Schachter’s Eye on Energy: Crude Prices Weaken As US Sees Fourth Week Of Commercial Crude Stock Builds, And Russia Succeeds In Exporting Record Seaborne Crude.

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 33 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, Political & Military Update:

The Federal Reserve today raised its Fed Funds rate by 25 BP to a range of 4.50 – 4.75% (their eighth increase) and again used the words ‘still see increases required’. The plural use “increases” was what spooked the markets. While they see some progress on the inflation front (mainly energy) it still remains elevated. Some areas of the economy are weaker but their main concern about an extremely tight labour market and rising entry level wage increases remains. Their next FOMC meeting is in March, then May and we may see 25 BP each time. Thereafter they may hold rates flat into year-end to see if labour sees some slackening in its tightness. They want unemployment rates over 5% and not the record low currently of 3.5%.They continue to shrink their balance sheet as Quantitative Tightening (QT) continues to remove liquidity from the economy. Higher interest rates and less money should defeat inflation but a recession is also likely. 

The battle for the key Central Banks is that some areas of the world’s economies and inflation pressure are weakening but others such as wages are not. Until there is slack in the labour market and wage increases rise in line with the future outlook of inflation the Central Banks need to be vigilant. 

Tomorrow the Bank of England and the ECB are expected to raise rates and they may be more hawkish and raise rates by 50 BP.

Weak economic data from around the world for Q4/22 is now being released and is disconcerting. 

Some of the recent negative world economic data includes:

• Sweden saw its Q4/22 GDP fall 0.6% and the outlook for Q1/23 remains weak thus recession very likely.
• In Q4/22 Germany saw its GDP fall 0.2% and they forecast a negative number in Q1/23 so recession is on the way here as well.
• The Eurozone as a whole had real GDP at an anemic 0.1%.
• South Korea’s Industrial Production fell 2.9% due to a decline in exports to China. 
• US layoffs continue in the tech industry and now Hasbro (the toy and entertainment company)  has said it will lay off 15% of its global workforce. Intel had a horrible quarter with all their numbers being below, low expectations. Its factories are underutilized and they have an inventory glut. FedEx announced today it will lay off 10% of its management ranks. 
• US Consumer Spending fell 0.3% in December helped by lower gasoline prices being down 9% but spending on goods and services was impacted. The US Personal Consumption Expenditures Price Index (PCI) rose by 5% in December. While down from 5.5% in November it is more than double the Fed’s 2% target. 
• The US ISM Manufacturing PMI came in today at 47.4 down from 48.4 in November and Construction Spending came in at -0.4% versus an expectation of up 0.2%. 

Front and center for the US Congress is the contentious fight over the debt limit (US$31.4T). Getting it extended may take some time and the Republicans want significant spending cuts on discretionary spending. Democrats don’t want any social spending cuts, so partisan warfare may occur over the coming months and could destabilize markets. While the Treasury Secretary has some leeway to fund the government for a few months, the risk of a government shutdown this summer remains. 

The US Q4/22 GDP report at first glance looked pretty good at an increase of 2.9% annualized pace. However, inventories rose by 1.5% of the increase and government spending rose by 0.6%, both not what you want to see. If the economy slows down from here and inventories are too high then future production will slow down as time is needed to eat through the inventory overhang. 

Labour is fighting around the world for wage increases above inflation.

• In the UK 500,000 workers went on strike today by unions representing civil servants, teachers (23,000 schools are closed), university staff, ambulance workers and train drivers. They want pay raises over the current 10% inflation rate and have been offered 5%. Border patrol officers working at airports and ports have joined the strike harming tourism. There are no trains today from Gatwick and Heathrow airports. 
• In Canada, the Public Service Alliance of Canada (PSAC) who have been without a contract for some time are asking for a 47% increase over three years to get their employees ahead of inflation. 

We think that a recession in the US is inevitable as the bond market is forecasting falling rates  despite the Fed’s plans to raise short term interest rates to cool inflation and to increase the supply of labour. One problem for the Federal Reserve is that companies are raising wages quickly to meet their staffing needs. Recently, Walmart raised their starting wage by 17% from US$12/hour to US$14/hour as they have 300,000 job vacancies and want to meet staff needs at stores. Walmart has 1.6M workers, 94% of them hourly employees. Their average wage will go to USD$17.50 for all employees or up by 25%. Such a big increase in pay is what will worry the Fed. If other wage deals are as large this could accelerate inflation. The Fed would need to keep their hawkish posture longer to get the slack needed in labour.

In the US people with high paid jobs are getting laid off while entry level minimum wage jobs are having tough times attracting workers. 

Russia continues to gain customers for its energy as prices are below the NATO price cap of US$60/b. Last month 4.4 Mb/d were shipped by sea from the Baltic and Black Sea to buyers in China, India, Turkey and Belgrade. As a result, India (buyer of 70% of Baltic crudes) has cut back Saudi purchasers forcing the Saudi’s to discount their crude in Asia. Baltic shipments alone grew 50% in January. 

Bullish pressure for crude prices continues with the proposed, but not initiated, production cutbacks by OPEC and winter weather demand for heating oil and propane. Russia is selling less oil to Europe but China and India are taking up these barrels at US$26.78/b discounts to Brent (Brent today at US$84.39/b and Urals at US$57.61/b). The economic and energy bulls hope that If China does reopen this would increase crude demand this year by over 1.0 Mb/d. However, the data so far does not support this growth in demand view. 

Bearish pressure for crude comes from the weakness in China’s manufacturing economy. Crude demand destruction due to weakening economies could be in the range of 5-7 Mb/d during 2023, more than offsetting any supply cutbacks from OPEC. The US alone has consumption down by 1.3 Mb/d according to the latest EIA Weekly Petroleum Report (see below). Nigeria seems to be making progress in getting its production back up.  Lastly Russia is having great success selling crude and products from its Baltic ports. Asian demand in January is 50% above December. India, the biggest buyer, is taking 1.7 Mb/d versus 1.0 Mb/d in December, according to Reuters. What is crazy is the sanction busting that’s going on. The US is buying from Reliance (India’s biggest refiner) 200,000 b/d of finished product which is made from Russian crude, going around the sanctions it has imposed. Russia is now seeing record exports from the Baltic Sea and the Black Sea as they are selling crude below the imposed price cap of US$60/b. 

EIA Weekly Oil Data: The EIA data of Wednesday February 1st (data from January 27th) was  bearish for oil prices. US Commercial Crude Stocks rose by 4.1 Mb to 452.7 Mb, the fourth week of increases in stocks. This compares to 415.1 Mb last year, so storage is up by 37.5 Mb from a year ago. The SPR saw no release of crude this week, the third week in a row. 

Motor Gasoline inventories rose by 2.6 Mb while Distillate Fuels rose 2.3 Mb. Refinery Utilization fell 0.4% to 85.7%. US production remained flat at 12.2 Mb/d. Cushing inventories rose 2.3 Mb to 38.0 Mb. US total product demand rose last week by 659 Kb/d to 20.10 Mb/d as Propane demand rose by 430 Kb/d and Distillate Fuels by 172 Kb/d. Motor Gasoline consumption rose 348 Kb/d to 8.49 Mb/d while Jet Fuel saw a rise of 172 Kb/d to 1.58 Mb/d. 

Demand destruction is real in the US. Total consumption fell by 1.3 Mb/d from 20.1 Mb/d  or down by 5.3% from last year. These numbers gyrate weekly but the important point is that demand has declined from last year.

EIA Weekly Natural Gas Data: The EIA data released last Thursday showed a decline of 91 Bcf for the week ending January 20th. Storage is now at 2.73 Tcf, still sufficient to meet US needs this winter. The biggest decrease was in the East (40 Bcf) and Midwest (36 Bcf). The five-year average for last week was a withdrawal of 139 Bcf. The largest withdrawals typically occur in January and February of each year and the largest weekly withdrawal so far was 359 Bcf in January 2018. US Storage is now 4.1% above last year’s level of 2.62 Tcf and 4.9% above the five year average of 2.60 Tcf. With the warmer weather and the healthy storage position, NYMEX has retreated from US$7.10/mcf in mid-December to US$2.56/mcf today. AECO today is at $3.64/mcf. The weaker US price is also due to the delay in getting the Freeport LNG plant back online. This large exporter (2.1 Bcf/d) needs to get regulatory approval to restart production and exports. Concern about the operational challenges the facility has had may delay the start-up for a few months according to some concerned buyers of this facility’s LNG. 

European prices have also declined due to warmer weather across the continent and sufficient storage. Germany has opened its first LNG import facility and has more coming online in the coming months. Energy stocks worldwide are in retreat with natural gas stocks under the most pressure (some down >4% today). 

Baker Hughes Rig Data: In the data for the week ending January 27th the US rig count was unchanged at 771 rigs (fell four rigs in the prior week). Of the total rigs working last week, 609 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 26% from 610 rigs working a year ago. The US oil rig count is up 23% from 495 rigs last year at this time. The natural gas rig count is up 39% from last year’s 115 rigs, now at 160 rigs. The industry continues to respond to higher international natural gas prices with materially more activity than last year. This should continue to lift US natural gas production in upcoming quarters as more LNG exports are expected. Companies divulging their plans for 2023 plan to spend more, with capex plans showing growth in production as well as funds to offset higher drilling and completion costs.

In Canada, there was an increase of six rigs (increase of 14 rigs in the prior week) to 247 rigs as crews returned from holidays. Canadian activity is up 14% from 217 rigs last year. Activity for oil rose 16% to 157 rigs versus 135 rigs last year. Natural gas rigs were up 10% or two rigs to 90 rigs from 82 rigs last year. Peak potential for staffed rigs is likely around 260 this winter and we are effectively there. The industry is having a quick start in this New Year and is very close to  full capacity. 

CONCLUSION: 

Historically, as a global recession unfolds, crude prices typically 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 is priced today at US$76.93/b (down around US$3/b from last week). Watch for a breach of early December’s low of US$70.08/b for the next (and probably last) decline phase of this correction/bear market phase. We continue to expect a panic spike bottom in the US$65-70/b area in the coming weeks. Below US$70/b we become bullish again. 

Energy Stock Market: For the overall stock market we expect a focus on Q4/22 earnings and negative guidance from companies to take hold of the market and see significant erosion. Overall US results Q4/22 are expected to decline by 7-9%. 

The inflation watch on food, shelter and wages will also be a focus of the markets. A breach of December 2022 low of 32,600 on the Dow Jones Industrials Index should speed up the fear phase and generate an important bottom in Q1/23.

The upcoming weeks should see further pressure on the energy sector and we intend to take advantage of this to add ideas to our Action Alert BUY list. Many ideas we cover are down more than 50% from their 2022 highs and are entering our BUY ranges. We currently have eight ideas on our Action Alert BUY list and we expect to have over 20 names on this list in the coming weeks. 

We now cover 33 companies and are working to add four new ideas (two E&P and two Energy Service). Coverage introduction of these new ideas should occur in our February Interim Report due out on February 16th. 

The S&P/TSX Energy Index today is at 242 (down three points from last week’s level of 245) on the China reopening optimism. Early 2023’s low of 223 is now the support level to watch. A bust of this level should drive the Index below 200 and get us into the climactic bottom liquidation area that will set up the fabulous buying opportunity. These BUY windows are infrequent so please decide what you want your energy weighting to be for the next major up-leg in this long energy super cycle. Our Coverage List includes ideas from the Pipeline & Infrastructure area, Canadian oil and natural gas ideas, energy service ideas and companies working internationally. Our list includes large Conservative ideas and small to large caps in our Growth and Entrepreneurial categories. 

We are having our Q1/23, 90 minute quarterly webinar, on Thursday February 23rd at 7PM MT. This should be a very important webinar for subscribers as we go over the new ideas on our Action BUY list and why they have been added as well as discuss the four new ideas we are adding to our Coverage List.  

Once we see the market showing climatic bottom signals we intend to send out Action Alert BUY ideas to subscribers. Become a subscriber to get these timely BUY Action Alerts, our Fearless Forecasts for 2023 and our four new investment ideas coming out in our next Interim Report. Go to https://bit.ly/2FRrp6k. 

I will be speaking this Friday at Michael Campbell’s World Outlook Financial Conference in Vancouver to be held on February 3-4 at the Bayshore Hotel. My keynote topic will be the ‘Energy Super Cycle Pause Is Nearly Over – Significant Upside For Investors In 2023. To learn more go to https://mikesmoneytalks.ca/wofc-2023-event-info/ for details.

Five Canadian E&P companies and two energy service providers will be in attendance and will present their stories during the breakout sessions and will also be available for discussion with interested investors at their booths. 

The Schachter Energy Report will also have a booth at the conference so if you are attending please come by and say hello. 

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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