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Each week Josef Schachter gives you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold newsletter covering the general energy market and 30 energy, energy service and pipeline & infrastructure companies with regular updates. We also hold quarterly webinars and provide Action BUY and SELL Alerts for paid subscribers. Learn more.
Russia/Ukraine War Update:
Diplomatic talks in Turkey between Russia and Ukraine are having some good progress followed by unfortunate intransigence. Ukraine’s offer to not join NATO and be an independent country (upon approval by Ukrainian referendum and needing security guarantees to Ukraine from Turkey, Poland, the UK and Canada etc.) opened the door for more progress. However, Russia’s demand that Ukraine acknowledge Crimea as Russian is a non-starter for Ukraine. In addition, independence for the Donbas is not acceptable to Ukraine. The best we can hope for in the near- term is safe corridors for refugees to escape the areas still under attack by Russia. There are some refugee convoys getting out and now over 5M have left the country while 9M are displaced. Massive global humanitarian aid is assisting this migration, the largest since WWII.
After Russia overplayed its three pronged invasion of Ukraine and found it had taken on more than it had capacity for, it has gone to a new plan to just focus on taking over the whole of the Donbas region and complete their land bridge from the Donbas to Crimea. The total destruction of Mariupol was part of this phase. If they do succeed on this front then the issue of going for Odessa as well becomes part of Putin’s calculations. So for now, most of the fighting will be in the east and with some bombing in the west and around Kyiv, to keep Ukrainian troops in those areas. He appears to have lowered his manpower near Kyiv but the US sees this as taking manpower from the front for some reforming and rearming or being moved to the Donbas to speed its encirclement.
This next phase of the Russian invasion may be more destructive. Tsar Putin is planning to add experienced foreign fighters from Syria and Chechnya to his invasion force. The numbers range from 16,000 to 40,000 fighters. These are fighters who fought in urban environments and Putin needs them for the final takeover of Mariupol and maybe Odessa.
If Putin does not accept Zelensky’s Austria-like option of an independent state, then the war is likely to enter a more vicious and deadly phase in the coming weeks. Once Putin’s additional fighters enter the Ukrainian arena we may see an escalation of pressure on the unconquered cities. Russia’s willingness to attack bases in western Ukraine and calling aid convoys from the west as legitimate military targets shows where his focus is heading. If he cuts off food and munitions aid to Kyiv then the war from his perspective could be won. The failure to make faster progress in taking over the country is impacting Putin’s diatribes. That is why the EU is worried he will use his foreign fighters to rubbilize the cities not yet captured and may use WMDs including thermobaric bombs and chemical or biological weapons.
If a diplomatic solution is not seen in the coming week then the risk of the war escalating becomes more likely. Putin needs to capture Mariupol for bargaining power when diplomatic talks get real. Russian forces are now using naval assets to target Odessa (Ukraine’s largest Black Sea Port). If he succeeds in taking Odessa he will have captured a large land position with total control of eastern and southern Ukraine and landlocked the remaining part of Ukraine. These are the prizes he wanted but stiff Ukrainian opposition is thwarting his chances of achieving this military goal. His goal of decapitating the leadership in Kyiv and putting in a puppet regime is now gone off his menu.
EIA Weekly Oil Data: The EIA data of Wednesday March 30th was moderately bearish for domestic energy prices. US Commercial Crude Stocks fell 3.4Mb to 409.9Mb versus the forecast of a decline of 1.0Mb. Motor Gasoline Inventories rose 0.8Mb while Distillate Fuel Oil Inventories rose 1.4Mb. Refinery Utilization rose 1.0 points to 92.1% as refiners work to add more product to offset the cut-off of Russian products. US Crude Production started to rise again and rose by 100Kb/d to 11.7Mb/d.
The end of winter peak demand and the slowdown in the US economy are now impacting demand data. Total Demand fell 5.9% on the week by 1.25Mb/d to 19.87Mb/d Distillate Demand fell 16% or by 712Kb/d to 3.80Mb/d. Motor Gasoline usage fell a modest 138Kb/d to 8.50Mb/d as high prices lowered demand. Jet Fuel Consumption fell 20% or by 352Kb/d to 1.38Mb/d. Cushing Crude Inventories fell 1.0Mb last week to 24.2Mb.
EIA Weekly Natural Gas Data: Weekly winter withdrawals continue but at a much slower pace as winter nears its end. Last week’s data showed a withdrawal of 51 Bcf, lowering storage to 1,389 Tcf. The biggest US draws were in the East (22 Bcf) Midwest (19 Bcf) and in South Central (12 Bcf).
The five-year average for last week was a withdrawal of 44 Bcf and in 2021 was 32 Bcf. April starts the new injection season. Storage is now 17.4% below the five-year average of 1,682 Tcf. Today NYMEX is US$5.56/mcf. AECO is trading at $5.10/mcf. After winter is over natural gas prices typically retreat and as the general stock market continues to decline, a great buying window should develop at much lower levels for natural gas stocks in Q3/22.
Baker Hughes Rig Data: The data for the week ending March 25 showed the US rig count up seven rigs to 670 rigs (flat last week). Of the total rigs working last week, 531 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 61% from 417 rigs working a year ago. The US oil rig count is up 64% from 324 rigs last year at this time. The natural gas rig count is up a more modest 49% from last year’s 92 rigs, now at 137 rigs.
Spring break-up and road bans have returned to Canada. Last week 36 more rigs were removed from activity (down 30 rigs last week) to 140 rigs. The rig count level will continue to fall over the next few weeks. Only rigs staying on location drilling pad wells will be active shortly. Canadian activity however is still up 73% from 81 rigs last year as more activity moves to pad drilling. There was a 27 rig decrease for oil rigs and the count is now 76 oil rigs working. However this is up from 31 working at this time last year. There are 64 rigs (down nine on the week) working on natural gas projects now, but still up from 50 rigs working last year. Staffing of rigs in Canada is a problem and adding significantly more rigs this summer may be problematic. While rig and frack day rates are rising, so are costs, so margin improvements are not what one should expect as the industry activity picks up. Service industry margins need to rise materially in 2H/22 if drilling and completion activity is to rise.
The overall increase in rig activity from a year ago in both the US and Canada should translate into rising liquids and natural gas volumes over the coming months. The data from many companies’ plans for 2H/22 support this rising production profile expectation.
Security of energy supply for Europe is now a more important goal of US policy. This, despite the Biden administration’s desire to rein in the worldwide use of fossil fuels. The near-term battle with Russia appears to be taking precedence.
We expect to see US crude oil production reaching 12.0Mb/d in the coming months. Companies are taking advantage of attractive drilling and completion costs and want to lock up experienced rigs, frack units and their crews as staffing issues continue to be difficult for the sector. The EIA forecasts US production reaching 12.5Mb/d by the end of this year. From a focus on paying down debt and then increasing shareholder returns, we see companies adding growth to their 2H/22 plans.
Conclusion:
Bullish pressure on crude prices:
- Russia’s invasion of Ukraine has rallied European nations against Russia. They, with help from the US, are trying to replace the energy they import from Russia by the end of 2022 but so far the volumes expected to arrive in Europe are miniscule while the rhetoric seems to imply that it has been solved. Now tankers owned by Russia, India and China can handle the trade that is being done. It appears that 2.5Mb of Russian crude is finding buyers in China and India, however 2Mb/d+ is not, even at US$30/b discounts. India is working with Russia to pay for Russian crude in Rupees (or trade goods), Yuan or Roubles. China is moving to expand its alternative world reserve currency, the Yuan, to become the second most used currency ahead of the Eurodollar. The US has now threatened sanctions against China and India for trading with Russia. A global political war could create unforeseen clashes. Many of the global commodity trading houses are working around the sanction protocols to find ways to transact business with Russia. Historically this type of business is extremely lucrative. Recently the Rouble has strengthened in value since its collapse when the tough SWIFT sanctions were announced.
- The Biden administration continues talks with Iran to conclude a nuclear deal and then remove sanctions so that they can increase crude sales by 1.3-1.5 Mb/d in the near- term. Now he has his administration dialoguing with Venezuela. It seems buying oil from despotic murdering thugs is more palatable to Biden for US consumers, than buying from Canada or expanding the cleaner and more ethical US oil and gas.
- Putin wants payments for his energy shipments to Europe (that are allowed under the tough sanction regime) to be paid in Roubles. Europe has refused to do so. Russia in return has said that it needs to be paid effective April 1st and no free energy or other products will be supplied unless paid for. This could turn into a major flare point.
Bearish pressure on crude prices:
- China has locked down more cities due to Covid outbreaks with the largest being that of Shanghai with its 25M people. Overall China has lockdowns on 60M people and 20% of its GDP in the eastern cities of Shanghai, Shenzhen and Hong Kong. Demand for crude energy in the country of 14.5Mb/d (2021 data) could decline by 1.5-2.0Mb/d during the lockdowns. Europe is also seeing rising caseloads with Austria adding 44K cases. The biggest increases seem to be occurring in Asia with Vietnam adding 254K cases and South Korea adding 382K new cases. World death rates now exceed 6.13M of which 978K are US deaths.
- The Iran nuclear negotiations are working towards sealing a deal and having sanctions removed so that they can sell their oil around the world. President Biden may be giving away more concessions to Iran in order to have sanctioned Iranian oil available. This one has neighbors in the Middle East apoplectic. US politicians from both sides of the aisle are also opposed. What is Biden doing – is there any moral line he will not cross?
- Venezuela appreciates the olive branch offered by the US. Will there be a thaw in the relationship? Will the US just give them sanction relief but not require a unity government formed? It looks like barrels may win. Venezuela could increase production by over 2Mb/d (from 680Kb/d in February) but how quickly is not known due to the poor maintenance of their fields and infrastructure.
- The US and allies are releasing 60Mb of oil from their strategic oil reserves. The US will supply 30Mb of those volumes in April and May.
- The likelihood of a worldwide recession is rising. The high cost of energy is lowering consumers’ and industry’s capacity to handle the cost pressures. Many businesses are closing or limiting their hours in Europe. Food costs are exploding! Russia and Ukraine produce one-third of global wheat and barley production. Ukraine provides European livestock farmers with corn and other grain additives. None of this is being shipped now from the Black Sea ports. Nickel prices have exploded to the upside and the London Metal Exchange (LME) suspended trading for a while and canceled trades as producers who presold production got margin calls that they couldn’t meet. This may be a multi-billion dollar margin call disaster like the ‘Lehman event’ of the 2008 financial crisis.
- Inflation is now exceeding 10% in the US and around the world. Do they fight inflation by raising interest rates and lower financial liquidity? The Federal Reserve has been behind the eight ball and is being pushed to react by the unfolding bad news. The US Treasury bond structure has gone from positively sloped to an inversion in recent days. This has historically led to US recessions which other countries follow. A global recession is now very possible this year due to the ongoing and persistent inflation pressure on food, transportation and shelter. Central banks are behind the inflation curve which they themselves caused by their generous accommodation during the pandemic.
CONCLUSION:
The invasion of Ukraine has spiked up crude prices. We expect that higher energy costs will knock down crude demand by 4-5Mb/d later this year due to a global recession. When global recessions unfold, crude prices plunge sharply. In 2008-2009 during the financial crisis demand fell by over 5Mb/d (from over 88.5Mb/d to 83Mb/d). The price of crude fell from US$147.27/b to US$33.55/b in eight months. During Iraq’s invasion of Kuwait prices rocketed from US$16.16/b in July 1990 to a high of US$41.15/b in October and then plunged in four months to US$17.45/b as recessionary demand destruction occurred. WTI today is at US107.85/b.
Energy Stock Market: The stock markets around the world are gyrating with large daily price moves. Today the Dow is down slightly after a few decent up days. The S&P/TSX Energy Index is flat with last week at the 224 level.
Our March SER Report comes out tomorrow Thursday March 31st. It will include a detailed review of the economic impact and likely difficult recession the world will be facing in the coming months. Previous recessions, after parabolic energy and other commodity inflationary price spikes, have been severe and stock markets have been crushed. The current market declines are just the tip of the iceberg. Downside for the Dow Jones Industrials is towards the 24,000-25,000 range during Q3/22 (today 35,250 – down from the high at the start of this year of 36,953).
In the upcoming SER Monthly report we go over in detail the financial and operating results of 11 companies that have reported. The financial results have been for the most part quite healthy given the war premium in commodity prices. The exception is the energy service sector which is having a tough time getting a decent return on capital employed and passing through the large cost increases they face. Our energy company models have the war and supply disruption windfall cash flows removed from Q3/22 onward. Energy, Energy Service and Pipeline and Infrastructure stocks are trading at or close to our one-year targets so the appreciation upside is limited. Use days of strength to lower exposure and build cash reserves for the next great buying opportunity.
If you want access to this encompassing and timely market update report and to know which energy sector stocks provide the most attractive returns longer term and at what prices they would again be attractive for purchase (when the phase of the energy Bull Market re-commences) become a subscriber. Go to https://bit.ly/3jjCPgH to subscribe.
We are moving forward with our 2022 ‘Catch The Energy’ conference after the two year pandemic hiatus and booked the event for Saturday October 22nd in Calgary at Mount Royal University. Meetings with corporate presenters are underway and we will start to release names once we have sign up documents completed. Our goal is to have 600+ attendees (up from 400 in 2019) and 30+ companies presenting (up from 22 in 2019). With the expanded conference space we are open for applications for presentation slots and sponsorship opportunities. Presenting companies must be public energy companies, energy service companies, energy innovation technology or infrastructure companies. Sponsorships are open to corporations that service the energy sector. Inquiries should be sent to [email protected]. We appreciate any referrals.
Please feel free to forward our weekly ‘Eye on Energy’ to friends and colleagues. We always welcome new subscribers to our complimentary energy overview newsletter.
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