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:
OECD economies are facing recession to tame inflation and how severe it becomes or how long it lasts is the issue, not the direction. Consumer demand declines are being seen around the world as household budgets are strained by the inflation pressures of food, housing and energy. Adequate supplies of food may be problematic as crops this year may shrink due to extremely hot weather in key growing areas and the high input costs of fertilizers and fuel for farmers.
The Central banks cannot affect the supply side of the economy, only the demand side. Fed Chairman Powell talks regularly about impacting aggregate demand. Slowing economic growth and moving to recession is the main tool they have to lower inflation. The pressure needs to come off of rising prices. Shelter costs have risen as mortgage interest rates doubled over the last 18 months. Energy costs doubled since the start of the Biden administration. Sharp spikes have been seen in food prices, but some costly ingredients like grains still have to move through the supply chain. There is concern that the rate of inflation in the US could exceed 9% in August and September. Nothing the Fed does today can affect this rising trend in the near term. An aggregate demand decline takes time.
As recession unfolds, global demand for energy will decline. This demand destruction might be 4-5Mb/d and turn the current tight supply situation into a clear inventory build. Crude prices are very vulnerable to the downside. We see WTI below US$90/b in Q3/22 and quite a bit lower if the recession has a hard landing, which we expect.
Russia/Ukraine War Update: NATO is looking at adding new sanctions after the horrific bombing of a shopping mall near Kiev. One item already decided is banning buying Russian gold. Russia exports US$15B per year. This will not likely be effective. China, India and Switzerland have buying interest. There is a shortage of physical gold so this move helps these buyers. A more troublesome move was to stop rail shipments of certain goods from Russia through LIthuania to Russian Kalilningrad. The restricted list includes coal, metals, construction materials and advanced technology. Some of these items can be shipped by sea going forward but the supply chain challenges will take time to resolve. In retaliation Russia hit Lithuania with a massive cyberattack. No serious damage was done by this attack but more are expected if there is no resolution of the embargo.
NATO has announced a troop build up on the borders with Russia (to 300,000 from 40,000) and if implemented this would escalate tensions.
EIA Weekly Oil Data: The EIA data of Wednesday June 29th was moderately bearish for US oil prices. US Commercial Crude Stocks fell 2.8Mb to 415.8Mb. The Strategic Petroleum Reserve (SPR) had a release of 7.0Mb last week. Motor Gasoline Inventories increased 2.6Mb while Distillate Fuel Oil Inventories increased 2.6Mb. Total Stocks excluding the SPR rose by 6.3Mb. Refinery Utilization rose 1.0 point to 95.0% and is up from 92.9% last year. US Crude Production grew by 100Kb/d to 12.1Mb/d. Total Demand last week rose 93Kb/d to 20.0Mb/d as Distillate consumption fell 294Kb/d. Motor Gasoline usage rose due to the holiday long weekend by 417Kb/d to 8.92Mb/d while Jet Fuel Consumption fell 215Kb/d to 1.48Mb/d as bad weather caused flight cancellations and airlines are having difficulty staffing flights. Cushing Crude Inventories fell 700Kb last week to 21.3Mb.
EIA Weekly Natural Gas Data: Natural gas storage is now being built up for winter 2022-2023. The data released last Thursday showed a build of 74 Bcf which compares with a build of 92 Bcf in the prior week. Storage is now at 2.169 Tcf. The biggest increase was in the Midwest (24 Bcf). The five-year average for last week was an injection of 93 Bcf while in 2021 it was an injection of 76 Bcf. The lower injection rate this week is due to strong air conditioning demand with high temperatures across most of the US east coast and the US south. Storage is now 13.2% below the five-year average of 2.500 Tcf. Today NYMEX is at US$6.73/mcf. AECO is trading at $5.56/mcf.
In Europe mandatory gas storage rules are being implemented. In Germany measures are being added to conserve gas as Russian imports decline. Germany has restarted coal-fired power plants to meet electricity demand.
Baker Hughes Rig Data: In the data for the week ending June 24th, the US rig count rose 13 rigs (up seven rigs last week) to 740 rigs. Of the total rigs working last week, 594 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 60% from 470 rigs working a year ago. The US oil rig count is up 60% from 372 rigs last year at this time. The natural gas rig count is up 60% from last year’s 98 rigs, now at 157 rigs. The biggest rig increase was in Permian basin activity, with rig count up four rigs to 349 rigs. The industry is responding to higher prices with more activity which should lift overall US production in the coming months. Industry E&P companies are forecasting shortages of fracking crews later this year with prices rising materially.
In Canada there was a decline of two rigs last week versus 15 added in the prior week due to wet weather conditions. The total count is now 154 rigs. Canadian activity is up 22% from 126 rigs last year. Staffing of rigs in Canada and the US is a problem and adding significantly more rigs this summer may be problematic. While rig and frack day rates are rising, costs are as well. In the coming months the Canadian rig count should grow to in excess of 200 rigs again (peak potentially 220-250 rigs).
We expect to see US crude oil production reaching 12.5Mb/d in the coming months (now 12.1Mb/d, up 100Kb/d last week). The EIA recently forecasted US production reaching record highs over 13.1Mb/d in 2023.
Conclusion:
Bullish pressure on crude prices:
- Ecuador saw its production fall in half to 275Kb/d as indiginous nationalities demanded fuel subsidies. Over a dozen oil fields have been vandalized.
- China is beginning to reopen and demand for crude energy is expected to recover in the coming months. China is buying large quantities of Russian crude at a significant discount to Brent ($US34/b) to rebuild their Strategic Reserve (SPR). Russia is now China’s largest crude supplier supplanting Saudi Arabia.
- India is sharply increasing imports of discounted oil as the Indian government asked state energy companies to take advantage of the cheaper oil from Russia.
- The US has given permission to Venezuela to sell crude to Europe. ENI, an Italian energy producer, and Repsol (Spanish) are producing crude in Venezuela and are shipping it to their own host countries but also to their subsidiaries across Europe.
- OPEC has not met their monthly production growth targets and some of their members have had difficulty keeping production flat.
Bearish pressure on crude prices:
- The US economy is slowing quickly which will lower energy consumption. The US Consumer Expectations Index plunged to its lowest level in a decade at 66.7. The University of Michigan’s Consumer Sentiment Index fell to 50 this month, the lowest level on record. This survey was started in the 1940s so this is the lowest reading in 80 years.
- Europe is moving to reopen coal-fired power plants to meet their electricity demand. Germany is leading this movement with surprising support from their country’s Green party. Rationing of crude, crude products and natural gas are being considered as well. Other countries moving to add back their coal fired power plants are Italy, Austria and the Netherlands. The Dutch government has activated the first phase of their energy crisis plan.
- The likelihood of a worldwide recession is rising, shrinking aggregate demand by 4-5Mb/d worldwide.
- The high cost of energy is lowering consumers’ and industry’s capacity to handle the cost pressures. Some grain prices have doubled resulting in food costs exploding. Energy input costs have skyrocketed forcing many farmers to grow less of their acreage.
CONCLUSION:
The Russian invasion of Ukraine and the resultant tough sanctions against Russian crude oil sales to Europe has spiked up crude prices. We expect that higher energy costs will push economies into recession and this will drive down crude demand by 4-5Mb/d in the coming months. The US demand alone is down by 1.4M/d according to last week’s EIA data (20.0Mb/d versus 21.4Mb/d at the start of 2022). When global recessions unfold, crude prices 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$112.49/b due to NATO’s plan to add new sanctions against Russia.
Energy Stock Market: The stock markets around the world are gyrating with larger daily price moves mostly to the downside. Earnings and outlook forecasts have led to the downside pressure for the US markets. Results for Q2/22 start coming out in a few weeks and if disappointing, will accelerate the markets’ declines.
The S&P/TSX Energy Index is at 236 down six points today. A breach of 213, the mid-June low, could freak out bullish energy participants and cause a sharp decline to the 145-150 area this fall. Lower lows are possible if the global recession is more severe than we expect.
We are holding our next quarterly webinar on Thursday August 18th. If you want to join this event become a subscriber. Go to https://bit.ly/3jjCPgH.
Downside for the Dow Jones Industrials is towards the 24,000-25,000 range during Q3/22 (down from the year high at 36,953). Hold cash for the next great buying opportunity expected during Q3/22. A breach of June 17th’s low of 29,889 (the year low so far) would be very bearish for the market. Today the Dow is at 30,968.
Our 2022 ‘Catch The Energy’ conference is on Saturday October 22nd in Calgary at Mount Royal University. Our registration website will be opening in August. Please keep this date open and we will provide you with additional details as they become available.
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