March 2023 – Commentary from Dan Pickering

Underneath the collapse of Silicon Valley bank and the resulting fears of a financial/banking crises, March’s stock market remained about the tug-of-war between the economy and interest rates...

March was a forgettable month for energy.  While the S&P500 rallied +3.7%, energy took another breather.  Diversified Energy (S&P 1500 Energy, S15ENRS) fell -0.7%, with subsector performance as follows - Midstream -1.2% (AMZ), Upstream/E&P -3.3% (XOP), and Oilfield Services -10.9% (OIH).  Clean energy gained +3.0% (ICLN). Crude oil dropped -1.8% (~$75.67/bbl) while natural gas went south to the tune of -19.3% (~$2.22/mcf).(1)

Underneath the collapse of Silicon Valley bank and the resulting fears of a financial/banking crises, March’s stock market remained about the tug-of-war between the economy and interest rates.  It doesn’t take a genius to see that banking problems tighten credit availability and intensify rising rates.  It does take a genius to accurately forecast the timing and severity of a recession, the subsequent inflation impact and the follow-on interest rate actions of the Fed.  

Even though WTI oil is down -13.5% y/y as of April 11th (from $94.29 to $81.53/bbl) and Henry Hub US natural gas is -67.1% (from $6.64 to $2.19/mcf), energy costs have an inflationary vibe.  In fact, following OPEC’s actions in early April, the ghost of the 1970’s and stagflation is flickering.  For energy market participants, demand side vigilance is key as the supply side story remains quite tame.  

Within the energy sector, the most significant fireworks started in April.  On Sunday, April 2nd, players within OPEC signaled a voluntary cut of ~1.1mmbbls/day.  Saudi led this coalition with a reduction of 500kbbls/day, with pledges from Iraq (211kbopd), UAE (144kbopd) and Kuwait (128kbopd) making up the bulk of the remainder.  

Our initial reaction was….wow!  No foreshadowing, no hinting, no signaling.  Just a short-smashing, price-protecting, in-your-face-Biden-administration production cut.  WTI oil had dipped all the way to $64/bbl during the worst of the US banking saga.  By the end of March, it had clawed back to only -2% for the month ($75.67/bbl).  The OPEC-driven rally tacked on +$5/bbl (+8%) and put oil back into the $80’s.  

Some thoughts on the implications of OPEC’s move:

* Is this an OPEC move from strength or weakness?  Given all its buyer interactions, OPEC should have a decent feel for the health of crude demand.  Did the cartel cut to get ahead of demand softness?  Or did it sense enough demand resiliency that higher prices could be absorbed?

* OPEC can act more boldly given muted US shale activity.  In 2014, OPEC kicked off a downward spiraling price war after relentless production increases from US shale.  Today’s situation is dramatically different with US producers happily entrenched in capital discipline mode and US production ~1mmbopd below previous highs.  Until it is sustained for many consecutive quarters, $80 or $90 or even $100/bbl is unlikely to drive US rigcount and supply increases.  

* Saudi doesn’t appear worried about disappointing its “allies”.  With the United States now clearly in the frenemy category, Saudi/OPEC decisions appear focused on revenue maximization.  There are almost certainly longer-lasting implications of waning US influence in the Middle East.  We’re hard pressed to find any that are bearish for crude prices.  

* Less SPR firepower to counteract OPEC’s cuts.  US President Biden called the OPEC cuts “misguided”.  Talking is now the most powerful weapon in the US oil price arsenal after releasing 180+mmbbls from the Strategic Petroleum Reserve in 2022 and pulling inventories to the lowest levels in decades.  Talk was cheap with E&P companies in 2022 as calls for higher production fell on deaf ears.  Those ears are likely just as deaf in 2023.

* OPEC’s increasing spare capacity helps constrain non-OPEC supply.  Higher prices should encourage non-OPEC spending and supply growth.  However, non-OPEC supply growth is likely to remain muted given the triple combo of an uncertain economic outlook, the overhang of at least 1.5mmbopd OPEC barrels that can quickly return to the market and shareholder demands for capital discipline.

* What the heck is going on with Russia? As an OPEC+ member, Russia is piggybacking on OPEC’s April 2ndmoves.  It is hard to handicap what is actually happening with their production levels and/or production capacity.  Are Russia’s cuts simply masking falling capacity?  Will their production be reduced at all (it’s holding quite high 2023 YTD)?  We remain convinced of Russia’s inevitable supply atrophy over a 3-5 year time frame.  They are a wildcard in the 3-5 quarter time frame.

Following on to our prior US inventory commentary, we saw another big acquisition in early April as Ovintiv paid $4.3B for the Permian assets of three Encap portfolio companies.  In the game of musical chairs, it feels like the music is playing faster.  Rumors also surfaced of Exxon as a potential buyer of Pioneer Resources (which currently sports an enterprise value of ~$57B).  Exxon has been a consistent buyer of Permian assets - the two most recent being a joint venture with Endeavor Energy in 2014 and the 2017 ~$10B purchase of Bass Operating.  Is Exxon hunting for more?  Almost certainly…at the right price.  And if they wind up buying, the signal for investors will be that the price is indeed right.  

In the clean energy world, the market continues to wade through the minutiae of the Inflation Reduction Act to understand exactly how to interpret and capitalize on all the new tax credits, grants and loan guarantees.  New US battery plants are being announced and momentum on overall decarbonization spending is fairly strong.  Meanwhile, many clean energy stocks continue to wallow as they digest good IRA news, slow paths to revenue/profitability and generally expensive valuations.

Energy stocks have had a soft start to the year on both an absolute and relative basis with the S&P1500 Energy benchmark -5% compared to a +7% S&P500.  This isn’t surprising after a fabulous two year run and ongoing questions about the health of the economy.  We expect energy to beat the market again in 2023 and remind our readers that we’re only 25% through the year.  As has been the case since 2020, patience will be rewarded!

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