Schachter’s Eye on Energy: WTI Crude Oil Falls US$6/b Over The Last Week As European & China Economies Head Into Recessions.

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:

To fight rampantly rising food, power and shelter costs plus rising wage pressure, Central Banks have increased their interest rates to slow economic growth down. Today the ECB followed Canada and raised their rate by 75BP. In Europe’s case it was to slow down economic growth but also to stabilize the rapidly falling Euro. Markets expect the Fed to raise interest rates later this month by 75BP so the tightening of the price of money continues as does the cutting back of the supply of money as the ECB and the Fed sell down their balance sheets. In the Fed’s case they will sell this US$95B month. This two phase move is partially offset by the largesse of fiscal spending increases by governments. 

Europe and the US are moving to make sales of crude and natural gas by Russia subject to their low selling pricing models and that required shipments to get special insurance coverage. Russia is not willing to play that game. Russia is selling self insured cargoes, India is permitting their insurance companies to cover shipments to their country and China just does their own thing with its own ships moving cargo to China and other Asian countries in their orbit. So the new high profile sanctions have no impact just as they are being announced and the politicians declare victory. Yet Russia is selling as much oil as before the invasion just to different buyers who are getting a discount. But remember prices are still higher than in 2019, so financially there is no Russian pain on exports although their imports have fallen dramatically due to the sanctions. 

Russia has now cut off exports of natural gas to Europe entirely forcing them to use up storage supplies needed for this winter. This ‘tit for tat’ move does not appear to change Putin’s behavior nor help EU citizens which are facing large increases in heating bills this winter. Russia wants to see Europe use up a significant amount of their storage reserves making this winter more difficult if it is a cold one. Russia wants to divide Europe’s citizens from their governments support of Ukraine and a lack of natural gas during winter could trigger a large increase in domestic protests. 

Some of the nasty fallouts of the recent moves are:

• EU utilities are facing bankruptcy as electricity prices have rocketed higher and they can’t pay those bills and still deliver electricity at contracted retail prices.
• The Kremlin said they would stop selling oil and gas to countries that impose price caps on Russian energy sources. Price controls did not work in the 1970s as supplies disappeared. Going to this option sounds good politically but does not work practically.
• California asks residents to avoid charging their electric vehicles due to blackout risks. They have not allowed new natural gas cogen facilities and the recent drought has impacted hydro capability. Their drive to get use of more EV’s just hit the wall of doubt.
• China is making a profit selling LNG cargoes to Europe as they don’t need them as demand has fallen with more cities and provinces under lockdown. China oil imports fell 9.4% in August according to Chinese customs data. This clearly shows demand destruction. 
• OPEC now sees the global recession spreading and has cut October production targets by 100Kb/d. 
• Margin calls are being faced by energy producers in Europe. Norwegian giant Equinor sees energy trading desks needing US$1.5T to meet margin calls. This could be worse than the Lehman incident in 2008. The problem is not with the physical markets but with the derivatives market. This is a financial crisis of much greater magnitude than the Global Financial Crisis of 2008-2009 (GFC).
• The EU has called for energy rationing this winter, wanting voluntary cutbacks of gas consumption by 15%.
• Britain has forecast that without Russian natural gas this winter 60% of British factories will need to close as energy bills soar. MakeUK,  a manufacturing lobby, announced that 42% of manufacturers have seen electricity and natural gas bills rise by 100% in the past year reducing hours of operations. British Pound hits 40-year low. 
• Germany’s Economic Minister Robert Habeck says energy has become too expensive and sees a ”manufacturing shutdown that threatens to collapse the nation”. Some have already closed before the recent Russian cutoff. ArcelorMittal, the second largest steel producer in the world, announced the closure of one of their two blast furnaces in Bremen. 
• Switzerland is planning to crack down on citizens who do not comply with new rules to regulate gas use this winter. People who violate the new regulations could face fines or even jail time of up to three years as reported by the Swiss daily Blick. Temperatures in buildings cannot exceed 19 degrees Celsius.
• Dutch bakeries are planning to close as energy costs surge and with natural gas cutbacks and higher input costs, they can’t make products and keep the doors open. 

EIA Weekly Oil Data: The EIA data of Thursday September 8th was mixed for oil prices. US Commercial Crude Stocks rose 8.8Mb to 427.2Mb. The forecast had been for a decline of 275Kb. The US Strategic Petroleum Reserve (SPR) had a release of 7.5Mb last week. The key was that US Imports rose 8.8Mb/d for Commercial Stocks. US Exports fell last week by 534Kb/d. Motor Gasoline Inventories rose 0.3Mb. Distillate Fuel Oil Inventories rose 0.1Mb. Refinery Utilization fell 1.8% to 92.7%. US Crude Production was flat at 12.1Mb/d. 

Total Demand last week fell 181Kb/d to 19.9Mb/d as Other Oils demand fell 527Kb/d. Motor Gasoline demand rose 136Kb/d to 8.73Mb/d. Jet Fuel Consumption rose 136Kb/d to 1.43Mb/d. Cushing inventories fell 500Kb to 24.8Mb on the week. 

The very bearish part of the report was the sharp decline in consumption versus last year. Motor Gasoline consumption fell 9.2% or 881Kb/d from 9.61Mb/d. Jet Fuel consumption fell 189Kb/d, or 11.7% from the prior year. Demand destruction is clearly occurring in the US. 

EIA Weekly Natural Gas Data: US Natural gas storage is being built up too slowly for winter 2022-2023. The US data released today showed a build of 54 Bcf which compares with a build of 61 Bcf in the prior week. Storage is now at 2.694 Tcf but needs to get over 3.50Tcf by November 1st, which is unlikely in the nine weeks left before the withdrawal season starts. The biggest increase was in the Midwest (29 Bcf). The five-year average for last week was an injection of 79 Bcf while in 2021 it was an injection of 83 Bcf. So US storage is way behind what it needs for this winter. US Storage is now 11.5%, below the five-year average of 3,043 Tcf. Today NYMEX is at US$8.03/mcf. AECO is trading at $3.90/mcf. 

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. European leaders are complaining about the use of natural gas volumes as a ‘weapon of war’ but Putin points out correctly that the US and NATO move to reduce access to the ‘SWIFT’ payment system was a similar weaponizing of the financial clearing system and an act of war against Russia. 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 and Germany are two countries 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 September 2nd the US rig count fell five rigs to 760 rigs (up three rigs last week). Of the total rigs working last week, 596 were drilling for oil (down 9 rigs) and the rest were focused on natural gas activity. The overall US rig count is up 53% from 497 rigs working a year ago. The US oil rig count is up 51% from 394 rigs last year at this time. The Permian basin saw a decrease of six rigs to 342, up 37% from a year ago’s 250 rigs. The natural gas rig count is up 59% from last year’s 102 rigs, now at 162 rigs. The industry has been responding to higher natural gas prices with more activity than last year which should continue to lift overall US production even further in the coming months. 

In Canada there was an increase of eight rigs last week to 208 rigs. Canadian activity is up 37% from 152 rigs last year. While rig and frack day rates are rising, peak potential for staffed rigs is likely around 225 so we are nearing the high rig count for this summer. Activity for oil grew 55% to 143 rigs up from 92 last year and natural gas rigs rose by 8% to 65 rigs from 60 a year ago. This minor increase in rig activity for natural gas likely relates to the low current prices 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 during winter 2020-2023 (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: 

The Russian invasion of Ukraine and the resultant tough sanctions against Russian crude oil and now natural gas sales to Europe has spiked up prices globally. Higher energy costs are pushing economies into recession. This is driving global crude demand destruction by 4-5Mb/d. 

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$82.64/b down >US$6/b from last week’s level of US$89.04/b when we wrote the report.  Next stop is a breach of US$80/b which we see happening in the next few weeks. WTI in just two weeks has fallen 17% from an intra-day high of US$97.66/b to US$81.20/b today.

The final corrective low for the ‘pause that refreshes’ this new nascent energy super cycle, should occur during October as WTI prices fall 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. Over the last 4 weeks the Dow Jones Industrials Index has fallen 3,300 points. We are in the early part of a waterfall decline. A breach below 29,700 for the Dow (the mid-June low) should start the most painful phase of the decline down to the 24,000 – 25,000 area by late September or into October.  

The S&P/TSX Energy Index today is at 228 down 11 points or down nearly 5% from last week’s level of 239 when we wrote the report. 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. 

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. Today the Dow is at 31,775. Once we see the market showing climatic bottom signals we intend to send out Action Alert BUY ideas to subscribers. To become a subscriber and get these timely Alerts Go to https://bit.ly/2FRrp6k

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