Each week Josef Schachter gives you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold newsletter covering the general energy market and 30 energy, energy service and pipeline & infrastructure companies with regular updates. We also hold quarterly webinars and provide Action BUY and SELL Alerts for paid subscribers. Learn more.

Russia/Ukraine War Update:

The second installment of sanctions against Russia have been crippling. They target financing and moving exports & imports, those around Tsar Putin and the Central Bank of the country. This makes for even a more dire moment in history. WTI today rose to over US$112/b. How high crude prices go in the near term depends upon what amounts of crude that Russia is able to sell and the nastiness of the next phase of the war. Russia is now using more carpet bombing (like in WWII) and if Putin uses thermobaric or hypersonic weapons (WMDs) in Ukraine this will mark a significant increase in the intensity and ferocity of the war. If this occurs, then even more painful sanctions are likely to be added by the US and its NATO allies. Putin has threatened to use tactical nuclear weapons as he is finding a lack of success on the battlefield and doesn’t seem to care about casualties.

Russians are facing currency runs on their banks, a sharply falling currency, rapidly rising inflation and shockingly higher interest rates. A severe and lengthy recession is now likely. This war has been going on for a week now and the forecast of a 2-4 week invasion now looks to be taking a longer timeline. Russia has now added their best troops to the forces moving towards Kyiv and has added to its captured land in eastern and southern Ukraine. The Ukrainian held cities of Kharkiv, Kherson and Mariupol are now encircled and likely to be captured in the next week. The decapitation of the civilian and military leadership of Ukraine seems to be Putin’s next major goal. An attempt (authorized by Putin) by two Chechan attack groups to go and kill President Zelensky has been stopped with the help from Russian FSB members who are against the invasion (reported today by Newsweek).

EIA Weekly Oil Data: The EIA data of Wednesday March 2nd was moderately bearish for energy prices but the price of WTI and Brent crude are reacting to the increased escalation by Russia. WTI as I write this is US$110.65/b, down slightly from the day’s high of US$112.51/b. How high it goes in the coming weeks depends upon the ferocity of the next phase of the war or if diplomacy has a chance. Some pundits see prices rising to US$150/b if WMDs are used.

US Commercial Crude Stocks fell 2.6MMb versus the forecast of a rise of 2.75Mb. The main reason for this difference is that Net Imports fell 2.171Mb/d or by 15.2Mb on the week. Had Net Imports been flat, Crude Stocks would have grown by 12.6Mb on the week. Motor Gasoline Inventories fell 0.5Mb while Distillate Fuel Oil Inventories rose 0.3Mb. Refinery Utilization rose 0.3 points to 87.7 US Crude Production remained steady at 11.6Mb.

Total Demand fell 654Kb/d to 20.83Mb/d as Other Oils demand fell by 452Kb/d to 4.47Mb and Propane/Propylene consumption fell 403Kb/d to 1.48Mb/d. Motor Gasoline rose 86Kb/d to 8.74Mb/d. Jet Fuel Consumption fell 6Kb/d to 1.47Mb/d. Cushing Crude Inventories fell 1.0Mb to 22.8Mb.

EIA Weekly Natural Gas Data: Weekly winter withdrawals continue. Last week’s data showed a withdrawal of 129 Bcf, lowering storage to 1.782 Tcf. The biggest US draws were in the Midwest (46 Bcf), and the East (39 Bcf) and in South Central (34 Bcf).

The five-year average for last week was a withdrawal of 184 Bcf and in 2021 was a whopping 338 Bcf due to the severe weather that week. Storage is now 10.7% below the five-year average of 1.996 Tcf. Today NYMEX is US$4.72/mcf due to an expected colder spell in the coming days. AECO is trading at $4.47/mcf. After winter is over natural gas prices typically retreat and if the general stock market decline unfolds as we expect, a great buying window should develop at much lower levels for natural gas stocks in Q3/22.

Baker Hughes Rig Data: The data for the week ending February 25th showed the US rig count rose by five rigs (up 10 rigs in the prior week) to 650 rigs last week. Of the total rigs working last week, 522 were drilling for oil and the rest were focused on natural gas activity. The overall US rig count is up 62% from 402 rigs working a year ago. The US oil rig count is up 69% from 309 rigs last year at this time. The natural gas rig count is up a more modest 38% from last year’s 92 rigs, now at 127 rigs. Texas had the largest increase in rigs with four added last week and the total rising to 312 rigs. The Permian (Texas and New Mexico) added three rigs taking the total rigs working in this lucrative basin to 309 rigs.

Canada had an increase of four rigs (up one rig last week as well) to 224 rigs. Canadian activity is up 37% from 163 rigs last year. There was a three rig increase for oil rigs and the count is now 138 oil rigs working up from 92 last year. There are 85 rigs working on natural gas projects now, up from 71 rigs working last year. Staffing of rigs in Canada is becoming a problem and adding significant more rigs in the near term is unlikely. While day rates are rising, so are costs and therefore margin improvements are not what one should expect as the industry activity picks up. The current view is that margins should rise after spring breakup.

The overall increase in rig activity from a year ago in both the US and Canada should translate into rising liquids and natural gas volumes over the coming months. The data from many companies’ plans for 2022 support this rising production profile expectation. We expect to see US crude oil production reaching 12.0Mb/d in the coming months. Companies are taking advantage of attractive drilling and completion costs and want to lock up experienced rigs, frack units and their crews as staffing issues are difficult for the sector. The EIA forecasts US production reaching 12.5Mb/d before the end of this year.

Conclusion:

Bullish pressure on crude prices:

• Russia’s invasion of Ukraine and the severe destruction of the country has rallied European nations against Russia. Germany, the closest to Russia, has announced that Nord Stream 2 will not be approved to start up and that they are sending lethal weapons to Ukraine. They even reversed their pacifist military spending and will raise the total to over 2% of GDP which the US has been pushing them to do for the last few decades. The tough ‘SWIFT’ financial transaction limitations (just excluding exports of energy products) will be crippling to Russia as they were providing 2.5Mb/d to Europe. Even the US has imported from them. Two weeks ago they imported 106Kb/d according to EIA reports. Even though exports of crude oil are allowed, tanker companies are finding getting insurance difficult and have abandoned this business. Tankers owned by Russia and China will handle the trade that can be done which may be only 30% of the prior amount according to industry experts. Natural gas should not be impacted unless some of the current export pipelines are destroyed.

Bearish pressure on crude prices:

• The Iran nuclear negotiations are working towards sealing a deal and having sanctions removed so that they can sell their oil around the world. Negotiations appear to be making a breakthrough with a timeline of next week. President Biden may be giving away more concessions to Iran in order to have sanctioned Iranian oil available if Russia is precluded from sales to Europe and the US. If a deal is concluded in the next week or so and Iran receives sanction relief, Iran could increase production by 1.3-1.5Mb/d immediately. Iran also has over 100Mb in floating storage around the world near its buyers and another 100Mb ready to sell.
• The preliminary report of February OPEC production shows that they increased volumes by over 420Kb/d, exceeding their stated 400Kb/d goal and much above the January increase of a miniscule 64Kb/d. It appears that the invasion risk and the arm twist by President Biden has worked.
• The US and allies plan to release 60Mb of crude to meet short term needs from their strategic reserves. The US will supply 30Mb of the volumes to meet near term needs.

CONCLUSION:

The invasion of Ukraine has spiked up crude prices. In the end the higher energy prices will knock down demand and we are likely to see recessions around the world later this year. Russia will feel the most pain as it goes into a severe recession. If a worldwide recession unfolds then total demand could fall 3-5Mb/d and the price of crude will fall from its current war premium, elevated level. In 2008-2009 during the financial crisis demand fell by over 5Mb/d (from over 88Mb/d to 83Mb/d).

Energy Stock Market: The stock markets around the world are gyrating with large daily price moves. When the focus was on the invasion and sanctions then the stock market had big down days (March 1st down 598 points for the Dow). Today the upside is 563 points as we write this, as the focus is on the Fed as Chairman Powell testifies before Congress. He has soothed fears of a rapid rise in interest rates. In his testimony he said he supports only a 25 basis point increase in rates. Today the S&P/TSX Energy Index is up two points to 214 as higher crude prices lift the sector. Security of supply is now an attractive focus of investors and Canada is a beneficiary as is US domestic companies.

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