Finally The Takeoff Year. Our Fearless Forecasts!
With the negative psychology, bearish outlook and very low (and in some cases recent record low) energy and energy service stock prices, here’s why we see the energy sector coming out of the doghouse into the limelight in 2020 after a disappointing 2019. In our view the negatives that hit the sector this year change to supporting issues in 2020.
- Low oil prices in late 2019 in the US$60/b area should see US production not grow meaningfully in 2020 from its current 12.8Mb/d. Tier one wells are not performing as well as forecast, companies are not planning to spend more than cash flow and many plan to use any free cash flow to pay down debt and buy back shares.
- With 2020 a US election year, the focus will be on keeping the economy as strong as possible and this will require President Trump to finalize a trade deal with China that helps him in the farm belt and industrial states. This should improve Asian demand for energy.
- An underfunding of investment over the last few years should show non-OPEC Reserve Life Indices shrinking. This should come out with the reserve reports that are released in late Q1/20. Non-OPEC production which is forecast to grow by over 1.0Mb/d in 2020 may only grow by 300Kb/d-500Kb/d, giving OPEC more demand and pricing power as inventories tighten.
- Many leveraged players in the US could see lenders pull the plug especially if they show significant impairments of assets at the end of 2019. A few notable bankruptcies would provide a focus on the industry needing higher prices to justify the capital spending.
- In Canada the October election giving the Liberal a minority government has meant a change in attitude towards the energy industry. A respected politician, Chrystia Freeland, has taken on the intergovernmental role and is now meeting regularly with western Premiers (listening to them versus ignoring them as before by the PM), and the Energy Minister, Seamus O’Regan, is from Newfoundland and Labrador which has an active and growing energy industry.
- Egress issues should see some alleviation as more demand for natural gas in Alberta and more takeaway capacity for both oil and natural gas provide decent volume growth in 2020 and even more so in the outlier years.
- OPEC and Saudi Arabia are moving their modus operandi from increasing market share to higher profitability of every barrel sold. The issue of ARAMCO going public this month is a game changer for Saudi Arabia. They will need a successful stock issuance if they are going to be able to sell more ARAMCO shares in 2021 and beyond, using the funds to diversify their economy. Therefore their focus will be on maximizing revenues with profitability and the ability to raise dividends over time. Now they will want gradually rising prices for crude rather than market share. Saudi Arabia as a result, is now a price hawk versus a market share player. They need to see a rising stock price for ARAMCO.
A new commodity bull market cycle started in 2016 and currently the precious metals are leading the commodity board higher. Palladium is the winner so far and is at all time highs (Chart #19) now at US$1,914/oz, much above its 2000 high of US$1,090/oz.
Gold has broken its seven year bear market and has risen to US$1,472/oz (Chart #20) but is still below its all time high of US$1924/oz seen in 2011. If the Central Banks continue with the monetary easing (both the price and volume of money) and government deficits remain large and growing; then currencies will be debased and precious metals will prosper. Even Central Banks are now adding to their gold holdings as they get weary of holding currencies of countries that are likely to debase or default on their debts.
Commodity prices are very low on a valuation basis and appear to be the cheapest asset class out there. In Chart #21 and #22, one can see how cheap the sector is versus the Dow Jones Industrials Index and the S&P500. In fact it is now at the lowest relative valuation since the early 1970s when the last commodity boom took off.
The CRB Index (Chart #23) is made up of various components the largest being energy (39%), agriculture (34%), industrial metals (13%), precious metals (7%) and livestock (7%). We will be watching each of these subsectors to see rising prices helping to lift each component. If there is a successful and meaningful trade deal with China in Q2/20 then the agriculture, industrial metals, livestock and energy components should all see upside. A breakout above 190 (now 181 – Chart #24) would be a great sign that this is occurring. The all time high was in 2008 at 474 for the CRB when crude oil peaked at US$147/b. The low was in early 2016 when crude oil was at US$26/b driving the CRB down to 155.
Our forecast for crude oil is for flattish prices in 1H/20 (US$56-68/b) followed by much stronger prices of over US$70/b (range US$65-80/b) in 2H/20 (Chart #25) as it becomes apparent that non-OPEC crude volumes are not growing anymore (key the US shale industry). As you can see from the chart we see even higher prices in 2021 and a big jump in prices as we head into the peak of this commodity cycle around 2025. Crude oil should peak at the end of this new commodity cycle at over the high seen during Q2/08 of US$147.27/b. A likely high could be over US$150/b on some supply disruption event in the Middle East from one of the larger OPEC members.
The keys for energy are (Chart #26 & 27):
- Natural gas demand will see the largest growth of fossil fuels over the period into 2040.
- Renewables will grow at the fastest rate due to government incentives.
- Coal will see only minimal growth as countries move off this environmentally problematic fuel.
- Nuclear and biomass are inconsequential to meet the overall demand growth for energy.
- The largest growth in North American power capacity generation into 2040 will come from natural gas followed by renewables.