Markets Flash Back to the Past

Stock market candlesticks trending upwards

Before you get too excited, NO, I’m not giving away any financial advice. However, whatever the global markets are doing right now doesn’t match the physical reality of the Iran war.

We’re seeing major disruptions, yet prices and trading patterns reflect high confidence that everything is fine. That’s far from the truth. A quarter of globally traded oil is gone. Key industrial inputs are gone. Refineries in Europe and Asia are stuttering due to supply issues. Commercial and strategic inventories have been tapped.

The discrepancy comes from the way markets are designed; they’re meant to respond to marginal changes, not a catastrophic loss in production capacity. Markets just don’t know how to factor that in and price it appropriately. And sooner or later, reality is going to catch up to everyone…

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Transcript

Hey, all Peter Zeihan here, coming to you from Colorado. Today we’re going to do something a little different and talk about markets. Don’t worry, there’s no trading advice in this. I don’t do that. But markets have been very, very strange since the Iran wars started. They’ve been gyrating but really have not shown any understanding of the threat that we have been facing. 

We have roughly one quarter of all internationally traded oil that floats on the water that has not simply been disrupted, but is gone. Even if the war were to end the second, most of that’s not going to come back on before the end of the year. Some of it will be gone for a couple of years. That’s before you consider natural gas or alumina or aluminum or fertilizer or the various products that come out of gutters, natural gas processing facilities, these things, these things are gone. 

We now have a weapon system in place that has a reliable range of 600 miles, which is triple what they need in order to disrupt things on the other side of the Gulf. They are difficult to jam, they are difficult to intercept. And with the technologies in place and in existence at the time, it can’t be done at cost in any sort of reasonable cost. 

The markets are pretending to themselves that we are simply hours away from peace and going back to things as they were before, and with every Trump troop social post, we get gyrations up and then something like, say, the United States hijacking a supertanker comes along and we barely get a response. This degree of retardation in the markets makes very little sense to me. 

And then I thought about it a little bit more. It is because the markets are being presented with something they’ve never been presented with before. You see, since 1945, we’ve had a globalized system where the United States upholds what makes it all work. And I remember that whenever I walk into a room full of finance people explaining that the world after 1945 is based on American security guarantee, this is something that surprises them. 

In the United States, the idea that economics for the US is a subset of security is something that really never gets processed, and the financial crowd is arguably either the top or the second most globalized of America’s industries. So for them, the idea that the entire underpinning of their sector is now gone is something that really takes a while to get their mind around. 

And so the money keeps flowing. So stock markets are stable to up all prices despite the gyrations have been trading within a reasonable band. And we haven’t seen anything like the disruptions in oil markets like that we saw back in 2007 at the dawn of that financial crisis, and those disruptions were largely non-existent. The ones now are permanent. 

So what is going on here for real, and what should we expect? Well, let me give you a few items. Just kind of file away in the back of your head. Number one, we are seeing reduced refinery runs across Europe and across East and southern Asia. This is not demand destruction. Demand destruction is when prices reach a certain point that people change their economic activity because they can’t afford the energy or what product, whatever it happens to be, that’s not what we’re seeing. 

We’re nowhere near those 2007 highs that triggered real demand destruction. And that’s before you consider inflation index terms were barely half of that level. No, the refineries aren’t slowing down operations because there’s no demand. They’re slowing down operations because there’s no feedstock. We’ve had such a deep and ongoing disruption to energy outflows from the Gulf that over half a trillion barrels of crude now have not been produced, have not been shipped to port, have not been loaded on tankers, have not sailed out of the Strait of Hormuz, have not gone to their end destinations. 

Which means that if we’re seeing refinery runs reduced, it’s not just that there’s not enough crude making it out of the Gulf, it’s that the crude oil reserves of the various companies and countries are being depleted to the point that it’s affecting refinery operations. We’re also seeing already reductions in things in shipping, most notably diesel. In the case of trucks in places like Australia or China or Europe, and jet fuel pretty much everywhere except for the United States. 

That means that these shortages aren’t just a throughput issue. They’re not just a reserve issue. It’s a commercial inventory of refined product issue. And that sort of breakdown is something we have never seen in the post-World War II environment, not once. And markets don’t know how to price that, because how do you price a barrel of crude that is never produced in the first place? 

What modern markets do is they look for price signals, slight changes in supply or demand from this market or that market or that subsector, whatever it happens to be. And then the price of crude adjusts around that, and that provides forward price signaling for things like producers. We are not seeing that because that is not happening. We have seen a gross dislocation of the structure of production and transport, and they don’t know how to price that. 

Under normal circumstances, higher prices would stimulate more production. But most fields take somewhere between 4 and 11 years to come online. In the United States, that has shrunk down because of the shell revolution to weeks to months. But that just is at the wellhead. If you want to export crude to a world that can’t get enough of it. 

Well, then you need export infrastructure. And you don’t do that in a day or in a month or in a year. Which means at some point in this year, we have a fundamental break between the reality of what’s going on in the ground with energy and this facsimile that exists in the financial markets. What we’ll look on the other side of that break, don’t know. 

But two things. Number one, it’s coming soon because we’re reaching the point. There just isn’t enough product to carry out normal activity. And number two, I can guarantee you it’s going to involve rationing. And rationing is not something the market does well. That’s something that requires government intervention. And when that happens the question is what our markets what is their purpose then it’s supposed to be about the efficient allocation of capital. 

But that’s not the world we’re about to be in. We’re going to be in a world of absolute energy scarcity and the financial markets arguably not going to be a player in that. Now, whether that’s a buy or sell trade, I will leave up to you. I don’t think it really matters at this point. One of the things that most people forget is over the long run of global history and the period before World War two, it was the nature of almost every market in existence to ultimately go to zero, as the foundations that allowed it to exist broke. Well, get ready return to the past later this year.

El Jardinero Gets Trimmed by Mexican Authorities

A Mexican solider leans against a military truck

Mexican authorities have arrested Audias Flores Silva (aka El Jardinero…not the scariest nickname I’ve heard), a senior figure in the Jalisco New Generation Cartel.

El Jardinero had been trying to forge cooperation with the Sinaloa Cartel and utilize their distribution network, but his arrest will likely kill that effort. The removal of El Jardinero will further destabilize the cartel, as a fight for power breaks out and factions begin to splinter off.

While this arrest is a positive overall, Mexico’s near-term outlook will likely be much more unstable. Oh, and drugs flow to the U.S. won’t stop until all of y’all cool it with the white stuff.

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Transcript

Hey all, Peter Zeihan here. Coming to you from Colorado. Today we’re going to talk about an arrest in Mexico. A guy by the name of Audias Flores Silva, also known as El Jardinero. The gardener was a high up leader in the New Generation Cartel. He was arrested on the 28th of April. And barring surprises, we will never hear from him again. 

If you remember back a few months ago, El Mencho, who was the leader of the New Generation cartel, was killed in a raid by the Mexican authorities with some Intel provided by the United States. And so the question has been who, if anyone, is going to be able to take over. So quick backstory, then we’ll look forward. Historically speaking, in the last decade, we’ve had two big cartel alliances form and dominate the organized crime space in Mexico. 

First, Jalisco New Generation which was run as a corporate entity by a guy by the name of El Chapo that became the largest organized crime group on the planet, as well as the largest one in the United States in New Mexico. Basically, he had this idea that drug smuggling is our primary business, so we’re not going to muck with anything else. 

That is not that. And in doing so, he basically bought the loyalty of a lot of local governments throughout the system. Eventually, that became a massive corporate empire, and the Obama administration made him public enemy number one. Eventually we got him. He’s serving a permanent sentence in the United States. Now, that meant that the Sinaloa cartel started to break down from the inside, and El Mencho’s Kids Los Torpedoes started running their own little factions, as well as other regional leaders and even their accountant. 

That led to a break that allowed New Generation to rise to become the most powerful organized crime group on the planet and in the United States and in Mexico, run by a guy named El Mencho. Jalisco new generation who had a very different corporate philosophy. It’s more of a franchise model, but everyone was basically told, you know, when you go into a new town, you shoot the police chief and maybe a bunch of random people just to make it very clear who’s in charge. 

And in doing so, they generate a lot more fear. Their income isn’t as strong. They are not as diversified, and they’re more likely to come up against resistance from the state, especially in the United States, because of that. But that doesn’t mean it’s model that doesn’t work. Anyway, when I fell because it’s kind of a franchise model, everyone started going the wrong direction. 

El Jardinero is one of the guys who basically tried to come up with a new path. And what made him particularly interesting is while he is a regional leader, specifically in the northwestern part of Mexico, he reached out to Los to basically cut a deal. See, new generation is more powerful militarily within Mexico, no doubt there. 

But the remnants of the Sinaloa cartel have a better distribution system within the United States. So if you put the two together just in that tactical manner, you could really produce not necessarily a super cartel, but you could shove a lot more cocaine through the system. With El Jardinero gone and with half the Chupitos either dead or in jail, that’s probably not going to happen now, and that’s probably a good thing. 

Just keep in mind when you have an organization, whether it is Sinaloa or that doesn’t have a clear leader, you tend to get a lot of competition within the factions, and eventually that turns into a shooting war. So El Jardinero was in charge a lot of the militant aspects. And now that he’s gone, he isn’t there to kind of hold a lid on everything else. 

So this would suggest a lot more violence as generation breaks down. And so, yes, the US and Mexico isn’t particular are getting some of the kingpins. And that feels really good. But it does change the personnel leadership, the personal structure of these things. And without that top layer, it becomes a lot more violent and doesn’t necessarily stop the flow of cocaine. 

So Mexico’s near-term future is probably more fighting as the most violent cartel they have ever had now falls into infighting as well. The only real solution to this is actually pretty simple one don’t do cocaine. And if everyone would abide by those three words, this would all just go away.

Russia Tucks Tail in Mali

National Flag of Mali

The Russians are getting the boot from the Sahel, and it’s all thanks to an unusual alliance between Tuareg separatists and a local branch of Al-Qaeda. These rivals have teamed up in Mali to drive back the Africa Corps, Russia’s paramilitary force.

When the French withdrew from the region, the Russians stepped in and picked up operations. However, maintaining control in the region is no easy feat, and the Russians are figuring that out. The Sahel’s harsh geography, the war in Ukraine, and now, jihadist groups partnering with Tuareg separatists, are all weakening Russia’s position

Without reinforcements or easy extraction points, this could turn into an embarrassing retreat from the region for Russia.

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Transcript

Hey all. Peter Zeihan here. Coming to you from Colorado. Today we’re talking about Africa, specifically the central African country of Mali, which is in the transitional zone where the tropics bleeds into the desert and an area called the Sahel. What we’ve had is over this past weekend, Tuareg forces, their local ethnic separatists and a branch of Al-Qaeda which operates in this area. 

Both of these have been militant forces operating in the area for quite some time, decided to coordinate their attacks, their normally quite robust rivals, and attack the city of Kadal in the northern part of the country, in the Sahara, as well as a number of other places throughout the country. And in doing so, they forced Russia’s Afrika Korps into full retreat. 

The Afrika Korps is the successor to what used to be called Wagner, basically, a group of people who have had the ethical part of their brain. Mellon scooped out and basically sent to kill people for the power of Russia. In the case of the in general in Mali, in specific, they cut security agreements with local governments that are not particularly nice to their people, and in exchange, they get mining concessions, most notably. 

And for them, definitely, what they’re after is gold, because it allows the Russians to evade sanctions more effectively. They just fly gold for payment instead of having to worry about, say, the US dollar system. Anyway, the quick back story is as Ukraine war got going really, really hard in the last couple of years, Wagner became more a group of paramilitaries. 

With the ethical center scooped out, Ragnar became more and more important to the Russians in manipulating not just events in Ukraine, but throughout the world, because they were basically soldiers for higher that would carry out the interests of the Russian state, which in general is to cause as much trouble in as many places as possible to cause problems for Western governments. 

So in the case of the Sahel, the target was always France, where in French former colonial territories here and the French had troops throughout the countries in order to fight the jihadist remnants of al-Qaida. And in that they were doing, I would argue, a relatively decent job. 

For the French, Al-Qaeda was the target, and they would cooperate with anyone who had helped them against al-Qaida in this case, including the Tories. And the government of Mali was like, well, you’re cooperating with one of our secessionists against the militants. We don’t like that. It’s a sovereignty issue. And then the Russians came in and the French were booted out. 

And some version of that has happened throughout what is once known as French West Africa. And the French footprint in the region now is basically zero. And we have Russians now across the entire band. But as as I said, what happened when this went down is the cell is not a particularly great place for anybody. There’s not a lot of water. 

So you don’t have population density, which means you have these isolated populations, posts like Cadle that have a few tens of thousands of people. And that’s it, which means that any sort of rebel group or militant group can run fast and free through the rest of the country, just like we saw in Iraq or Afghanistan and the war on terror, just like we see sometimes in northern Mexico with the cartels, just like we see in Syria with ISIS. 

You can’t really impose any sort of control over this region long term, because you can’t have the civilizational tools that are necessary to do it. And so now it’s the Russians turn to get their asses kicked. And so the issue here for the Russians is unlike France, which is not involved in any sort of broader military conflict, and unlike France, which actually has some expeditionary capacity, the Russians don’t. 

They’re involved in a large war. So only so many forces can be dedicated to the Afrika Korps or Wagner or whatever you want to call it. And in addition, there’s no chance of backup, which is a real problem. So the Russians only have about 2500 troops in region, and that includes their logistical tail. So most of what they have been focused on is destabilization and wealth extraction. 

And now that the actual fight has been joined, they are not doing very well. I always assume that by this point, countries be working to remove the Russians for any other reasons, because they are really a trouble. But when it comes to the countries of the Sahel, where state capacity is so low, getting any sort of assistance is good, especially once you’ve kicked out the French. 

So the the Russians are still fighting these groups in other parts of the country. They’ve only evacuated Cadle. But if the Tuareg, Al-Qaeda, it’s not an alliance that’s too strong. But if their truce holds, they can keep up the attacks. The Russians really have nowhere to go. You’re looking at a potentially a particularly embarrassing retreat they can’t count on the Russian state airlifting them out because the capacity isn’t there. 

And it’s just way far, too far away. Whether or not this will be the beginning of the end of the Russian presence across the cell. We’ll see. But there is a relatively embarrassing retreat in store now that will probably continue from north to south across the entire country.

Japanese Weapons Are Open for Export

Japan tanks and military parade

Japan has lifted its long-standing restriction on exporting weapons. This will bring some fresh dynamism to the global defense industry, specifically in naval manufacturing and drones.

While the impact will likely be gradual, Japan is already fleshing out plans to supply ships to Australia. The real impact will be seen when Japan’s decades of investment in automation are on display, which positions it to become a major drone producer. Collaborations with Ukraine are just the first glimpse of what could evolve from this.

As Japan leans into defense exports, it could very well reshape modern warfare and emerge as a leading global drone power.

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Transcript

Hey all. Peter Zeihan here. Coming to you from Nashville. Today we’re going to talk about something actually happened about a week ago. The Japanese changed their legal structures so they can now, for the first time since World War two, export weapons. So the question is, how big of an impact that this have? In what sectors over what sort of time? 

Japan has the world’s second largest navy, but they have always, by design, not had a particularly large military because of the whole World War II thing. And in all operational terms, the United States more or less operates their military on a tactical level whenever we decide what we want to. So that is, encourage the Japanese to not do a whole lot. 

And so in terms of percent of GDP, which is a threshold that most people use for defense spending, the Japanese have actually dipped down to as low as about 1% as of ten years ago. Now, as China has become more of a threat, that has risen and they’re now spending just under 2%. And, you know, if you double the size of your defense budget, you would think that your military industrial complex would expand. 

And it has, but not by as much as you might think. The Japanese are working from the theory that before we get all the hardware, we should make sure that we have the right people and the training regimen works hard to argue, and that means that the defense expansion hasn’t really kept up. So a sudden change and the ability to export weapons doesn’t immediately translate into those weapons being available. 

But this is still Japan, one of the most technologically advanced cultures with the fastest rate of change in technology, in manufacturing, in human history. And now that they can access the market, they’re going to. So kind of phase one is there are 20 countries that they consider allies, which can includes most of NATO where weapons are now legal to sell to. 

And the question is what are they going to do? The obvious one is ships, especially small ships. And they’ve already cut a number of deals, including with, say, Australia, to turn more ships out of their shipyards and get them out there. And since the Japanese Navy is one of the three most powerful on the planet at the moment the Brits, the Japanese and the Americans, I don’t doubt that they can do that in number in a relatively short period of time, but it’s the second phase that I’m really interested in. 

Japan is a partially robotic society. This is a country that has been aging very, very quickly and as the world’s oldest average population. And so 15 or 20 years ago, they established a national robot strategy to basically automate and robotics, whatever part of their economy that they could, because they knew they weren’t going to have the people and they knew that the people were going to need the obsessed. 

You mate that with what is going on in this second phase of the revolution in military affairs, and all of a sudden some really interesting things can come out of the drone world, because when it comes to actuators and things like that, the Japanese have been doing it for decades. So we now have a deal in place already between the Japanese and the Ukrainians to bring Japanese production capacity to Ukrainian drone tech. 

You put those two things together a fast adapting, automated workforce with a very quick turnaround on things like prototyping. And you’re talking about Japan becoming a massive drone power in probably less than two years. And now they have export capacity. So I don’t know what they’re going to look like, but we’re going to have Japanese built drones produced in mass and exported in mass in the not too distant future. 

And we’re only at the very beginning of understanding what drone warfare means in general. We are utterly unprepared for what it means when the Japanese take lead in that sector.

The Iran War Approaches a Tipping Point

Missiles with Iranian flags on them

The Iran war is approaching a painful tipping point this week. Global energy flows remain in a chokehold, and economic conditions are worsening worldwide.

This week’s shift will be caused by Iran’s oil storage reaching capacity. Once that happens, Iran will have to shut in wells, which will cause long-term damage to production capacity. The fallout from that will be sure to get the IRGC riled up.

Now that the real decision-makers will feel the pressure, there will be an opening for policy change. The outcome, however, remains uncertain.

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Transcript

Hey, all. Peter Zeihan here coming to you from Nashville. You are going to see this video on Monday the 27th. And this week is going to be a big week in the Iran war. We’re in this painful economic state where both the Iranians and the United States are blockading traffic in and out of the Strait of Hormuz, which has caused any number of problems downstream, whether it’s jet fuel shortages or just general economic dislocation, it’s bad. 

It’s getting worse. It will continue to get worse for months. This is not something we’re going to fix this year or probably even next year. But for the first time, by the end of this week, the people in Iran who matter will finally feel some pain. One of the aspects of the American blockade is to make sure that the Iranians cannot get crude out. 

Now, normally, Iran only exports about a million barrels a day, but based on buffers in their storage system at a place called Kharg Island, they can surge out if they have stuff that’s already on site. What that does mean, however, is that once the blockade is in, that storage starts to fill up. Most people estimate that they have between 30 and 35 million barrels of storage and Kharg. 

And that’s really all the storage they have in the country for crude. And now that we’ve had the blockade in place for quite a bit, we’re probably going to see that storage hit full capacity this week, probably on Thursday or Friday, which means for the first time, it’s not an issue of short term income disruption. It’s a question of the Iranians then having to forcibly shut in their wells. 

You see, it’s one thing to cut off their day to day income for a few days, a few weeks, a few months, a few years, whatever happens to be if they know they can ultimately still get it out. But if you clog up the system and prevent exports completely, then they have to shut in wells, and those wells will never come back on in the same way. 

And they might have to do some redrawing, which means a long term degradation of their capacity to generate income at all over the years to come. Now, the people who are calling most of the shots right now are with the IRGC. That’s the paramilitary organization that enforces security, that controls the missile force that has been doing most of the drone attacks, and they make their money by a combination of smuggling and oil sales. 

So for the first time in this war, they actually have a reason to change policy. Is that something that is going to happen? You know, who knows. But this is the first time they will actually feel pain. And if there is going to be something that the Trump administration is going to do to take advantage of that, we get the beginnings of that strategy by the end of this week. 

Way too soon to suggest that there’s going to be success or failure in any particular direction. But this is the first thing that the United States has done for long enough that matters to the people who are actually making the decisions.

Underwater Drones and the Future of Naval Warfare

An unmanned Underwater vehicle drone about to be dropped into the ocean | Courtesy of Wikimedia Commons: https://en.wikipedia.org/wiki/Unmanned_underwater_vehicle#/media/File:Unmanned_Underwater_Vehicle_operations_130605-N-AZ907-046.jpg

Drones have been all the rage in the Ukraine War, and they will continue to be one of the primary topics of warfare in the near future, but do underwater drones have any place in this conversation?

Underwater drones just don’t have the same use case that airborne drones have. Torpedoes have been around since the 19th century, so these underwater drones aren’t doing anything groundbreaking. Surface maritime drones are a different story. These remote-controlled jet skis strapped with explosives have been wreaking havoc on Russian vessels.

So, forget the underwater drones and focus on the surface-drone tech, especially if you’re in places like the Taiwan Strait or the Japan Strait. As these innovations roll in, we’re looking at a full restructuring of the global maritime shipping sector.

Note: This video was recorded last year during one of Peter’s backpacking trips.

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Transcript

Hey, all. Peter Zeihan here. Coming to you from Lost canyon. Got a little interesting stuff. I’m gonna have to climb through tomorrow, but you know, that’s tomorrow’s problem. Today we are taking a question from the Patreon page, and it’s specifically about drones, specifically underwater drones. And the question is, as did globalization really kicks in, do I expect underwater drones to play a role in some of the major things that are coming, like the just incorporation of China or perhaps Korean unification? 

Probably not. Unlike airborne drones, underwater drones are missing a couple key factors and its range and detection radius. The technologies that have allowed airborne drones to do their thing better optics, better power management, lighter materials really don’t change the math for an underwater, weapons platform, but can’t see any further than they did before. 

The range is limited by the fuel type. It’s having a little bit bigger Battery isn’t going to do all that much of a difference. And being able to get things to where they need to go, probably not a very big play. The only way that underwater drones might make, might see bigger plays are, is if they were dropped off by submarines closer to their targets. 

But, you know, we would call those normally torpedoes. We already have that technology, so we’re not really, doing much here. We’re just kind of reinventing the wheel. Now, that’s under water. Drone. So does it mean that maritime drones aren’t moving forward and don’t have a role to play? But it’ll probably be surface drones. One of the things that the Ukrainians have shown us is they can take a jet ski or a small motorboat packed with an explosives, basically strap a control system to the steering column and off it goes with five, six, 700 pounds of Boom-boom. And when it hits a ship, that ship has a big problem. And using water, drones, maritime drones, surface drones, Ukrainians have done an immense amount of damage to the Russian Navy because pretty much all of the weapon systems that are on traditional naval vessels are designed to shoot up at things like planes. They’re not designed to shoot down at things that are in the water. 

And so we’ve seen the Russians basically have to defend their vessels with dudes on the deck with machine guns and RPGs, and it’s not a very effective thing. So if you take maritime drones and introduce them into constrained waters like, say, the Taiwan Strait or the Japan Strait, all of a sudden you do have a very different sort of system because these sorts of drones do have ranges of a few hundred miles, already. 

And that’s just by retrofitting, platforms like jet skis that already exist. As soon as you start taking, the technologies that the Ukrainians have built and use them on a completely new chassis, you can have a lot more range. And then we’re talking about a fundamentally different system. And if you’re talking about defending a civilian vessel in that sort of environment, that’s going to get a lot harder. 

At least naval vessels have the possibilities of having jamming and having things like a ready supply of RPGs. Now, this does bring us to another topic that we’re going to have to find out the hard way. And that’s the general militarization of cargo ships. Because it’s coming soon. There are not not not not enough military vessels on the planet, to be able to patrol the sea lanes to a degree that would be necessary for the type of security breakdown that we’re facing. 

So the only way we’re going to be able to maintain even a modicum of globalized trade is if cargo ships, whether they’re container ships or, bulk ERS or tankers themselves, are able to mount their own weapons systems, and that will also most likely be airborne drones, because that’s the only thing that can get the radius and maybe the strike capacity to take out something like a surface drone before it gets to you.

America’s Leg Up on Petrochemicals

Petrochemical plant

The Iran War has caused a massive disruption in global petrochemical production. Since most of the world relies on oil-derived naptha, the ~12 million barrels/day shortage is taking a toll.

Many countries in Asia and Europe are beginning to feel the pressure, but the U.S. has a leg up on everyone else. Thanks to the shale revolution, America’s cheap and abundant natural gas is used to produce its petrochemicals. This has enabled the U.S. to avoid shortages and become a dominant global supplier of key petrochemical inputs.

Nearly every industry, from plastics to fertilizers, is impacted by these materials. So, the global industrial landscape is getting shaken up once again.

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Transcript

Hey, everybody. Peter Zeihan here, coming to you from Walla Walla, Washington. Today we’re talking about the Iran war and the impact that it is having on petrochemicals. 

The way most of the world decides to make petrochemicals is they start with crude oil and then refine it into an intermediate product called naphtha and then naphtha. 

Then it goes on and is processed into tens of thousands of things that we all use every day. That’s not how it operates in the United States. In the United States, because of the shale revolution, we have basically a bottomless supply of natural gas. Based on whose math you’re using, roughly one third of the natural gas that is produced in the United States, it’s produced is a waste product, or at least as an associated production of oil, which means that in the United States, natural gas is significantly cheaper compared to the cost of oil. 

So in the rest of the world pre-war, the ratio between oil and natural gas on a point of view was about 5 to 1. In the United States, it’s closer to 2 to 1. So we use natural gas to produce products that, everyone else would use naphtha for. Well, what has happened? Two things. Number one, all that natural gas means that the United States can produce most petrochemicals at a significant cost advantage versus everyone else. 

Second, with the Iran war going on now, there’s a global shortage of oil to the tune of about 10 to 12 million barrels a day. So everyone else is hardware is designed to turn oil into naphtha, into petrochemical products. But all of a sudden, the price of oil on the availability of oil means that basically everyone in the East Asian rim, and very soon, everyone in Europe, simply can’t access the product they need at all, and they don’t have access to enough natural gas in the first place to switch over. 

And even if they did, they’d have to change their hardware to be able to do it. So the United States is becoming, from an economic point of view, the only real functional, large scale supplier of the butadiene and methyl groups, which is where we already had, huge advantage. And that’s things like, particleboard and silicones and octane for gasoline and nitrogen fertilizers and melamine, plastics, a lot of things like that. 

Whereas everybody else is now discovering that they don’t have the price structure that’s necessary to maintain competitive production of really any of this. Third problem, because the United States, is able to have an advantage now in all of the product sets. We’re seeing a significant shift in production quantities as well as qualities. So let me show you this chart here. 

If you start at the bottom left, that gray bars oil, you turn into naphtha, which goes on to make all the water products go to the right side. At the bottom you start with natural gas. You crack it to get ethylene, and then you turn that into products. But this whole set can be made with natural gas. 

And so the United States has not just a price advantage now, but just a huge advantage in the quantity, the type of products that can be made in mass. You play this forward for six months, two years, which is easily going to happen because of the Iran war. And we’re looking at a shattering of the petrochemical supply chains on a global basis outside of North America, and that’s going to have massive impacts downstream on pretty much every industrial sector.

The Return of Kremlin Terrorism

Image of St. Basils Cathedral and the Kremlin in Moscow, Russia

During the Cold War, Soviet intelligence agencies actively sponsored or even created terror cells throughout Europe. A recent mass shooting event in Ukraine suggest a return to old habits could well be happening.

The most obvious fertile ground would be pro-Russian or Russian-speaking populations in Ukraine. Next on the list would be far-right political movements across Europe.

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Transcript

Hey, everybody. Peter Zeihan here. Coming to you from Colorado. Over this past weekend, we had some interesting developments in Ukraine. Not on the front, but back in Kiev. A Moscow born individual who had lived in Bakhmut in eastern Ukraine previously, took seven people hostage in a supermarket and, caused quite a bit of ruckus before police took him out. 

Russian intelligence is not what it was during the Soviet period, but in bits and pieces it’s been rebuilding its capacity. And among the many tricks that the Russians developed during the Cold War was some really good divide and conquer ideas. Despite the size of the Soviet Union, Russian leader, Soviet leaders always had a very good appreciation for just how technologically backwards and corrupt and untrained their forces were. 

And they knew if it came to a direct fight with NATO, they really only had two options. Number one was to absolutely swarm, NATO forces with superior numbers. And number two was to provide some sort of distraction back in the Western countries so that the Western attention would be divided. Now, they never really got chance to test that theory in combat. 

And God forbid they’re able to. Now, but they’re starting to rebuild some of those distraction policies. And I’m not now talking about those, Novichok poisonings we’ve seen or dragging and anchor on the seabed. Those are all really easy things to do. If we ever get into a real hot fight with the Russians, expect to see dozens of those every week. 

This is different. This is sponsoring the creation of terror cells. Across the West. We had a number of groups who were basically ideologically motivated to hate capitalism that, the Soviets would basically work to build out supply and sometimes even task. 

Now, I’m not suggesting that this specific case in Kiev was Russian instigated. I really have no idea. What I can tell you that even though Ukraine is at war and is awash with weapons, this is the first mass shooting event that we have seen in the country during the conflict, and it is going to make a few people in the Kremlin think wistfully of old tools from old days. So regardless of whether or not the Kremlin was involved, it has certainly occurred to them now that there is something to work with here. 

What they can work with kind of falls into two general categories. First, pre-war, roughly one fifth of the Ukrainian population was, ethnic Russians. And another fifth was Ukrainian ethnics. But Russian speakers, primarily, even though the Russians have caused the most damage to the pro-Russian parts of Ukraine, complete, with looting and rape camps. You’re still going to be able to find a small minority of pro-Russian groups in those areas. 

The Ukrainians would call them collaborators that might be willing to do something along these lines. And remember, it doesn’t take a lot of people. You don’t even need 1% of the population. You just need a handful of people who are broken and zealots and who are willing to kill for someone, whatever that reason happens to be. And in a place like Ukraine, where there has been shooting for so long, and where the Russian intelligence network is so deep and where there are still millions of Ukrainians and Russian ethnics of Ukrainian nationality living under Russian control, the recruitment might not be as hard as you think. 

If you go further west, you fall into the second category. We have probably past peak far right in Europe. One of the things that we have seen over the course of this war is, as a rule, Europeans becoming more and more anti-Russian because the Russians have been doing sabotage throughout their countries, in addition to now threatening their direct, military and strategic existence with the Ukraine war. 

And what would happen after that means that hard right forces, whether either in Finland or in Hungary, are broadly in retreat. I mean, this is Europe. There’s 30 countries. I don’t want to make that two blanket of a statement, but they’ve really found it difficult, to get too much traction in the current environment. And that is before Donald Trump kind of lost his mind and started berating all of his allies, including the ones on the far right. 

So in just the last couple of weeks, we’ve seen links between elected officials in places like Italy fall apart, and in places like Hungary, where Trump actually personally campaigned for the former prime minister or caretaker prime minister. Now, we’ve seen that for soundly rooted when the political appeal of these groups fails and their chances of getting power, the, the traditional way through the ballot box starts to fade, you’re going to have zealots and hardcore groups among those, factions that are going to be willing to seek other options. 

I mean, we’ve certainly seen that here in the United States. And we probably will in the months and years to come as Donald Trump basically implodes conservativism in America. And until the Republican Party can reform with more traditional conservative forces like, say, business interests, you’re going to see elements of MAGA really get ugly. That is happening in Europe, right now. 

And if you take the Russians on one side with their Intel network and take a disintegrating kaleidoscope of rightist groups in Europe, on the other, the idea that you can form these ideological based violent groups, terror groups is really not much of a stretch. The biggest difference is that the last time around, because it was communism, Moscow generated support among the hard left, whether it was environmentalists or radicals or pro-worker groups or anarchists, where this time they’re going to be doing it among the right the nationalist groups, the neo-Nazis, the biker gangs. 

It’s a different feel. About the only good news I have out of this is that it’s it’s new. These groups don’t have a history of being violent in the pattern of militant groups in the 60s or 70s. And the Russians are out of practice for this specific sort of work. It’s one thing to send an agent to Salisbury and poison a guy’s tea. It’s quite another to actively plan militant attacks in countries that, ever since 2001, have really been upping their internal security, capabilities. So this will happen. A lot of these people will be caught, the Russians will be exposed. But the volume of people that you need to stir up to start this sort of process is so low. And there are broken people in every community. 

The Russians are just going to be taking advantage of them in a way that they haven’t until now.

Italy Gives Trump the Cold Shoulder

Photo of Italian Parliament

Trump’s chaotic and isolated approach to the Iran War has caused rifts between the U.S. and many of its closest European allies. Topping that list is the Italians.

Trump went into the Iran War without consulting allies and determining how they could support, and then turned around and criticized each of those allies for not helping. This put unnecessary strain on long-standing partnerships with the UK, Spain, France, and Italy. And Trump portraying himself as Jesus Christ and arguing with the pope, doesn’t even help with the non-religious crowd in Italy.

As leaders like Giorgia Meloni begin withholding logistical and military cooperation, the U.S. will face major challenges in projecting military power abroad.

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Transcript

Hey, all. Peter Zeihan here coming to you from Prosser, Washington, where I’m at the Davin Law Winery, one of my all time favorites. Today we are going to talk about the end of the American alliance with Europe, specifically the Italians. Now, there are a lot of things going on in alliance politics right now that are really, really bad at the top of the list, of course, was Donald Trump saying that all of the allies are, quote, useless and powerless. 

Short version. Is it normally when you carry out a military operation, the United States, you consult with the allies and get as many countries on board as possible so that even if they’re not providing troops, they can provide logistical support. This may be a surprise, but the United States is in the Western Hemisphere, and most of its military operations are in the Eastern Hemisphere. 

And while the U.S does have a fully blue water navy, that doesn’t mean you can just sail a random ship into a random location and prosecute a conflict. There’s a logistical chain for fuel and people and medical and weapons that goes all the way back to the mainland. And if some of those steps can be carried by allies, then the operation is more effective, it’s more durable, it’s cheaper, it’s more likely to be successful. 

And so in every war, the United States has ever been going back to formation. Whenever we’ve operated beyond our shores, we’ve always done it hand-in-glove with some allies. Until this one. This is the first war in American history where the normal logistical chain was completely ignored. And so even countries like the United Kingdom, who have done everything with us hand in glove since World War two, weren’t even consulted. 

And so a month into the Iran war, when things started, look really sketchy from a security point of view, in a shipping point of view, Donald Trump started to make public appeals, not private, not through ambassadors, not democracies, not to their equivalent of our State Department, to their foreign ministries just publicly screaming at them for not doing more, even though not a single one of them was consulted on any aspect of the operation. 

And that’s brought us to the point where the Trump administration says it’s publicly considering removing itself from NATO because the allies have been useless. 

Problem number one. Problem number two, we’re not going to share the images because I’m not into that. But Donald Trump has posted a number of heretical, blasphemous things, basically claiming to be Jesus. We’re a friend of Jesus. 

How many, how many, how many affairs you have to have before that really doesn’t resonate with people anyway. Truly awful, awful graphics that he has shared with the world, about how he’s basically the, the Second coming, heretical, blasphemous. And in the United States, he has also become somewhat infamous for basically dumping on the Pope in quite egregious manners. 

Now, American Catholics and American evangelicals and AmericanChristians in general have to come to terms with that on their own, whether or not it affects their politics or their decisions about whether or not Donald Trump is a horrible, horrible human being or not, that’s their business. But abroad, in certain places, those statements, those images are really resonating. And nowhere more than in Italy, where Giorgia meloni, the prime minister, has been a fan of Trump, an ally of Trump in every way that matters. 

She’s on the right herself. But when you start shitting on the Pope and pretending Jesus, it changes things. And so Italy has gone from being in somewhat lockstep with Donald Trump’s foreign policies to, in just the last couple of weeks, has basically broken away from the United States, gone dead silent on things like Iran has stopped shipping weapons or providing logistical support to Israel. 

And for all intents and purposes, the alliance is now over. For the United States, this is going to be a big problem because we now have a number of European states. They weren’t consulted, they didn’t agree with. The war is hurting their economies. And the moral questions of what Donald Trump is are in such question that they are not allowing their equipment and their, their, their bases to participate in American logistics and military support. 

So we now have Italy and Spain and France and the United Kingdom that are giving the United States a cold shoulder in any number of ways. And that just leaves Germany. And if Germany goes, that is the entirety of the American ability to project power to the Middle East. So in the last two weeks, independent of the war, what Trump has done is shattered the moral fabric of the alliance. 

It is difficult to underline how bad this is, because while the United States does have a fully blue water navy, that doesn’t mean that each individual ship can operate from the homeland and operate in the Eastern hemisphere. Just the sailing time alone would be a problem. But when you talk about ships that are supporting, say, the super carriers, the super carriers are nuclear powered. 

They don’t have to stop to refuel, but they have to replenish. And all of their carrier rings are not necessarily nuclear powered, and they need fuel. So we’ve actually seen in just the last two weeks a collapse in the United States, its ability to function outside of home waters. And that is something that will resonate in American and global strategic thinking for decades to come.

Iran War Winners and Losers: North American Energy

Satellite view of north american lights and energy

As Persian Gulf and Russian exports collapse, global prices will rise, which should benefit the U.S. and Canada. However, if exports are halted to keep gasoline prices down, then North America would become oversupplied. This would effectively cap oil prices near production costs, despite the rest of the globe facing shortages and rising prices.

This means the producers wouldn’t see much upside, with refiners becoming the only real winners (even though they still have to retool to use that domestic light crude).

Prefer to read the transcript? Click here

Transcript

Hey all, Peter Zeihan here, coming to you from Colorado. And today we’re doing another one of our Open-Ended series on winners and losers in the Iran war. And today we’re talking about energy markets, specifically in North America, where the two big players are the American shale patch and Canadian producers primarily, although not exclusively, in Alberta. All right, first things first. Let’s get an understanding from where we were the day before the war. 

U.S. shale output is at record levels, and by itself is the single largest producer of crude in the world. But most of that crude is light and sweet. The issue is that in shale formations, there’s not a big pool of crude for you to stick a straw into. It’s tiny, microscopic little packs, and so you drill into it, inject liquid which cracks the rock. You inject sand, which then goes into the cracks. You pull the water out and the sand keeps the cracks propped open. So the facility then generates its own pressure as this stuff drains up. And because of that, the oil never migrated through a rock formation. So it’s very pure. It’s, very light, very sweet, low viscosity. 

Canada’s oil sands are very different. It’s basically Bitterman, or oil sand where you’ve got a relatively porous rock and the petroleum is migrated through a lot to kind of almost make it a sludgy gel. So it’s very thick and very heavy, and some of the crazy stuff is actually solid at room temperature. So they have to often inject steam in order to make it liquid so they can pump it up. 

Sometimes they literally electrify it, sometimes they strip mine it. Anyway, it’s a lot more energy intensive than what happens with U.S. shale, but in both cases, the cost per barrel is pretty high. It’s rare that it’s, under 30. Sometimes it’s over 60. So in both shale patches and the, Albertan oil sands, if prices are too low for too long, a lot of the work just stops. 

Anyway, on the surface, with having the Persian Gulf go away right now, we’re at 10 to 12 million barrels a day off line. even if the war ends tomorrow, that will remain that way for at least three months, because these fields can’t just be flipped back on. Some of them will take at least two years, probably more. 

And that assumes no additional damage, which, considering the path we’re on right now, is a laughable, scenario. We’re probably looking at the bulk of the 22 million barrels per day that comes out of here never coming back, or at least not within a decade. In that scenario, oil prices have nowhere to go but up and starting strongly, strongly, strongly. 

So. So it would appear that US shale and the Canadian shale patch are big winners here mid term. Because, you know, if the price of oil doubles or more and you production costs don’t change and you have access to the world’s largest market and you’re nowhere near the the shooting, it seems like all positives, right? Wrong. Because when oil prices go up, there’s another piece in play here. 

First the Ukrainians are taking out basically the western half of the Russian oil complex. They’ve already destroyed the ability of the Russians to export through the Baltic. They’re going to be working on the block very soon. That’s at least 3 million barrels a day of Russian crude, maybe as much as five. That simply isn’t going to come back either. 

So we’re looking at Persian Gulf crude and Russian crude disappearing from the market at the same time, which will send prices even higher, which again, is great for Canada shale. Right? Wrong. Because I don’t know if you guys noticed this, but the American president, Donald Trump, is pretty populist. And if we start getting $10 gasoline in places that you know, aren’t California, there’s going to be a bit of a rebellion. 

And this is something that Trump doesn’t have to stretch the law to deal with. Back in 2015, when shale oil was new, there was a big debate in Congress over solar and wind versus oil exports, what was necessary to push the American energy complex forward. And the compromise that was reached was that we would allow oil exports that used to be illegal, and we would subsidize the development of solar and wind, and to make sure that we had a stopgap, the president was given the authority without having to go back to Congress, without having to even have a hearing to end U.S. oil exports if market conditions argued for problems. 

However, he defines that, which means that the 5 million roughly barrels a day of crude that the United States exports right now could go to zero with the stroke of a pen. And if we enter in a situation where the American internal oil market gets really expensive, to the point that it becomes a political problem for Trump and an economic problem for the country, you bet your ass he’s going to do that. 

So now we’re looking at a scenario where Persian Gulf crude and Russian crude and American crude all go offline at the same time, sending prices sky high. So this sounds like it would be great for the Canadians, right? Wrong. Because most of the crude that Alberta produces is shipped south to the United States, and it can really only be refined in refineries that the United States operates. 

They do have a one pipeline that isn’t doing very well, by the way, called Trans Mountain, that goes out west to British Columbia. That one pipeline will obviously be filled up to its capacity in this scenario, and anyone can get the crude out that way. We’ll be able to sell to the global market at a high price. But with that one exception, most of this is actually probably going to be seen energy prices in the United States and Canada going down. 

Because in a scenario where you can’t export, we’re in an environment of super saturation. And as long as you can produce crude in the United States and Canada for $60 a barrel, that’s pretty much as high as prices can go when you’re in such a huge surplus situation. So we get a situation in North America where prices are kind of capped at 60 to 70. 

We get a price situation in the rest of the world where 200 is a good day, and that’s where we are. That doesn’t mean that there are winners in the North American energy complex. It’s just not in production. It’s in processing. You see, the restriction on U.S. exports doesn’t apply to crude, refined products just to raw crude itself. 

So if you operate a refinery and you have export options, you can export your naphtha, your crude or your gasoline, your diesel, whatever it happens to be to the wider market at inflated prices was just one little glitch. U.S. refiners for the last 30 years have steadily retooled their entire complex to run on heavy, sour, imported crude, for example, from Canada. 

But with the United States locking itself off, most non-Canadian sources of heavy crude are simply not going to be available anymore, and they’re going to be forced to deal with the light sweet that comes out of American fields. Now, this can be done. The modifications are easy. They’re actually going to be dumbing down the refineries to run on higher quality crude. 

But in the process of doing that, they’re writing off a lot of capital investment. At the same time, they have to invest in a different kind of fractionated system. It’s not that that’s particularly expensive. It’s not. But that takes a long time. But it is definitely going to cut into the rate in which they can benefit from these situations. 

And in the meantime, they’re probably going to be having runs that are going at significantly lower efficiencies than they would prefer. In the long run. It’ll be great. In the long run, they’ll be making more money, but they have to get to the long run first. So for the first year or two, there’s going to be a lot of stress on their hardware before they can change over some of the infrastructure. 

So again, just as we’ve discussed with almost every other country, the conventional wisdom that a lot of people saw in the first couple of weeks of the conflict really doesn’t apply. As soon as something happens, there’s a reaction and oftentimes it’s the second, third, and even fourth order effects that are the ones that really stick. That’s definitely how it is with this topic.