January 2022 - Monthly Commentary from Dan Pickering

Thinking about stocks, the chickens came home to roost in January. Rising interest rates and tightening commentary from the Federal Reserve sparked a meaningful downdraft by the major stock indices.

Happy New Year (in every sense of the word)! In the midst of a very, very tough overall stock market environment, energy had a stellar absolute and relative January. The S&P500 fell -5.3% during January, while Diversified Energy gained +18.1% (S&P 1500 Energy, S15ENRS), with the following energy subsector performance – Upstream/E&P +11.2% (XOP), Midstream +10.1% (AMZ) and oilfield services +22.2% (OIH). WTI oil was strong at +17.2% (~$88.15/bb) and natural gas ripped +30.7% (~$4.90/mcf).

Why did oil markets jam higher in January? Multiple narratives are at work. On the demand side, Omicron’s intensity is fading. It’s hard to find a virus mention on CNBC as deaths are down, market volatility is up and Q4 earnings are in focus. Rampant inflation fears drove increased interest from the financial community in hard assets and inflation protection. On the physical side, OPEC++ has consistently underdelivered on the promise of incremental barrels. In December, OPEC++ added only +90kbbls/day of its +400kbbls/day targeted production increase. Russia and Nigeria are the two largest “misses”, but at least half a dozen OPEC++ participants were below allowables. This is creating an increasingly prevalent undercurrent to the market that “spare capacity” is running short, which subsequently allows oil market participants to remain bullish, even though global inventories will likely rise during 2022. Finally, the drumbeat of war between Russia/Ukraine has to be adding some supply risk premium to near-term crude prices.

Looking at long-dated oil prices as a gauge of sentiment, enthusiasm and/or conviction – calendar year 2025 WTI crude futures have moved from the high $50’s to the mid $60’s since December 2021. In January 2022, the gain was +10%, compared to the ~+17% move in both front month WTI and calendar 2022 WTI. Perhaps it is OPEC spare capacity fears, perhaps it is growing conviction in US shale capex discipline, but the market is starting to believe there is something structural about the tightness in crude markets.

Away from unforecastable geopolitical events, our eyes remain glued to US shale capital discipline. So far, so good. We’ll be watching Q4 earnings results and commentary very closely. Both Chevron and Exxon recently highlighted Permian production growth. Yes, the Permian will grow in 2022, but we expect overall US 2022 production growth to come in well below consensus expectations. Wrap it all together – we’re not changing our $65-$85/bbl price range for 2022, which ironically lands us somewhat more “bearish” than many in the market. My, how things have changed in the past year! For the record, we aren’t bearish, we’re simply not using triple digit oil prices as our base case expectation.

US natural gas – strong as horseradish, with help from weather, rising oil prices and continued strength in global LNG prices. At this writing, 2022 full year natural gas is $4.90/mcf and 2023 is almost $4/mcf. History over the past decade says take the “under” when gas prices are at this level, and we’re not inclined to argue with that mindset. We’ll watch the Haynesville rig count for potential volume responses.

As the calendar turned to 2022, the US energy industry continued to consolidate. Chesapeake Energy purchased private Appalachia producer Chief, oilfield compression companies Exterran Corp and Enerflex Ltd. merged, and Permian basin E&P Earthstone Energy (ESTE) bought recently restructured Sable Energy from its creditor owners. Even with high(er) commodity prices, scale matters.

Maybe, just maybe, the pendulum is swinging back to rationality and more realistic expectations regarding decarbonization and the energy transition. The quick transition to renewables in Europe contributed to their ongoing energy crisis and the need to source expensive emergency supplies of fossil fuels. Perhaps as a result, the European Union is considering classifying natural gas and nuclear as a “sustainable investment”, a process that has sparked fierce debate amongst member countries. Acknowledging the practicality of a long energy transition, BlackRock CEO Larry Fink stepped back somewhat from prior aggressive statements regarding divestments from hydrocarbons and oil and gas companies. Meanwhile, letters from BlackRock fund managers highlighted natural gas “will play an important role” in the net zero transition. We believe the reality of the next several decades is All-Of-The-Above, so tradeoffs like the ones discussed above will have to be made.

Thinking about stocks, the chickens came home to roost in January. Rising interest rates and tightening commentary from the Federal Reserve sparked a meaningful downdraft by the major stock indices. The S&P500 fell by -5.3% and the Nasdaq Composite dropped -9.0%. The ensuing Growth-To-Value rotation was fierce. With rising oil prices, an inflation angle and clear “Value” characteristics, traditional energy was a significant beneficiary. Energy subsectors rose +10-22% in January. Cleantech was not so lucky. The Ishares Global Clean Energy ETF (ICLN) fell -11.4%, following a -25% downdraft in 2021. We are getting intrigued to sift through this wreckage but feel no particular urgency to step into the breech. Conversely, we stick by our view that traditional energy stocks are cheap on an absolute and relative basis and have the potential to re-rate higher during the year. Despite impressive performance in 2021 and January 2022, the deck remains stacked in favor of the sector.

As always, we appreciate your interest and welcome your questions.