Schachter’s Eye on Energy: Energy Bulls Are Focused On Big (>1.0 Mb/d) Cuts From OPEC+ In July. If This Did Not Occur Than Prices Are Likely To Head Down For A While.

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 39 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 battle between fiscal and monetary policy hawks continues. Elected officials around the world don’t want to balance budgets and see giving largess via special interest needs, as good political policy to stay in power. Deficit spending is out of control and it has moved to the monetary policy side to cool inflation (that the Central Banks created with low interest rates and significant liquidity). Now Central Banks have raised interest rates in most OECD countries to over 20 year highs and are doing Quantitative Tightening (QT). The push and pull of this is creating stresses that may in election years find themselves in unpalatable situations to keep their economies from heading into more than a soft landing scenario (the current thesis). 

Some of the items moving around the bulls and the economic bears are:

• The US got its credit rating downgraded on August 1st by Fitch to AA+ from AAA. In their reason for doing so they stated what it called an ‘erosion of governance’. Fitch projects US deficits will rise from 3.7% of GDP in 2022 to 6.3% this year (a whopper of an increase) and then to 6.6% in 2024 and to 6.9% in 2025. These highlight the  unsustainable spending on the fiscal policy side. Fitch sees a US recession starting in Q4/23 and lasting through 2024 but does not indicate the severity of their expectation. 
• Negative M1 and M2 money supply measures in many countries.
• Lending has tightened in many OECD countries especially in the US due to bank runs continuing and lending standards have tightened due to potential tighter Fed requirements commencing October 1st.
• Last week the FDIC took over a weak Kansas bank, Heartland Tri-State Bank and merged it into a competitor Dream First Bank. The FDIC expects to lose 40% of the failed banks assets in the forced deal.  
• The US government is planning a record US$1T of net marketable securities in Q3/23, 37% above the market expectation. Rates across the spectrum have lifted. US 2-year Treasury yields are now 4.97% up from 4.59% in mid-July but still below the high of 4.99% seen in early July. A rise over 5.0% would spook the markets. Recent bond issues have seen low bid-to-cover ratios and banks have not been big participants of longer dated paper as they work to meet tougher balance sheet requirements. 
• US Core PCE remains too high at 4.1%. This is the Fed’s favourite inflation number and they want this down to 2%. 
• US Real GDP rose 2.4% aiding the soft landing view. 
• China announced that its manufacturing data fell to 48.7 (below 50 is a contraction) and was the lowest level since June 2020.
• Manufacturing in Germany, France and Italy are showing marked declines since June.

The war in Ukraine is seeing more escalations as one side hits the other and this is now spreading to daily drone attacks on Moscow by Ukraine and the Black Sea Ukrainian grain ports being blockaded and attacked by Russia. A lot of the grain infrastructure at the export Ukrainian ports has been severely damaged. 

Some recent events: 

• The major offensive by Ukraine has started according to President Zelensky now that the NATO trained and equipped brigades are in the front lines. Total forces by Ukraine are believed to be over 150,000.  So far no bragging rights for Ukraine as stubborn defending by Russian forces behind trench lines and massive mine fields slows down the Ukrainian forces. An incredible number of drones (tens of thousands daily) for intelligence and attacking are being seen across the battlefield. Russia seems to have learned from their earlier battlefield mistakes and with multiple lines of defense seem to be keeping the  Ukraine offensive from succeeding. 
• Biden has ordered more military reserves to backstop NATO forces and to maintain equipment given to Ukraine. 
• Ukraine’s accuracy with its drones is getting better. They hit buildings in the heart of the Oligarch’s compounds, and the Moscow airport. This is bringing the war to everyday Russian citizens. 
• The Wagner group has moved to Belarus and is rebuilding. They are also training Belarusian troops to join them when they next go on the offensive. Some forecasters see them going after Ukraine from the north (maybe towards Kiev), others that they may attack NATO supply depots in Poland, Romania or the Baltic States. Euro news speculates that the Wagner troops could ‘cut-off’ the Baltic States from NATO.
• Bottom Line:  This war is dragging out and the Russians would love to see miniscule success by the Ukrainian counter-offensive once fall is over and winter arrives, moving the next fighting season to spring 2024.

Market Movement:  Overall earnings expectations for the S&P 500 are a decline of >7% in earnings comparisons from last year. Stock multiples are high and if earnings are heading downward there can be a material near term correction. We are watching the 33,600 level for the Dow, which if breached would complete a topping formation for the Dow. A close below 32,600 would set up the waterfall decline phase to below 30,000. Stay patient with cash reserves and be ready to BUY at the next low risk entry point. Don’t get trapped by this current euphoria. 

The start of energy earnings results shows weaker comparisons. Last year in Q2/22 WTI prices averaged US$108.57/b and this year US$73.99/b or down by 32%. So comparison this quarter may prove disappointing especially for natural gas focused entities. Last year AECO traded at C$6.27/mcf and this year at C$2.35/mcf, or down by 63%. The early E&P reporters are showing weaker cash flows and free cash flows. 

Get ready to be buyers once this expected correction has lowered stock prices and fear has returned to the markets. The CNN Fear & Greed Index was recently at an extreme greed reading of 84, pushing near a record high. Recent market weakness has pulled it down to 68 today. Bottoms usually occur below a 20 reading. The S&P Energy Bullish Percent Index rose last week to 91% (a take profits level). It is now backing off and we expect to see when the general stock market plunges into near exhaustion that it will again give a BUY signal below 10%. 

We are waiting for the stock market to get oversold again to add to our energy investments. Many energy stocks are down over 50% from their 2022 highs, and many trade again below Proved Developed Producing (PDP) Reserve valuations levels. If you want to see what our subscribers are looking at, 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 10% and triggers the next BUY signal. 

Bullish pressure for crude prices comes from the announcements of August production cuts by Saudi Arabia, and Russia which they plan to now extend into September. This squeezed crude short sellers and drove the price of WTI up by over US$10/b over the last five weeks. The question is are these real barrel cuts at the levels announced or just more rhetoric to squeeze shorts. The cuts that have been announced have been mostly of heavier sour grades, while light oil grades remain plentiful. Iraqi exports via Turkey remain held up by the Iraqi government adding to the tightness. 

Bearish pressure for crude comes from the weakness in OECD economies in the US, Europe and Japan. China’s manufacturing weakness and sluggish consumer spending add to the malaise in that country. 

EIA Weekly Oil Data: The EIA data (data cut-off July 28th) was supportive of crude prices as Crude Commercial Crude Stocks fell 17.0 Mb (forecast a decline of 1.35 Mb) to 439.8 Mb as an an EIA adjustment, lowered volumes by 1.92 Mb/d or 13.4 Mb last week. Net Imports fell 391 Kb/d taking 2.7 Mb/d out of storage. Storage is now 13.2 Mb above last year’s 426.6 Mb in Commercial Stocks. The SPR saw no change again last week, the third such result this year. Motor Gasoline inventories rose 1.5 Mb while Distillate Fuels saw a decline of 0.8 Mb/d. Refinery Utilization fell 0.7% to 92.7%. US crude production remained at 12.2 Mb/d. Compared to a year ago US Crude Production is only up 100 Kb/d. Cushing inventories fell 1.26 Mb to 34.5 Mb. This fits with our view that by winter 2023-2024 WTI crude prices will exceed US$90/b as global demand exceeds global supplies during the highest demand period of winter. 

Motor Gasoline consumption fell 100 Kb/d to 8.84 Mb/d. Jet Fuel saw a decrease due to flight issues and was down 81 Kb/d to 1.73 Mb/d. Total Demand fell 1.254 Mb/d to 20.0 Mb/d as Other Oils consumption fell 972 Kb/d to 4.59 Mb/d. 

Total US consumption is now slightly above last year. This week consumption was at 20.0 Mb/d versus 19.95 Mb/d last year at this time. This of course is a big contributor to the bullish case going forward for crude oil now.  

EIA Weekly Natural Gas Data: The EIA data released July 31st showed a build of a very low 16 Bcf for the week ending July 14th (injections was expected at >30 Bcf) as electricity demand rose sharply during this very hot summer. Storage is now at 2.99 Tcf. The biggest increase was in the Midwest (16 Bcf). This compares to the five-year injection rate of 24 Bcf and the 2022 injection of 32 Bcf. US Storage is now 23.7% above last year’s level of 2.41 Tcf and 13.1% above the five year average of 2.64 Tcf. NYMEX is at US$2.50/mcf as some weather forecasters see a cooling trend next week. Electricity availability is very tight in many places across the US and rolling blackouts may occur in the coming weeks if temperatures again rise over 110 F degrees. Many electricity providers have requested less usage during the peak hours so as not to face the blackouts. 

Our forecast is for NYMEX to rise >US$3.50/mcf this fall as hurricane season commences and to rise over US$4.50/mcf during winter 2023-2024. Europe may see rising natural gas prices as the Netherlands closes Europe’s largest gas field (Groningen) in October. This will tighten up supplies for winter 2023-2024 and if winter is cold, lift prices materially. We recommend buying the very depressed natural gas stocks during periods of general market weakness. We intend to add additional natural gas names to our Action BUY list when we get the next low risk energy BUY signal. 

Baker Hughes Rig Data: In the data for the week ending July 28th the US rig count fell five rigs (down six rigs last week) to 664 rigs. Rig activity is now 13% below the level of 767 in 2022 as low commodity prices slow down spending. If this lower activity persists over the next few months then production will fall off for both commodities and this will set the stage for the next upward cycle for crude and natural gas pricing. Of the total rigs working last week, 529 were drilling for oil and this is 13% below last year’s level of 605 rigs working. The natural gas rig count is down 18% from last year’s 157 rigs, now at 128 rigs which will impact production levels materially in the coming months. The natural gas focused Haynesville now has 44 rigs working down from 69 rigs working last year or down by 36%. Natural gas supplies could fall 2-3 BCF/d by year end due to the lack of drilling and demand should pick up once annual maintenance is completed at key LNG facilities and winter exports ramp up. 

In Canada, there was a six rig increase in the rig count (no change last week) to 193 rigs as summer drilling activity picked up. Canadian activity is now only down 5% versus last year when 204 rigs were working. Activity for oil is now at 121 rigs compared to 137 last year. Activity for natural gas rose five rigs to 72 versus 67 last year. The focus on natural gas drilling has been on the liquids rich condensate Montney and Duvernay plays.

Catch the Energy Conference Update: Tickets are now on sale for the public. Become a subscriber and get two free tickets to the conference (tickets to the public are on sale at $119 per ticket each during the early bird window into the start of September). To find out more go to https://gravitypull.swoogo.com/catchtheenergyconference2023. We did sell out last year so if you would like to attend please get your tickets as soon as possible. Thank you to our Sponsors, Exhibitors and Presenters. It is going to be a great lineup this year!

Energy Stock Market: The S&P/TSX Energy Index today is at 242 up three points from last week on the rise in WTI to >US$82/b. As the general market decline unfolds and the Dow Jones Industrials breaches 30,000, we expect the S&P/TSX Energy Index to fall below 200. This would trigger another key BUY signal for us. Get your BUY List ready!

New BUY ideas will be issued as energy stocks fall into our BUY ranges. 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 recommendations. We expect that WTI should lift above US$90/b during Q4/23 as demand recovers and demand then will clearly exceed supplies. That should give the energy sector large capital appreciation potential.

CONCLUSION: 

We see the March crude price decline to US$64/b as being the low for 2023. However, we may test levels below US$70/b over the coming weeks. Our optimism on the sector is due to our view that in Q3/23 we will seen WTI exceed US$80/b (this has now occurred) and in Q4/23 we see WTI breaching US$90/b and in 2024 US$100/b as demand rises and exceeds supplies. The rise in the last week to US$80 met our third quarter price target forecast. Near term we expect to see a backoff in prices as the general stock market correction impacts most areas and energy is normally one that corrects. 

WTI is priced today at US$79.61/b, up nearly US$1/b from last week on the optimism that OPEC+ will cut 1.5 Mb/d (1.0 Mb/d from Saudi Arabia and 500 Kb/d from Russia) over the July/August/September period. We don’t see such a major cut coming as Russia especially needs all the revenues it can get. Yes, it will export less from western Baltic ports (200-300 Kb/d) but it will sell more crude and products via eastern ports to its major buyers in China, India and the Middle East. These Middle East producers are buying Russian products at discounts to Brent (naphtha, jet fuel, gasoline, propane etc.) and then sell their crude oil at full Brent pricing. The next OPEC Monthly Report comes out next Thursday August 10th and if OPEC cuts are less than 600 Kb/d and Russia is a net zero, then crude prices will retreat. Some forecasters see the Saudi cuts for July at 311 Kb/d, others at 500 Kb/d and the most bullish at 860 Kb/d. Next week the official data will confirm if the bulls are right or was this another move by Saudi Arabia to beat up commodity short sellors. 

If our stock market view is correct then we should see WTI crude trading below US$70/b once again. This should be a temporary market event as we see prices rising materially (to over US$90/b) once the cold weather of winter 2023-2024 arrives. 

As markets retreat we expect to take advantage of the bargains in energy stock prices. More BUY ideas will be added to our Action BUY List when we get the next low risk BUY window. Down market days during that time are the best days to build your positions for the lengthy energy super cycle we see lasting into the end of the decade. 

Our next SER Interim Report comes out Thursday August 17th. We start the Q2/23 earnings results and review 17 companies in this issue. We intend to terminate Coverage of one E&P entity which is doing a big no-no, that of increasing its debt load while seeing a production decline. We go through all the reasons for this in that report.  If interested in our review of the covered companies in our upcoming Q2/23 result write-ups and the info on the terminated company then please become a subscriber. Go to https://bit.ly/2FRrp6k.  

Please also note that we are having our third quarter webinar for subscribers on Thursday August 17th at 7PM MDT. This will be a 90-minute review of Q2/23 reporters and highlighting the best BUYS that we see at that time if the decline we expect in the coming weeks occurs. 

Our 2023 ‘Catch The Energy’ has its Presenter line-up almost complete. We expect to have 45 Presenters (10 Presenters from the TMX on Clean Tech and important renewable materials, up from five in 2022). We have taken more space this year and have expanded our booth rooms so attendees can spend more time with the Presenter companies and their senior executives. We have increased MRU capacity to 750 attendees due to the oversold condition last year. Early bird tickets are available now for $119 each at https://gravitypull.swoogo.com/catchtheenergyconference2023.

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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