Schachter’s Eye on Energy: US Budget Deficit And Debt Limit Negotiations Will Be Tough And Create Anxious Markets. Market Downside Could Be >10%.

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 remains challenged by sectoral forces of economic slowdown and general forces of inflation pressure. While the markets are forecasting that a pause in rate hikes is likely at their next FOMC meeting on June 13-14, the data will be the determining factor of what they do and recent data may require them to make another hike. 

Some examples of too strong data:

• The April US Jobs report showed a rise of 253K jobs way above the forecast of an increase of 180K. Average hourly earnings rose by 0.5% or at 4.4% annual rate above the 4.2% forecast. The unemployment rate fell to 3.4% from the prior 3.5%.
• Unit Labor costs in the US rose by 6.3% in Q1/23 way above the survey of 5.6%, 3.3% in Q4/22 and the Fed’s wish for this to go down to the 2-3% level. Non-farm productivity has worsened to a negative 2.7% in Q1/23 from 1.6% positive in Q4/22. 
• Today’s CPI data remains hot. It came in showing an annual increase of 4.9% (expectation of 5%), so a cooler number, but still more than double the Fed target. Core inflation came in at an increase of 5.5%, definitely a troubling number for the Fed. 

The banking and lending crisis in the US for Regional Banks is not over. With four bank failures so far and US$54B of losses for equity and debt holders, regional and smaller banks are still facing loss of deposits. The worry now is that the weak banks have large exposure to commercial real estate lending (landlords struggling to fill office buildings and shopping centers) which is a trouble area due to rate rises and lack of affordability. PacWest (PACW) and Western Alliance (WAL) may hit the wall in the coming weeks and who will be the savior next time after the FDIC takes over any weakened bank as it did with First Republic. Individuals are feeling the pain with the average interest rate on a 48-month new car loan at 7.46%. Additionally people are using their credit cards more to make ends meet. Loans were up US$85.8B in Q1/23. 

Deposit outflows in the last three weeks appear to have been over US$360B. The largest outflow seems to be foreign banks in the US. Some Canadian banks with branch systems in the US have been impacted by this. 

The near term 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 talked yesterday with Speaker McCarthy but no progress was made. They meet again this Friday. At least now budget cuts are on the agenda. This may drag out and each move will either help or hurt markets. A nasty gyrating market may occur over the next few weeks as the deadline approaches. We see overall markets having a downside of 10%, with the Dow potentially breaching 30,000 (now 33,332) if a partial closure of some government departments occurs. In the end a last minute deal should occur but it may just be for a short term deal to keep the issue in the mind of voters during the upcoming 2024 election cycle. 

On the global political and military scene, the Ukrainian offensive is expected to start soon and how effective it is and how long they can move aggressively will tell the tale of which side has more men and more munitions. Israel is facing problems in the GAZA and fears Iran, so these areas may turn into hotter spots. 

So now we will wait to see what unfolds. If a significant market decline unfolds, we will likely see additional 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. The S&P Bullish Percent Index is now at 35% and is down over the last four weeks from 70%. In March as the markets plunged this Index fell from 43% to the 8.7% trigger (below 10%) in two weeks. So things can move fast in large downside market declines.

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 4.3% 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 May 5th) was moderately bullish for oil prices. US Commercial Crude Stocks rose 3.0 Mb to 462.6 Mb. Commercial Crude Storage are now 38.4 Mb or 9.0% above a year ago. The SPR saw a release of 2.9 Mb of crude again due to the administration approval. Total Stocks (excluding SPR) are up 78.4 Mb from a year ago or up by 6.8% to 1,234.7 Mb. One key item was that Exports rose by 1.86 Mb/d or by 13.0 Mb, draining US reserves to aid Europe. 

Total product demand rose last week by 358 Kb/d to 20.2 Mb/d from 19.8 Mb/d in the prior week. Motor Gasoline inventories fell 3.2 Mb while Distillate Fuels fell by 4.2 Mb. Refinery Utilization rose 0.3% to 91.0%. US production remained at 12.3 Mb/d last week. Cushing inventories rose 400 Kb to 34.0 Mb. Motor Gasoline consumption rose by 685 Kb/d to 9.3 Mb/d while Jet Fuel saw a rise of 378 Kb/d to 1.9 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 4.3% (19.8 Mb/d versus 20.7 Mb/d). 

EIA Weekly Natural Gas Data: The EIA data released last Thursday showed a build of 54 Bcf addition for the week ending April 28th. Storage is now at 2.06 Tcf. The biggest increase was in the East (up 20 Bcf). This compares to the five-year injection rate of 79 Bcf and the 2022 injection of 77 Bcf. US Storage is now 32.6% above last year’s level of 1.56 Tcf and 19.8% above the five year average of 1.72 Tcf. NYMEX has retreated from US$7.10/mcf in mid-December to US$2.20/mcf today. Natural gas prices may remain weak until the summer air-conditioning season increases demand. 

Some scientists believe that we will experience an El Nino pattern starting in September. It could have a meaningful impact on the weather this winter. The last time this occurred was in 2018-2019 and we saw cold weather early in the winter and NYMEX spiked from US$2.45/mcf to a peak of US$4.92/mcf. 

Baker Hughes Rig Data: In the data for the week ending May 5th the US rig count was down seven rigs to 748 rigs (up two rigs in the prior week). Of the total rigs working last week, 588 were drilling for oil (down three from the prior week) and the rest were focused on natural gas activity. The overall US rig count is up 6% from 705 rigs working a year ago. The US oil rig count is up 6% from 557 rigs last year at this time. The natural gas rig count is up 8% from last year’s 146 rigs, now at 157 rigs.  

In Canada, there was no change in the rig count this week (down 12 rigs last week) which was at 93 rigs. With fire issues in NW Alberta and NE BC, we expect to see a decline this week. Fortunately no one has been hurt and the people moved to safety (nearly 30,000)  have been well taken care of. Many companies announced shut-ins of production as they await progress on putting out the fires. The Drayton Valley area seems to have been the worst hit. Recent wet weather has also helped to alleviate the challenges in fighting the fires. Canadian activity is up 2% from 91 rigs last year. Activity for oil is lower by two rigs to 34 rigs working and is down 19% from 42 rigs last year. Natural gas rigs were up two rigs to 59 rigs and were up from 49 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 on the sector  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$72.36/b. 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 on 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 225 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 what 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 hard to beat in other market sectors.  Many of the service companies are trading debt free or near debt free and some are now paying material 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. 

We are working on our next SER issue and in it we will cover 20  companies that have recently reported their Q1/23 results. This will be released on May 18th. 

Our next SER quarterly Webinar will tomorrow 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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