November 2021 - Monthly Commentary from Dan Pickering

November was generally a bust across the market, but energy was worse.

November was generally a bust across the market, but energy was worse. The S&P 500 closed down -0.8%, while Diversified Energy softened by -6.3% (S&P 1500 Energy, S15ENRS), with most subsectors performing notably worse – Upstream/E&P -8.4% (XOP), Midstream -8.6% (AMZ) and oilfield services -15.2% (OIH). WTI oil turfed -21.3% (~$66.20/bb) and Henry Hub natural gas lost -11.9% (~$4.60/mcf).

The near-term oil markets endured a November one-two-three punch of a SPR reserve release announcement, the emergence of a new COVID variant and a sloppy overall stock market which traded worse than the -0.8% S&P 500 decline. Front month WTI fell -22% or almost $20/bbl peak-to-trough ($84.15 closing high). The market is clearly much more concerned about near term dynamics than long term dynamics as the structure of the WTI futures curve flattened dramatically. At the end of October, the front month to calendar 2025 backwardation was ~$24/bbl (~$83.60/bbl vs. ~$59.40/bbl). At the end of November, that backwardation had shrunk by 63% to ~$9/bbl (~$66.20/bbl vs. ~$57.30/bbl).

After jawboning for at least a month, on November 23rd the Biden Administration announced a release/swap from the Strategic Petroleum Reserve. We could go down the rabbit hole of discussing how the stockpile was created in 1975 to prevent “severe supply interruptions” and is instead being used to combat inflation fears and pacify the voting public. But we won’t. The release announcement, in conjunction with cooperation for China, India, Japan, South Korea and the UK, highlighted just how scary commodity inflation has become to consuming nations. Overall, 60-70 million barrels turned into the market over a few months is small potatoes equivalent to 14-17 hours of global demand. BUT, in any commodity market, incremental units of supply have an impact at the margin. The SPR release quelled the upside momentum of crude markets and pulled price down by $5+/bbl in anticipation of the announcement.

Conjuring up memories of 2014’s Black Friday OPEC market share announcement, the arrival of COVID’s Omicron variant resulted in crude traders pulling out the virus playbook and running for the hills. WTI dropped ~$10/bbl (~13%) on Friday November 26th to ~$68.20/bbl. Per the discussion above, calendar 2025 WTI fell only 6%. We are not scientists and there is much to learn about Omicron, but our anecdotal observation is that the public and governments in developed countries are materially less willing to crimp economic activity in the name of public safety. Whether it be college football games, church, holiday parties or working at the office, the world is much closer to (the old) normal than with prior COVID outbreaks. This should mute negative oil demand impacts, but black gold is guilty until proven innocent (bye-bye to $100/bbl upside in the near term).

With all these factors in play, the early December OPEC meeting was closely watched to see if the cartel would attempt to slow down the scheduled return of production. Status quo was the outcome of the meeting, meaning an ongoing increase of +400k bbls/day in January and February 2022. Although pausing the production increase would probably have tacked on $5+/bbl to near term oil, OPEC’s actions help it “win” in the intermediate term. 1) More oil helps heal the public rift between OPEC and its big customers. 2) OPEC+ regains market share it lost via 2020 production cuts. 3) OPEC+ provides no price support for US producers during 2022 budget periods, keeping its biggest competitive threat away from higher drill bit activity. With monthly meetings already scheduled, OPEC retains the ability to scale back production if demand/oil markets weaken notably.

Just like pitcher Ebby Calvin LaLoosh in the classic movie Bull Durham, OPEC has “announced its presence with authority”. OPEC is the big dog in oil markets. OPEC’s strategy, along with COVID and the SPR release, has clearly taken the upside momentum out of the oil markets, but the presence of a steady hand makes this author feel more comfortable about the downside risk. We’ve probably now got a downside floor in crude at ~$65/bbl and if price falls into the $50’s for whatever reason, it probably won’t stay there very long. This is a very acceptable outcome for oil & gas investors and oil & gas companies.

On the decarbonization front, COP26 was the macro biggie while Rivian’s IPO was the market/micro biggie. After a couple of weeks in Glasgow, the UN climate summit adjourned with a commitment to phase down coal and a pledge to boost climate-related financial support to poor countries. Sounds great, right? Highlighting the conundrum of the entire decarbonization issue, China and India lobbied hard (and successfully) to adjust the coal wording from phase out to phase down. Hydrocarbons are so inexpensive compared to other alternative energy sources that it is economically hard to switch. Everyone agrees conceptually that in the “long term” (2050-2070) time frame there must be dramatic changes. But in the meantime, blow out those oil barrels from strategic reserves to keep gasoline cheap and allow people to keep using their hydrocarbon transport. This tug-of-war will last for several more decades at least and is the key reason we are skeptical of Net Zero 2050 and the consensus pace of decarbonization. The globe will push hard, but true/meaningful change will be frustratingly slow.

Electric vehicle maker Rivian came public on November 9th, selling 153MM shares (upsized) at $78/share (upsized). The stock traded over 100MM shares on Day One, meaning 2/3 of the entire float changed hands. The stock rallied 29% the first day (~$101/share), peaked on November 16th at $172/share (+120% from the IPO price) and has subsequently retrenched ~40% to ~$105/share or ~$93B equity value. The idea of disrupting traditional transportation via electric vehicles has created a cadre of electric vehicle companies that are valued several times higher than the aggregate conventional auto industry. Whether Rivian or Tesla are fairly priced is the topic for another day. But the stock market is telling us loud-and-clear that change is coming. We consistently highlight that the expectations of the pace of decarbonization are overly optimistic. We must also consistently highlight that decarbonization overall is a megatrend.

Turning to conventional oil and gas stocks, November’s silver lining was the fact they weren’t that bad compared to 20% downdrafts in the underlying commodities. It doesn’t necessarily feel like many are willing to try for a year end hero trade, but there is some dip buying going on in the current correction. Stabilization of the commodities will bring out equity buyers, as will calming news about the Omicron variant. Aside from commodity prices, the next meaningful datapoint will be 2022 E&P budgets, along with share repurchase announcements and variable dividends. Patience is warranted and will be rewarded.

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