It’s not about price, but volume

Falling prices in oil obscure the real damage in Hormuz

Summary

Thesis: The Ceasefire between the US and Iran is fragile. Not oil prices will drive inflation, but the consequences of physical oil supply constraints. This will show first in Southeast Asian manufacturing.

Argument:

· Ceasefire included weapons checks at the strait, this will be a bottleneck for the foreseeable future.

· Southeast Asia is particularly vulnerable to these disruptions, because of small oil reserves (15-60 days) and few alternatives

· Clothing companies are suggested as the main bellwether sector, as their supply chains are heavily reliant on SEA (i.e. H&M ~33%, Adidas ~45%, Puma ~59%)

· Their Q2/Q3 earnings and forward guidance will inform investment decision and test thesis, if

Trades:

Short-term: Nothing

Mid-term: underweight consumer stocks, especially those with exposure to SEA

Long-term: overweight on Utilities and Commodities, if forward guidance shows inflation pressure on consumer brands such as clothing

Thesis

Markets have rallied in the days since the beginning of the ceasefire. This rally is misplaced. The ceasefire is evidently brittle, as Iranian attacks on Gulf Cooperation Council (GCC) states have shown hours after it came into effect. And it does not address the problems which were caused by the war. Very large crude carriers (VLCC) are still stuck in the gulf and even if the strait opened in the coming weeks the damage to infrastructure in the GCC countries and the pace of a tanker will pose a serious risk to global supply chains going through Southeast Asia (SEA). This is a physical reality, and falling oil prices won’t make oil more plentiful. The rally is based on sentiment and ignores these issues at large.

The Change of Regime in Hormuz

Before the war Hormuz was an international water, free for everyone. This has changed dramatically. During the war it was closed, as Iran threatened to attack tankers, and the risk of the conflict reigniting is non trivial. The 10-point ceasefire plan that is currently assumed to be the basis for negotiation, puts free transit directly onto the chopping block.[1] The proposed tolls are not the direct issue, as $2m USD would roughly translate to about 1$ extra per barrel.[2] This extra 1.5% increase on Februarys prices[3] is almost negligible in comparison to the price hikes we have experienced since the start of the war.

Much more important for the thesis is that Iran also seems to be intent to monitor each passing ship for weapons,[4] which will lengthen transit times further and reduces the daily amount of passing ships to what can be inspected by the IRGC. This will keep daily transits much lower than before the war and is a real economic risk under a ceasefire agreement or peace deal.

Investors have been focusing on oil prices; they do not paint the full picture. Volume matters just as much.

Physical Infrastructure and Realities of Energy Supply Chains

The destruction of crucial infrastructure is not reversible by diplomacy. Ras Laffan, one of the world’s largest LNG facilities, will operate at reduced capacity for the next 3-5 years. QatarEnergy suspects the strike will reduce its exports by 17%. The United Arab Emirates have been hit the hardest by Iran and with 48 confirmed hits on significant and strategic sites.[5] We must assume an additional reduction of exports from them. The damage of an Iranian attack against Saudi Arabia’s East-West Pipeline, which occurred after the ceasefire was implemented, is still being assessed as of writing this paper.[6]

On top of these physical constraints of oil production comes the risk of reduced investment in the region in the future. Hailed as stable and safe just last year, with good growth and a sustainable future by the World Economic Forum[7], this outlook has clearly changed. These changes in physical reality and practical outlook leads me to believe that the region, and its customers, might face a rougher future than rallies in the market have suggested.

Another factor is the time economics of oil supply chains. VLCC are not just very large, but also very slow. To illustrate: a VLCC takes about 20 days to go from the Persian Gulf to Japan one way. Meaning the round trip adds up to around 50 days including time for loading and maintenance.

Energy Supply Chains in Southeast Asia and its Consequences

The USA started the war on the 28^(th) of February this year. Therefore, at the time of writing 40 days have passed since. Accounting for the pace of a VLCC and a little bit of guesswork regarding the differences between the travel time to Japan and the states of SEA, we can assume that these countries have been without new oil from the Gulf for around 25-30 days at this point.

SEA consumes about 5 million barrels per day (b/d) and produces only around 2 million b/d. This gap between production and consumption is covered most often with oil from the Gulf states. This reliance made especially the smaller nations incredibly vulnerable to the supply shock we are currently living in.[8] It is further enforced by reportedly small oil reserves. According to what little I could find on the subject the reserves in days are: India 74, Thailand 61, Philippines 60, Indonesia 20, Vietnam 15.[9] These numbers were reported on March 4^(th). Due to their source, it is difficult to consider these as accurate, but we can see that even at double these numbers Indonesia and Vietnam are in trouble. Another (more credible) source highlights the damage that has already been caused by the lack of fuel. Bangladesh implemented rationing and LNG access, India is experiencing country wide shortages, Pakistan closed schools for two weeks and introduced a 4-day week to lower fuel demand, the Philippines declared a state of emergency, and Vietnam is limiting domestic flights.[10]

Southeast Asia is clearly under stress and even though many of these countries have started looking for a bilateral agreement with Iran to get access to oil,[11] the new regime within the Strait of Hormuz makes timely delivery unlikely and shortages will likely continue. Even if VLCC start traversing the Strait of Hormuz again, they will take roughly another two weeks to get to Southeast Asia.

This region is the manufacturing hub of the world, especially in sectors like clothing, and trickle-down effects from its struggle with oil scarcity are bound to show up in the prices in the west, creating inflationary pressure.

Key sectors that act as signals for the thesis

If the analysis is correct, we should find confirmation for it in the forward guidance of consumer-facing stocks that have their supply chains in SEA during their Q2 or Q3 earnings calls. To quantify supply chain risk, publicly available suppliers’ data was used and quickly analyzed within Excel to extract the SEA exposure. H&M, a Swedish clothing brand, is a clear example of this and has according to their Suppliers List[12] about a third of their suppliers in SEA. For Adidas, a sports clothing brand, it’s about 45%.[13] Puma, another sports clothing brand and Adidas’ direct competitor, sources even more from SEA. Vietnam, Cambodia, Bangladesh and Indonesia made up 59% of their suppliers in 2023.[14]

As clothing brands are heavily exposed to manufacturing in SEA, they are appropriate bellwethers to judge how that sector is doing. Especially, if one cannot do on the ground research and wants to judge by earning calls and forward guidance.

Another important sector to investigate is shipping and logistics. Major misses in that sector would confirm the signal given by clothing suppliers. Maersk and Hapag Lloyd cover the European side, Cosco Shipping and Nippon Yusen the Asian freighters. Again, we would be looking at forward guidance in Q2 and Q3.

The Ceasefire cannot reverse the damage

Why is this thesis still in play, even though tensions around the Strait of Hormuz seem to be going away?

Firstly, because they aren’t at this point. We have an unsteady ceasefire and negotiations this weekend, yet the American negotiators have nothing to bargain with. Either they find some middle ground, which undermines the American Hegemon claim, or they manage to get a resolution signed by Iran, that gets nullified by the first Israeli strike against Hezbollah. The tension is still there, the market simply pretends as though it isn’t. In a region, where ceasefires mean so little, why should this one be any different.

Secondly, a ceasefire or even a peace deal does not immediately fix the damage caused by the war. SEA is still reliant on oil, that will only come in 10-14 days, if at all. Iran would control the Strait, only this time with US approval.

Overall, a ceasefire in its current form is not a reason to pull back from this thesis.

Investment Implications

These arguments lead to one thing and that is further inflation of consumer goods. This, in combination with the lacklustre jobs data in the US during the last six months, can quickly become stagflation. It supports the broader stagflation prediction through a different perspective than fiscal or monetary analysis. On supply chain mechanics alone, inflation is more likely to happen this year, improving the odds of inflation further.

The hedges against this are known. I suggest going overweight on commodities, such as Miners, or utilities, such as energy providers. I also want to mention hidden utilities, which act as such because of their pricing power. To start with the more classical approach would be Tobacco stocks, that have high dividend and basically complete pricing power. ERP companies, such as SAP, on the other hand are shielded from inflation, as their customer