Schachter’s Eye on Energy: Global Recession Fears At The Same Time As Rising Inflation Data Spooks Stock Markets

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 making some progress as Russia gains more territory. They may have nearly 200,000 rekitted and rearmed troops in position (up 50,000 in recent weeks as troops from Russian Asia have been transferred in for the next phase of the war). They face nearly 50,000 of Ukraine’s best troops in the Donbas sector. This battle may take months to conclude with massive casualties on both sides. Russia has given notice that they intend to gain all the ports in southern Ukraine and are now heavily bombing Odessa. Russian military releases report that the Russian army will move all the way to Moldova. 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 land assault in the east, 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 neighboring NATO countries. Rail and electrical grids are being particularly attacked to stop military aid getting to the front lines and to disrupt any attempt to get the Ukrainian economy back on track. Some bombings are happening just after high profile western leaders have been in the areas. 

The EU announced a plan to cut off all sales of Russian oil and coal in the next few months and all crude products by year-end. The announcement 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$5/b today, even at Urals discounts of US$30/b+, Russia is receiving more revenues than before the invasion of Ukraine. India is driving the toughest bargains. 

EIA Weekly Oil Data: The EIA data of Wednesday May 11th was moderately bearish for oil prices. US Commercial Crude Stocks rose 8.5Mb to 424.2Mb versus the forecast of a decline of 457Kb. The main reason for the rise was due to the Strategic Petroleum Reserve (SPR) having a large withdrawal of 7.0Mb last week. Motor Gasoline Inventories fell 3.6Mb while Distillate Fuel Oil Inventories fell 0.9Mb. Refinery Utilization rose 1.6 points to 90.0%. US Crude Production fell 100Kb/d to 11.8Mb/d. Total Demand last week was 19.23Mb/d (and down 2.2Mb/d from January winter peak consumption of 21.4Mb/d). This week it was down 235Kb/d as Propane Demand fell by 204Kb/d to 777Kb/d. Motor Gasoline usage fell 154Kb/d to 8.70Mb/d. Jet Fuel Consumption rose 1Kb/d to 1.44Mb/d. Cushing Crude Inventories fell 600Kb last week to 28.2Mb. 

EIA Weekly Natural Gas Data: With winter over in most parts of the US we are seeing storage rebuilding but at a sluggish pace as significant volumes of US natural gas are being shipped to  Europe. The data released on May 5th showed a build of 77 Bcf last week which compares with a build of 40 Bcf in the prior week. Storage is now 1.567 Tcf. The biggest increase was in the South Central (40 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 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 79 Bcf and in 2021 was an injection of 60 Bcf. Storage is now 16.3% below the five-year average of 1.873 Tcf. Today NYMEX is at US$7.69/mcf. AECO is trading at $7.28/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 withholding export volumes to Poland and Bulgaria as they were not willing to pay in Roubles. Ukraine today shut off some natural gas volumes from Russia to the EU and this escalation will hurt Europe and cause Russia to punish Ukraine. Russia will escalate even further and this war of annihilation will get worse. 

Baker Hughes Rig Data: In the data for the week ending May 6th, the US rig count showed an increase of seven rigs to 705 rigs (up three rigs last week). Of the total rigs working last week, 557 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 57% from 448 rigs working a year ago. The US oil rig count is up 62% from 344 rigs last year at this time. The natural gas rig count is up a more muted 42% from last year’s 103 rigs, now at 146 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. However cost increases are keeping pace so margin improvement may take some time. 

Spring break-up and road bans continue in Canada. Last week four more rigs were removed from activity (down six rigs last week) to 91 rigs. Only rigs staying on location drilling pad wells will be active. Canadian activity however is up 65% from 55 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 42 oil rigs working. However this is up from 22 working at this time last year. There are 49 rigs (down one on the week) working on natural gas projects now, but still up from 33 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 Q4/22. Once breakup is over we expect a rapid increase in Canadian rig activity drilling for both oil and natural gas and the rig count exceeding 200 rigs again (peak winter 2022-2023: 220-250 rigs).

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. Ukraine’s action today makes this more problematic and disconcerting. 

We expect to see US crude oil production reaching 12.5Mb/d in the coming months (now 11.8Mb/d). The EIA recently forecasted US production reaching record highs over 13.1Mb/d in 2023. 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. The cutting of natural gas supplies to the EU by Ukraine today has lifted WTI by US$5/b as fears rise of other potential pipeline disruptions. WTI was trading below US$100/b yesterday on recession worries in the EU, China and the US. Asian countries like India and China have stepped up their purchases of cheaper Russian crude. Crude exports from Russian terminals reached 5.03Mb in April with India taking 900,000 b/d.
• 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 in more than half of their largest cities, which 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 are in gridlock with 10% of the global container fleet waiting but unable to load cargos. TESLA reported that its plant was closing in Shanghai due to Covid restrictions and lack of supplies to manufacture its cars. Auto sales in the country fell 48% last month according to the China Auto Association. 
• 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.
• The likelihood of a worldwide recession is rising. Today Core US CPI rose 0.6% month over month and was higher than the forecast of 0.4%. The headline CPI came in at 8.3% above forecast. The US PPI data comes out tomorrow and is forecast to come in at up 0.6% putting it up 8.9% year over year and force the Fed to tighten even faster. Germany saw an anemic growth rate of 0.2% in Q1/22 and they expect their GDP to go negative in Q2/22 as the Ukraine war and product and energy shortages hurt their economy. German employers and unions have united to oppose EU Russian gas boycotts. Today’s Ukraine cut-off of natural gas could be a major difficulty for them. 
• The high cost of energy is lowering consumers’ and industry’s capacity to handle the cost pressures. 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. 

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 this year due to a global recession. The US alone is down by 2.2M/d according to recent EIA data. 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$104.69/b. WTI has fallen from the high at US$130.50/b in early March and may only exceed that level if significant WMDs are used in Ukraine.  

Energy Stock Market: The stock markets around the world are gyrating with large daily price moves. Volatility is rising and large price swings are becoming the norm which is not good for the markets and investors. Last week we had our first down day of >1,000 (down 1,063) points for the Dow Jones Industrials. Earnings and outlook disappointments have led to the downside pressure for the US markets. The NASDAQ has fallen more than 27% and is now clearly in a bear market. 

The S&P/TSX Energy Index is up 8 points today to 243 as energy markets rally on Ukraine’s cut-off of supplies of natural gas to Europe. Russia will retaliate and the upticking of economic warfare could lead to more use of WMDs. Significant downside is ahead as the battle to rein in inflation is fought and the Ukraine war moves into an uglier and more brutal phase. 

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. 

We added one new idea to our Action Alert BUY list yesterday as the stock had retreated over 50% from its February 2021 high. Near term catalysts make the stock attractive despite our concern about a general market sharp decline still unfolding. 

Our May Interim Report comes out tomorrow 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 nine early Q1/22 reporters.  Recessions, after parabolic energy and other commodity inflationary price spikes, have historically 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 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 or the webinar 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). 

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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