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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.
Global Economic Update:
Persistent and rising inflation is impacting consumer spending around the world. Central banks have been slow to react to this problem so until interest rates and quantitative tightening (QT) exceed the rate of inflation they cannot get relief from this economic noose. With inflation (CPI and PPI) at 8-10% in many countries around the world, this may take months for interest rates to rise sufficiently to lower rising prices. Consumer inflationary expectations have shocked Central Bankers and they are now increasing interest rates faster than their prior guidance.
The FOMC raised interest rates by 75 basis points last week and will probably increase the Fed Funds rate by this same amount at their July meeting. It may take a Fed Funds rate over 5% to impact inflationary pressures sufficiently to allow the Fed to relent. Canada may raise its rate by 75 BP when the Bank of Canada meets in July. The most aggressive OECD Central Bank is the Bank of England.
OECD economies are facing recession to tame inflation and how severe or how long it lasts is the issue, not the direction. The Central banks cannot affect the supply side of the economy, only the demand side. Fed Chairman Powell talks regularly about impacting aggregate demand. Slowing economic growth and moving to recession is the main tool they have to lower inflation. Too bad they didn’t start it sooner.
The pressure needs to come off of rising prices. Shelter costs have risen as mortgage interest rates doubled over the last 18 months. Energy costs doubled since the start of the Biden administration. Sharp spikes have been seen in food prices, but some costly ingredients like grains still have to move through the supply chain. There is concern that the rate of inflation in the US could exceed 9% in August and September. Nothing the Fed does today can affect this rising trend in the near term. An aggregate demand decline takes time.
As recession unfolds, global demand for energy will decline. This demand destruction might be 4-5Mb/d and turn the current tight supply situation into a clear inventory build. Crude prices are very vulnerable to the downside. We see WTI below US$90/b in Q3/22 and quite a bit lower if the recession has a hard landing, which we expect.
EIA Weekly Oil Data: The EIA data of Wednesday June 23rd has been delayed due to system issues on the EIA website. We will cover the data in next week’s Eye on Energy issue as we do not know when the data will be released today or maybe tomorrow.
EIA Weekly Natural Gas Data: Natural gas storage is now being built up for winter 2022-2023. The data released today showed a build of 74 Bcf which compares with a build of 92 Bcf in the prior week. Storage is now at 2.169 Tcf. The biggest increase was in the Midwest (24 Bcf). The five-year average for last week was an injection of 93 Bcf while in 2021 it was an injection of 76 Bcf. The lower injection rate this week is due to strong air conditioning demand with the high temperatures across most of the US east coast and the US south. Storage is now 13.2% below the five-year average of 2.500 Tcf. Today NYMEX is at US$6.39/mcf. AECO is trading at $6.45/mcf.
US natural gas prices have retreated US$1/mcf over the last week as the Freeport LNG facility (17% of US LNG processing capacity) that ships 2.2Bcf/d to the export markets, is down due to a fire. It may take until year-end for this facility to be fully back on line. The volumes used here (14Bcf/week) will be put into domestic storage when not needed for electricity for air-conditioning.
Baker Hughes Rig Data: In the data for the week ending June 17th, the US rig count rose seven rigs (up six rigs last week) to 740 rigs. Of the total rigs working last week, 584 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 57% from 470 rigs working a year ago. The US oil rig count is up 57% from 373 rigs last year at this time. The natural gas rig count is up 59% from last year’s 97 rigs, now at 154 rigs. The biggest rig increase was in New Mexico and its Permian basin activity. 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, input and wage cost increases continue to impact margin improvement.
Spring break-up and road bans are over in most areas of Canada. Last week 15 more rigs were added to the operating fleet lifting the total to 156 rigs (up 24 from the prior week). Canadian activity is up 33% from 117 rigs last year. There was a 10 rig increase for oil rigs and the count is now 104 oil rigs working. This is up from 74 working at this time last year. There are 52 rigs working on natural gas projects now, up from 43 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, costs are as well. Service industry margins should rise starting in Q4/22. In the coming weeks the Canadian rig count should grow to in excess of 200 rigs again (peak potentially 220-250 rigs).
We expect to see US crude oil production reaching 12.5Mb/d in the coming months (now 12.0Mb/d, up 100Kb/d last week). 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 the energy company Board of Directors is now as important as returns to shareholders. President Biden is using the Presidential bully pulpit to cajole refiners to lower margins and increase production so that gasoline at the pump doesn’t rise to US$6/gal this summer. It now averages over US$5/gal and in high cost states like California, over US$8/gal. Biden has proposed lowering the Federal gas tax but this may not get passed by the intransigent Congress.
Conclusion:
Bullish pressure on crude prices:
- China is beginning to reopen and demand for crude energy is expected to recover in the coming months. China is buying large quantities of Russian crude to rebuild their Strategic Reserve (SPR). Russia is now China’s largest crude supplier supplanting Saudi Arabia.
- India is sharply increasing imports of discounted oil as the Indian government asked state energy companies to take advantage of the cheaper oil from Russia. Indian banks will finance the imports getting around EU sanctions. India imports 85% of its crude needs, so the US$34/b discount on Russian crude oil is a big win for them. The Indian government is also considering backstopping the insurance for ships and shipping to keep Russian crude flowing to India.
- Russia’s invasion of Ukraine has rallied European nations against Russia. Russia is seeing demand fall quickly in the EU. This forces EU countries to pay higher prices to get access to other oil. OPEC has not been able to supply increasing volumes. President Biden heads to the Middle East in July to see if he can open the taps. This is very unlikely as many OPEC countries have not spent sufficiently to increase production (Nigeria, Libya etc.).
- The US has given permission to Venezuela to sell crude to Europe. ENI, an Italian energy producer, and Repsol (Spanish) are producing crude in Venezuela and are shipping it to their own host countries but also to their subsidiaries across Europe.
Bearish pressure on crude prices:
- Europe is moving to reopen coal fired power plants to meet their electricity demand. Germany is leading this movement with surprising support from their country’s Green party. Rationing of crude, crude products and natural gas are being considered as well. Other countries moving to add back their coal fired power plants are Italy, Austria and the Netherlands. The Dutch government has activated the first phase of their energy crisis plan.
- China is in talks with Russia for purchases of large volumes of crude to restock their SPR. If so, this will take up all the Russian crude available.
- The likelihood of a worldwide recession is rising, shrinking aggregate demand by 4-5Mb/d worldwide.
- 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. Energy input costs have skyrocketed forcing many farmers to grow less of their acreage.
CONCLUSION:
The Russian invasion of Ukraine and the resultant tough sanctions against Russian crude oil sales to Europe has spiked up crude prices. We expect that higher energy costs will push economies into recession and this will drive down crude demand by 4-5Mb/d in the coming months. The US demand alone is down by 1.8M/d according to last week’s 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$105.33/b, down US$10/b from last week on the Fed tightening and the fear of recession.
Energy Stock Market: The stock markets around the world are gyrating with larger daily price moves mostly to the downside. Earnings and outlook forecasts have led to the downside pressure for the US markets. Results for Q2/22 start coming out in a few weeks and if disappointing, will accelerate the markets’ declines.
The S&P/TSX Energy Index is at 224 today, down 36 points from last week and down 64 points from the high in early June. Significant downside is ahead as the battle to rein in inflation is fought and crude prices falter, pulling energy stock prices down. A breach of 216, the late April low, could freak out the overly bullish newbie energy participants and cause a sharp decline to the 145-150 area this fall. Lower lows are possible if the global recession is more severe than we expect.
The June 23th Schachter Energy Report comes out today. It will include a detailed review of the economic impact and likely difficult recession the world will be facing in the coming months. Become a subscriber to access the full report and our Company Coverage Lists. Go to https://bit.ly/3jjCPgH to subscribe.
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). Hold cash for the next great buying opportunity expected during Q3/22. A breach of June 17th’s low of 29,889 (the year low so far) would be very bearish for the market.
Our 2022 ‘Catch The Energy’ conference is on Saturday October 22nd in Calgary at Mount Royal University. We will have space for 600+ attendees (up from 400 in 2019) and 35 companies presenting (up from 22 in 2019). Our registration website will be opening in August. Please keep this date open and we will provide you with additional details as they become available.
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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