Schachter Energy Report

Eye on Energy: June 26
Schachter's Eye on Energy

Total US Energy Stocks Rose 9.4 Mb Last Week. WTI Crude Should Breach US$80/b In The Coming Days.

Global Economic, Political & Military Update

Mixed economic data continues to sway markets from euphoria to concern as each data piece is scrutinized for signs of economic progress with declining inflation or signs of economic weakness and job layoffs with rising inflation. 

Canada got a surprise on the inflation front on Tuesday with the core May CPI (month over month) which rose 0.6%, way above the forecast of up 0.3%. The headline rate was up 2.9% but the service sector increase was up 4.6%. This will keep the Bank Of Canada from cutting again in the near term.  The culprits for this increase were service sector components such as higher flight costs, rents and cell phone plans. 

California’s implementation of higher minimum wages caused a sharp increase in unemployment as many businesses could not afford the higher wage costs and just closed. Nationally jobless claims are at 11% of the workforce and in California it is 20%. So with 20% unemployed in California the data suggests that that state may have entered recession in October of 2023.

Other data of note:

  • US Housing Defaults hit the highest level since 2011, 2006-2008 and the 2022 peak. 
  • Costco is seeing weakening sales across its consumer base. Shopping for large quantity items is no longer attractive as family budgets are squeezed. If earnings slow this quarter and upcoming quarters keeping a 53x P/E multiple may be hard to do. 
  • Japan’s Norinchukin bank (US$800B of assets) is in trouble and plans to sell US$63B of US debt that it holds. Its large derivative book is their trouble spot and they are working to keep the bank functioning. It is positioned in collateralized loan obligations (CLO’s). These loans are tied to corporate debt. The fear is that this will spread to other banks that hold this toxic instrument and the Lehman analogy is being used. When banks won’t trade with you as they fear your repayment may not occur or the collateral will not be sufficient then the house of cards occurs. The bank has already taken US$10B of losses on their CLO’s. Now they will take losses on their US bonds which have fallen in value as interest rates have risen over the last three years. 
  • US Manufacturing has flatlined. This has dampened diesel usage. 
  • The Treasury has a US$183B three tranche auction this week of 3’s, 5’s, and 7’s. We will be watching to see the success of this large funding and the rates needed to move the debt. 
  • The US Leading Economic Index (LEI) has dropped 14.7% from the cycle peak. Such a drop has only been seen before recessions.
  • The Dallas Fed Manufacturing Index fell by 17 points to -15.4. This is the lowest reading since mid-2020 during the Covid collapse. A large trucking company filed for bankruptcy in Texas last week. 
  • JPMorgan’s Jamie Dimon told an audience in Shanghai that persistent stagflation and inflation warned of a potential US “hard landing”. 

Summarizing – The Fed is boxed in by their own policy mistakes. They kept saying in 2023 that inflation was transitory and we now know this as false. They also erred by prematurely calling a pivot in December 2023. If inflation persists and goes higher in the coming months, some FOMC voting members have indicated that they may want to raise rates. So the most likely case is ‘higher for longer’. Stagflation is here and consumers are spending less while still facing an onslaught of higher prices making household budgeting tighter. We may be in the early stage of a consumer recession which is nearly 70% of the US economy. Not a good situation during an election year. 

On the wars front:

  • Lebanon’s Hezbollah backed by Iran has used more precise missiles against Israel’s north. It is now gearing up for war with Israel. The Hezbollah Red Beret Brigade has been training for an invasion of northern Israel. Israel is moving troops from Gaza to be rearmed and then sent to the north to prepare for any offensive on that border. The Israelis have warned that they would even attack Beirut if the war widened. They have intelligence that this airport is where Hezbollah has its major weapons storage. 
  • Kuwait has ordered its citizens to leave Lebanon and other Arab countries are suggesting this as well. More and more evidence is surfacing that the next move by Iranian proxies will be from Lebanon with attacks planned for all of Israel that could overwhelm Israel’s IDF. 
  • Hezbollah has shown drone footage of the Israeli naval base in Haifa showing Israel’s naval vessels and sensitive bases and factories. A warning to Israel of its capabilities. It has received advanced weapons (drones and missiles from Iran) and these weapons can hit all of Israel. 
  • The US wants to restrain Israel from invading Lebanon and widening the war in the Middle East. Netanyahu has blasted President Biden and the White House has lashed back. The US has restricted sending 2,000 pound bunker busting bombs out of concern Israel is using them in Rafah and endangering civilians. The US has also slowed the delivery of other offensive weapons as a hammer against the Netanyahu government. This break in the relationship with Israel is due to Netanyahu not listening to US advice any longer but rather is meeting the more aggressive stance of his right wing coalition. 
  • The US forecasted today that there may only be 50 living hostages in Gaza. 
  • The Houthis have struck 12 vessels in May making this the second most active month for their attacks against shipping in the Gulf Of Aden and the Bab-el-Mandeb chokepoint. They even claim to have fired at a US navy carrier in the Red Sea. There was no damage or injuries aboard the carrier. 
  • China has seen more naval challenges in the Spratly Islands against the Philippine navy. More saber rattling in this contested area that may have significant energy reserves. China is building the world’s largest nuclear arsenal increasing its stockpile from 410 to 500, according to the Stockholm International Peace Institute. 
  • Ukraine will be getting more air defense missiles from the US to protect Kiev and Kharkiv. They are redirecting this aid from other allied countries. Such armaments are in high demand yet the manufacturing of these weapons is difficult due to supply chain and limits to the western defense industrial base. 
  • Russia has added a new offensive weapon, an ultra-advanced intercontinental ballistic missile the S-500. Another warning to the US to not give more advanced weapons to Ukraine or send trainers into the country.
  • Russia is very annoyed that the US used its satellites to guide long range ATACMS missiles that hit Crimea last week. They blame the attack on the US which provided the targeting information. 

Market Update:  We are watching the economic data carefully as it appears that consumers are getting tapped out and this could drag down the economy. The offset is the 6% US deficit and large war spending that are keeping some areas of the US, with hot economies.  The military industrial complex and areas where weaponry is built are strong economic centers these days.

China has throttled back crude imports as weak domestic demand and refinery margin pressure persists. So if the two largest energy consuming nations see weaker end user demand then crude prices could breach US$75/b once again and we may even see prices breach US$70/b in the coming weeks. This should set up the next low risk BUY window for energy stocks. 

Energy stocks peaked in early April as crude reached its high of US$87.67 on the mideast war potential to expand with direct fighting between Israel and Iran. Prices retreated to US$72.48/b in early June as no escalation occurred and global inventories grew. It recovered thereafter to US$82/b on optimism of a strong summer driving season. We continue to believe that the weekly EIA storage data will be key to the near term price action. If we see a breach of US$70/b then we should get another low risk BUY signal, the first since early February 2024. At that low risk entry point we added some new BUY recommendations. The run from early February was very rewarding and the ideas on our SER BUY List for the most part did very well. 

We now see the general market and the energy sector as vulnerable. A correction is in its early stages and we expect the next low risk BUY signal to occur during Q4/24. The S&P/TSX Energy Index peaked at 308 in week two of April and has fallen to 279 today. Our downside target is below 240. The overbought condition in April can be confirmed from the S&P Energy Sector Bullish Percent Index which rose from 39% bullish in February 2024 to 91%. Recent weakness has pulled this Index down to 50% yesterday. Over 90% is an overbought reading. It should decline below 20% to give off an oversold level and a BUY window once again. We show a chart of this in our SER report coming out tomorrow for subscribers. 

Our SER issue feature called ‘TOP PICKS NOW’ highlights the best ideas at the time of each SER report. The ideas have worked out very well as not all stocks rise and peak at the same time nor do they bottom at the same time. If you want to see what our subscribers are looking at, sign up now for access to the Schachter Energy Research reports.

EIA Weekly Oil Data: US Inventories are Growing Sharply

The EIA data released today June 26th showed material increases. US Total Stocks rose 9.4 Mb. Commercial Stocks rose 3.6 Mb, The SPR was up by 1.3 MB on the week. The SPR is now 23.6 MB higher than last year. Motor gasoline inventories rose 2.7 Mb and are now 11.9 MB above 2023 levels. Distillate fuels saw a decline of 0.4 Mb but are 6.9 Mb above last year’s storage levels. Total Stocks including the SPR are now 55.7 Mb above last year or at 1,612.5 Mb. US refinery rates fell 1.3% to 92.2% flat with the level in 2023. Cushing inventories fell 200 Kb to 33.9 Mb. 

US Crude production remained at 13.2 Mb/d and is up 1.0 Mb/d above last year’s level. Motor Gasoline consumption fell 417 Kb/d to 8.97 Mb/d and is down modestly from 9.31 Mb/d consumed in 2023. Jet Fuel saw a decline of 23 Kb/d to 1.68 Mb/d but is down 260 Kb/d from 1.94 Mb/d in 2023. Total Demand fell by 392 Kb/d to 20.7 Mb/d. Year-to-date US total demand is up 0.3% to 19.94 Mb/d. Gasoline demand year-to-date is down 1.5% from last year’s 8.85 Mb/d. 

The next few weeks through the end of July will tell if the demand optimists are right or that household spending challenges will restrict a material pick up in gasoline demand this summer. So far the data supports the bearish case. 

EIA Weekly Natural Gas Data

The natural gas report out last Thursday showed a lower storage rise than expected. The increase was 74 Bcf, with the largest rise in the East at 28 Bcf. This compares to an injection of 84 Bcf last year and the 5-year average injection rate of 55 Bcf. Storage is now at 2.97 Tcf. US Storage is now 13.9% above last year’s level (down 0.9% points in a week) and is at 23.9% (down 1.2% points in the week) and above the five year average of 2.40 Tcf. 

NYMEX is today priced at US$2.67/mcf. The recovery was due to demand rising in Asia which is facing record heat waves. Spot cargos are in strong demand with 41% of US exports going to Asia. Europe is facing delivery cutbacks from Norway as an undersea pipeline crack cuts back deliveries. It is not known how long this will take to repair. European prices have reached 2024 highs. India is also buying more LNG due to the hotter-than-normal weather. Japan is also looking to buy spot cargo. 

We recommend buying the very depressed natural gas stocks during periods of market weakness (these stocks are very cheap now) as we see higher natural gas prices in Q4/24 (above US$3.50/mcf this summer) and much higher prices in 2025. We plan to add additional natural gas names to our Action BUY list when we get the next low risk energy BUY signal. 

The Haisla Nation and Pembina have approved their BC LNG project. The cost forecast is US$3.4B. The Haisla nation will own 50.1% and Pembina the operator will own 49.9%. This plus the LNG Canada project should impact Canadian pricing in 2025. We believe that LNG Canada will approve Train #2 later this year adding to the good news of the growing LNG export business on the west coast. 

Baker Hughes Rig Data

In the data for the week ending June 21st, the US rig count saw a decline of two rigs to 588 rigs (down four rigs in the prior week). Rig activity is now 14% below the level of 682 rigs in 2023. Of the total rigs working last week, 485 were drilling for oil and this is 11% below last year’s level of 546 rigs working. The natural gas rig count is down 25% from last year’s 130 rigs, now at 98 rigs. This decline in drilling should continue for a few more months as the industry wants to see inventories declining and prices higher. Recent data shows US daily natural gas production at 95.5 Bcf/d down from the high in December 2023 of 105.5 Bcf/d. Once storage comparisons improve we should see natural gas prices lift even faster. 

In Canada, there was an increase of six rigs to 166 rigs working (versus an increase of 17 rigs last week). Canadian activity is down 2% from last year’s 169 rigs. Activity for oil is at 109 rigs compared to 110 last year or down by 1%. Activity for natural gas is at 57 rigs compared to 59 last year and condensate rich wells are the focus of this activity. The industry needs north of $2.50/mcf to see the economics attractive to drill more gas wells. As we get closer to LNG Canada ramping up in Q4/24 and natural gas fills the Coastal GasLink pipeline, prices should lift. Current AECO prices are below $1.00/mcf.

Energy Stock Market

The S&P/TSX Energy Index today is at 279. We would not chase the sector here but wait for the developing correction to lower prices and then add to portfolios. We are bulls but we don’t want to chase stocks. We like to BUY when stocks are cheap and are being ignored. That is not the case now. There still are some stocks that are BUYS but that list has shrunk. We cover those that remain cheap in our TOP PICKS NOW  section of our SER reports. 

Investors should decide what you want your energy weighting to be for this long energy super cycle. Our BUY 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. We expect that WTI should lift above US$90/b in Q4/24 as winter 2024-2025 demand should exceed supplies at that time and we see recovering economies globally. 

Our new ‘TOP PICKS NOW’ section in each report has been very well received and has had significant positive performance. It covers the best ideas from our five groupings that we cover (Pipelines/Infrastructure/Royalty Companies. Domestic Natural Gas Companies, Domestic Liquids Producers, International E&P Companies and Energy Service Companies). Not every issue will have an idea in every grouping if the stocks in such a group are not at bargain buy levels. If interested in these reports, become a subscriber.

In our June 27th SER issue (out tomorrow) we cover the difference between major market declines from the early 1980’s and normal corrections in the energy sector. We see the decline now unfolding as a normal 10-15% issue and not the massacre that was seen in 2000, 2008 or 2020. If you want to access this report you need to be a subscriber.

We are also working on reports adding two new attractive company ideas (one income focused and one growth focused) to our Coverage List. These should be released to subscribers in our July 11th SER issue. That would take our team coverage to 39 energy entities.

Please save the date for our 2024 ‘Catch The Energy’ conference on Saturday October 19th at MRU. We have received confirmation that the Honourable Brian Jean, Minister of Energy and Minerals of Alberta will be our opening Speaker. We are meeting with Presenter energy companies and have signed up most of the presenter slots for this year's conference. As this list completes we will start providing you with the names of the Presenting companies in our upcoming reports as we did last year. We have space for 35 companies in the energy industry of today and 10 spots for the TMX sponsored energy industry companies of the future (clean-tech, renewable energy, and critical minerals).

As usual SER subscribers will receive two complimentary tickets to the event. We look forward to seeing you all there.

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