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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.
I will be away on holiday next week so our next issue of Eye on Energy will be August 31st.
Global Economic Update:
China’s lockdowns of 20% of their GDP on top of a housing crisis is destabilizing the country and it is getting worse as builders fail to complete projects and purchasers default on mortgage loans. Banks that worked with the large home and apartment builders are facing massive losses (US$350B+) and those with low liquidity are limiting depositors’ access to their funds. Massive line-ups and protests across the country are being met by military troops and tanks to keep the protests from getting violent. One stark problem for the country is that 20% of China’s youth (ages 16-24) were unemployed in July.
China reports that 460,000 firms associated with the housing industry have closed or defaulted this year. This credit crunch is bigger than the Lehman event in 2008 as housing is the main store of value for Chinese investors and in dollar terms is bigger than the US real estate sector. Their stock and bond markets are much smaller than in the US. This is affecting demand right across the country. China slowing down means less imports of raw materials and an impact on economic activity around the world. China’s slowdown announcements, almost alone, have taken crude oil prices down by over US$8/b over the last week from US$95/b to below US$87/b today. Chinese refiners processed only 12.53Mb/d according to the Chinese Bureau of Statistics, down 8.8% from the prior year. This is the lowest level since the height of the pandemic in March 2020. Demand destruction is clearly occurring in China.
European electricity prices have gone up 11x in just two years and have doubled just in the last few months as natural gas prices rocket higher and nuclear power production slows as river water levels shrink due to droughts. Also the price of thermal coal for coal fired power plants has reached new record high prices. This winter could be a major shocker to consumers and industry if blackouts or sharp allocation cutbacks of electricity or natural gas occur. The UK reported today that their inflation rate in July rose at a 10.1% pace and they expect higher rates as food and energy prices spike in the coming winter months.
Soaring food prices around the world due to the Ukraine invasion, droughts worldwide in major food growing countries, rising fertilizer prices and migrant worker access is driving food prices over 10% across the world. While gasoline prices have abated, these other consumption areas are still rising. Egg prices are up 47% in the US as one harsh example. Add in wage pressures, and the ongoing non-transitory inflation pressure persists. Central banks will continue to be forced to lift rates and tighten liquidity if they are to drag inflation back down to their target rate of 2%.
EIA Weekly Oil Data: The EIA data of Wednesday August 17th was mixed for oil prices. US Commercial Crude Stocks fell 7.1Mb to 425.0Mb. The forecast had been for a modest decline of 275Kb. The Strategic Petroleum Reserve (SPR) had a release of 3.4Mb last week. The big miss was due to US Exports rising a whopping 2.89Mb/d or 20.2Mb on the week, a record export level. This is insane. Taking from US Commercial storage and the SPR to export to Europe and China just before winter peak demand is nuts. Let those rich countries get their own supplies! As a result of the large increase in crude and product exports, Motor Gasoline Inventories fell 4.6Mb. Offsetting this Distillate Fuel Oil Inventories rose 0.8Mb. Refinery Utilization fell 0.8% to 93.5%. US Crude Production fell 100Kb/d to 12.1Mb/d.
Total Demand last week rose 1.75Mb/d to 21.2Mb/d as Other Oils demand rose 819Kb/d. Motor Gasoline demand rose 225Kb/d to 9.35Mb/d. Jet Fuel Consumption fell 177Kb/d to 1.60Mb/d. Cushing inventories rose 200Kb to 25.4Mb on the week.
EIA Weekly Natural Gas Data: US Natural gas storage is being built up too slowly for winter 2022-2023. The US data released last Thursday showed a build of 44 Bcf which compares with a build of 41 Bcf in the prior week. Storage is now at 2.50 Tcf and needs to get over 3.50Tcf by November 1st. The biggest increase was in the Midwest (20 Bcf). The five-year average for last week was an injection of 49 Bcf while in 2021 it was an injection of 46 Bcf. Storage is now 11.9% below the five-year average of 2.84 Tcf. Today NYMEX is at US$9.351/mcf due to the extreme heat in many areas of the US. Some US electrical grid systems are running at capacity. AECO is trading at a depressed $3.28/mcf as plant maintenance and lack of takeaway capacity keep domestic prices low.
This winter Europe may see even higher natural gas prices depending on the allocation of natural gas volumes by Russia. Putin wants to force Europe to loosen sanctions and is using food and natural gas as tools to get what he wants. Some countries in Europe already seem to be tired of the war and the demands on their military by Ukraine’s persistent requirements for more and more money and weapons to fight Russia. Exasperated European nations could slow down support for Ukraine as they take care of their domestic needs. Italy is one country facing such pressure already. The UK is planning on blackouts this winter as they set up an emergency energy plan. Cutbacks of around 20% of supplies are being planned for across Europe. This will surely throw the area into a hard landing recession.
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Baker Hughes Rig Data: In the data for the week ending August 12th the US rig count fell one rig to 763 rigs (down three rigs in the prior week). Of the total rigs working last week, 601 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 52% from 501 rigs working a year ago. The US oil rig count is up 51% from 398 rigs last year at this time. The natural gas rig count is up 57% from last year’s 102 rigs, now at 160 rigs. The industry has been responding to higher prices with more activity than last year which should continue to lift overall US production further in the coming months.
In Canada there was a decrease of two rigs this week (down one rig last week) and the total count is now 201 rigs. Canadian activity is up 23% from 164 rigs last year. While rig and frack day rates are rising, costs are as well. Peak potential for staffed rigs is likely around 225 so that may be the high rig count for this summer. Activity for oil grew 37% to 137 rigs up from 100 last year and natural gas rigs rose by 2% to 64 rigs from 63 a year ago. This minor increase in rig activity for natural gas likely relates to the low prices being received now in Alberta. Once we get closer to winter, activity should pick up as prices usually strengthen once the drawdown season starts.
We expect to see US crude oil production reaching 12.5Mb/d before year-end (now 12.1Mb/d). The EIA has forecasted US production reaching record highs over 13.1Mb/d during 2023. This could rise even higher if the Republicans gain control of Congress and reverse Biden’s anti-energy stance, remove bureaucratic delays, and give some supportive policies for the industry to make long term growth plans.
Conclusion:
Bullish pressure on crude prices:
- The US, Japan and NATO are working towards a deal 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. Their problem is the 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.
- OPEC’s production is now 2.84Mb/d, below their official target. Part is due to production difficulties in some countries but also due to the desire to keep supplies tight so that the members can maximize revenues. They announced a miniscule increase of 100Kb/d for September but they have yet to meet one of their official quota levels. They are clearly enjoying the uncertainty that has kept crude prices high. In the August OPEC Monthly Oil Market Report they noted a drop in demand this year and next. OPEC increased July production by 215Kb/d of which the Saudis added 158Kb/d to take their production level to 10.7Mb/d, way below their official capability of 12.5Mb/d.
- Russia has halted deliveries on some of its export pipelines to disrupt Europe. They recently cut back deliveries on their Druzhba line.
Bearish pressure on crude prices:
- Libya has been able to get production back up over 1.2Mb/d from 632Kb/d in July.
- 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 their three remaining nuclear power plants (Germany) to meet their electricity demand. Rationing of crude, crude products and natural gas are being implemented as well. Germany is implementing plans to cut back natural gas access to some industries. For some large and important industries like chemicals they are talking of cutting back access by 50% which will be a job killer and add to the economic braking they are planning. How severe the recession will be is the question and this depends on what natural gas Russia does send to Germany this winter.
- 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 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$86.72/b. We have now conclusively busted the US$90/b level as we expected. Next stop is a breach of US$80/b which we see happening in September. The final corrective low for the ‘pause that refreshes’ this new nascent energy super cycle, should occur in October and reach below US$70/b. This upcoming climactic low should provide fabulous buying opportunities at great prices for energy stocks, much lower than current prices.
Energy Stock Market: The stock markets around the world are gyrating. Today is a day for the bears. In the coming weeks we see the market focusing on the next round of economic data. When economic data is supportive of continued economic strength, markets rally but markets fall when data showing recessionary trends and corporate profit declines.
The S&P/TSX Energy Index today is at 228. A breach of 195.68, the low of early July and the low for 2022, could cause a sharp decline to the 145-150 area in the coming months.
We are holding our next quarterly webinar tomorrow Thursday August 18th. We will go over the Q2/22 results of companies that have reported and highlight the bargains that are developing. One major part of the webinar will focus on what could be the bargain levels to watch for, for all 30 companies on our Coverage List. As the next decline phase unfolds there should develop low risk entry points. 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 in the coming months (down from the year high at 36,953). Continue to hold cash for the next great buying opportunity expected during October. 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 34,038. We expect the next major downleg in the market to start shortly.
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