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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:
Rampant, persistent and spreading inflation is impacting consumer spending around the world. Central banks are behind in this fight and until interest rates exceed the rate of inflation they cannot tame this spreading problem.
The EU held a special meeting today and the Federal Reserve finished their two day meeting. The FOMC raised interest rates by 75 basis points (above their prior guidance of 50BP for this meeting). The range of expectations was for a 50-100 basis point rise. In the US the CPI rose 1% last month, the fastest pace in 40 years with some food components up over 20%. Overall grocery bills are up over 10% from earlier this year. US Retail Sales fell 0.3%, so that unit volume was a very negative 10%+ given the inflation. In a recently produced paper former Treasury Secretary Larry Summers noted that if inflation was calculated as it was in the 1980s it would exceed the 1980s peak of 15%. The government has made two adjustments to the data collection so as to lower the cost of COLA payments. For consumers in low and middle income households or those on a fixed income this is egregious. The Fed remains behind inflation pressures and has much more to do to overcome the high current and spreading inflation.
The largest OECD economies are facing recession and how severe or how long it lasts is the issue, not the direction. The Central banks cannot affect supplies. They can only affect aggregate demand. So slowing economic growth and moving to recession is the main tool they have now to lower inflation. They need to take the pressure off rising shelter (mortgage rates have doubled over the last 18 months) energy costs (doubled since the start of the Biden administration) and continuing sharp rises in food costs (some costs 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 the coming months. Nothing the Fed does today can affect this rising trend in the near term. An aggregate demand decline takes time, likely many months as the pain impacts individual spending plans meaningfully.
In the US and the UK the recession data is already visible. If not for the federal deficit spending of over US$1T or around 5% of GDP, the US would be in a severe recession with a decline of over 6%. If the Democrats lose the House or the Senate, their deficit spending days may be held back by the Republicans who don’t support Democratic spending. This would weaken the economy and make more trouble for the Biden administration and help Republicans to regain the White House in the 2024 elections.
The deflationary problems in Japan have been ongoing for years and Germany is talking about rationing energy supplies this winter and closing down industries.
Will we have a soft landing as the Fed hopes or will the US and other nations face a hard economic landing? This is unknown at this time. Depending upon the aggressiveness of the fight against inflation (how quickly interest rates rise and QT occurs) will determine the length and severity of the outcome. President Biden wants to show Americans his determination to lower gasoline prices has targeted the largest US refiners demanding that they increase supplies, not gouge consumers and that they not continue to make above normal profits. He is contemplating an excess profits tax and is looking at price controls (but not wage controls as he placates his left wing of the Democratic party). CNBC reported today that he is even considering banning stock buybacks for large energy companies. Biden is blaming the energy companies and Russia for high prices, and forgetting his detrimental anti-energy policies that played a major part.
Whichever outcome occurs, demand for energy will decline. This demand destruction might be in the 4-5M+b/d area 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.
The war in Ukraine is using up a lot of weapons and the availability of Russia to add more troops and munitions is suspect. The same goes for Ukraine’s allies and their ability to continue to send support when their shelves are nearing bare. This may become a slower war of attrition due to the war logistics and supply chain issues. Russia is gaining the Donbas and what happens next will be determined by their remaining war supplies and manpower.
EIA Weekly Oil Data: The EIA data of Wednesday June 15th was bearish for US oil prices. US Commercial Crude Stocks rose 2.0Mb to 418.7Mb versus the forecast of a decline of 1.3Mb.The increase was due to the Strategic Petroleum Reserve (SPR) having a release of 7.7Mb last week, offset by US Exports which rose 1.49Mb/d and by 10.5Mb on the week. Motor Gasoline Inventories fell 0.7Mb while Distillate Fuel Oil Inventories increased 0.7Mb. Total Stocks excluding the SPR rose by 4.9Mb. Refinery Utilization fell 0.5 points to 93.7%. US Crude Production grew by 100Kb/d to 12.0Mb/d following the increase in drilling activity. Total Demand last week fell 524KKb/d to 19.7Mb/d as Propane consumption fell 525Kb/d. This week Motor Gasoline usage fell 106Kb/d to 9.09Mb/d and Jet Fuel Consumption fell 5Kb/d to 1.52Mb/d as high prices impacted demand. Cushing Crude Inventories fell 600Kb last week to 22.8Mb.
EIA Weekly Natural Gas Data: Natural gas storage is now being built for winter 2022-2023. The data released last week showed a build of 97 Bcf which compares with a build of 90 Bcf in the prior week. Storage is now 1.999 Tcf. The biggest increase was in the East (30 Bcf). The five-year average for last week was an injection of 76 Bcf while in 2021 it was an injection of 16 Bcf due to strong air conditioning demand. Storage is now 14.5% below the five-year average of 2.339 Tcf. Today NYMEX is at US$7.58/mcf. AECO is trading at $7.66/mcf.
US natural gas prices have retreated US$2/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 (the largest US LNG plant is the Sabine Pass LNG plant with 5.2Bcf/d of capacity). It may take until year end for this facility to be fully back on line. The volumes used here will not be put into domestic storage. This has lowered domestic prices for now. The key in the weeks ahead will be the demand for electricity as summer air conditioning demand takes off with the hotter summer months.
OPEC April Monthly: On June 14th OPEC released their June 2022 Monthly Forecast Report (May data). As repeated in the past few months they have not added the 400Kb/d (their stated monthly production increase). In May, they could not add to their production at all due to difficulties in Libya (down 186Kb/d to 707Kb/d), Nigeria (down 45Kb/d to 1,262Kb/d) and Gabon (down 32Kb/d to 166Kb/d). In total five OPEC members had declining production. Overall production fell by 176Kb/d to 28.5Mb/d even though Saudi Arabia added 60Kb/d to reach 10.4Mb/d.
This was disappointing to markets as it remains below the 29.4Mb/d produced in December 2019 before the pandemic hit. Moral suasion by the US does not seem to be influencing OPEC’s production decisions. President Biden goes to the area next month to patch up relations with the Saudi Crown Prince and arm twist him and other area producers to ramp up production significantly to aid Europe in weaning off Russian supplies. This must gall the President who considers the Crown Prince a ‘pariah’ and a ‘murderer’. Will one visit change the game for the Saudis? Will they want help to win the war in Yemen? Will they want more armaments and more types? The President is in a bind as the King is ill and the Crown Prince will become the King when his dad passes away.
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, with Q2/22 consumption at 98.2Mb/d, down 250Kb/d from their prior forecast. With current production by OPEC at 28.5Mb/d and the call on OPEC at 28.0Mb/d in Q2/22 and the addition of 1.5Mb/d from world SPRs there should be builds in inventory in upcoming quarters.
OPEC announced a plan to increase supplies by 648Kb/d for the months of July and August (200Kb//d from the Saudis) but this is very unlikely given the ongoing production difficulties of the OPEC members. It is now reported that Libya may be producing under 200Kb/d (707Kb/d in May).
Baker Hughes Rig Data: In the data for the week ending June 10th, the US rig count rose 6 rigs (unchanged last week) to 733 rigs. Of the total rigs working last week, 580 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 59% from 461 rigs working a year ago. The US oil rig count is up 59% from 365 rigs last year at this time. The natural gas rig count is up 57% from last year’s 96 rigs, now at 151 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, input and wage cost increases are keeping pace so margin improvement is still not visible.
Spring break-up and road bans are over in more areas in Canada. Last week 24 more rigs were added to the operating fleet lifting the total to 141 rigs (up 14 the prior week). Canadian activity is up 52% from 93 rigs last year. There was a 22 rig increase for oil rigs and the count is now 94 oil rigs working. This is up from 59 working at this time last year. There are 47 rigs 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, costs are as well, so margin improvements are not what one would expect or what companies are forecasting. 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 on the 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 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 (now averages over US$5/gal and in high cost states like Californian nearing US$8/gal).
Conclusion:
Bullish pressure on crude prices:
- China is beginning to reopen and demand for crude energy is expected to recover this summer.
- India is in talks with Russia to double its imports of discounted oil. Indian banks will finance the imports getting around EU sanctions. India imports 85% of its crude needs so the US$30-35/b discount on Russian crude oil is a big win for them.
- 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 may stay high due to the logistics challenges and longer shipping times to buyers until recessionary conditions lower demand materially.
- The US is also in discussion with Venezuela to open the governing of the country to the opposition in return for removing sanctions on oil sales. So far sanctions have been removed for Italy and Spain and they are now receiving oil produced in the country by ENI and Repsol.
Bearish pressure on crude prices:
- 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. In doing so, they will not be buying for their SPR from other oil producers. China wants to take advantage of the large price discount this crude is being sold at. Russia will expand their ESPO pipeline which connects Russia’s Siberian oil fields to Chinese customers and has a current capacity of 1.64Mb/d.
- The likelihood of a worldwide recession is rising. US Retail Sales fell in May, the first decline in five months. After inflation this decline in unit volumes may be over 10%.
- 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 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 this 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$115.92/b, down US$3.01/b on the bearish EIA Weekly Petroleum Report and the Fed tightening.
Energy Stock Market: The stock markets around the world are gyrating with larger daily price moves mostly to the downside. Volatility is rising and large price swings (over 800+ Dow Jones Industrials down days) are becoming the norm which is not good for the stability of markets. Earnings and outlook disappointments have led to the downside pressure for the US markets. Results for Q2/22 start coming out in a month.
The S&P/TSX Energy Index is at 260 today, down 26 points from last week. Significant downside is ahead as the battle to rein in inflation is fought and crude prices falter, pulling energy shares 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 summer. Much lower lows are likely if the global recession is as severe as we expect.
Our second June report comes out Thursday June 23rd. It will include a detailed review of the economic impact and likely difficult recession the world will be facing in the coming months.
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. Today the Dow is up 303 points at 30,668 (but down from 33,063 as we wrote this report last week) due to Fed Chairman Powell’s massaging the Fed’s message after the 75BP rate rise. A breach of Monday June 13th’s low of 30,144 (the year low so far) would be very bearish for the market.
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Our 2022 ‘Catch The Energy’ conference is booked 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). We are working to have the full roster of Presenters completed by the end of this month. If you want to attend please keep this date open and in August when our conference website is up we will provide you with additional details.
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