Schachter Energy Report

Eye on Energy: June 7
Schachter's Eye on Energy

China Exports Declined 7.5% In May. This Weighs On Crude Prices.

Global Economic, Political & Military Update

The passage and signing of the debt ceiling bill last week gave the stock markets a bit of a bounce. President Biden got credit for getting a deal done with bipartisan support (more Democrats voted for the deal than Republicans 165 versus 149) and Speaker McCarthy took a victory lap as he did get some spending cuts (as well as limits to growth of spending) and gutted the planned increase in IRS agents. Now that this issue has been deferred into 2025, after the next Presidential election cycle, the ball now gets passed to the Treasury to refill its coffers.

Over the next 30 days or so we should see US$400-$US600B raised via T–Bills and Treasury notes/bonds to give the Treasury the funds it needs to pay day to day expenses. Markets will be watching to see if this large funding requirement will crowd out other borrowers. Next Wednesday we get the results of the June FOMC meeting. Some forecasters expect a hike skip, while others expect the Fed to raise rates by 25 BP. The press conference thereafter will be watched closely for the wording the Fed Chairman uses about the go forward in their thinking.

Today’s Bank of Canada increase of 25 BP to 4.75% (their highest level in 22 years) will likely impact what the Fed does. The US economic data between today and next Wednesday will be of particular importance. Right now the balance is towards a rate rise due to the strong May jobs report released last week. Non-Farm payrolls were expected to grow by 180K jobs but increased much faster, at up 339K jobs. In the data, wage inflation remains problematic. Average hourly earnings grew by 4.3%, double the rate that the Fed wants to see. The tight labour market and rising wage rates are critical for the Fed which wants to see this key area of their mandate less inflationary.

The spring offensive by Ukraine has started but appears to have stumbled. The counteroffensive against five areas taken by Russia was stopped by strong Russian defensive action. To slow down the wide area of the fighting, one of the protagonists blew up a strategic dam (Kakhovka) which has now flooded a large area around the Dnieper river. Both sides blame the other. Russia benefits as it halts Ukraine’s southern offensive in the flooded area and they can move resources to other areas under attack. For Ukraine it limits Russia moving on the offensive in this same area. Ukraine also benefits when the waters decline as the area’s fortifications and minefields are expected to have washed away. In the meantime civilians have been forced to move north to Ukrainian controlled areas and had to leave their homes in a hurry. One big concern is that the dam’s water supply was being used to cool the nearby Zaporizhzhia nuclear power plant. Levels in the plant cooling pond are reported to be sufficient for now but will become problematic in the coming weeks.

The aggressive activity and rhetoric from China about taking over Taiwan is seeing escalation. Chinese fighters have been making aggressive moves against US recon flights in the South China Sea. China sees these flights as provocative in their area of influence and control. How would the US see Chinese fighters flying from Cuba or Venezuela to the international waters along the US east coast? Additionally in recent days there have been incidents of Chinese warships moving near US warships and sometimes moving aggressively in front of them to force the ships to maneuver away from the Chinese coast. The concern that China may be planning to blockade Taiwan remains. This could have a significant impact on world economies given Taiwan’s strategic place in producing high-end semiconductor chips.

We are in the bullish camp for this energy super cycle but are concerned about too much speculation in the tech sector, particularly the AI stocks. We suspect a general stock market correction will unfold in the near term which will take the Dow down >10% to below 30,000 (now 33,611), the S&P 500 down >15% to 3,600 (now 4,278) and the NASDAQ Composite down around 17% to <11,000 (now (13,219). We had expected the market to have broken down already but this has been delayed by the debt ceiling agreement and the recent love affair with AI related stocks. A breach and close below 32,900 for the Dow should start the downside pressure for all the indices. This decline could extend into late July versus our prior expectation of late June.

Get ready to be buyers on this dip/correction. We are waiting for the next overall stock market to get oversold again 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, sign up now for access to the Schachter Energy Research reports. 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.

EIA Weekly Oil Data

The EIA data (data cut-off June 2nd) was bearish for crude prices as demand was weak and Net Imports rose 1.6 Mb/d or 11.4 Mb on the week. US Commercial Crude Stocks fell 0.5 Mb to 459.2 Mb. Energy demand fell 221 Kb/d on the week as Other Oils demand fell 523 Kb/d. Commercial Crude Storage is now 42.4 Mb or 10.2% above a year ago. The SPR saw a release of 1.9 Mb of crude last week. Overall stocks (excluding the SPR) rose 12.8 mb on the week.

Total product demand fell by 221 Kb/d to 19.2 Mb/d from 19.4 Mb/d in the prior week and won 1.0 Mb/d from 20.2 Mb/d last year at this time. Motor Gasoline inventories rose 2.7 Mb while Distillate Fuels rose by 5.1 Mb. Refinery Utilization rose 2.7% to 95.8%. US crude production rose by 200 Kb/d to 12.4 Mb/d last week and is up 500 Kb/d from 11.9 Mb/d last year. Cushing inventories rose 1.7 Mb to 40.6 Mb. Motor Gasoline consumption rose by 120 Kb/d to 9.2 Mb/d while Jet Fuel saw a decline of 288 Kb/d to 1.49 Mb/d.

EIA Weekly Natural Gas Data

The EIA data released last Thursday showed a build of 110 Bcf for the week ending May 26th. Storage is now at 2.45 Tcf. The biggest increase was in the East (up 33 Bcf). This compares to the five-year injection rate of 104 Bcf and the 2022 injection of 90 Bcf. US Storage is now 29.5% above last year’s level of 1.89 Tcf and 16.8% above the five year average of 2.10 Tcf. NYMEX retreated from US$7.10/mcf in mid-December 2022 to a low of US$1.95/mcf in April. It is up six cents today to US$2.32/mcf. We are now in the air-conditioning season so prices should see even more of a bounce as the weather gets hotter and electricity use rises.

Scientists believe that we are experiencing a major El Nino event this year. The effect has already been seen in Chile. China is feeling this via the hottest weather for this time of year ever. More forest fires are being seen around the world as dry conditions leave forests vulnerable. Eastern Canada and the US are experiencing dark skies and heavy particulates that affect breathing. Western Canada is experiencing hotter temperatures and the risk of more fires is high.

This system is forecasted to have a meaningful impact on the weather this winter with much colder weather and more precipitation (rain and snow). The last time this occurred was in 2018-2019 and we saw NYMEX spike from US$2.45/mcf to a peak of US$4.92/mcf in three months.

Our forecast is for NYMEX to rise to US$3.50/mcf this summer and to rise over US$4.50/mcf during winter 2023-2024. 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 June 2nd the US rig count was down 15 rigs to 696 rigs (down nine rigs in the prior week). Rig activity is now 4% below the level of 727 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 up the next upward cycle for crude and natural gas pricing. Of the total rigs working last week, 555 were drilling for oil (down 15 from the prior week) and below last year’s level of 574 rigs working. The overall US rig count is down from 727 rigs working a year ago. The natural gas rig count is down 9% from last year’s 151 rigs, now at 137 rigs. The natural gas focused Haynesville now has 52 rigs working down from 68 rigs working last year or down by 24%.

In Canada, there was a 10 rig increase last week (up two last week) to 97 rigs as activity picked up after the recent fires. Canadian activity is down 17% from 117 rigs last year. Activity for oil is now at 51 rigs compared to 72 last year (down 29% from a year ago). Activity for natural gas was up one rig to 46 rigs and up one rig from the 45 rigs focused on natural gas last year. The focus on drilling has been on the liquids rich condensate Montney and Duvernay plays. This summer we expect the rig count in Canada to recover to over 200 rigs during the pearl of the summer drilling season.

Energy Stock Market

The S&P/TSX Energy Index today is at 231 (up 10 points from last week) due to rise in crude prices due to the debt ceiling deal and the Saudi short squeeze. 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.

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. Review the coverage of all our companies and their Q1/23 results in our recent research reports.

Many E&P companies trade below their 1P levels (proven reserves) and some even below their PDP levels (proved developed producing). You get the probables, land and tax pools for free. Some also pay shareholders healthy dividends (regular and specials). Yields of over 7% are available from many ideas on our Action BUY List, which is hard to beat in other market sectors.

Many of the service companies are trading debt free or near debt free and are paying decent 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 or 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 should lift into the US$80s during Q3/23 and for crude to trade in Q4/23 above US$90/b. That should give the energy sector large capital appreciation potential.

As the market decline unfolds, we expect additional BUY signals to be 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% is a BUY signal) from 43% just a week earlier. The S&P Bullish Percent Index is now at 39%. 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.

Our next SER Report comes out next week Thursday (June 15th) and includes the quarterly update on the last of our 37 covered companies. In addition, we have added a new feature ‘Timely Investment Ideas’ with our first recommendation. This E&P company has significant near term activities that could lift the stock price as the production milestones are achieved.
If you are interested in access to the review of all 37 companies Q1/23 results covered in our recent reports, become a subscriber. You will also get our timely BUY Action Alerts when they are issued.

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