Transcript
Hello, this is Callum Turcan, Associate Director of Research at Valuentum Securities.
WTI and Brent have pulled back moderately from recent highs, though near-term futures remain just above $100 per barrel which is well above levels seen last year. As of early July, both WTI and Brent are in backwardation, meaning spot prices are trading at a higher price than later dated future contracts. In other words, the trajectory of future crude oil prices is expected to have a downward slope. Please note that backwardation does not mean that things are going to rapidly deteriorate for the global energy complex, as this dynamic is due to global oil inventories steadily declining over the past two years or so. Backwardation encourages energy producers to pump more and for those with crude oil in their inventories to sell those resources as soon as possible to keep up with demand.
According to the International Energy Agency’s May 2022 Oil Market Report, global oil inventories fell by roughly 1.2 billion barrels from June 2020 to March 2022. While the group’s oil market report the following month noted that global oil inventories recovered by roughly 77 million barrels in April, it also noted that OECD industry stocks remained approximately 290 million barrels below their 2017-2021 averages. Recent coordinated efforts, primarily by Western nations, to release strategic oil supplies in a bid to keep a lid on elevated fuel prices will eventually require those nations to rebuild their strategic stockpiles. Commercial stockpiles will also need be to built back up.
The US Energy Information Administration noted in its June 2022 Short-Term Energy Outlook report that world liquid fuel inventories, which is different than crude oil inventories, experienced an implied stock draw from the third quarter of 2020 through the first quarter of 2022, as measured by comparing the difference in world production and consumption of liquid fuels. For reference, the EIA defines liquid fuels as “all petroleum including crude oil and products of petroleum refining, natural gas liquids, biofuels, and liquids derived from other hydrocarbon sources (including coal to liquids and gas to liquids)” according to its website. Looking ahead, the group sees global stocks of liquid fuels steadily rebuilding over the coming quarters, though that may prove quite difficult to achieve.
By 2023, the IEA expects global oil demand will reach 101.6 million barrels per day, surpassing pre-pandemic levels. The EIA generally agrees and forecasts that global liquid fuels consumption will exceed pre-pandemic levels in 2022. Broadly speaking, global energy demand has recovered at a robust rate since the worst of the COVID-19 pandemic and supplies have had a difficult time keeping up. The easing of lockdown measures in Western nations and the more recent easing of various lockdown measures in China has been key to supporting energy demand.
As it concerns the production side of things, the OPEC+ oil cartel has been limiting supplies since 2020 in a bid to prop up prices. After agreeing to cut their collective oil output by about 9.7 million barrels per day starting in May 2020, the group has since been steadily rolling back those cuts at a pace of 400,000 barrels per day each month. More recently, the OPEC+ cartel has agreed to boost their collective output by 648,000 barrels per day in both July and August of this year, though we must stress here that these headline figures are arguably misleading and will not necessarily represent the actual increase in production from the OPEC+ oil cartel.
Data cited by Bloomberg noted that in May 2022, the OPEC+ cartel was producing roughly 2.7 million barrels per day less than its quota, largely due to a decline in Russian volumes in the wake of Western sanctions though Reuters reported that other nations in the group such as Angola, Nigeria, and Libya are also having trouble ramping up production to meet their quotas. It is an open question regarding how much spare capacity the OPEC+ cartel really has, with an eye towards Kuwait, the UAE, and Saudi Arabia.
Outside of the OPEC+ group, potential sources of oil supply growth could come from the US, Canada, Australia, Brazil, Guyana, and various other nations. However, it will take some time for these non-OPEC nations to ramp up their production. Due to the short-cycle nature of fracking activities, primarily conducted in the US and Canada, and to a lesser extent, Argentina, the most immediate source of potential crude oil production growth largely comes down to North America. As most private energy producers are keeping a lid on their capital expenditures after years of bleeding cash during the 2015-2020 oil market downturn, we do not expect any potential North American energy production growth in the medium-term to resemble the kind of growth seen during the 2010s decade.
As it concerns natural gas prices, whether that be TTF Dutch gas futures, Henry Hub futures based in Louisiana, or the Japan-Korea-Marker assessed by Platts to gauge LNG spot prices in East Asian markets, supply disruptions due to the ongoing Russian invasion of Ukraine and the effect that is having on global energy markets has seen natural gas prices surge higher since the start of this year. We expect natural gas prices to remain elevated for some time, especially as Russian natural gas supplies to various European markets have declined substantially in recent months, likely due to geopolitical considerations. Rising crude oil prices tends to push up natural gas prices, particularly LNG prices as many long-term LNG supply contracts are linked to Brent in some fashion, though various regional natural gas pricing benchmarks could also benefit from elevated Brent pricing as well.
In our view, the outlook for crude oil prices remains quite bullish which in turn should enable Chevron and Exxon Mobil, two of our favorite newsletter portfolio ideas, to churn out “gobs” of free cash flow over the coming quarters. Additionally, both Chevron and Exxon Mobil have substantial exposure to natural gas prices, in part through their enormous LNG export facilities in Australia, which should further support their cash flow generating abilities. We will caution here that a key downside risk the global energy complex faces is potential demand destruction as consumers adjust their lifestyles accordingly to reduce their energy and fuel bills. With that in mind, we have yet to see energy demand falter in a meaningful way, though we are keeping a close eye on the state of the global economy.
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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE. As of June 28, Callum Turcan owns shares in DIS, META, GOOG, VRTX, and XLE and is long call options on DIS and META. Some of the other securities mentioned in this presentation may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.