John Dizard: Higher Prices for Energy, Consumer Products & Food
In this special edition of The Institutional Risk Analyst, we feature another fascinating conversation with John Dizard, a veteran financial journalist and columnist known for his in-depth analysis of global macro investing, commodities, and currency markets. He is best known for his 21-year tenure at the Financial Times. When we want to know what is happening in the world of energy, John is our first call. We first published his views on the approaching economic collapse due to the US-Israeli war against Iran in April and then again in July (see below). But nobody in Washington or on Wall Street wanted to hear it.
With a midterm election less than two months away, the Trump White House is not remotely interested in talking about an impending surge in prices for energy, consumer products and particularly food, but that is precisely what John is now predicting. The Trump Administration is focused instead on important things like banning media from the White House or remodeling the Kennedy Center. John’s views are disturbing but also suggest some investment themes which we will address in our next quarterly discussion for subscribers to our Premium Service.
The IRA: John, thanks for making the time. We spoke earlier with our contributor Mickey Maini, author of the Entropy Trap, and he predicted that if oil prices stay above $75 per barrel the Republicans lose the Senate in November. Current price for WTI is just below $100, for what it's worth. But there is barely any reporting in the US media about energy.
Dizard: The triviality of what's being debated in the mainstream American media compared with the seriousness of what's going on in the rest of the world is astounding. I've never seen any greater divergence. So, you know, what can you say?
The IRA: We can say that your prognostications on energy and the impact of the Iran war have been spot on since our first discussion in April. Our readers certainly appreciate your insights.
Dizard: Thank you, Chris. Our little talk back in April about Group III base oils turned out rather interestingly. They're on allocation now by the major suppliers. There will probably be panic buying by some people, which will make the allocation a little worse. I don't think people ever quite realized what was going on with improving mileage for cars. Consumers thought that better mileage was for free. No, it was being bought at the cost of dependency on a type of oil that we weren't actually making in the U.S.
The IRA: Before the conflict with Iran, more than 45% of U.S. imports of Group III base oil came from the Middle East, with the Persian Gulf supplying roughly 47% of total U.S. Group III demand/imports and 72% of European imports. The Independent Lubricant Manufacturers Association places the Persian Gulf's share close to 40% of total global Group III production capacity worldwide. This capacity is now gone. We are well and truly screwed.
Dizard: The situation would be manageable if Washington were engaged, but they are not. Chevron (CVX) and Exxon (XOM), which are run by some moderately well-informed people, decided a couple of years ago they were going to make a little more Group III base oil in the states. That production will come on line in 2027, which will be a little late, and it won't be quite enough.
The IRA: So when it is time to service your car or truck, there may not be any synthetic oil available?
Dizard: Yes. And in the meantime, oil we might import from formerly friendly countries such as Canada may go to Europe. European refineries have just this past week been informed that they will not be getting 550,000 barrels a day from Saudi.
The IRA: Yes, we saw that. They were canceling contracts all over the place.
Dizard: The Saudis cannot ship the oil, you know, if it isn’t there. Oil is, as we've discussed, not a generic product you can simply buy to make up for your contract volumes by buying it elsewhere. The Europeans, I think, have a serious problem this winter on lubricants. They are also down to only 64% of their gas storage requirement which should have been filled by now. So the Europeans are short of gas and they're now short of oil, and they're also now concerned about this hybrid warfare with Russia.
The IRA: Everyone assumes that Putin will make peace in Ukraine, but are the Europeans prepared for more of a war? The Europeans supply weapons to Ukraine and Russia is slowly destroying the country. Nobody's ever prepared for war. But the Europeans are going to have a big political problem this fall and winter if energy supplies run out. The pro-war parties in Germany lost big last week in Berlin and Mecklenburg-Western Pomerania.
Dizard: Correct. We're going to be bidding against the Europeans for our synthetic oil which isn't all synthetic, but which is definitely high viscosity. We're going to be bidding against them because they're not going to be getting lubricants from the Middle East and their oil refineries are not going to be supplied with crude by Saudi. This is going to be educational. The Saudi news was, I think, the most dramatic news of the past week because the breakthrough of Ansar Allah, or the Houthis, as they're called, on the Red Sea. It puts them in the position to not only knock out any Saudi shipping, but if Mohammed bin Salman (MBS) or the Saudis more generally choose to counterattack, then the Houthis can destroy their refineries. And they've demonstrated their ability to do just that. Not only pipelines, but also refineries, which will take a lot longer to fix. And the Saudis do not know exactly what to do next.
The IRA: So not only has the Trump Administration started a war in Iran that we cannot win, but we’ve also destabilized the Saudis, who have never been particularly adept at defending themselves.
Dizard: The Egyptians were less than completely enthusiastic when the Saudis broke the idea of having Egyptian and/or Israeli joint military action against the Houthis because it means the Houthis would then go after all traffic in the Red Sea, not just the Saudis. They're currently allowing American and all other ships except Saudi vessels to go through.
The IRA: Focusing on the Saudis is smart. If Ansar Allah close the Red Sea entirely, then they would force a coalition of nations to come after them.
Dizard: Yes. Assuming that coalition is competent enough. The Egyptians do have some ability to do raids and even occupy an island. They might be able to do that. But that's also a war. The Houthis are very clever and determined fighters who are motivated by ideology rather than a paycheck, unlike the mercenaries that have been employed by the Saudis.
The IRA: Ansar Allah translates from Arabic as "Partisans of God" or "Supporters of God" (anṣāru llāh), where Ansar (أنصار) means "helpers" or "supporters". What do the Houthis want from the Saudis? Do they want the Saudis to make peace with the Iranians?
Dizard: Well, it gets more complicated than that because it goes to tribal politics. Of course, the Ansar Allah have kinship relations with some Saudi tribes on the border And tribal politics in Saudi Arabia has been repressed for a long time. We'll see if that remains the case.
The IRA: Do the Houthis want to overthrow the Saudis? We're seemingly winding the clock back 100 years, John.
Dizard: Well, you know, that's certainly what the Houthis would like to do. And incidentally, while they look ragged when you see pictures of them, the Ansar Allah are actually very sophisticated people with a very old culture. They consider themselves the fount of culture and enlightenment on the Arabian Peninsula, not the Saudis.
The IRA: They've probably been there and been organized in terms of towns and cities for quite a long time. The Horn is very different than the rest of Arabia.
Dizard: That's for sure. The Ansar Allah have been there for a few thousand years longer, and they've been a civilized country for a few thousand years longer. They dispute parts of the border with Saudi Arabia. And the original peace there was negotiated for the Al Saud in 1934 by St. John Philby, Kim Philby's dad.
The IRA: It’s a small world, John. Of course, Kim Philby was a high-ranking officer in British intelligence who secretly worked as a double agent for the Soviet Union.
Dizard: Philby is another one of these strange characters that comes up. This is not something that can be fixed with some carrier strike by Secretary of War Pete Hegseth, who I think has had enough of actually trying to bomb the Houthis into submission.
The IRA: Houthi light infantry armed with sophisticated anti-aircraft weapons are not great targets for complex aircraft.
Dizard: No. And, you know, the Houthis turn out to be rather resilient people and smarter than they look. The Afghans looked primitive and ragged, too. So that was the interesting news of the week, and it's not fully absorbed here. The Houthi presence on the Red Sea does mean that yet more refining capacity has been knocked out. So product exports from the Saudi refinery at Jazan on the Red Sea, for example, are suspended. That's the real choke point in the world, is not just crude supply, but it's really product supply. And that's one more refinery that's crossed off the list. Did they actually destroy it? No, they didn't destroy it. They damaged it, but they have said no Saudi ships.
The IRA: So Iran has flanked the Saudis and the western countries are not in the mood for an invasion of Yemen. What’s the endgame here, John? What do you think happens? Do the tribes rise up and get rid of MBS? The Iranians revile the Saudis for their corruption.
Dizard: Well, the politics within the royal family are complex and MBS had been in a strong position especially with the urbanized, international people who have run the country, so there isn't really any visible opposition. The only problem is what's underneath that calm. The Saudi armed forces have not covered themselves with glory in recent years or even in the decades before. Saudi Arabia is not a country that can contest Iran militarily.
The IRA: No, they can't. If the Houthis had the logistics, they could probably topple the Saudis tomorrow. What is the endgame for the United States?
Dizard: As long as we're concentrating on keeping up the illusion that we've won, we're not going to fix what was broken. It's not a war you can win in the air or from the sea. No, no, it's complicated. The Iranians are hurting, yes, but they can hurt for a lot longer than we can hurt. And they showed that with the war with Iraq. These are people who, whatever their, you know, many... faults or vices and corruption and general unpleasantness, are battle-hardened fighters. They will hang on for a long time. The U.S. will have a hard time maintaining its blockade beyond six months for the obvious logistical and mechanical reasons. It'll be difficult. That will hurt the Iranians a lot, but it's not going to knock them out.
The IRA: How does this situation impact capital investment in the industry. In other words, if I'm one of the majors or even a country and I'm worried about future production, where do I start building new refinery capacity?
Dizard: Well, a good place to start would be to repair existing capacity and to bring it back into service. Finding skilled workers to build new capacity and the materials to do that is problematic. The California refineries that were taken offline, for example, have got to be reopened or nationalized or however that's done, because we're going to be short of capacity in the western US. There's a somewhat defective refinery in the Virgin Islands, which maybe could be brought online, but how quickly is the question.
The IRA: So we need an end to hostilities?
Dizard: Yes. And for the Russian refineries, which have been knocked out, repeated attacks have an increasing effect on how long it takes to restore refinery capacity. You can fix something, and then if it gets hit again, yet more damage will be done, which will be harder to repair. The Ukrainians have also gotten more sophisticated about which units and refineries they attack, so the fluid catalytic converters are the first thing they hit. Those take a while to fix and the Russians have responded to degradation by lowering the grades of gasoline and diesel they produce for sale. Russia is now on Euro 2, which is a grade of fuel you would buy 20 or 25 years ago. That type of fuel will do really bad things to modern engines. The Russians are facing significant problems.
The IRA: So bottom line, the world has a deficit in refinery capacity for years to come?
Dizard: I think that rather than building new refinery capacity, fixing old ones is a good place to start. There are several refineries that need to be repaired in the Gulf. At Bapco, the Bahraini refinery, heavy damage was done, so that needs to be repaired. Also, the Kuwaiti refineries, the ADNOC, the Abu Dhabi refinery, of course, even the Iranian refineries. The Iranians are not going to be happy if everyone else gets to fix their refineries, so the Iranians will get to fix theirs. The only way to even begin to get started is to have a truce. Not a peace for the ages, but some kind of working truce with the Iranians means dealing with them in a very different way we've been dealing with them.
The IRA: Where does Washington start?
Dizard: First, Iran has not been defeated. We have to admit that. We have to admit, oh, actually, they've done very well. And it has to be admitted by people in authority. So those people in authority can then negotiate with their Gulf counterparts, including the Saudis. That’s how this thing gets fixed. Now, doing this before the October 27 Israeli election is going to be difficult to impossible, and also before the U.S. midterms, which means that before the U.S. midterms, things are going to get really quite bad.
The IRA: How bad does the shortage of refined product get?
Dizard: With Diesel, we're close to seven bucks now. Does it get beyond that? Yeah. Is there a temptation for Washington to impose export controls for diesel? Yeah, but there are problems with that because you wind up also not being able to produce enough gasoline, because of the way refineries work.
The IRA: Ah, if we cut diesel production we also cut production of gasoline? Ah, life is not simple is it? President Trump has indicated that the supports export restrictions on diesel, but this sounds like a really bad idea. To restrict diesel exports, we must produce less gasoline. The US price of diesel is the cheapest in the world, but nobody in DC seems to understand that basic fact. The US has plenty of diesel except in the west where the progressives closed all of the refineries. But the rest of the world is short diesel and bidding up the price.
Dizard: There's some simplistic ideas from, you know, politicians about how we just have to end diesel exports. Yeah, there are operational problems with doing that because we cannot store the diesel. Because you'd produce less diesel and less gas, prices will rise. Our pipeline network is not configured to support an export ban. Also, U.S. crude is not well adapted to diesel production. You need medium crude, at least, such as is produced in Canada, or heavy crude. Being able to produce a lot more Canadian oil would be good.
The IRA: But we we’re in a trade war with Canada. Yeah, that was pretty bad timing by President trump wasn't it?
Dizard: What's even better than medium crude is medium sour, crude that has a lot of sulfur in it, meaning that you extract that sulfur, but then you use that sulfur to produce fertilizer, which I'll get to in a second. The crisis in lube oil is here now. That shortage is here now. My advice to people, it's practical advice they might need, is if you have a modern car and you need a 0W-20 oil, don't put in a lower grade. You will wind up with problems with your engine. You can, with modern lube, drive further. So you can drive 10,000 miles or 12,000 rather than 4,000, but don't put in an inferior grade of oil. And it's going to be a problem. To the degree people can't get high viscosity oil, they'll have problems with their bearings, pumps, generally their engines. Just don't do it.
The IRA: Oh yeah. You'll destroy the engine.
Dizard: Right. And don't do it. So anyway, back to the sulfur thing right now, what's happened is the price of sulfur is kind of normalizing in a way around a thousand dollars a ton, which is up eight times from a year and a half ago. The problem is it can't go up further because the fertilizer companies who buy it to make sulfuric acid can’t go higher. About half of all sulfur produced in the world goes to sulfuric acid then most of that goes to producing phosphoric acid, which is then used to make phosphate fertilizers. So the problem is that with the price of sulfur having gone up as much as it has, farmers can't afford more fertilizer.
The IRA: So they just won’t buy or apply fertilizer. That’s bad.
Dizard: They can't afford those prices. So rather than raise prices, the fertilizer companies are simply cutting production, partly because farmers can't afford it and partly because there's not the physical availability of the sulfur to make it. This is going to result in food shortages. We had a good harvest for grains this year. There were favorable crops most of the world, including, by the way, Iran, which is why they're not going to starve to death. But that carryover will be limited. And crop yields are already declining in the US. And next year, they'll decline not only in the US, but around the world because farmers will not be applying as much from winter planting, spring planting on. There will be a food crisis starting next year.
The IRA: We certainly don’t hear the White House preparing for a food crisis.
Dizard: Food prices will have to go up a lot further for farmers to make a profit. Every dollar they have to pay for diesel is a dollar they can't pay for fertilizer. And the farmers, even at higher grain prices than they have now, can't cover their costs. They're losing money. You know, there is no transfer payment that's going to change that. So they're are hurting badly. Bankruptcies are up. Farm income is down. So there's going to have to be a major, major increase in food prices next year. We'll see how much of the Russian and Ukrainian crops actually manage to get to market because they can't ship out to the Black Sea because both sides, neither side will agree on it.
The IRA: The Ukraine war was the start of food inflation. How bad does this get?
Dizard: The Russians and Ukraine can't agree on a truce. The Ukrainians have to ship out by rail. They can't ship up the Danube River. The Russians have to ship out through Baltic ports, which don't have grain handling facilities. The food crisis is going to be the crisis of next year. I mean, it's bad when you can't drive as much as you feel like. It's much worse if you don't have the food. And it's already baked into the cake. There a were about 75 million tons of phosphate fertilizer used in the world last year. Next year, 30 million tons of that will not be there. Think about that and there's a multiplier on food production when you don't get a phosphate application or for that matter enough nitrogen fertilizer.
The IRA: So it sounds like the world is going to force the US to make peace with Iran?
Dizard: Something has to be done because the U.S. is not going to step up its prosecution of the war. It has to make some kind of truce agreement that will go beyond the memorandum of understanding. And the terms on which that truce is made are not going to be favorable. No, of course not. I mean, they're going to wind up effectively recognizing Iran has some kind of a gating function or some sort of partial control over the Strait of Hormuz because that's what they already have.
The IRA: Well, Turkey has control over the Dardanelles.
Dizard: Yeah, that was established by the Treaty of Sèvres and then another treaty in 1938. And, you know, Turkey is paid a transit fee for ships based upon the weight of the vessel calculated in gold francs. Transit of the Dardanelles under Turkish control came through the Montreux Convention of 1936. So, you know, this has happened before. It's unfortunate that we can't have free transit. It's very, very much a problem for the people in the Gulf. And the Iranians have to consider their long term interests there as well. The U.S. is simply going to have to reverse its public position that it's won the war or the Trump Administration just has to change its position.
The IRA: You’ve said that these supply shortages and price increases are already baked into the cake. Can you expound on how bad this gets?
Dizard: You're talking about food prices and prices for other consumer goods going up significantly in the next 12 months and thereafter. They've already published the CPI increases for Social Security, for example, for next year. But that won't include the price increases that are going to hit between now and the end of the year, which are significant. So, I think that you'll get to the price levels that destroy economic activity in the east that you have in the west. So $7-8 diesel, perhaps higher after the midterms. Maybe $7 or $8 regular gas.
The IRA: Could we see diesel at $10 per gallon in the East? It’s almost double digits in the West.
Dizard: At $10 diesel, you start to get projects canceled, you know, shipments canceled, you start to get real demand destruction.
The IRA: But that's not going to make people terribly happy. Well, they wanted to slow down the economy and fight inflation. This is how they'll do it. With these sorts of increases, the Fed may be cutting interest rates next year.
Dizard: This will be a painful shock to Americans and it is a shock to the Europeans. They also are short of gas. And the Poles are going to DEFCON 2, let's say. They're preparing for war. The British, who have far from a hawkish Labor government, are preparing to recall the army's reserves to the colors. They're mobilizing their reserves because they think something will happen immediately. They don't know exactly what will happen, but they think that this war is widening. And they're concerned about a hybrid war that is happening now. What happens after that? Well, they don't want to be unprepared when it does happen.
The IRA: Imagine if the shock from energy shortage causes a wider war in Europe, a war nobody can even remotely afford.
Dizard: And the British take it seriously enough that they're already mobilizing reserves of people who haven't been in active service for at least months and probably years. So you have to remobilize them. And Germany and France have already started to prepare hospitals for mass casualty events.
The IRA: You hear nothing about this in the American media.
Dizard: What's amazed me is how poor is the response from the high end of the U.S. government. The command levels just have responded to this very badly. Why do you think the Chinese satellite images of US bases in Jordan can be seen in the rest of the world, but not in the US? That's not for security reasons. That's for PR reasons. The Trump Administration does not want US media to report how badly the US bases were hit. And by no coincidence, JPMorgan (JPM) suspended issuing its estimate of oil prices for next year.
The IRA: Right on time. Thanks John.
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