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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:
The Russian battle plan for control of the east and the south of Ukraine has made progress with Mariupol falling to Russian forces and Ukrainian soldiers surrendering. Over 200 wounded or dehydrated soldiers were taken to Russian territory (many needing medical attention) and may be swapped for Russian soldiers captured by Ukraine according to the reports. Gaining the land bridge from the Donbas to Crimea and full control of the Sea of Azov is the first important victory for Russia after many defeats in Kyiv and Kharkov. After some rest and getting rekitted and rearmed, Russian troops are likely to go after Odessa. 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 their land assault in the east and south but it has used its air capacity in western Ukraine to destroy 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, Hungary and Italy particularly. These 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. Russia is receiving more revenues now than before the invasion of Ukraine. India is driving the toughest bargains. With imports down in Russia due to sanctions, Russian foreign reserves have increased. Bloomberg reports that the best currency performance so far in 2022 is the Rouble which outperformed the even appreciating US Dollar.
EIA Weekly Oil Data: The EIA data of Wednesday May 18th was bullish for US oil prices. US Commercial Crude Stocks fell 3.4Mb to 420.8Mb versus the forecast of a rise of 1.38Mb. The main reason for the decline was due to Exports rising by 641Kb/d or by 4.5Mb on the week. The Strategic Petroleum Reserve (SPR) had a release of 5.0Mb last week. Motor Gasoline Inventories fell 4.8Mb while Distillate Fuel Oil Inventories rose 1.2Mb. Refinery Utilization rose 1.8 points to 91.8%. US Crude Production recovered by 100Kb/d to 11.9Mb/d. Total Demand last week was 19.66Mb/d (but down 1.7Mb/d from January winter peak consumption of 21.4Mb/d). This week it was up 430Kb/d as Motor Gasoline usage rose 325Kb/d to 9.03Mb/d. Jet Fuel Consumption rose 184Kb/d to 1.63Mb/d. Cushing Crude Inventories fell 2.4Mb last week to 25.8Mb.
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 12th showed a build of 76 Bcf last week which compares with a build of 77 Bcf in the prior week. Storage is now 1.643 Tcf. The biggest increase was in the South Central (28 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 also 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 86 Bcf and in 2021 it was an injection of 71 Bcf. Storage is now 16.0% below the five-year average of 1.955 Tcf. Today NYMEX is at US$8.31/mcf. AECO is trading at $7.55/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 are all 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 last week shut off some natural gas volumes from Russia to the EU and this escalation will hurt Europe and cause Russia to punish Ukraine.
OPEC April Monthly: On May 12th OPEC released their May 2022 Monthly Forecast Report (April data). As repeated in the past few months they have not added the 400Kb/d (their stated monthly production increase). In May only 153Kb/d was added after adding only 57Kb/d in March. This was disappointing to markets and crude prices rose. Production rose to 28.65Mb/d but remains below the 29.368Mb/d produced in December 2019 before the pandemic hit. So they still have 720Kb/d to bring on just to get back to pre-pandemic levels. Moral suasion by the US and the UK do not seem to be influencing OPEC’s production decisions. Saudi Arabia and the UAE alone could add 2.5Mb/d if they wanted to, but they are friendly to Russia, an OPEC+ member and are not happy with the US over its stance in the Middle East regarding Iran and Yemen.
The biggest increase came from Saudi Arabia at 127Kb/d followed by Iraq at 103Kb/d and then by the UAE at 36Kb/d. Sanctioned Iran saw production rise by 16Kb/d to 2.56Mb/d. Venezuela saw a rise of 14Kb/d to 707Kb/d as they got more diluent this month. The problem was the loss of 161Kb/d from Libya which saw disruptions in supplies as the various warring factions stopped shipments. OPEC sees 2022 consumption growing at a slower pace this year as they see weakness developing in Asia and Europe. Demand in 2022 is now seen at 100.3Mb/d, down 210Kb/d from the prior month. In Q2/22 they see demand coming in 670Kb/d from their prior forecast.
With current production by OPEC at 28.65Mb/d and the call on OPEC at 28.01Mb/d in Q2/22 and the addition of 1.5Mb/d from world SPRs there will be builds in inventory in upcoming quarters. The near term issue is the cut-off of Russian oil sales to Europe and then the global supply chain readjusting crude products around the world.
OPEC holds its next meeting on June 2nd. We expect they will lower consumption data and forecasts even more in their next review.
Baker Hughes Rig Data: In the data for the week ending May 13th, the US rig count showed an increase of nine rigs to 714 rigs (up seven rigs last week). Of the total rigs working last week, 563 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 58% from 453 rigs working a year ago. The US oil rig count is up 60% from 352 rigs last year at this time. The natural gas rig count is up a more muted 49% from last year’s 100 rigs, now at 149 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 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 three more rigs were removed from activity (down four rigs last week) to 88 rigs. Only rigs staying on location drilling pad wells will be active. Canadian activity however is up 49% from 59 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 five rig decrease for oil rigs and the count is now 37 oil rigs working. However this is up from 25 working at this time last year. There are 51 rigs (up two rigs this week) working on natural gas projects now, up from 34 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 11.9Mb/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 has lifted WTI in recent days as fears rise of other potential pipeline disruptions and a lack of supplies in Europe. Asian countries like India and China have stepped up their purchases of cheaper 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 lockdown. Some are surmising that this may be adjusted slowly to reopen the economy. 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 to 12.5Mb/d according to Bloomberg reports. Ports in China are in gridlock with 10% of the global container fleet waiting but unable to load cargos. Auto sales in the country fell 48% last month according to the China Auto Association. Retail and Industrial Production are in negative territory and below the pandemic levels in early 2020.
- The US and allies are releasing oil from their strategic petroleum reserves. This has added 1.5Mb/d. The US released 5.0Mb from its SPR last week.
- The likelihood of a worldwide recession is rising. 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. 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.
- Russia is finding help selling its oil via smaller oil traders who are not being sanctioned or can get around the sanctions. Geneva based Litasco is the largest player having moved 22Mb over the last month. Traders attached to Chinese refiners continue to bring crude into the country. Russia is clearly finding middlemen, shippers and buyers even with sanction challenges.
- To get more oil to Europe, the Biden administration has cozied up to the Venezuelan government, eased sanctions and penalties against 12 Venezuelans and has allowed Italy’s ENI and Spain’s Repsol to operate in the country and receive exports. Chevron had some restrictions eased but is still not allowed to drill or export oil. Talks with the opposition have given the US the reason to open the door a little to Venezuela for now. If more progress is made the US may soon allow Chevron to drill and also export heavy crude oil to the US.
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 1.7M/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$110.16/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. Two weeks ago 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 (Walmart and Target – recent examples). The NASDAQ has fallen more than 30% and is now clearly in a bear market.
The S&P/TSX Energy Index is down 2% or 5 points today to 250. Significant downside is ahead as the battle to rein in inflation is fought.
We are having our Q2/22 Webinar tomorrow night 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 last week as the stock had retreated over 50% from its February 2021 high. Near term production growth catalysts make the stock attractive despite our concern about the general market.
Our May SER Report comes out next Friday May 27th due to Monday’s Victoria Day holiday. 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 eleven 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. Today the Dow is down 1,240 points as we write this report.
If you want access to this encompassing and timely report or to the webinar tomorrow night 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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