Schachter’s Eye on Energy: Stock Markets Are Getting Hit And Could Soon Drag Down Energy Stocks Despite The Strong Fundamentals.

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:

Russia overplayed its invasion of Ukraine going with three targeted areas (north, east and south simultaneously). It now realizes that it had taken on more than it had military capacity and supplies for. It has now adjusted its goals to focus on taking over the eastern 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 in achieving this objective after the troops move, rekit and rest, then the issue of going for Odessa becomes part of Putin’s calculations. So expect most of the fighting to be in the east with some bombing in the west to keep Ukrainian troops tied down in those areas. This next phase of the Russian invasion may be more destructive. Putin has added experienced fighters from Syria and Chechnya to his urban fighting force as he needs them for the complete takeover of Mariupol and then of Odessa. After he has control of the east and the south he may be ready to negotiate with Ukraine from a position of strength. 

The massacres of civilians as the Russians withdrew from Kyiv have startled the world. More sanctions are being applied. The US will not allow any investment in the country and has put individual sanctions against Putin’s adult daughters. The EU is talking about adding a ban on imports of Russian coal, but this will hurt their own economies if they can’t find alternative supplies when winter 2022-2023 arrives. High prices and curtailments of electricity will force business closures and home heating costs will rise even further. The German economy is heading towards a severe recession and this additional hit will make the situation worse.  

President Zelensky addressed the UN Security Council and talked about the horrific toll the invasion has caused on his country and people. He challenged the Council to either kick Russia out of the group (and thus its veto) or that the UN should “dissolve itself” for its failure to act against aggressor countries. Don’t expect this inept group to remove Russia as China could still use its veto. 

EIA Weekly Oil Data: The EIA data of Wednesday April 6th was moderately bearish. US Commercial Crude Stocks rose 2.4Mb to 412.4Mb versus the forecast of a decline of 2.1Mb. The storage increase would have been higher by 4.6Mb if not for Net Imports falling by 4.6Mb on the week. Motor Gasoline Inventories fell 2.0Mb while Distillate Fuel Oil Inventories rose 0.8Mb. Refinery Utilization rose 0.4 points to 92.5% as refiners work to add more product to offset the cut-off of Russian products. US Crude Production rose again. Production increased by  100Kb/d to 11.8Mb/d. So now we have two weeks in a row of 100Kb/d gains.  

The slowdown in the US economy is impacting demand data. Total Demand fell on the week by 59Kb/d to 19.82Mb/d. Distillate Demand fell by 157Kb/d to 3.65Mb/d. Motor Gasoline usage rose a modest 63Kb/d to 8.56Mb/d. Jet Fuel Consumption rose 65Kb/d to 1.45Mb/d. Cushing Crude Inventories rose 1.7Mb last week to 25.9Mb. 

EIA Weekly Natural Gas Data: Weekly winter withdrawals are likely over as we had our first injections last week. The data showed an injection of 26 Bcf, increasing storage to 1.415 Tcf. The biggest injection was in the South Central (22 Bcf). 

The five-year average for last week was a withdrawal of 18 Bcf and in 2021 was an injection of 14 Bcf. Storage is now 14.7% below the five-year average of 1.659 Tcf. Today NYMEX is at US$6.30/mcf. AECO is trading at $5.74/mcf. 

The low storage levels for natural gas in Europe and the increase in US LNG shipments, is raising prices in the US and Canada. Europe needs to refill storage levels ahead of the summer air-conditioning electricity season. The market is also worried about increased sanctions against Russia due to the recent civilian massacres as they withdrew from the Kyiv area. Russia could  withhold needed export volumes. So far the data shows that Russia has met its contractual volumes but payment issues remain a challenge.

Baker Hughes Rig Data: The data for the week ending April 1st showed the US rig count up three rigs to 673 rigs (up six rigs last week). Of the total rigs working last week, 533 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 57% from 430 rigs working a year ago. The US oil rig count is up 58% from 337 rigs last year at this time. The natural gas rig count is up 52% from last year’s 91 rigs, now at 138 rigs. Texas saw an increase of five rigs to 331 rigs working. The area with the largest rigs is the Permian with 323 rigs active, up four over the last week.

Spring break-up and road bans have returned to Canada. Last week 16 more rigs were removed from activity (down 36 rigs last week) to 124 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. Canadian activity however is up 80% from 69 rigs last year as more activity moves to pad drilling and returns on new wells are under one year (some under six months). There was a 12 rig decrease for oil rigs and the count is now 64 oil rigs working. However this is up from 24 working at this time last year. There are 60 rigs (down four on the week) working on natural gas projects now, but still up from 45 rigs working last year. Staffing of rigs in Canada and the US 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. There are indications that the E&P companies are budgeting increases for drilling but much of their forecast is for higher steel tubular costs. 

The overall increase in rig activity from a year ago in both the US and Canada should translate into additional volumes of liquids and natural gas 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 an important goal of President Biden. This, despite the Biden administration’s desire to rein in the worldwide use of fossil fuels. Last week the President partially reversed course (you could see him ready to barf when he made the pronouncement). He pushed for the energy industry to move from a focus on dividend growth and share buybacks, to increased capex and lifting US oil and natural gas volumes to new record highs.

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. With help from the US, Europe is trying to replace the energy they import from Russia by the end of 2022. So far the volumes expected to arrive in Europe are miniscule while the rhetoric seems to imply that it has been solved. Currently oil 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 significant 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. 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 to levels seen before the Ukraine invasion. 
• 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. 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 in the coming weeks and months. 

Bearish pressure on crude prices:

• China has locked down more cities and provinces due to the new strain of Covid outbreaks. The largest impact being on Shanghai, a city of 25M people which is under an extended lockdown. Overall China has locked down 60M people that produce 20% of its GDP.  Demand for crude energy in the country was 14.5Mb/d (2021 data) and could decline by 1.5-2.0Mb/d during the lockdowns. Ports in China see gridlock with over 500 ships or 10% of the global fleet waiting but unable to load cargos. 
• 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. 
• The US and allies are releasing additional oil from their strategic oil reserves. The US will supply 180Mb of those volumes. The IEA countries have disclosed that they will release a further 60Mb. This should add 1.5Mb/d to partially offset the 2-3Mb/d potential loss of Russian crude to the sanctioning countries. 
• 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.
• Inflation is now rising to around 10% in the US and around the world. 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 with the two and five year yields above the 10-year yield. This has historically led to 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 monetary heroin accommodation during the pandemic. The US may increase interest rates in May by 50BP versus the prior forecast of 25BP, and also announce that they will be reducing its balance sheet at a rapid pace. This could mean letting maturities of US$100B occur and this would remove significant reserves from the system. This is a very aggressive tightening move. Raising both the price of money and reducing the quantity of money will be painful and speed up the move to recession. The IHG Monthly GDP report showed that the US economy peaked in October 2021 and in February fell 1.7% from the month earlier. The Dallas Federal Reserve warned in a Fed report “The Russian OIl Shock of 2022” that “ongoing sanctions will lead to a global recession.”

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 US$107.85/b. WTI has fallen from the high at US$130.50/b in early March to US$99.60/b today (down today by US$2.36/b). 

Energy Stock Market: The stock markets around the world are gyrating with large daily price moves. Today the Dow is down 200 points so far after a 280 point decline yesterday. The S&P/TSX Energy Index is flat with last week at the 224 level. 

Our April SER Interim Report comes out next Thursday April 14th. It will include a detailed review of the economic impact and likely difficult recession the world will be facing in the coming months. A review of Q4/21 and 2021 annual results for the last two companies from our Coverage List will be included. Recessions, after parabolic energy and other commodity inflationary price spikes, have been severe and stock markets have been crushed. The current daily 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 34,400 – down 1,000 points from a week ago and down from the year high at 36,953). Use days of any remaining strength to lower your exposure and build cash reserves for the next great buying opportunity expected during Q3/22.

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 next phase of the energy Bull Market starts) become a subscriber. Go to https://bit.ly/3jjCPgH to subscribe.

We are moving forward quickly 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 35 companies presenting (up from 22 in 2019). Meetings have been wonderful with a large number already committed to attend. We are looking to have both large and smaller entities present and the mix will likely include companies in the E&P (domestic and international), energy service, infrastructure and royalty and innovation technology.

With the expanded conference space we are open for applications for presentation slots and have a few remaining sponsorship opportunities. Sponsorships are open to corporations that service the energy sector. Inquiries should be sent to [email protected]. We appreciate any referrals. 

I am tentatively scheduled to be on BNN/Bloomberg’s Market Call show on Wednesday April 20th at 10AM MDT. The show will be done virtually. I am hopeful that they return to studio shows soon as I enjoyed the repartee with the hosts which is not easy to do in the current virtual format. 

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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