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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 for electricity, food and wages even though gasoline prices at the pump have retreated somewhat and provided the US with a July CPI that was unchanged from June. The stock markets liked this piece of news. This may keep the Federal Reserve from increasing their Fed Funds rate by 75BP next month as was feared before this data point release. The markets remain focused on the daily noise which today was seen as positive. Investors are ignoring the year over year CPI which remains high at 8.5% with food and shelter costs still rising sharply. To really get a grasp on inflation and drive it down to the Fed’s 2% target, we suspect that they will need to double the current Fed Funds rate to the 4-5% range to reverse inflationary expectations.
From day to day we see a glimmer of hope on the inflation and economic front but on other days (more of these) we see data that shows a recession is underway. Europe, China and the US are the three economic powerhouses and their overall economic data is not supportive of the optimists’ view. Inflation is still a problem as wage pressure is accelerating. This is one of the key determinants of Central Bank policy moves. Energy, which helped the July data, fluctuates a lot and while pump prices have moderated, electricity prices have risen materially around the world. As the global recession unfolds, demand for crude oil will decline. This demand destruction could go as high as 4-5Mb/d.
EIA Weekly Oil Data: The EIA data of Wednesday August 10th was mostly bearish for oil prices. US Commercial Crude Stocks rose 5.5Mb to 432.0Mb. The forecast had been for a modest rise of 73Kb. The Strategic Petroleum Reserve (SPR) had a release of 5.3Mb last week. The big swing was due to US Exports falling by 1.4Mb/d or by 9.8Mb on the week. Motor Gasoline Inventories fell 5.0Mb while Distillate Fuel Oil Inventories rose 2.2Mb. Total Stocks (excluding the SPR) rose by 13.0Mb to 1221.9Mb. Refinery Utilization rose 3.3% to 94.3%. US Crude Production rose 100Kb/d to a new year high of 12.2Mb/d.
Total Demand last week fell 475Kb/d to 19.47Mb/d as Other Oils demand fell 801Kb/d. On the positive side, Motor Gasoline demand rose 582Kb/d to 9.12Mb/d from 8.54Mb/d in the prior week. Jet Fuel Consumption rose 342Kb/d to 1.78Mb/d. Cushing inventories rose 700Kb to 25.2Mb 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 41 Bcf which compares with a build of 15 Bcf in the prior week. Storage is now at 2.457 Tcf and needs to get over 3.5Tcf by November 1st. The biggest increase was in the Midwest (18 Bcf). The five-year average for last week was an injection of 42 Bcf while in 2021 it was an injection of 49 Bcf. Storage is now 12.1% below the five-year average of 2.79 Tcf. Today NYMEX is at US$7.71/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 $4.25/mcf.
This winter Europe may see very high natural gas prices depending on the allocation of natural gas volumes by Russia. Putin wants to force Europe to lower 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 demand for money and materials 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.
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Baker Hughes Rig Data: In the data for the week ending August 5th the US rig count fell three rigs to 764 rigs (up nine rigs in the prior week). Of the total rigs working last week, 598 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 56% from 491 rigs working a year ago. The US oil rig count is up 55% from 387 rigs last year at this time. The natural gas rig count is up 56% from last year’s 103 rigs, now at 161 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 one rig this week (nine rigs were added last week) and the total count is now 203 rigs. Canadian activity is up 30% from 156 rigs last year. While rig and frack day rates are rising, costs are as well. Peak potential for staffing rigs is likely around 225 so that may be the high rig count for this summer. Activity for oil grew 47% to 140 rigs up from 95 last year and natural gas rigs rose by 5% to 63 rigs from 60 a year ago.
We expect to see US crude oil production reaching 12.5Mb/d before year-end (now 12.2Mb/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.
- 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 629Kb/d in June.
- 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 (Germany especially) 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 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$91.95. WTI fell as low as US$86.66/b today but has rebounded strongly as the optimists expect the Fed to not be as hawkish to raise interest rates.
Energy Stock Market: The stock markets around the world are gyrating with larger daily price moves. Today is a good day for the bulls. In the coming weeks we see the market focusing on earnings and the next round of economic data. When economic data is supportive of continued economic strength it rallies but falls sharply when data shows recessionary trends and corporate profit declines.
The S&P/TSX Energy Index today is at 222 (down six points from last week’s issue and down 23% from the year’s high of 288). 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 on 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 the 30 companies on our Coverage List. As the next decline phase unfolds there should be lower 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 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 33,193. We expect the next downleg in the market to start shortly.
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