Schachter’s Eye on Energy: Energy Prices Declining Due To Concern About US Banking Crisis And Demand Falling As Credit Crunch Occurs.

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 37 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 increased rates by 25 BP to 5.00 – 5.25% at today’s FOMC meeting decision. They are likely to pause now for the next few meetings to let the economic data provide more information before they make their next interest rate move. The markets want to see a pause for the next few meetings and then a decline in the Fed Funds rate starting in September. We don’t see any rate declines in 2023 as the economic data is too hot. The data coming out recently provides some support for the hawks as well as the doves at the Fed. They changed the forward guidance language to keep their options open to the banking crisis and the economic data. 

Some examples of too strong data:

• The Fed’s favourite inflation measure is the Core PCE Price Index and it has stayed high which will be a constraint on the Fed to stop its fight to lower inflation. The result for March came in with a rise of 4.6% above the forecast of 4.5%. This is more than double the goal of the Fed of 2%, so this holds the Fed back from being less restrictive.
• Today the April ADP jobs report showed a gain of 296K which was much higher than the expectation of 148K new jobs and the March gain of 142K jobs. The Monthly Employment data comes out this Friday. The Fed wants to see the unemployment rate rise over 1% before it relents on the inflation battle. Wage inflation pressure is one of their main concerns. 

Some examples of weaker data:

• The GDP for the US in Q1/23 saw a slowdown from 2.6% in Q4/22 to 1.1% and was lower than the forecast at 2.0%. With the recent banking problems and credit crunch the forecast for Q2 and Q3 are for negative data and an official recession underway. Will it be a soft landing or a significant recession? This is still unknown. 
• M2 has now declined for four straight months and is declining at a 4% rate. This will drag down US growth going forward. 

The banking crisis in the US for Regional Banks is not over. The third bank failure occurred last weekend with the FDIC taking over First Republic Bank (FRC-N) that had US$213B of assets. This failure (the second largest bank collapse) lifted total assets from bank failures this year to over US$500B and exceeds the total of the Global Financial Crisis (GFC) of 2008-2009. Then 25 banks failed. The First Republic collapse was after the Silicon Valley Bank’s failure with US$209B. The biggest bank failure was during the GFC when Washington Mutual Bank failed with US$432B. So now we  have two of the three largest bank failures occurring in 2023 and the fallout is still to come. JPMorgan bought the assets from the FDIC and will get US$13B of support to handle losses as they mark to market the failed bank assets that they accepted under the deal. The equity and bond holders of FRC will be wiped out. This mess is clearly due to the reduction of regulations and the removal of some regulatory reporting and the too low level of supervisory oversight. 

More regional banks have been under severe pressure after the FRC collapse and the market is wondering who (which domino) is next. Yesterday PacWest (PACW – NASDAQ) plunged 28% while Western Alliance (WAL- N) fell 15%. Today they are getting a bit of a reprieve. If depositors decide to take their funds from regional banks to larger money center banks than the current bank crisis will extend. Last week large banks saw an outflow of US$2.4B while smaller banks saw an outflow of US$7.9B. 

The problem is that smaller banks provide 80% of commercial real estate loans (Axios) and 45% of consumer lending. Commercial real estate lending in the US is a US$20T industry. With smaller banks needing to mark to market their underwater assets, they will need to restrict their lending as they build up their equity bases. Working from home during Covid completely changed the financial viability of commercial office buildings. Empty office buildings due to employees working from home is not an easy issue to resolve.  Also, going forward small and regional banks will be more scrutinized by the FDIC and the Fed due to these failures.

One other issue weighing on the markets is the debt ceiling which the Treasury Secretary, Janet Yellen, says could come as early as June 1st. President Biden plans to talk to the leadership of the House and Senate next week and try to get a deal done. Stock markets are watching this anxiously.

On the global political and military scene the attack on the Kremlin building last night may push Putin to use more offensive weapons against Ukraine. Some speculate that this drone attack was done by Russia to enrage its population and others that this was done by Ukrainian special forces to show that no target in Russia is out of reach. One other item of note is that the offensive by Ukraine that they say will start soon may not be feasible. The Polish Armed Forces Chief of Staff, General Rajmund Andrzejcak offered a bleak assessment of their ability to send ammunition to Ukraine. He said last Saturday that “we simply don’t have the ammunition. Our industry isn’t ready to send equipment to Ukraine and maintain our own dwindling reserves.” They are not the only NATO country not able to provide Ukraine munitions to sustain an offensive against Russian positions in the Donbas region. 

We continue to expect overall stock market weakness into June as many companies report problems in their businesses and that Q1/23 earnings and guidance are disappointing to the markets. Advanced Micro Devices (AMD -N) is down today by 8.5% as it reported a net loss for Q1/23 of US$139M versus a profit of US$786M in Q1/22. In addition their guidance was pessimistic. Our expectation is that the Dow will fall to below 30,000 before the end of next month. If there are more bank problems in the US, Europe or China during this period, the downside could be more painful. In this scenario the Dow would fall below the low of October 2022 at 28,700. 

So now we will wait to see if this unfolds. If it does, we may have the other two energy BUY signals triggered and we will add more ideas to our Action BUY List. The one I would love to see is the S&P Energy Bullish Percent Index falling below 5% which would trigger a Table Pounding BUY signal. The March 13th first BUY signal occurred when this Index fell to 8.7% (below 10% a BUY signal) from 43% just a week earlier. 

We are officially in the bullish camp for the energy sector but overall stock markets are currently overbought due to strong lifts in the FAANG tech names. We are waiting for the next oversold condition to add to our energy investments. Many energy stocks are down over 50% from their 2022 highs. If you want to see what our subscribers are looking at (the seven new ideas added on each of March 13 and March 15th to the eight already there – now a total of 22 energy investment ideas), sign up now for access to the Schachter Energy Research reports at https://bit.ly/2FRrp6k. We expect to add additional ideas during this next decline phase especially if the S&P Energy Bullish Percent Index falls below 5% and triggers a Table Pounding BUY signal. 

Bullish pressure for crude prices continues with the questionable production cutbacks by OPEC and rumors of more cuts to balance supply and demand as the banking crisis issues get resolved.  

Bearish pressure for crude comes from the weakness in economies in the US, Europe and Japan and where the recent OPEC report showed declining consumptions. Crude demand destruction due to weakening global economies could be greater than any supply cutbacks from OPEC. The US alone has consumption down by 4.8% from 2022 levels according to today’s EIA Weekly Petroleum Report (see below). China’s recent April manufacturing PMI at 49.2 versus 51.9 in March shows a slowing in activity. Over 50 shows growth, below 50 economic contraction.

EIA Weekly Oil Data: The EIA data (data cut-off April 28th) was moderately bearish for oil prices. US Commercial Crude Stocks fell 1.3 Mb to 459.6 Mb. Commercial Crude Storage is now 43.9 Mb or 10.6% above a year ago. The SPR saw a release of 2.0 Mb of crude again due to the administration approval. Total Stocks (excluding SPR) are up 87.8 Mb from a year ago or up by 7.7% to 1,234.3 Mb. . 

Total product demand fell last week by 403 Kb/d to 198 Mb/d from 20.2 Mb/d in the prior week and up 339 Kb/d from a year ago due to strong other oils demand. Motor Gasoline inventories rose 1.7 Mb while Distillate Fuels fell by 1.2 Mb. Refinery Utilization fell 0.6% to 90.7%. US production recovered 100 Kb/d from last week’s decline back up to 12.3 Mb/d last week. Cushing inventories rose 500 Kb to 33.6 Mb. Motor Gasoline consumption fell by 893 Kb/d to 8.62 Mb/d while Jet Fuel saw a rise of 7 Kb/d to 1.54 Mb/d. 

Demand destruction is real in the US. The numbers gyrate weekly but the important point is that demand has declined from last year. On a cumulative daily average for 2023 versus 2022, demand is down 5.2% (19.78 Mb/d versus 20.78 Mb/d). 

EIA Weekly Natural Gas Data: The EIA data released last Thursday showed a build of 79 Bcf addition for the week ending April 21st. Storage is now at 2.01 Tcf. The biggest increase was in the East (up 27 Bcf). This compares to the five-year injection rate of 74 Bcf and the 2022 injection of 40 Bcf. US Storage is now 35.4% above last year’s level of 1.48 Tcf and 22.2% above the five year average of 1.54 Tcf. NYMEX has retreated from US$7.10/mcf in mid-December to US$2.12/mcf today. AECO hovers around C$2.62/mcf. Natural gas prices may remain weak for a while until the summer air-conditioning season increases demand. 

Baker Hughes Rig Data: In the data for the week ending April 28th the US rig count was up two rigs to 755 rigs (up five rigs in the prior week). Of the total rigs working last week, 591 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 8% from 695 rigs working a year ago. The US oil rig count is up 7% from 552 rigs last year at this time. The natural gas rig count is up 12% from last year’s 144 rigs, now at 161 rigs.  

In Canada, there was a decrease of 12 rigs (down six rigs last week) to 93 rigs as spring break-up road bans are in place. Canadian activity is down 2% from 95 rigs last year. Activity for oil is lower by six rigs to 36 rigs working and is down 20% from 45 rigs last year. Natural gas rigs were down six rigs to 57 rigs but up from 50 rigs last year. After spring breakup is over we should see the rig count in Canada recover to over 200 rigs during the summer drilling season. 

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. So far this war cycle of Russia invading Ukraine has lifted WTI to US$130.50/b in March 2022 (US$75/b at the beginning of the year) to a low in 2023 of US$64.36/b or down by 51%.

CONCLUSION: 

We see the March crude price decline to US$64/b as likely being the low for 2023. However in light of the current banking crisis we may test those lows. Our optimism is due to our view that in Q4/23 we see WTI breaching US$90/b and in 2024 US$100/b. 

WTI is priced today at US$68.66/b down US$5.70/b from last week. We expect crude to trade down over the next few weeks as this current global banking crisis continues and intermarket margin calls weigh on liquids sectors. Take advantage of the bargains in energy stock prices. I expect at least one of the remaining two BUY signals to be triggered in the next few weeks and more ideas added to the SER Action BUY List. Subscribers, keep an eye in your in-basket when you see big down market days. These down market days are the best days to build your positions for the lengthy energy super cycle I see lasting into the end of the decade. 

Energy Stock Market: The S&P/TSX Energy Index today is at 221 (down nine points from last week) as the market reacts to the intermarket mayhem. We expect this Index to fall below 200 in the coming weeks. New BUY ideas are likely as more energy stocks fall into our BUY range. Decide where you want your energy weighting to be for 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. Add to your current ideas or add new ideas when we send out the next low risk entry point info . Review the coverage of all our Coverage companies and their Q4/22 and 2022 results that have been released in recent issues. Starting in May we will be covering Q1/23 results so there will be more recent information for you to review. 

We rejoined the bull camp on Monday March 13th when the first of our four BUY indicators kicked in. We added seven great ideas to the original eight. This took us to 15 great BUY ideas. On March 15th crude busted US$70/b (dropping to US$65.65/b) as fear of a global recession due to the financial crisis woke up memories of 2008-2009. The market got hit that day by the problems and later forced merger of Credit Suisse by UBS in a take-under that reminded investors of the forced merger of Bear Stearns into JPMorgan, another takeunder where Crude fell over US$5/b that day. We added seven more ideas that day taking the Action BUY List to 22 ideas. 

Many E&P companies now trade below their PDP levels (proved developed producing reserves). You get the proved non-producing, the probables, land and tax pools for free and with some you are being paid dividends (regular and specials providing yields in excess of 10%). That’s not easy to beat in other market sectors.  Many of the service companies are trading debt free or near debt free balance sheets and some are now paying dividends. And on the pipeline and infrastructure side you have companies trading with 6-7% yields and are trading 20-25% below their 2022 highs. In a recovery they should see 15%+ capital gains for total upside returns in this conservative sector of over 20% in the next twelve months. For E&P and Energy service stocks we see 50%+ upsides from capital gain potential and dividends for those that pay them. Why such upside?  We forecasted in recent months that WTI would lift into the US$80s during Q2/Q3 and for crude to trade in Q4/23 to reach above US$90/b. That should give the energy sector large capital appreciation potential.

If you are interested in access to the new BUY ideas and our research reviews, become a subscriber and get our timely BUY Action Alerts as well, go to https://bit.ly/2FRrp6k. 

Our next SER quarterly Webinar will occur on Thursday May 11th at 7PM MT. To join this 90 minute timely update on the markets and the best BUY ideas that we have one needs to be a paid SER subscriber. 

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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