ENERGY MARKET OVERVIEW
Crude prices have been rising since the start of the Biden Presidency when he declared war on the fossil fuel industry fulfilling the goals of his environmental focused Congressional supporters, mainly in the House. With a slim House and Senate majority he cancelled drilling on some federal lands and terminated the XL pipeline from Canada. This drove WTI prices up from US$75/b to US$95/b into mid-February. Then the Russian invasion of Ukraine started and crude prices rocketed higher as tough sanctions were applied and Russia lost access to the SWIFT financial clearing system. WTI rocketed to US$130.50/b in early March (Chart #25).
Since then the price has retreated to below US$100/b (Friday close US$102.07/b) as Russia was able to find ways to sell its oil and they only are having problems selling around 1Mb/d of their production of over 11.8Mb/d. With prices much higher than before the invasion Russia is making more money now. President Biden wants to stop this flow and is sending US crude from storage to Europe so that they can wean themselves off Russian oil if more sanctions are applied. Last week the US exported 14.6Mb with the bulk going to Europe. If Russia uses WMDs in their current military actions in the east and south of Ukraine, then Europe may trigger the end of Russian crude imports and the price of crude could spike to a new all time high. In 2008 the price reached US$147/b and we could see US$150/b or higher if the cut-off of Russian supplies is done quickly and without a backup plan to offset the volume loss.
The high oil prices that could result would make the recession in Europe more severe and the rest of the world would feel this pain. Central Banks will be forced to lower demand by pushing more financial austerity and weaken economies even faster. This is the outcome we expect. With a quick decline into recession, demand across the board for all commodities will weaken and the prices will reverse. In this scenario, we could see crude falling within a few months to below US$60/b. In recent articles we have highlighted the possibility that we could see US$150/b and also US$50/b in 2022. The high number in the next month or so and the low number in late Q3/22. Speculative investors have crammed into the energy trade (Chart #26) and this trade is crowded with bulls. If we see recession in a few months these traders will be hit with margin calls as prices retreat and we could see a fast plunge in price as margin calls force rapid selling. Just look at what happened in 2020 and how quickly prices collapsed. Oil speculators – Caveat Emptor!
Canada has been a big beneficiary of the Biden Administration’s reversal in policy towards the energy sector. In order to increase exports of lighter grade oils to Europe from Commercial Stocks, the SPR and rising light oil shale production, Gulf coast refineries need large amounts of Canadian heavier barrels of crude. Canada has met the challenge thanks to the expansion of Enbridge’s Line 3. Last week the EIA reported that Canada increased supplies to the US by 312Kb/d on the week to 3.465Mb/d, providing 61.2% of US Imports (Chart #27). What stands out is that Canada is providing 564Kb/d more than a year ago.
US crude production is also benefiting. Production has risen and reached 11.9Mb/d last week. In the key basins in the US (Chart #28) drilling activity is picking up due to the fabulous economics and President Biden’s 180 degree reversal to now ask the industry to grow production as a matter of national security! The EIA projects in their monthly US Drilling Productivity Report (Chart #29) that the main shale basins will see production rise by 132Kb/d in the month of May to 8.65Mb/d. Overall crude production in the US is forecast to grow to 12.5-13.0Mb/d by year end. The all time high was 13.1Mb/d and this could be exceeded this year if spending ramps up faster than consensus.
The E&P companies in Canada have responded to the need for more productive capacity. The weekly Baker Hughes drilling data (Chart #30) support the production volume growth thesis. The US rig count is up 59% from last year to 695 rigs of which 549 are drilling for crude oil (up 60% from a year ago). In Canada the rig count is currently depressed by the road bans during spring break up but are still up 84% to 101 rigs versus 55 last year. Once breakup is over this should recover quickly to over 200 rigs. An important point is that todays rigs drill faster and with pad drilling production can come on faster.
Insiders in the US have seen their stocks rocket higher this year and become one of the best performing sectors. They are now taking profits after the tough years that they faced when the industry was a pariah and access to capital was limited. Insider selling is now at the highest level seen in over a decade (Chart #31).
Natural gas volumes are also ramping up to meet domestic demand and the LNG export market. All US LNG export facilities are at full capacity so new operations need to get approvals. The industry has on the drawing board potential to more than double the current 14-15Bcf/d of capacity. The current high prices make this attractive to do but operators need long term commitments to justify the high capital costs.
The EIA forecasts that natural gas production in the US will grow by 0.72Bcf/d in May (see Chart #29 again) to 90.8Bcf/d. The biggest production rises are expected from the Haynesville, the Appalachia area and the Permian.
Storage right now is below the five year average and is not refilling as it has in the past due to the rise in LNG export volumes. Last week 53Bcf were added to storage (Chart #32) and this was just above the five-year injection rate of 44 Bcf (Chart #33). The problem is that storage is 16.8% below the five-year average and 22.8% below last years storage level. That is why NYMEX and AECO prices are staying at high levels. NYMEX last week traded at US$6.47/mcf and AECO at C$6.23/mcf. These are fabulous prices for this time of year and why natural gas stocks have been great performers.
The price of natural gas is now quite overbought and speculators are heavily involved (Chart #34). This is a recipe for a quick reversal if there is a market disruption or demand is curtailed by weather events (a cooler summer than forecast or the recession hits and lowers demand materially).
We like natural gas for the long term and see strong demand as we transition to renewables. However, a recession will hit this area just like it would hit crude oil. So be patient and wait for the next low risk entry point. In March 2020 we sent out a long list of Action Alert BUYS with a focus natural gas stocks and we believe such a window could occur during late Q3/22. Patience for now.