Schachter’s Eye on Energy: EU Plan To Cut Off Russian Oil & Product Supplies Lifts Crude Prices. Russia Likely To Retaliate.

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:

The Russian battle plan for control of the east and the south of Ukraine is underway and making some progress. They may have over 150,000 rekitted and rearmed troops in position for this phase and are moving additional Russian troops from Siberian Russia to augment these forces. Their focus is on capturing the whole of the Donbas with a target of May 9th, the day they celebrate the defeat of NAZI Germany at the end of WWII. They have given notice that they then intend to gain all the ports in southern Ukraine. Russian military releases report that the Russian army will move all the way to Moldova (and its breakaway area) before the campaign is over. This would give Russia control of all the ports along the Black Sea and a stranglehold on the Ukrainian economy.

Russia has focused the current phase in the east on the land portion while its air campaign has increased in western Ukraine to destroy the rail infrastructure needed to move military and humanitarian aid across the country. The attacks have been close to neighbouring NATO countries. Rail and electrical grids are being particularly attacked. Some attacks are happening just as high profile western leaders have been in the areas. 

The EU announced a plan to cut off all sales of Russian oil in the next few months and all products by year-end. The announcement today gives room for a few countries to have longer withdrawal periods. These few countries receive large amounts of Russian crude and will need longer to find alternative supplies. Buyers in India and China are taking advantage of the lower prices Russia is offering. With Brent and WTI rising by US$3-4/b today, even at discounts of US$10+, Russia is receiving more revenues than before the invasion of Ukraine. Russia will find some way to reciprocate and this escalation could be severe for the Ukrainian population. At some point, Putin is going to authorize some form of WMD (likely thermobaric bombs). He needs to cut off the supply of weapons to Ukraine from NATO and this may be his most effective option. 

EIA Weekly Oil Data: The EIA data of Wednesday May 4th was moderately bearish for oil prices. US Commercial Crude Stocks rose 1.3Mb to 415.7Mb versus the forecast of a decline of 829Kb. The Strategic Petroleum Reserve (SPR) had a withdrawal of 3.1Mb last week. Motor Gasoline Inventories fell 2.2Mb while Distillate Fuel Oil Inventories fell 2.3Mb. Refinery Utilization fell 1.9 points to 88.4% and which negatively impacted product inventories. US Crude Production was flat at 11.9Mb/d. Total Demand last week was 19.47Mb/d down 354Kb/d as Other Oils Demand fell by 437Kb/d to 3.94Mb/d. Motor Gasoline usage rose 117Kb/d to 8.86Mb/d. Jet Fuel Consumption fell 152Kb/d to 1.44Mb/d. Cushing Crude Inventories rose 1.3Mb last week to 28.8Mb. 

EIA Weekly Natural Gas Data: With winter over in most parts of the US we are seeing storage rebuilding but at a slow pace as significant volumes of US natural gas is being shipped to  Europe. The data released on April 28th showed a moderate build of 40 Bcf last week which compares with a build of 53 Bcf in the prior week. Storage is now 1.490 Tcf. The biggest increase was in the South Central (31 Bcf). There is concern that the US may not have sufficient natural gas in storage for the summer air-conditioning season and that the build into November for winter 2022-2023 will be insufficient. President Biden’s approach to send as much LNG to Europe to aid them in cutting off Russian gas is having an unpleasant and expensive  cost to US individual and business consumers.  

The five-year average for last week was an injection of 34 Bcf and in 2021 was an injection of 15 Bcf. Storage is now 17.0% below the five-year average of 1.795 Tcf. Today NYMEX is at US$8.40/mcf. AECO is trading at $7.07/mcf. These are fabulous prices for this time of year and is why natural gas stocks have been such great performers. 

The low storage levels for natural gas in Europe, the US and Canada and the increase in US LNG shipments to Europe is keeping prices in the US and Canada higher than normal. Europe needs to refill storage levels ahead of the summer air-conditioning electricity season. Russia is now withholding export volumes to Poland and Bulgaria as they were not willing to pay in Roubles. 

Baker Hughes Rig Data: In the data for the week ending April 29th, the US rig count showed an increase of three rigs to 698 rigs (up two rigs last week). Of the total rigs working last week, 552 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 59% from 440 rigs working a year ago. The US oil rig count is up 61% from 342 rigs last year at this time. The natural gas rig count is up 50% from last year’s 96 rigs, now at 144 rigs. The industry is responding to higher prices with more activity which should lift overall US production in the coming months. Industry E&P companies are forecasting shortages of fracking crews later this year with prices rising materially. Overall day rates for drilling and fracking may rise over 15-20% in Q4/22 and much higher in 2023 as utilization increases.  

Spring break-up and road bans continue in Canada. Last week six more rigs were removed from activity (down two rigs last week) to 95 rigs. Only rigs staying on location drilling pad wells will be active. Canadian activity however is up 86% from 51 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 three rig decrease for oil rigs and the count is now 45 oil rigs working. However this is up from 20 working at this time last year. There are 50 rigs (down three on the week) working on natural gas projects now, but still up from 31 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 would expect. Service industry margins should rise starting in Q3/22. Once breakup is over we expect a rapid increase in Canadian rig activity drilling for both oil and natural gas.

Security of energy supply for Europe is now an important goal. With Russia adding to the stress on supplies by cutting off natural gas to Poland and Bulgaria the urgency to find alternatives has risen. The problem is that this will take quite a while given the logistical problems.

We expect to see US crude oil production reaching 12.5Mb/d in the coming months (now 11.9Mb/d). The EIA forecasts US production reaching 12.8Mb/d by the end of this year, others are more optimistic and see volumes growing to over 13.0Mb/d and reaching all time high crude oil volumes. From a prior focus on mainly paying down debt and increasing shareholder returns, we see companies adding a volume growth wedge to their plans. The security of supply discussion by energy company Boards is now as important as directing returns to shareholders.

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. Prices should stay high due to the logistics challenges and longer shipping times to buyers but this is all in Russia’s favour at this time. Asian countries like India and China have stepped up their purchases of Russian crude.
• The Biden administration continues talks with Iran to conclude a nuclear deal so that they can remove sanctions and increase crude sales by 1.3-1.5 Mb/d in the near-term. So far no deal has been announced and there is fear that Iran is just weeks away from having nuclear weapons which will make any deal impossible. 

Bearish pressure on crude prices:

• China has locked down more cities and provinces due to their Covid outbreaks. The largest impact is on Shanghai, a city of 26M people which is under an extended lockdown. China has now some form of lockdown on more than half of their largest cities, that produce >20% of its GDP.  Demand for crude energy in the country was 14.5Mb/d (2021 data) and appears to have declined around 2.0Mb/d. Ports in China see gridlock with 10% of the global container fleet waiting but unable to load cargos. 
• Covid deaths worldwide have now reached 6.24M and in the US 994K and may breach 1.0M next month, a shocking number given the initial forecasts.
• The US and allies are releasing oil from their strategic oil reserves. This should add 1.5Mb/d to partially offset the 1Mb/d potential loss of Russian crude to the sanctioning countries. The US released 2.9Mb from its SPR last week.
• Russia has increased its exports to Asia to 4.0Mb/d from ports in the Black Sea, the Baltic and the Arctic coasts. Shipments to Asia are up over 750Kb/d from a month ago. 
• The likelihood of a worldwide recession is rising. The US saw Q1/22 GDP fall 1.4% versus a growth forecast of +1.0%. US real disposable income in March fell at a 19.9% rate versus March 2021. Cutting off Russian oil supplies could throw Germany into recession in the coming months.
• 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. Some grain prices have doubled resulting in food costs exploding. Central banks are behind the inflation curve which they themselves caused by their generous monetary heroin accommodation during the pandemic. Raising both the price of money and reducing the quantity of money will be painful and speed up the move to recession. The US will release its FOMC decision later today. A rate rise of 50 BP is expected and the rundown of the balance sheet of nearly US$95B/month may also be announced. This will result in a 10% swing in liquidity in less than a year. 

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$106.09/b. WTI has fallen from the high at US$130.50/b in early March and may only exceed that level if WMDs are used in Ukraine.  

Energy Stock Market: The stock markets around the world are gyrating with large daily price moves. Over the last two weeks we have had down days of 981 and 939 points for the Dow Jones Industrials. Volatility is rising and large price swings are becoming the norm which is not good for the markets and investors. Earnings and outlook disappointments at Amazon, Netflix, Meta, Lyft GE, and Boeing have led to the downside pressure for the US markets. The NASDAQ has fallen more than 23% and is now in a bear market. China’s stock markets are seeing declines of over 5% on some days and the markets there are leading the world’s markets lower. 

The S&P/TSX Energy Index is up one point today to 251. Significant downside is ahead as the general stock market malaise drags the sector lower despite current strong fundamentals. Recessionary pressure can offset strong fundamentals as was seen in 2008-2009. 

We are having our Q2/22 Webinar on Thursday May 19th at 7PM MDT. We will cover the sharp decline in the markets over the last few weeks and what we see occurring from here. In addition the webinar will go over those companies that have reported their Q1/22 results before the event.  Most have had very nice comparisons due to the higher commodity prices and some volume growth but there have been some disappointments as well. We will cover these in depth during the webinar. 

Our May Interim Report comes out next Thursday May 12th. It will include a detailed review of the economic impact and likely difficult recession the world will be facing in the coming months. The issue will include a review of the early Q1/22 reporters. We expect to have eight company analyses in this report. Recessions, after parabolic energy and other commodity inflationary price spikes, have been followed by severe stock market declines. Downside for the Dow Jones Industrials is towards the 24,000-25,000 range during Q3/22 (down from the year high at 36,953). Use days of 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 or the webinar one needs to become a subscriber. Go to https://bit.ly/3jjCPgH to subscribe.

We are moving forward nicely 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. Our goal is to have 600+ attendees (up from 400 in 2019) and 35 companies presenting (up from 22 in 2019). 

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