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Shazam!!! March saw very strong performance as the energy sector surpassed the overall market YTD. All conventional energy subsectors were higher and beat the S&P500 during March. The S&P500 gained +3.2%, the Nasdaq added +1.8% and Diversified Energy gained +10.6% (S&P 1500 Energy, S15ENRS) with energy subsector performance as follows: Oilfield Services +13.2% (OIH), Upstream +10.9% (XOP), Midstream +4.5% (AMZ) and Clean Energy +0.5% (ICLN). Front month WTI oil rallied +6.3% (~$83.15/bbl), while front month NYMEX natural gas fell -5.2% (~$1.75/mmbtu).(1)
The oil market gained steam during March. It wasn’t just the +6% price move, but rather the confluence of factors that mattered. On the supply side, Houthi interventions in the Red Sea have kept tanker transit times elevated versus normal, Ukrainian drone strikes on Russian refineries tightened gasoline margins, while Mexico will reduce crude exports to support internal refining goals. The US economy strengthened, which bolsters the overall oil demand outlook and moderates the pace of interest rate cuts. When US rate expectations / inflation expectations increase, oil looks better to financial players. Speculative (non-commercial) net long positions hit 12-month highs during March as money flowed toward the financial side of the commodity.
Oil has further strengthened during early April as Israel-Iranian tensions escalated. Following an Israeli strike on the Iranian embassy in Syria, Iran has vowed retribution. As of Monday, April 8th, the retaliation has not materialized, but it is fair to say that a geopolitical risk premium has crept into WTI at the current ~$86/bbl. Like night follows day, upward crude momentum and Brent over $90/bbl have reawakened calls for triple digit oil price. The April 7th Bloomberg home page sported an article entitled “Supply Shocks: Odds of $100 Oil Are Rising as Tensions Convulse Market”. Puhleeeze (translated as Pleeeeze or Please).
Sentiment, momentum and money flow can drive price higher. Actual supply constraints driven by geopolitical events (namely escalation of the Middle East conflict) could drive oil price much higher. BUT but but but but but but, there are 3+mmbbls/day of shut-in capacity sitting in OPEC countries (~2mmbbls/day within Saudi Arabia alone). It is 90% folly to think that OPEC would maintain status quo in a $100/bbl world. First, it is leaving cash money on the table. Second, it puts demand at risk. Long time readers of this commentary know that we adamantly believe $100/bbl oil (not $100/bbl inflation-adjusted, but $100/bbl in today’s currency) is a price at which demand contracts. OPEC doesn’t want to discourage oil consumption – it wants peak demand as far away as possible. Oil-driven inflation and economic slowdown does OPEC+ no good in the intermediate-to-long term. So they will jawbone, cheat on quotas or relax quotas if oil continues to strengthen.
There is a school of thought that believes Saudi Arabia would like to punish the Biden Administration and/or hurt its chances in the 2024 US presidential election. This means Saudi will support high oil prices and high US gasoline prices to influence US voter mindset in November. Up to a point, this resonates with us and might support status quo at $90/bbl WTI. But not $100/bbl, in our opinion. Triple digit crude bulls also think that the US might tighten sanctions on some combination of Venezuela, Russia and Iran, boosting oil prices. No way this happens if the Biden administration is worried about gasoline prices for US consumers (which we know they are).
Bottom line – a) we are thrilled at the tightening supply/demand situation in oil, b) we love the fact that oil is over $80/bbl, c) crude is getting toppy here (absent true, conflict-induced physical capacity limitations) and d) we’ll be fading $100/bbl via both stocks and commodities if it occurs.
Moving on to natural gas, this commodity is wallowing in an ugly trough. Things will improve but it is going to take time. No meaningful supply/demand changes happened in March, but the concept of AI-driven, gas-fired power demand became a very hot topic. Data centers consume huge amounts of electricity. As grid interconnects and low-carbon power are increasingly delayed or difficult to access, the market is turning toward gas-fired power as a possible solution. We’ve seen sellside research reports talking about 10-40bcf/day of incremental gas demand associated with AI/data centers by 2030-2035 (remember the current US market demand is ~100bcf/day). Not necessarily helpful to the 2024 gas market, but a shining star for the future.
After a January and February frenzy, upstream consolidation took a pause in March. The only public E&P doing a deal was EQT Corp (symbol EQT), but theirs was a vertical integration with Appalachia midstream-player Equitrans (ETRN). In the OFS space, rather than go public via IPO, private Innovex merged public with small cap DrilQuip (DRQ). In early April, SLB joined the fray with two transactions – first buying 80% of Aker Carbon Capture (~$400MM deal) and then merging with ChampionX (CHX) in a $8B combo. As E&Ps get bigger, the midstream and OFS space must follow. As we say every month, there will be more. 2024 is (another) Year of The Deal.
Energy stocks quietly went from goats to heroes in March. The sector finished Q1 as the second best in the market, lagging only Communications Services (think Magnificent Seven). We attribute the strength to several factors. 1) Oil price rally – thank you commodity gods, 2) economic strength and slower interest rate cuts making energy a defensive/rotation area for some, 3) a sloppy/down March for some of the tech darlings and 4) a catch-up trade after lagging badly for the past year. Fundamentally, energy company discipline remains good, capital return programs are firmly entrenched and valuations are supportive (albeit less cheap after the March rally). Importantly, energy has now “broken out” in technical terms, so the fundamental rally now has some chart/algorithmic tailwinds. We may not always understand charts, but we certainly respect charts. We’ll take the tailwind.
Net, net we are close to Goldilocks territory with the energy sector. Oil prices are good, but not yet too good. Fundamentals are solid. Valuation is appealing. Technicals are improving. Money flow is trending toward the sector. We must stay vigilant, particularly toward demand-destroying $100+/bbl oil and the technology sector where a reacceleration could suck some of the oxygen from the energy rally. Meanwhile, surf the current wave.
(1) Source: Bloomberg
