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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:
Inflation pressure continues to persist and Central Banks are moving between hawkish statements about reining in inflation and attempting to reassure the public that economies remain healthy with low unemployment rates and more job openings than employees looking for work. Central Banks have walked this tightrope successfully so far. As news flows come out supporting either of these two divergent views, it is making for large daily price swings in stock markets and in the price of crude oil. It is expected that the Fed will tighten next Wednesday by 75 BP and they will guide the next increase in September (September 21st) which will be data dependent but likely around 50 BP. The fear of a 100BP rise next week has now lost proponents.
The strong inflation data in the US of 9.1% for June CPI and 11.3% for June PPI should warrant a more aggressive stance especially after a healthy June US jobs report. The strong US dollar is a problem for US Exports which is likely to take down the GDP rate and keep the Fed from a more aggressive rate increase which would strengthen the dollar even further.
We see persistent data pointing to recession gaining traction around the world. Consumers are facing tighter budgets and with food and energy costs still rising, discretionary spending is being cut back. The US may already be in a recession according to the Atlanta Fed data as they see Q2/22 with a decline of 1.5- 1.8%. Remember Q1/22 was adjusted downward to negative 1.6% and a strong dollar hurts US exports.
China is again facing covid lockdowns (it has shut in gambling mecca Macau totally) and is facing widespread protests as rural and urban banks close and won’t tell depositors when they will be able to access their savings. The real estate market remains problematic and many investors in properties being built are no longer paying their purchase payments as they fear the projects will never be completed. This is a bigger problem than the Lehman collapse in 2008 and we go over this in detail in our next subscriber SER. China’s Q2/22 GDP may have fallen 2.2% from its Q1/22 level according to preliminary data.
As recession unfolds, global demand for energy will decline. This global demand destruction might be 4-5Mb/d (with the US over 1.5Mb/d of this decline and with a 1.1Mb/d decline so far) 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$75/b in Q3/22 (low so far US$90.56/b in early July) and quite a bit lower if the recession has a hard landing, which we expect. This week’s EIA data supports this view.
EIA Weekly Oil Data: The EIA data of Thursday July 20th was mixed for oil prices. US Commercial Crude Stocks fell 0.4Mb to 426.6Mb. The forecast had been for a rise of 1.4Mb. The Strategic Petroleum Reserve (SPR) had a release of 5.0Mb last week. The big swing was due to US Exports rising 735Kb/d or 5.1Mb on the week. President Biden continues to sell oil to Europe to meet their needs due to Russian supply disruptions but the US is also selling crude to China and is getting attacked politically. Why send reserves from the US SPR to China? Let them find their own oil. Aren’t they close to Russia? This is seen by opponents as a political move by Biden to help his family members doing business in China. Naughty if true! Motor Gasoline Inventories rose 3.5Mb while Distillate Fuel Oil Inventories fell 1.3Mb. Refinery Utilization fell 1.2% to 93.7% but is up from 91.4% last year. US Crude Production fell 100Kb/d to 11.9Mb/d.
Total Demand last week rose 2.3Mb/d to 21.0Mb/d as other oil demand rose 876Kb/d. Motor Gasoline usage rose by 459Kb/d to 8.5Mb/d but is down 7.6% from a year ago’s use of 9.5Mb/d. Jet Fuel Consumption rose 280Kb/d to 1.64Mb/d. Cushing inventories rose 1.2Mb to 22.8Mb on the week.
EIA Weekly Natural Gas Data: Natural gas storage is being built up too slowly for winter 2022-2023. The US data released today showed a build of 58 Bcf which compares with a build of 60 Bcf in the prior week. This should have been higher due to the 2 Bcf/d LNG shutdown. Storage is now at 2.369 Tcf. The biggest increase was in the Midwest (24 Bcf). The five-year average for last week was an injection of 45 Bcf while in 2021 it was an injection of 55 Bcf. Storage is now 11.9% below the five-year average of 2.69 Tcf. Today NYMEX is at US$7.48/mcf due to the extreme heat wave across the US South which is increasing electricity demand for air-conditioning. Some US electrical grid systems are running at capacity. AECO is trading at $4.63/mcf.
Europe is facing even more difficulties due to supply cut-offs of natural gas by Russia and France’s nuclear fleet seeing a drop of 27% of its power generation capacity due to corrosion in their reactor cooling systems. This may be a long-term problem. Coal usage is growing in Europe as a result. The machinations over Russian exports via the Nord Stream 1 line is pushing natural gas prices to the US$43-US$45/mcf level during the current unprecedented heat wave.
OPEC July Monthly: On July 12th OPEC released their July 2022 Monthly Forecast Report (June data). As repeated in the past few months they have not added the 400Kb/d (their stated monthly production increase). In June, they could not add to their production target due to difficulties in Libya (production down 78Kb/d to 629Kb/d and production off from 1.14Mb/d a year ago) Overall production rose 234Kb/d to 28.7Mb/d as Saudi Arabia added 159Kb/d to reach 10.59b/d. This level is still way below their stated productive capacity of 12.0Mb/d. Biden’s begging tour (even with his fist bump) did not get an agreement to increase crude production immediately. OPEC meets next on August 3rd to decide their next increase. US industry is lowering production modestly as a warning sign to the Biden administration of their hypocrisy in going for dirty and despotic foreign crude versus incentivizing domestic production.
This level is 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.OPEC sees 2022 consumption growing at a slower pace this year as weakness develops in Asia and Europe. Demand in 2022 is now seen at 100.3Mb/d, with Q2/22 consumption at 98.3Mb/d, down 150Kb/d from their prior forecast. With current production by OPEC at 28.7Mb/d and the call on OPEC at 29.5Mb/d in Q3/22, the addition of 1.5Mb/d from world SPRs is the perceived balancing act. We are watching demand destruction as it is clearly occurring in the US, Europe and China. This could change the overall dynamics of the energy picture quickly as it did in 2008-2009.
Baker Hughes Rig Data: In the data for the week ending July 15th (covering the last two weeks) the US rig count rose four rigs to 756 rigs. Of the total rigs working last week, 599 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 56% from 484 rigs working a year ago. The US oil rig count is up 58% from 380 rigs last year at this time. The natural gas rig count is up 47% from last year’s 104 rigs, now at 153 rigs. The industry has been responding to higher prices with more activity than last year which should lift overall US production further in the coming months.
In Canada there was an increase of 16 rigs last week and the total count is now 191 rigs. Canadian activity is up 27% from 150 rigs last year. While rig and frack day rates are rising, costs are as well. In the coming months the Canadian rig count should grow to over 200 rigs again (peak potential 220-250 rigs). Activity for oil grew 33% to 125 rigs up from 94 last year and natural gas rigs rose by 20% to 66 rigs from 55 a year ago.
We expect to see US crude oil production reaching 12.5Mb/d before year end (now 11.9Mb/d). The EIA recently forecasted US production reaching record highs over 13.1Mb/d during 2023. This could be higher if the Republicans gain control of Congress and reverse Biden’s anti-energy stance.
Conclusion:
Bullish pressure on crude prices:
- Russia is contemplating halting flows of Kazakh oil to Europe through their pipelines, removing supplies from non-sanctioned Kazakhstan. One more gun to hold against weary Europe in their support of Ukraine.
- The US, Japan and NATO are moving to restrict sales of Russian crude with a cap of US$40-60/b which could reduce supplies to Europe. Russia will look to Asian buyers if this occurs. The problem is logistics of moving the crude and the longer time to get this to markets in Asia versus via pipe to Europe. Russia could also slash production and drive crude prices higher.
- China is buying large quantities of Russian crude at a discount to Brent ($US35/b) 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 requested state and private energy companies to take advantage of the cheaper oil from Russia. They are also importing record amounts of coal.
- Venezuela is ramping up sales of 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 and to their subsidiaries across Europe.
Bearish pressure on crude prices:
- The latest version of Covid (BA.2.75) is closing down China once again and Japan has also been hit hard.
- The EU, US, Japan, South Korea, Australia and Canada are heading into recessions which will lower demand for crude by 4-5Mb/d. Driving by US and Canadian consumers is down materially. It could see double digit declines once recession hits hard.
- Europe is moving to reopen coal-fired plants and delaying closure of nuclear power plants to meet their electricity demand. Rationing of crude, crude products and natural gas are being implemented as well.
- The high cost of energy is lowering consumers’ and industry’s capacity to handle the cost pressures.
CONCLUSION:
The Russian invasion of Ukraine and the resultant tough sanctions against Russian crude oil sales to Europe has spiked up crude prices. Higher energy costs are pushing economies into recession. This should drive down global crude demand down by 4-5Mb/d over the next 3-4 quarters.
As global recession unfolds, crude prices should 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$103.69. WTI fell as low as US$90.56/b in early July. A breach of US$90/b could start a major price decline to the US$70’s.
Energy Stock Market: The stock markets around the world are gyrating with larger daily price moves. Earnings results for Q2/22 have been mixed so far. Financials have shown the worst results so far.
The S&P/TSX Energy Index is at 219. A breach of 195.68, the low of early July and the new low for 2022, could cause a sharp decline to the 145-150 area this fall.
We are holding our next quarterly webinar on Thursday August 18th. Become a subscriber to join this timely event. Go to https://bit.ly/3jjCPgH.
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 closing 2022 low so far) would be very bearish for the market. Today the Dow is at 31,834. We expect the next downleg in the market to start shortly.
Our 2022 ‘Catch The Energy’ conference is on Saturday October 22nd in Calgary at Mount Royal University. Our registration website will be opening by early August. Please keep this date open and we will provide you with additional details shortly.
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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