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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 food and wages even though energy prices at the pump have retreated for now. With hurricane season soon here, some energy production facilities may get shut in and raise prices. 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. The Federal Reserve today raised their Fed Funds rate by 75BP to 2.25% even though they admitted the economy was softening. To really get a grasp on inflation we suspect that they will need to raise this rate to the 4-5% range in the coming months.
Tomorrow we will get the first read on Q2/22 GDP. It is likely to be a negative read but this will be rejected by politicians as meaning a recession has started as they focus instead on the strong job market. We are concerned that this data will be revised downward as international trade data is a late addition and this will not be a good number due to the strong dollar. That is one reason the US is aggressively selling oil and natural gas to Europe to swing this number to be less problematic. The strong US dollar is a problem for almost all other US Exports which is likely to take down the GDP rate in later revisions.
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 down 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. A new development is that suppliers are not bringing construction materials to work sites unless they’re paid in advance. This real estate problem is worse than the Lehman collapse in 2008. China’s Q2/22 GDP has 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 1.15Mb/d decline so far according to today’s EIA release).
EIA Weekly Oil Data: The EIA data of Wednesday July 27th was mixed for oil prices. US Commercial Crude Stocks fell 4.5Mb to 422.1Mb. The forecast had been for a decline of 1.1Mb. The Strategic Petroleum Reserve (SPR) had a release of 5.6Mb last week. The big swing was due to US Exports rising 789Kb/d or 5.5Mb 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 this action is being attacked. Why send reserves from the US SPR to China? Motor Gasoline Inventories fell 3.3Mb while Distillate Fuel Oil Inventories fell 0.8Mb as Refinery Utilization fell 1.2% to 92.2%, but this is up from 91.1% last year. US Crude Production rose 200Kb/d, getting back to 12.1Mb/d, the peak so far this year.
Total Demand last week fell 1.05Mb/d to 20.0Mb/d as other oil demand fell 1.46Mb/d. Motor Gasoline usage rose by 724Kb/d to 9.3Mb/d but is down 80Kb/d from a year ago’s usage. For the four weeks of 2022 compared to 2021, Total Demand is down 2.9% and Motor Gasoline is down 7.1%. Jet Fuel Consumption rose 127Kb/d to 1.77Mb/d. Cushing inventories rose 0.7Mb to 23.5Mb 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 32 Bcf which compares with a build of 58 Bcf in the prior week. The massive heat covering across the US was the reason for greater consumption as the natural gas was used to create electricity for air-conditioning usage. This would have been higher if not for the 2 Bcf/d LNG plant repair work and current shutdown. Storage is now at 2.401 Tcf and needs to get over 3.5Tcf by November 1st. The biggest increase was in the Midwest (22 Bcf). The five-year average for last week was an injection of 35 Bcf while in 2021 it was an injection of 36 Bcf. Storage is now 12.0% below the five-year average of 2.73 Tcf. Today NYMEX is at US$8.67/mcf due to the continuing extreme heat wave across the US. Some US electrical grid systems are running at capacity. Texas may be the most vulnerable to meet demand as hurricane season can disrupt operations. AECO is trading at $5.65/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. The price is nearing the highs seen just after the Russian invasion of Ukraine started. This winter may see even new record natural gas price highs depending on the allocation of natural gas volumes to Europe. 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. They claim that they can defeat Russia and chase them out of the whole country but the facts on the ground dispute this view.
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Baker Hughes Rig Data: In the data for the week ending July 22nd the US rig count rose two rigs to 758 rigs (up four rigs in the prior week). 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 54% 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 49% from last year’s 104 rigs, now at 155 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 four rigs this week (16 rigs were added last week) and the total count is now 195 rigs. Canadian activity is up 31% from 149 rigs last year. While rig and frack day rates are rising, costs are as well. In the coming weeks the Canadian rig count should grow to over 200 rigs again (peak potential 220-250 rigs). Activity for oil grew 33% to 124 rigs up from 93 last year and natural gas rigs rose by 24% to 71 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, and remove bureaucratic delays, and give some supportive policies for the industry to make long term growth plans.
Conclusion:
Bullish pressure on crude prices:
- Russia has attacked the port of Odessa and seems to be reneging on its agreement to allow the port to open to resume shipping Ukrainian grain to countries in need. EU members may increase sanctions on Russia versus Russia’s hope to get sanction relief.
- 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 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.
- 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.
Bearish pressure on crude prices:
- Lufthansa is shutting down most flights at main hubs Frankfurt and Munich due to ground crew strike action canceling 1,000 flights per day. The US is seeing the same and the UK is limiting flights from Heathrow. All of this lowers demand for Jet Fuel.
- Libya has been able to get production back up over 1Mb/d from 629Kb/d in June. However they are not targeting to get production back up to 1.2-1.3Mb/d in the coming weeks.
- 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.
- India is importing record amounts of coal which is readily available versus crude oil and distances to move it are shorter.
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$97.26 (US$6/b below last week). 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$70s.
Energy Stock Market: The stock markets around the world are gyrating with larger daily price moves. Earnings and economic data are swinging the markets around. Good days occur when economic data is supportive and down days when data shows recessionary trends.
The S&P/TSX Energy Index is at 227. 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.
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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 32,197. We expect the next downleg in the market to start shortly.
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