August 2023 – Commentary from Dan Pickering

Chipping away... On the oil macro front, the things we’ve been waiting for and expecting have finally started to play out. Inventories are beginning to draw, notably in the United States.

Chipping away - August 2023 saw Diversified Energy (S&P 1500 Energy, S15ENRS) advance +1.9% with subsector performance as follows - Upstream/E&P +4.0% (XOP), Midstream +0.5% (AMZ), Oilfield Services -0.9% (OIH), and Clean Energy -12.0% (ICLN).  Energy once again outperformed broader markets in August (S&P500 -1.6%, Nasdaq Composite -2.1%)..while still lagging noticeably YTD (+4.1% vs. +18.7% S&P500 and +34.9% Nasdaq). WTI oil moved moderately higher to ~$83.65/bbl (+2.2%) and natural gas gained +5.1% (~$2.77/mcf).(1)

On the oil macro front, the things we’ve been waiting for and expecting have finally started to play out.  Inventories are beginning to draw, notably in the United States.  OPEC+ discipline remains on display, with cuts extended to the end of September and then again until the end of the year.  Oil price has reacted accordingly, with WTI advancing from $81.80/bbl at the beginning of August to ~$83.65/bbl at the end of August to ~$89/bbl as this missive goes to print.  

When things are working, it’s obvious (in hindsight).  Demand is OK (although economies remain tenuous), supply is constrained, inventories are drawing and price is subsequently strong.  The broader financial market has started to pay attention.  Our anecdotal indicator is the number of mentions during the day on CNBC, which has increased notably.  $100/bbl call option buying has increased.  Energy stocks are outperforming recently, although still notably lagging the market YTD.

While savoring the current situation, this is no time for complacency or a victory lap.  The second largest oil consumer in the world (China) is having trouble with its economy.  Overall, Saudi/Russia/OPEC+ is playing a game of chicken with demand.  Successfully so far.  Strong prices are a good thing, until they aren’t.  

It is worth repeating our longstanding view that $100+/bbl oil is NOT a positive for energy investors.  At ~$100/bbl, marginal demand begins to deteriorate.  At $100/bbl (and the subsequent high gasoline prices), governments start to fiddle with tax regimes and strategic reserves.  Hence our game of chicken analogy.  The entire energy sector and energy investors win at strong prices but start to lose at “really strong” prices.  Ignore those who say demand is inelastic and oil can go to $120+/bbl before there are negative impacts; they are wrong.  We saw demand destruction in the summer of 2022 when oil was $100+….and the macroeconomic situation is more fragile today.  Fortunately, there is spare capacity via OPEC+.  Assuming the Saudi’s see the world anywhere close to the way we do, we’ll see a return of barrels in Q1 2024, perhaps even earlier if prices get too lofty.  

We are enjoying the current strength and have no inclination to raise or lower our $80/bbl WTI scenario through 2027.  The really bullish scenario emerges sometime in late 2024/2025/2026 as OPEC+ is producing close to full capacity, US producers have maintained their spending discipline and global economies are closer to a recovery than a recession.  Every investor in the world will love energy at that point.  A boy can dream.  

During August, European gas caught a strong bid as rumors emerged of potential strikes at LNG facilities in Australia.  The Dutch TTF gas price index traded from the low €30’s/Mwh to the high €30’s/Mwh in a single day (+27%).  Australia supplies <10% of global LNG and even less of Europe’s gas, but nerves are fraught when living under the specter of Russian supply dependency.  In our opinion, this type of knife-edge volatility will continue at least through 2025.

The US upstream consolidation train rolled on in August.  The most notable transaction was Permian Resource’s $4.5B (including debt) acquisition of Earthstone Energy (symbol ESTE).  Accretive on all metrics with substantial cost and operational savings, the market applauded the deal, taking PR’s stock from ~$12.90 prior to the August 21st acquisition announcement to ~$14.20 at month end.  Outperformance vs. the XLE was +990bps.  Scale matters.  This deal takes PR over $10B in equity market cap and onto many more institutional investor radar screens.  We say it every month: expect more deals.  When companies are constrained by investors and can’t grow with capex, they will grow with consolidation.  

Turning to clean energy, August was another month of notable capital deployment and terrible stock performance.  The iShares Global Clean Energy ETF (ICLN) fell -12.0%, bringing YTD performance to -18.4%.  Solar was generally a disaster as panel providers are fighting global overcapacity and high inventory levels, while residential-focused solar players are suffering from a dramatic slowdown in rate-sensitive customer demand. Existing wind projects are being cancelled due to project cost inflation and higher borrowing costs, while the UK North Sea’s most recent lease sale went unbid given the (too low) price caps set by the government.  Orsted is a poster child caught in this vortex, taking a $2B writedown on US offshore projects due to supply chain problems.

Several providers of wind equipment (notably Siemens Energy and TPI Composites) are experiencing meaningful warranty and replacement expenses as products are performing below expectations.  Ugh.  Meanwhile, massive capital continues to be deployed.  Several US Direct Air Capture (DAC) projects received government funding totaling more than $1B, while Occidental spent ~$1B to buy its DAC partner Carbon Engineering.  In a nutshell, we live in a world where the incredible allure and secular growth of clean energy exists in tandem with significant challenges to making money in the sector.  We don’t expect this to change in the near term.

Please remember the PEP organization is standing by to help – whether it be investment exposure, capital needs, energy market intelligence or help with a specific problem. As always, we appreciate your interest and welcome your questions.  

(1)    Source: Bloomberg