Rapidan Energy President Bob McNally on coronavirus’ energy impact
“The reverberations for energy will last quite a while and it will reshape how we think about and use energy.”
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The following is a transcript of the interview conducted by GovSight Vice President Miguel Pineda with former National Security Council Senior Director for International Energy Bob McNally on COVID-19’s impact on the oil markets, his time in the Bush administration and how he founded Rapidan Energy. The interview has been edited lightly for clarity.
Miguel Pineda: Alright guys sitting down with me today is Bob McNally the President of Rapidan Energy Group. Mr. McNally thank you for coming on the show today.
Bob McNally: Great to be with you Miguel, thanks for having me.
MP: Of course, so let’s just hop right in. Do you foresee any sort of issues pertaining to the energy industry because of the coronavirus?
BM: Absolutely. It is like two black swans mating or something like that. It is a very unusual and traumatic event and the impacts are still registering. And we still really don’t know — we are trying to figure out what the questions are really going forward. It’s really going to reshape energy.
I have been watching oil markets and energy for 30 years and wrote a book on the history of it going back to the mid 1850s. We have never see such a sudden collapse in demand like this — especially for oil, not so much for natural gas. And we have never really seen this level of intervention in the markets economically really in attempt to lessen the damage and to recover, and it’s going to change people’s behavior. I mean folks like me who are asking and look at energy are saying, “well who is going to be flying in the coming years and how much? What does it mean for commuting and working from home?” It has the potential to reshape the behavior of consumers and producers of energy.
The word black swan is often used, but this is genuinely an authentic black swan, the demand collapse. It’s still uncertain, we hope but don’t know if the reopening will work well and how this virus will play out, but even if we’ve seen the worst of it and there is a fairly smooth reopening, the reverberations for energy will last quite a while and it will reshape how we think about and use energy.
MP: Yeah definitely. Now crude oil obviously plays a major role in foreign affairs and international politics: Does having lower oil prices help or hurt our recovery from coronavirus?
BM: It will only really matter when economic activity recovers. Right? Having $1.80 gasoline doesn’t really help you much if you’re not allowed to go outside your house, or you’re afraid to go outside your house and drive. And so it’s only when economic activity resumes. And again there are big questions about how fast and in what form will people be driving more and flying less and so forth. It’s only then that I think you will start to see the benefit of low oil prices and the accumulation of inventory and this inventory glut that we have. Now that is when we will benefit from it.
But for the time being, the low oil prices really don’t help too much because economic activity has been shutdown. After things start to get going and demand increases partly because of the low oil prices, consumers can drive again — and maybe fly again — stores are opening and agriculture is booming again. That will then eventually work off the inventory surplus and we will have rising oil prices. So yes having lower oil prices will help eventually but we really need to see that restart in economic activity first.
MP: Yeah of course. Now speaking strictly in relation to the markets, we have talked about how oil prices are low, but could you walk us through what happened in the oil markets and why those prices shifted down so much? And also could you explain — there was a contango which is where, for our listeners who don’t know, the spot price of a commodity is less than the future price. Could you walk us through what happened with the oil markets and why that price drove down so much?
BM: Sure, and those are great questions, oh man I wish we had a couple hours! The oil market in a nutshell: Crude oil prices are naturally prone to wild swings. Consumption and production don’t really respond very quickly to price signals. And you know we can go into all kinds of economics for that, but you can take my word for it, oil has what they call very low price elasticity in terms of supply and demand in the short run. On the demand side it is a must-have commodity and there are few scalable substitutes. So if the price of oil goes up, its not like you’re going to quit your job, you’re still going to drive and pay the higher price.
But economic activity really drives oil demand, so when you have a sudden shutdown or world economic activity like we have had you have a sudden collapse in oil demand, no matter the low price like you were just talking about. So the collapse in oil prices reflected the sudden destruction of about 30% of demand for oil. The oil market is about 100 million barrels per day, thats what consumption is. And this month, the month of May-April, it was knocked down to 80 million barrels per day, maybe even less. That is a shocking shutdown in demand; you can’t turn oil supply off like a kitchen sink, it doesn’t work that way. Oil is flowing out of those fields, oil supply also responds very slowly to price changes; it’s going to go down and we will see big production cuts, but that’s going to happen in the summer and later this year. So you have — if you can imagine, it’s just a flow of liquid, right? You have a lot of liquid going into the system, but you certainly have consumers saying “no thanks.” Well what’s going to happen is that oil is going to flow into inventories and that gets us into the contango that you mentioned. You’re right.
Oil is traded in financial markets, in future markets as a monthly contract, so there is May, June, July and they settle towards the end of the month and what happens is when there is an excess of supply over demand like we have now, the contango emerges, which means the price for oil in the future — let’s say the September 2020 contract or the June 2020 contract, or the November contract, something down the road — wouldn’t be higher than what we call the prompt month, which is the near month futures contract or also called spot.
So right now the June contract would be prompt and then July, August and September are the out months. So what happens is the price of oil in November and December goes higher than the price now. That gives the incentive to the industry to store oil; that’s the markets’ way of saying, “hey we have too much oil, people aren’t driving you have to put this into storage — it will be more valuable in November than it is today.” And so this wild contango, and we have had very wide contango, says store that oil. Now you know because demand has fallen so far so fast and oil is still coming, we saw a rapid accumulation of inventory and some places filling up. When that happens, storage is scarce, so the value of storing oil goes really high and you see this wild increase in contango. Now it’s starting to come in and most folks think, assuming this virus doesn’t surge later this year, hopefully in July and August we can start reducing inventory and the contango will come down further and the market will start to rebalance.
MP: Moving a bit to your time in the Bush administration, you were on the N.E.C. and the N.S.C. Could you talk a little bit about what those are and what your duties were on those councils, and how they would be responding to the coronavirus today?
BM: Yeah I was honored to work on President Bush’s National Economic Council, which handles domestic policy, as an energy adviser, and then also on the National Security Council, which handles international policy, from 2001–2003. It was a very exciting time in domestic and international energy, with crises and legislation and policy, all kinds of things in high gear during that time. So in the White House, a very busy place, the president has a lot of advisers and the National Economic Council again is there to basically provide the information with analysis, making sure that the views of his department, whatever issues — the Department of Energy, the Department of State are well represented, the Environmental Protection Agency and so forth — so that the president has the benefit of the best information and the advice. You’re supposed to be a straight shooter and a process person when you’re on the N.E.C. and the N.S.C.
You’re not necessarily trying to push your own views so much as to make sure the president has the best information and advice so that he can make a sound decision. Again I really enjoyed that. I was in the White House for 9/11, the invasion of Iraq, the California electricity crisis: I had quite a few crises to deal with, nothing quite like the coronavirus though, from an energy standpoint.
The concern on both the domestic and international side is the hit to our oil industry, because the United States just recently became the world’s largest oil producer and net oil exporter. It was just the opposite when I was there and the concern with coronavirus and the collapse of oil prices and the shutting down of a lot of shale production is, are we going to lose this energy resurgence path? This energy revolution. And so then the question is how do we help our producers get through this and also how do we bring stability to global oil prices?
You know this president did I think what we would’ve done — and I think he did it well. The first thing he did is he went to the Saudis and the Russians who were having a bit of a price war which was causing a collapse and he said you have to cut it out and start restraining production and make these prices stabilize, and they did that. Now it’s still rebalancing because it takes time, but the Saudis and the Russians sort of came back together.
Secondly, he made sure that U.S. companies get the full benefit of economic recovery programs that had been put into place: the lending programs, the Federal Reserve and Treasury and so forth. But then you know you have to juggle other options. There are some folks, not a lot, who come in and say, “the president should be more interventionist in helping our companies. We need tariffs, we need a price floor, we need to, if necessary, nationalize oil companies and take stakes in them.”
And these are things that cause reasonable people to differ and disagree. And then it’s the job of the N.E.C. and the N.S.C., working with the relevant departments, to ensure the president, who has to make the those decisions, how far do I go to help the beleaguered U.S. oil industry? What’s appropriate and whats inappropriate? I think that’s the job of the White House staff.
One other thing the president has done — and I think it’s a wise decision, any president would’ve done this as well, its a no brainer — going into this crisis, the United States was selling off its strategic petroleum reserve, its large stock pile of oil that Congress had mandated that, given that the oil market was suddenly glutted, the last thing we wanted to be doing was adding to that glut by adding strategic oil to that glut. So the president stopped that and is now trying to offer the storage space that we have, similar to what we were talking about earlier with contango and how that could affect scarce storage capacity, well the President stopped selling the oil and now is ordering the storage capacity be made available to the private sector. So even though Congress has not given the actual money to buy oil, pop-ups like this, it’s the job of the N.E.C. and the N.S.C. to assess options, provide information and help the president make the best decision he or she, maybe one day, will make.
MP: You touched a little bit on this in your last answer, but broadly speaking, do you think the federal government has taken into account the needs of the oil industry and by extension the energy industry as a whole?
BM: Oh no question, the president has been very clear and open in saying he cherishes the U.S. energy industry. And again, the surprising boom in U.S. oil and gas production and our move towards being the largest producer of oil and a net exporter. So the president has been pretty clear this is important to him — it brings economic benefits, national security benefits, and he is very concerned about the energy industry, so I think he has taken that into account. I don’t think it is the only … I mean he has other things to worry about as well, the air and health care systems, the overall economy, small business, but I think he has been very clear what happens with the U.S. energy system matters to him.
MP: Now Mr. McNally you obviously, like we said, are the founder and president of Rapidan Energy Group, could you just walk us through how you actually founded Rapidan and what your company actually does?
BM: Sure. A little over ten years ago, I had decided to leave the hedge fund where I had worked, Tudor Investments — and they are a wonderful firm, proud to say [I’m] still a client — and set out on my own. I sensed that there was volatility coming in oil markets and energy policy and geopolitics. And all my career, I have been doing this for 30 years, had been at the confluence of those things. Energy markets, energy policy and geopolitics, and I thought there would be a new entry for independent consultants, so I struck out on my own and did that.
And we are now 13 people, most of us based down in D.C., but one down in Richmond below you in Fredericksburg, and one California and one in Connecticut. We sort of help risk managers and investors understand what is going on in markets. And so we try do the impossible to predict oil prices, supply-demand inventory analysis. We also analyze energy policy; we have an environmental attorney who helps us with that, we don’t have an agenda we are just trying to predict things. So we try to understand how environmental policy, decarbonization, climate change, all of those things are impacting energy. Not only oil but also alternative energy and geopolitical risk.
We have a colleague now who had been in the C.I.A. and helps us understand what is going on in countries where there might be domestic instability and disruptions and problems and wars and things, and how that might affect the global oil market. We also look closely at China with a colleague of ours. So that’s it: I sort of looked around and in the 1990s there weren’t too many folks who had spent their time straddling markets and policy in energy. So again things have gotten quite active in the last 10 or 15 years, so I am glad I made the choice. It has been a rewarding and exciting time with plenty of work to do for sure.
MP: Well Mr. McNally, we don’t want to take too much more of your time, we just have one last question for you. If there is someone out there who is interested in working on energy policy and they are wanting to work on energy policy or craft energy policy or they just want to study it, what is some advice you would give them to learn more about the energy industry as a whole and how to craft better, more effective policy?
BM: I’m really glad you asked that question. And I get asked that question a lot and I always tell folks my advice would be: there is the old Karate Kid and I think there have been two versions, one was the “wax on, wax off” with the little kid who wants to start doing the karate chops and the teacher takes him out and has him just paint the fence or just wax on, wax off. And in that vein, if you want to be a really successful policy maker and adviser, spend the first several years just learning how the oil or energy industry or markets work. Be an analyst. Spend a lot of time in an excel, pouring over data, reading company reports — just analyze and understand and I think that will make you a stronger policy analyst and adviser later on. That is the route I took.
When I first started, I wanted to be a military historian, I was not interested in energy when I was in grad school. I drifted into it because, having not gotten rich in the Peace Corps, I needed a job during grad school and I got a job at an oil consulting firm just because it paid. But it then struck me how interesting oil is, because it brings together policy, markets and geopolitics. But my first several years were spent bent over an excel spreadsheet, trying to monitor and analyze the market for gasoline or crude oil and how markets worked and how policy affects markets. But do it from an objective stand point, do it from just trying to understand. Then armed with that knowledge and experience and that judgement, I think you will be stronger in terms of understanding and promoting policies to impose and effect change. That would be my advice. Spend the first several years where you are not paid somewhere to get things done or to advocate, but you are paid to learn and understand.
Finally, I always make this recommendation too, since you asked Miguel. I think the smartest person on the planet when it comes to energy markets and policy is Vaclav Smil, a scholar and professor at University of Manitoba. He is very prolific, he has written all kinds of books. I think he stands head and shoulders above anyone else as the smartest person with that objective, analytical approach towards all things energy. So I would recommend folks read Vaclav Smil’s books, he writes at the expert level and also the generalist level. Read his books. And there are some fabulous monthly reports produced by the International Energy Agency, even the O.P.E.C. produces a nice monthly report and our Energy Information Administration. Read those reports because they tell you what’s going on in the oil markets in a pretty objective fashion and then look for opportunities to learn. Be an analyst before you become a policy adviser, that would be my main recommendation.
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