number gets thrown off because Saudi Arabia, the UAE, Iraq, they have onshore storage. So when tanker traffic's interrupted, you can actually

31:55 still fill up domestic tanks, but that's a finite number. So, so... we don't know that it's actually only 12 million. It could have been actually more than that. And then you're waiting for the, this sort of air pocket of supply that's not being moved normally to kind of work its way through the system. So when you start thinking about the inventory effects, they'll probably become much more significant in like week 10, 12, 14, as opposed to week five, six, seven, because it's kind of like getting punched and you don't see the bruise for two days. It's, It's not instantaneous. Okay. All right. Thank you for that PowerPoint, Mike. That was really good. Rick, you saw the same presentation I did. What are your thoughts as an investor? Just

32:46 kind of give us your macro picture, and then maybe we can kind of get into how your brain works of taking information like Mike just presented and putting that into a thesis. Well, first of all, it was a great presentation because I broadly agree with, of course, I think it's brilliant. Yeah. my methodology is very different. I'm not somebody who publishes studies. I'm somebody who invests money. But I think our conclusions are very similar. I believe, first of all, that the run-up that we've seen in oil prices is anticipatory. It doesn't reflect rationing by price yet. There was some floating inventory. There was also some strategic stockpiles. But what you

33:35 notice is an incredible difference in price between the so-called reference price and the delivered price, as much as $40 a barrel delivered into some markets. The price forecasts that he talks about in the out months reflect something very different. Non-anticipatory pricing and pricing where you're actually rationing oil by price, which is something that if the floating inventory north of the Straits of Hormuz doesn't get released very quickly, I think you'll see occur. I don't know, and I don't know that Mike knows how much floating inventory there is north of

34:20 the Straits of Hormuz. And I don't know how long it would last if it were released, in other words, how long it would take for the Gulf states in particular to make up for their production hiatus. What I do know from personal experience is the other part of his earlier equation, which is the damage done to non-OPEC supply, but particularly U.S. and Canadian supply as a consequence of deferred sustaining capital investments. When you don't make the sustaining capital investments, the damage to your ability to produce is cumulative and compounding, which is to say, if you

35:07 forestall a billion dollars in sustaining capital investments, as an example, as a country in 2025, you don't make it up dollar for dollar in 2026. One problem is inflation. The input prices that I experienced as a producer myself are increasing by 8 or 10% a year compounded, but there's also the cumulative damage done to your capacity. So a billion dollars in deferred expenditure generates something like a billion three or a billion five liability, if that's the right phrase in terms of maintaining your productive capacity. A second issue with regards to non-OPEC supply is that

35:58 Our inventory of high-quality drilling locations, undrilled high-quality drilling locations, is a function of the intersection of geology, the oil price, the cost of capital, and the social take. If you combine all of those things at $65 a barrel, several commentators, not the IEA but more like the API, American Petroleum Institute, has suggested that the United States has drilled between 85% and 90% of their tier one or grade A locations, as an example, in the Permian Basin. Now, that number can go up. That is the number of

36:46 undrilled high quality locations can go up with increases in technology, which we haven't seen lately, but That's a possibility or with a higher oil price or with lower tax, highly unlikely, or with a lower cost of capital, either lower interest rates or higher equity prices for oil companies. But we aren't seeing it. North of the border, we have a lot more undrilled locations, but we have a federal government in Canada for 12 years has been overtly hostile to the oil and gas business. That may be changing now. It may not be changing now. We don't know, you know. It's important to note that. But the conclusion is the same. And the other thing that Michael

37:36 pointed out, one of the things that I've grasped with my whole life, with no success, has been trying to determine what he describes as third world and emerging markets consumption. We do know. I don't have the statistical answer, but we do know, and somebody has that answer, that when poor people get more money, expenditures that generate the most utility for them are energy intensive and material intensive, which is to say when gross family income goes from $3,000 a year to $6,000 a year, they don't go out and buy an iPhone. The thing that makes their lives materially better are commodity centric and in particular energy is energy centric. And I have found

38:27 anecdotally because as you know, Steve, I've traveled the world mostly in frontier and emerging markets looking for extractive resource opportunities, which inconveniently for me primarily occur there. Anecdotally, the increase in living standards that I see in these countries, the Malawi's of the world, the Myanmar's of the world, The last 20 years has seen really spectacular increases in living standards. And that's very energy dense. And as Michael has pointed out, I think the consumption has outpaced the ability of the institutions to measure that consumption and measuring consumption on a global basis based on places where the stats are good, like the United States is, while

39:14 it would be convenient, it's erroneous. It's completely erroneous. And then the other thing that Michael points out can't be understated. The IEA, I would suggest, has an organizational bias to other forms of energy. And there have been various estimates about the global expenditure on alternative energies, which were supposed to replace oil. The IEA themselves suggested that peak oil demand will take place in 2030. I don't have a number, but 2060, 2065 feels better to me. One very interesting statistic that I wrote, that I read,

40:05 pardon me, not wrote, was that global expenditure on alternative energy generation has been somewhere between six and $11 trillion. And that expenditure has reduced the market share of fossil fuels from, I forget the exact number, but let's suffice it to say that between six and $10 trillion expenditure has reduced the market share of fossil fuels by 3% over 45 years. That doesn't seem to me like the twilight of demand, particularly given the fact that world population growth increases. And more importantly, that the material

40:55 standard of living among the poorest of the poor, which evidence the greatest increase in oil demand is increasing. So you have this wonderful vice, if you will, declining, sustaining capital investment, very, very little, new project investment, literally outside of Guyana, probably flat, declining ability in the U.S. to increase production from tier one locations, at least at this price point with this cost of capital, with this rate of taxation and this technology. And the inescapable conclusion, I think, is that the price has to go up. Steve, you know, and I had done

41:43 1% of the work that Michael has done in terms of documentation or, you know, suffice it to say, I had anticipated merely as a consequence of declining, sustaining capital investments. And some of that anecdotally, some of that had to do, I own, as you know, Steve, a fairly extensive portfolio of fractional mineral ownership across in particular, New Mexico and Texas. And one of the ways that I measure spending is the number of drilling proposals I get from operators on land where I have minerals, the Exxon's, the Occidental Petroleum's, the EOGs, you know, old fashioned stuff. Like

42:30 how many people ask me for money? And that number has fallen off precipitously. I mean, precipitously. I mean, to the extent that I've had to look for other tax management tools, frankly. And drilling is a wonderful forecaster. But beyond drilling, one of the things that you find, particularly in the gas side of the shale basins, is that a well, an unconventional well might generate 85 percent of its net present value in the first 18 months of production. the production declines are precipitous. And what we learned to do on the gas side, less well on the oil side, was to re-complete these wells. In other words,

43:18 you know, you drill, frack, treat a well. The well experiences really hyperbolic declines, but after four years, you re-treat the wells. And the number of AFEs that I've received as an independent guy not a study or just a guy who writes checks, the number of authorization for expenditures that I've received, never mind in development drilling, but rather in retreating or refracking or recompleting wells has also fallen precipitously. And anecdotally, that tells me that the non-OPEC production, at least in North America, at price

44:07 points that we, I'm going to use the phrase enjoyed, consumers would say paid, prior to the Gulf conflict, were simply insufficient to maintain production. Okay. So there's been not enough investment worldwide and otherwise and in the U.S. unless we get some amazing new technology like we got to experience in years ago with shale, we're going to ration by price. You alluded to it, Rick, and I want to ask you about it. Maybe you track this, Mike, rig counts in the USA are down a lot from years ago. Do you follow that? Yeah. So if you look at the

44:54 U.S. numbers and you think about the idea of the 75% of U.S. production is from shale and There's two metrics, which they're from legacy reports. It used to be something called the drilling productivity report. Now they release in something called the STEO. And there's other metrics. And you'll see two pretty critical numbers. One is what's called the drilled uncompleted, ducts. You'll hear the term duct, a drilled uncompleted well. And those have been whittled down pretty dramatically, which means you're taking a well that you drilled and now you're finishing it and bringing out production. And most of that inventory has actually been pulled down. That's one big metric. The other is if you look at drilling, you'll see that it's actually gone

45:42 down pretty sharply at levels where you say you're not going to be able to sustain capacity. We usually publish that to our clients every month. It's part of an analysis when we get this tranche of data. But they're basically just reinforcing what we see as this negative second derivative in output. In other words... If you look at production this year, 26, U.S. production will actually decline for crude. That's in place. Most people are not prepared for that because most people want to believe the reports they were seeing from some of the banks that U.S. shale was on its way to 20 million a day. And I know you probably think, my God, this guy's pulling my leg. I'm not joking around. These are real Wall Street firms, big banks, big balance sheets saying there's going to be 20 million a day of shale crude. And the... The math just doesn't work. I mean,

46:33 shale by definition is a short life resource. You know, guar is probably the most famous oil field in the world. Everyone knows about guar in Saudi Arabia. It's been producing for 70 years. Burgan and Kuwait's been producing for 60 something. I mean, you'll hear about traditional fields that are producing for decades, but shale is a different story. And of course the secondary issue, which hardly anyone ever talks about. And we know that because you can see the blank stare when you're explaining this to people, is shale crude is the wrong kind of crude for US refineries. For 40 years, the industry has been building conversion and upgrading capacity because the industry was told crude feedstocks are gonna get heavier and more sour. What does that mean? Heavier means

47:18 the API gravity goes down. So in non-scientific terms, when you think about crude, you hear the term API gravity. Higher gravity crudes have more hydrogen relative to carbon. Heavier crudes have more carbon relative to the hydrogen, right? That's what it refers to as. U.S. refineries have been adding all kinds of upgrading and conversion capacity for four decades. And then all of a sudden you now introduced shale crude, which is very light oil. It doesn't have a lot of impurities either. Can't be processed. That's why there were six and a half million barrels a day of export pipelines and tankage built to export U.S. crude. we're still the second biggest importer of crude in the world after China. People keep saying,

48:03 oh, we're independent. We're not going to get affected by, you know, Epic Fury or an Iran war. You're like, oh, man, you got to wake up and smell the coffee, man. That's happy talk. That's not real life. Yeah, that's four scotches and five cigars, you know, into a Saturday is what that is. But there's this whole idea of shale, was it's not even the right crude for us refineries. If you take a refinery built to process heavier oils, forget the impurities, just a heavier oil, and you put a light crude into it, you get way too much naphtha, you can't run your distillation capacity correctly, you can't actually process the same value of oil, and you have all this naphtha, what am I doing with this? And you don't have enough of the heavier ends, the gas oils and the residiums to then crack and

48:49 turn into things like jet fuel and diesel fuel, et cetera, et cetera, even gasoline. So, That's why it's exported. And it's kind of been a big joke. So you spend a gajillion dollars on bringing on this capacity. We're just helping tea kettle refineries in China and South America and other countries, but they're not really helpful for U.S. refineries. But no one likes to talk about that because God forbid you hit them with a fact. Yeah. Okay. Talking about refining, I'm going to share my screen here and we'll go to the gasoline price. So this is gasoline, one month futures out and it's at $3.41. This is going back about to, well, right down here is the COVID sell-off in

49:35 2020. Two months out, it's actually cheaper at $3.27. Why is it that with everything going on here, gasoline is cheaper than it was back here in 2022? Is this also fantasy land? I mean, it's only going two months out, so it's not really showing to the end of the year. So part of this is you're not into the summer grade season yet. And again, this is probably overkill for most of the people watching this. There's two main seasons in the year for gasoline. You have the winter grade season and you have the summer grade season. Gasoline demand in the United States peaks in the summer. It's actually harder to make gasoline. in the summer. That's your clean air act of play, vapor pressure rules that started back in 1989, et cetera, et cetera. The chart you

50:21 really want to pull up is heating oil or diesel. That's the real story right now. And I'll let you do that. It'll take you a second. Silver gas, diesel. Is that it? Yeah, even that looks almost understated. And that's the U.S. So the thing that happened on, again, day one was Iran lobs an ordinance into what's called a liquefied natural gas facility in Qatar. You never say it the right way unless you speak Arabic, but you'll hear Lafon or Rafan. You'll hear, but that's what it is. And that is like the equivalent of, that volume of 1.7

51:07 million barrels a day of diesel. Now, diesel was already a tight market. And now you lose this liquefied natural gas. And it was an immediate issue. It's like day one, price of heating oil, diesel, went up three times as much as crude. And diesel prices, jet fuel prices, are the highest they've ever been in human history. The spreads between jet fuel and diesel and crude, jet cracks or diesel cracks, the highest they've ever been, even higher than Marina and Katrina hit. So it's a secondary issue. But the problem is if you don't have enough feedstock, the refining margin is basically a signal to refiners to give me more of this product. So at $110 a barrel for a crack spread jet fuel over crude, the system is screaming,

51:57 please, God, give me more of this fuel. I'm giving you every economic incentive possible to make more of this fuel. So the problem that we see is if you're looking at this for what it is, not what you hope it becomes, just looking at it for what it is, the loss of supply because of interrupted shipping and shut in production from the Persian Gulf is not a far Eastern problem as many people assert. They're like, hey, 90-something percent of everything that came out of the Persian Gulf went east. Some went to Europe, very little coast of the U.S. That's all true, except it's a global system. I can promise you that when that gutter LNG facility went offline, the price of diesel in Topeka, Kansas

52:43 shot up. There's no immunity by region. And if you look at U.S. gasoline prices, it's something I just republished again in the last day. The single largest determinant of retail gasoline prices in this country is the price of Brent. Not WTI. It's a price of brand. It's tied to the global benchmarks. So the problem that I have here is that if you're looking at this and you're thinking the worst is over, A, clearly I don't agree with that. B, if you're thinking about it from the point of view of actual consumers, 413 or 415 prices that we recently had, that is not the top. If I'm right, which is always heroic and stupid to actually say out loud, but let's just say I'm in the ballpark

53:29 about the oil balance and what I see happening with prices. You're looking at another buck and a half, potentially close to $2 a gallon more at the pump than where we are right now. That's what you're staring down the barrel of. And I don't trade this. I don't have a vested interest. It's not like I'm long crude or something like that. I don't. participate in the markets because then I can't do something like this and be talking my book. So there is no book. The reality is the amount of supply that's kind of gone here and what it's going to do to prices has not been discounted, has not played out. And by the way, that's with no other assumption other than

54:17 we're talking about 10 weeks of losses. 10 weeks of losses is not a given. Yeah. This standoff between the people running Iran, which, by the way, is the Revolutionary Guard, it's not the mullahs, and the U.S. government has no expiration date on it. And I wish I could say I'm an oracle and it's going to be over at 91 days or something like that, but it would be a total lie. The answer is we're only assuming 10 weeks of disrupted exports. So the longer the interruption goes on, this process This problem just keeps expanding. And if the market was trading as if we were short, you know, 800 million barrels or 600 million, OK, not so not that interesting of a discussion

55:06 because it's already like happening, except that's not the market's doing. The market's trading like we only had a disruption of five weeks and that 300 million barrels came out of the SPR. That's the way the market's actually trading. Okay. That was awesome. We're going to go a little bit deeper with the premium subscribers. Mike, if our viewers want to follow you and your work, how can they do so? Just send an email to sales at cornerstoneanalytics.com. Not that complicated. Sales at cornerstoneanalytics.com. We'll put that link down below. Rick, any final thoughts? None. Again, Mike, great presentation. Thank you. Thank you. We're going to continue this conversation in the premium segment, and that is where things get very practical. We'll look at

55:51 just how exposed the global oil market really is to one critical shipping choke point. Why quick fixes like new pipelines or alternate supply may be more fantasy than reality. And which countries are going to feel the pain first. Then Rick will help translate that into our investors playbook. Which producers are actually positioned to benefit? What kind of companies may have weakened themselves by returning cash to shareholders instead of investing in future production? And could the real opportunity be hiding in the service side of the energy business? If you're trying to understand how this energy shock could affect markets and your portfolio, join us in the premium. There's a link down below that will take you straight to the episode. Thank you so much for your support. Have a wonderful

56:37 rest of your day and happy trading.