Ugh. September saw the S&P500 fall -9.2% bringing YTD performance to an ugly -23.9%. Energy generally underperformed with Diversified Energy -9.8% (S&P 1500 Energy, S15ENRS) with subsector performance as follows – Midstream -7.6% (AMZ), oilfield services -11.9% (OIH) and Upstream/E&P -13.1% (XOP). Crude oil had its fourth consecutive down month at -11.2% (~$79.50/bbl). US Henry Hub natural gas continued its whipsaw trading performance with a steep decline of -25.9% (~$6.75/mcf)(1).
The world is as complicated and nuanced as we have seen in our career. On the macro front, we have global inflation, sticky US employment and a strong dollar, central banks raising rates around the world, the remnants of the pandemic in China, a European energy crisis, sickly equity markets, sickly debt markets and an escalating conflict between Russia and Ukraine. On the energy front, we have recessionary demand concerns, OPEC with limited spare capacity making production cuts, the US releasing oil from its Strategic Petroleum Reserve, a decaying US/Saudi relationship, Europe’s situation igniting a global scramble for LNG, a push for Energy Security and impending tougher sanctions on Russia. Not to mention relatively anemic global oil and gas reinvestment rates, very strong energy company profitability and a continued energy transition push. Is it any wonder volatility and angst are high?!
We intentionally delayed the publication of this September recap commentary in order to have more clarity around OPEC’s actions. When the OPEC+ monthly meeting moved from virtual to in-person with less than a week’s notice, it was clear that a meaningful change in OPEC’s production strategy was coming. The typical pre-meeting chatter signaled a production cut of 1mmbopd or more, with the possibility of Saudi Arabia taking additional action. In response, West Texas Intermediate rallied from below $80/bbl to the mid $80’s, helped by an early October risk-on rally in global equity markets.
Despite what was characterized as a “flurry of outreach” by the US administration, OPEC+ ratified a 2mmbopd reduction that will likely result in an actual output reduction of 700-900kbopd. Markets further responded, briefly pushing WTI into the low $90’s. We have mixed emotions. Quantitatively, the necessity of a cut highlights the weakening nature of oil demand (never a good sign). However, the fact that OPEC took this action with WTI hovering around $80 is a clear signal that (relatively) high prices are a priority for the OPEC+ members. Higher oil prices will be a demand dampener, making it harder for the global economy to claw out of its malaise. Qualitatively, the cut raises the odds of some sort of US action – most likely a continuation of SPR releases. The circularity of the analysis is challenging.
Ultimately, we remain in the camp of strong prices for the foreseeable future in all but the most dramatic of economic slowdown scenarios. Relatively low inventories, limited supply response, likely conclusion of the US SPR releases, slow squeeze-out of Russian supplies and eventual covid recovery in China points toward an oil market that is more resilient than most others. Our $80-$120 WTI range is unchanged. As we have seen recently, nerve wracking excursions above/below the range can happen in the short term as markets react to near-term economic datapoints. We see these situations as opportunities to trade around core positions.
Side note – For those watching inflation, gird yourself for sticky influences from the energy complex. With minimal visible supply additions, any demand recovery will be met with tightening conditions and higher prices. And that is before Europe (and the globe) goes about rejiggering supply chains to reduce dependency on Russia. We haven’t heard the last laments around energy prices.
Turning to September energy market events:
On the investing front, the overall market has a sickly feel to it. Rallies are being sold, technical support levels are being breached to the downside and earnings warnings are plentiful. This keeps us somewhat wary (and at higher-than-normal cash levels) despite all the bullish underpinnings of the oil and gas business. During September, traditional energy subsectors fell a bit more than the broad market. While this reversed dramatically in October with the OPEC cut, it is a reminder that the sector is not bulletproof. If the economy really turfs, energy will buckle, regardless of OPEC+ support. Traders can sell faster/harder than barrels can be removed from the market. While a recession feels 100% likely, the odds of a “really turfing” economy feel less than 25%..but up from <15% a few months ago. We’ll be a buyer in that sort of environment, but it will be painful to get there. As always, vigilance required!
Please enjoy the 8th repeat of our 2022 mantra:
“The Russia/Ukraine conflict has elevated the strategic significance of oil and gas for the foreseeable future. Geopolitically risky barrels will be marginalized while Trustworthy Barrels will be more valuable, benefitting reserves and production in Western/developed countries. Energy can no longer dwell at the bottom of the S&P500 weighting as investors will be compelled to own more in the face of a potential or ongoing energy crisis. There will be significant volatility – both upside and downside – but the trend is stronger/bullish.”
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.