Date: 12/06/2021
Author: Kent Moors, Ph.D.
I spent last week in and by the Gulf of Mexico, first assessing some offshore rigs for a possible investment move by one of the global private groups I advise (more may be coming here as it has a possible impact on targets for retail investment) and second providing the keynote address before a conference in New Orleans.
The conference is the International Workboat Show, the world’s largest annual exposition of offshore service and technology companies. This is the fourth time I have addressed those assembled, although given a number of factors (including COVID) I have not appeared in several years.
On each occasion, the administrators have requested that I provide a bigger picture of what the energy market looks like. This is what I told them.
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Never let it be said that we live in dull times, especially in light of what has transpired in the last 72 hours and with an OPEC+ virtual meeting starting tomorrow along with a US Fed apparently intent on ending its open purchases of fixed instrument paper despite interest rate concerns by the market.
On Sunday, when I was completing what I foolishly thought was the final draft of this presentation, I intended to start by saying the following. Despite the degree of uncertainty that now besieges the market, it still makes sense to do so. And so, with apologies for misquoting Bette Davis, hang on, it’s going to be a bumpy ride.
The situation is significantly better than when I last addressed you folks. Then the market was wrestling with an OPEC decision (released on Thanksgiving 2014, no less) to defend market share rather than price leading to a hammering of prices across the board in energy. In benchmark crude, the low session closings were $27.94 a barrel for WTI and $30.39 for Brent, both on February 9, 2016. For reference, on the same date the Henry Hub natural gas price stood at $2 per 1,000 cubic feet.
Today, prices are markedly higher. WTI is almost 137 percent higher than the February 2016 low, Brent is 132 percent higher, while Henry Hub is up 118 percent. This is after WTI lost a full 15 percent of its value in only three trading sessions, Brent moving down 14 percent during the same period, and natural gas shedding 13.8 percent, although, as I will mention in a bit, the leveling off is likely to continue.
Despite WTI trying to claw its way back to $69 barrel, Brent below $72, and Henry Hub sitting at $4.58, I will stick to my already published pricing estimates of $85-87 a barrel for WTI, $90-92 for Brent, and a Henry Hub $6.25 for 1,000 cubic feet of natural gas, but I am moving these back to the end of first quarter 2022. These estimates may, of course, be subject to revisions downward should the recent COVID omicron and ongoing inflation angst intensify. That would easily push the averages for oil down into the high 70s (or below). The adverse impact on natural gas, however, may be less significant.
OVERVIEW
Sector wide, renewables (solar, wind, biofuels, and to a lesser extent geothermal) will continue to be the fastest growing fuel sources. According to my estimates (which remain slightly more conservative than IEA, IEF/OPEC, and EIA), renewables will account for about 19 percent of the global primary energy mix by 2035 (up from a little less than 13 percent today), nuclear 8 percent, and coal 20 percent. On the other hand, oil will still command 29 percent and natural gas 24 percent.
In other words, a decade and a half further on, energy usage will remain dependent on hydrocarbons.
The decisive observation is this: the energy balance among disparate sources will be the most important focus moving forward, rather than some ill-conceived attempt to find a silver bullet to wean the world from oil.
The energy industry is far more resilient than some commentators have concluded. We are hardly seeing any end of oil. Rather, there is a solidifying global energy sourcing balance forming in which crude oil will continue to play a central role as the fulcrum of energy use moves to Asia (and then about a decade later to Africa). The Asian push is the reason coal usage will not collapse as quickly as some have envisioned. The real challenge remains in integrating the sources.
THE CURRENT TREND: OIL DEMAND
The focus is moving more quickly to Asia than even I had anticipated. My current estimates point to China, India, and the rest of continental Asia accounting for more than 70 percent of the expected rise in global energy demand to 2035, with Africa accounting for just about all the remainder. North America and Europe will come in at negative numbers or at best flat.
Addressing more near-time expectations, IEA and EIA are projecting daily crude oil demand worldwide at about 99 million barrels; IEF/OPEC a bit higher (at 100.7 mbd). Yet these figures continue to underestimate the rising effective demand in less developed countries were the draw from close-in existing production (especially in Africa) actually moves the market impact demand figures up. My estimate is slightly more than 104 mbd by February.
Demand remains subject to significant outlier pressures, led by the COVID impact (on which I shall have more to say later).
THE CURRENT TREND: OIL SUPPLY
There is some spare supply in the market (as there must be to offset hyper volatility in pricing), but it can easily constrict due to geopolitical events in flash points (Persian Gulf; South China Sea; Ukrainian borders, the emergence of an Arab Spring 2 more protracted and violent than the one taking place a decade ago), and some global supply chain knock-ons (the backups at US ports and in the Singapore Strait are cautions of impacts rolling through the chain).
For that matter, even absent external pressures, forward supply curves in several parts of the world – especially the Permian in the US, offshore Mexico, advancing mature field declines in Western Siberia, collapses in basket cases like Venezuela, Libya, as well as Nigeria and Angola mean some of the booked and expected supply may not eventually flow into the wet barrel market.
As examples, OPEC has reported through the end of November an underproduction by its members of about 700,000 barrels per day (bpd), more than 70 percent of that coming from Nigeria and Angola. Libyan offtake has missed each of the last three truncated monthly targets, PDVSA in Venezuela has slashed its already declining lifting volumes, beyond OPEC PEMEX is again cautiously reducing expected Mexican production levels for the first half of next year, and there is even some question about the sustainable levels of some Permian and Bakken operations (especially in light of the increasing debt problems I shall briefly discuss in a moment).
The current surplus amounts to between a certainly too low estimate of less than 50,000 bpd (EIA) to more manageable figures of 1.1 million bpd (IEA), and a high of 2.5 mbd (from IEF/OPEC, a bit more extensive than surveys indicate). For what it is worth, my estimate comes about in the middle of these at about 850,000 bpd.
However, both IEA and EIA last week noted a matter I have also addressed in recently published analysis: any higher return of demand into the market than forecasted or any constriction on supply will quickly absorb the small amounts of surplus available.
This is good news for many offshore operations, where in situ volume and lower operating costs provide ready ability to move crude into the market at better pricing. Yet the main impediments here are once again pipeline and port capacity since the main premium pricing advantages at sale remain abroad.
THE CURRENT TREND: NATURAL GAS
We have just come off of a massive move up in US Henry Hub prices – about 65 percent between August 19 and October 15 with another increase building into the colder months (despite the current after oil shock pullback).
Elsewhere, however, natural gas pricing has exploded. The acute constrictions in Europe, even with the promise of additional Russian export volume, have propelled gas prices into uncharted territory with end users experiencing the highest costs on record, rises of several hundred percent with further spikes evident in future contracts set to expire in early 2022.
The LNG [liquified natural gas] market has already taken off in response. As regional markets compete for available spot shipments, hub prices have not been able to keep pace. As an example, Chinese LNG import costs have already exceeded records. By this time of the year, Chinese end users have already locked up shipments for the winter. But the people I talk to say requests keep coming in to buy at almost any price. Some of my contacts are suggesting that an unheard-of number, perhaps over 40 percent, have not closed their import ledgers. Of even greater interest are unpublicized moves by Beijing to engineer private state subsidized contracts to bail some of the larger domestic LNG users out of a mushrooming crisis.
Make no mistake about this. LNG will be the single most important ingredient in global energy trade moving forward.
Elsewhere, primary competition has emerged in power generation, as global electricity demand continues to advance. Natural gas is replacing coal on one end while experiencing some pressure from renewables on the other. However, and this has hit home during the acute rolling electricity crunch currently underway in the UK and Europe, any expansion of renewable sourcing requires that additional conventionally fueled sources of power remain online as backup. There is a composite of old and new rapidly emerging, with co-fueled gas/renewable power stations a primary choice. This is not a “winner take all” scenario.
Then there is the entire petrochemical sector, where demand will expand even faster than for generic energy. Here, we shall see continued replacement of petroleum with natural gas products for feeder stock. Renewables, on the other hand, do not factor in here at all beyond providing on site power for the process.
PRESSURES FORTHCOMING IN FOUR AREAS
COVID – as the emergence of the omicron variant attested last week, markets are extremely nervous about interruptions in a returning economic recovery. Much of this is overreaction about the impact of an unknown but it did wipe out over 12.9 percent of WTI and 10.6 percent of Brent valuation in a single day of trading last Friday. I had indicated in print that energy traders have learned to circumvent the virus element in setting forward prices. I still believe this is true at large, but there will be some roller coaster rides, nonetheless. Some of these, as I shall mention in a moment, are purely artificial attempts to rake trading profits from fabricated contract moves.
Debt – in the broader markets, inflation remains the main concern. Despite the dives in interest rates during the stock market meltdowns last week, bellwether indicators like the 10-year note yield still are trending up. The 10-year has had a short-term decline across the board (day/week/month) because of a massive 9.9 percent slide on Friday. However, it is still up a staggering 127.65 percent since September 1 of last year (the base for my proprietary algorithmic calculations).
Here is the problem for this audience. Most of the credit lines utilized in the energy sector (especially by operators who traditionally run cash poor) are the highest of the high-risk high-interest paper. The spread between investment grade credit and apex junk bonds is already expanding interest rates disproportionate to the rise in average yields. This is a worsening problem for operating companies who have been experiencing an acceleration in [oil field services] costs. As interest rates in general continue to advance, we are almost certain to experience another rise in defaults, bankruptcies, mergers, and acquisitions.
One of the larger global private investment groups I advise has already marshalled forces to seek out acquisitions. This includes a developing list of offshore targets in the Gulf of Mexico, off of Africa, and in deep water Asia (outside the South China Sea conflict area). The group’s investment reserves to commit to this shopping expedition are now in excess of $2.5 billion (leveraged to as much as 10 times that figure). And they are only one player.
Paper barrel games – some of those cutting paper for energy futures contracts are matching contracts with shorts and other derivative moves to dilute the actual pricing of volume and effecting an artificial yo-yoing of the arbitrage spread needed to match paper barrel and wet barrel pricing at expiration. Where this is possible, such machinations are expanding to include preventing actual barrel volume from market to accentuate the spread. This is a dangerous game that has already fueled some unnecessary volatility (off of which these darlings are reaping profits). Arbitrage will become more difficult and so will the hedging differentials of other upstream, midstream, and downstream end users (including I suspect a number in this audience).
The EV revolution – much attention has been directed to the rise in electric vehicles and the concern over displacement of gasoline and diesel as transport fuels. Some impact has already been felt in the transition of entire North American truck fleets to electricity and in the expanding interest in EV passenger cars. This will continue, especially with current policy preferences emanating from Washington, but there are two important caveats: (1) the capital requirements for a detailed EV passenger network are higher than proponents have estimated; and (2) EVs will increase worldwide but there will be an ongoing need for conventionally powered (gasoline, LNG/CNG, and hybrids) as well, especially in global regions where economic and lifestyle considerations require. And then there is on the horizon additional possible competition from fuel cells. All of this developing dynamic will fundamentally alter transport – especially in the “last-mile” delivery sector, the harbinger of what I foresee as the single most important change in delivery networks, especially in urban areas.
Three parting thoughts…and a counsel – (1) focus on the energy sourcing balance forming, where there will be a number of opportunities developing; (2) plan on operational cap ex increases (you need to put greater attention here in project and forward planning); and (3) expand planning flexibility and integrate risk assessment throughout the planning process, as events both expected and unanticipated in one part of the world have a tsunami-like roll on effect in others. As I have noted before, this may even include learning Chinese this year…and Swahili down the line.
I end with this counsel. All of us need to heed the advice provided by my favorite African proverb, probably the most famous from the continent, at last count claimed by over 30 countries. It goes like this:
Every morning a gazelle wakes up. It knows it must run faster than the fastest lion or it will be killed.
Every morning a lion wakes up. It knows it must outrun the slowest gazelle or it will starve to death.
Ladies and gentlemen, it does not matter whether you are a lion or a gazelle.
When the sun comes up, you better start running.
Dr. Kent Moors
This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).
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