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Crude Observations

Final Grade 2021

Well folks, I’m back. Here it is 2022 finally and ye Olde Crude Observations is set to make its triumphant return. As is customary, I take a few weeks off at the end of the year to recharge batteries (just not in my car), spend time with family and friends over the Christmas and New Year’s break and, if I’m lucky, travel to the United States and pick up vitamin D the old-fashioned way in Phoenix.

 

Unfortunately, nasty old Seamus Murphy O’Micron had different ideas this year so instead of all the accoutrements of Christmas it was mind-numbingly cold temperatures, indoor isolation and occasional Master Chef worthy cooking for a mostly appreciative immediate family.

 

You would think that with all that time to myself, this blob would already have been done ages ago and ready to publish, but you would be wrong. There were things to do, Tweets to read, cleanup to avoid and lots of marginal football to watch.

 

Besides, I like to take the time off to gather my thoughts on all the year end stuff happening around the world to set the stage for next week, when I deliver my annual Fearless Forecast.

 

Speaking of which, I suppose I better get on it and review my last year’s performance. Seems timely what with the end of the year and all.

 

And speaking of timely and typical, the time off I took was, as always, not quiet. There were big moves in energy prices, stadium cancellations, raging pandemics, COVD rule flouting flights to Mexico, Antonio Brown and, sadly, some celebrity deaths of note including Betty White, Dan Reeves and John Madden.

 

Last year at this time we were transfixed watching unprecedented events unfold at the US Capitol. This year feels like we are no closer to closing the books on this sordid episode and the only person with any real closure is the dude with the Viking hat.

 

While these events and others (Kazakhstan anyone?) will reverberate through the next year and impact my 2022 prognostications, they serve as a handy reminder how wild and unpredictable the world can be and how a forecast can be upended by exogenous factors.

 

Of put another way, all of this chaos and nonsense is a handy excuse to bail myself out of some pretty horrendous calls last year.

 

Excuse earwig planted.

 

Alrighty then. Without further avoidance let’s get into it.

 

The year end report card.

 

Broad Themes

 

Politics and Stuff

 

Last year, civil unrest and the US Presidential election was my pick to be front and centre on the North American and global front for the course of the year.

 

This year I figured it wouldn’t be much different and posited that without his presence on social media (banned from Parler, Twitter, Facebook, YouTube, Tiktok, SnapChat, Instagram, Shopify, MySpace) the influence of Trump and/or Trumpism, such as it is, would eventually die out.

 

As the first year of the Biden presidency have unfolded, it has in fact been quite refreshing to have Trump in the background and fading with none of his range of sycophants and family possessing even a fraction of his charisma or ability to command the limelight.

 

Jack Dorsey’s single most impactful contribution to civil society may not in fact be Twitter, but rather the decision to cut Trump off from it.

 

That said, there has been a gradual reinflation of Trump noise, from his ridiculous letters that he sends out (“from the desk of Donald J Trump” – good lord) to a few rallies and photo ops and his sycophants are continually trying to kiss his grits, but even this seems to be dying down and replaced by just pure animal partisanship that is threatening to paralyze the US government. Or at least make it default on its debt. You know, small stuff.

 

 

Following that theme, another comment I made was with respect to the fracturing of the Republican party. Unlike others, I don’t view it as permanent and I see it being put back together but at this stage, no leader has yet emerged with the chops to pull off any rebuilding effort. Time will tell and a third party could yet emerge, but so far, Q whackos aside, the party is holding together. Meanwhile, individual Republican led states are taking their revenge on an electorate that dared to support the Democrats and are systematically dismantling as many voting, civil and women’s rights as they can before the electorate figures them out.

 

I predicted that the lesson of course will be lost on Canada’s conservatives who are also fracturing, even if they don’t know it. Weak leadership and pandering to the fringes is a recipe for disaster that Canadian conservatives are all too familiar with such as the PC/Reform/Bloc/CCRAP/CPC evolution and our very own PC/Wildrose/UCP and resultant Humpty Dumptying. Don’t even get me started on the Maverick and PPC clownshows.

 

 

Against this backdrop is my biggest US forecast, namely that Biden will deliver, in my estimation, the single most boring US administration in memory.

 

Joe Biden’s mandate is clear. Manage through the pandemic, restore the economy, which was in much worse shape than anyone wants to talk about, rebuild the US brand internationally and create a sense of unity and common purpose around all the preceding. It is a tall task for a president who probably should be taking afternoon naps at this stage of his life, but it’s his moment and while the resurgence of COVID via the Omicron variant may delay policy implementation, it sure hasn’t seemed too big for him yet. Stimulus, infrastructure, vaccines. So far he’s on plan.

 

 

Sure, there will be continued protest and conflict. It’s a big diverse country with many opposing viewpoints. The pull-out from Afghanistan was a disastrous mess, but a majority of Americans (on either side of the aisle) wanted the 20-year, multi-trillion dollar effort over. But starved of oxygen, I don’t how Trumpism survives. Reality is I don’t believe that deep down anyone actually wants it to anyway – even the most ardent supporters. It’s just too damn exhausting.

 

 

Here in Canada, I boldly predicted that we are about to have (another) Federal election. My reasoning? Because the Liberals are sharks while the opposition is basically a couple of muppets with paper cuts flailing in the water. My reasoning was that if the tide turns against the pandemic with vaccines and cash, then that is the time to engineer an election as opposed to when the bills come in.

 

 

Turns out I was right. Yay me! My other prediction was a Trudeau/Liberal majority (whoops!) and Trudeau quits by year end and PM Freeland takes charge. Clearly a swing and a miss on both of these. A second minority government with even less popular support isn’t a real vote of confidence but I guess Trudeau really likes the job. Which is weird, because it’s truly a lousy one.

 

 

I predicted 2021 should see a return to and continuation of some regional tensions.

 

 

The Iran crisis, which has been ongoing for more than 40 years will continue to percolate. A robust nuclear program is their goal and they will challenge Biden early. So far, Iran has not disappointed but then again Biden is actually more of a badass than they bargained for. The nuclear deal renegotiation is stalemated and they are enriching more uranium than previously thought. Time to turn up the heat.

 

 

China is the elephant in the room. Donald Trump’s unilateral and confusing approach to China did absolutely nothing to rein in this emerging superpower but the steps taken so far by Biden appear to have restored a quiet détente with the new yin to America’s yang. Hong Kong is lost so attention needs to be placed on Taiwan, Africa and South America to stem Chinese influence. Sports diplomacy is suddenly back in the news as the world contemplates an Omicron winter Olympics

 

 

Russia is a big deal to the United States and Europe and a lesser deal to other countries around the world. I predicted that despite aspirations, Mother Russia will soon find itself increasingly hemmed in by a vengeful US government intent on exacting its pound of flesh for election interference and systems hacking, not to mention questionable loan guarantees to failed real estate developers. The prediction was that it may not be in 2021, but Putin is on his way out. You can only assassinate so many people. Ukraine, Nord Stream 2 and natural gas politics weren’t on my radar at the beginning of last year, but clearly they will be major factors in 2022.

 

Venezuela, which is in its 1219th year of economic stagnation seems destined to fall off the collective radar of powers that should want a peaceful resolution. This could create a vacuum that leads to conflict in South America.

 

Another area I had on watch for conflict and humanitarian crises is Africa, whose countries comprise at least half of the top 10 humanitarian crises list for yet another year. Whether it’s starvation in the Democratic Republic of Congo, sectarian violence in Ethopia, Nigeria, Burkina Faso and South Sudan, 2021 looked to be a volatile year for the whole continent.

 

Grade: I will give myself a B-. All the usual players lived up to expectations but Trump and COVID won’t go away so until we see a path forward, there is no big pass here.

 

Energy and Environment

 

 

On the energy and environment front, I predicted that 2021 was going to be a year of transition.

 

 

How’s that for risk taking?

 

 

My theme for the year was going to be ESG and renewable energy as the Biden administration rejoined the Paris Accord, rolled out its massively ambitions green infrastructure agenda and the world continues to ambitiously pursue a net zero by 2050 agenda.

 

So far so good! Except for all the energy scarcity, supply hoarding and pleading phone calls to OPEC, I had it all perfect.

 

 

To be fair though, I did highlight the role for oil and gas in the energy transition and pointed out that pandemic ravaged capital programs are leading to pockets of energy shortages. Like all just in time worlds, while globally we may have access to ample supplies, local crises (like a cold snap or heat wave or hurricane or supply chain disruptions) can have lasting impacts.

 

 

Stop spending here, create a shortage there and cause a mini-boom in yet another place. I predicted quiet in the Permian (a slow recovery) but a big comeback for Canada’s oilsands in 2021 and 2022 – at least for shareholders. While we do tend to float under the radar a bit too much, Canada’s Free Cash Flow vomiting producers are ignored at your peril.

 

 

Finally, continued retirement of coal and nuclear generation facilities in the United States (2021 is going to be a BIG year for this) and abroad cannot be serviced by renewables alone which means that gas-fired generation will have to play a role. Or the lights go out. Like I actually said that. Are you paying attention to my predictive skills yet Texas? California? Germany? United Kingdom? China? Anyone?

 

 

So, a renewed focus on energy transition, ESG and a bull market for natural gas and Canadian Oil Sands.

 

 

Grade: Bro. This is a win. A+.

 

Price of oil

 

Every year this is the flagship call. It is the Toronto Maple Leafs of forecasting. Always looks good to start and then completely craters as the year unfolds.

 

First off, I predicted oil and gas demand was expected to increase by about 2%-3%, as the pandemic recovery continued. By mid year I figured we could be dipping into spare OPEC capacity and lo and behold I was correct.

 

I noted that supply issues and a lack of investment are creating a bit of a perfect storm for prices that will take some time resolve, even if Iran were to officially report its exports to China.

 

As a result during the year, OPEC+ started gradually adding barrels and fielding the aforementioned calls from the Biden administration to step it up, which they may.

 

Despite this, alternative suppliers will be unable to ramp up supply fast enough – Iran will likely still be under sanction, Venezuela is a gasoline importing basket case and producers in the Permian are currently acting like the alligator armed cheapskate at the pub when the bill comes.

 

This leaves Canada as a place that can actually provide a steady, low decline and predictable supply. Through some shiny new pipe to boot.

 

My year end WTI price was $65.23 and my average price for the year was $57.38. At the end of the year these numbers were $75.33 and $67.97 respectively

 

Grade: Instead of overshooting, I went for the under! B-

 

Price of Natural Gas

 

Ah natural gas, I can’t quit you!

 

Up until September and for the 55th year in a row, everyone’s favourite transition fossil fuel, natural gas, had been disappointing me and pretty much all of Canada with lousy pricing. Showing great potential at times before collapsing back to “super-cheap alternate fuel – why don’t we use even more of it” status.

 

Then all of a sudden, blammo! Europe starts to go nutso, LNG is on fire (not literally) and there are shortages everywhere!

 

For what it’s worth, here’s the thesis. Gas consumption in the US is way up. Exports of LNG are growing rapidly and exports to Mexico are also rising. Thanks to a variety of price and COVID induced factors, supply in the United States has stalled out, even with the reliable Canadian relief valve. The catalyst for gas that was still a year or two out is now right in front of us – LNG Canada, more export capacity out of the US, the completion of the coal to gas power conversion. Demand in Asia and Europe was expected to be strong, with the phase out of coal and nuclear happening faster than renewables could accommodate so prices should firm up.

 

My call was that it was a multi-year play, with 2022 better than 2021 and 2021 better than 2020 which was an OK gas year.

 

All that stuff above? It all happened after Labour Day. Like seriously. All of it. Renewables shit the bed. Europe and Asia are going bananas for backup power and no one has any coal. So demand for natural gas, yet another fuel that everyone hates, went ballistic. And so did prices. Ah sweetness.

 

My year end price for natural gas (NYMEX) was $3.93 and the average price $3.07. AECO will again have a better year than I think many Canadian producers are used to, which, combined with oil sands prospects should be a welcome bonus for the Alberta government’s coffers. At the end of the year, gas was $3.82 and mcf and the average was $3.68. Holy shit.

 

Grade: I finally get a gas call right and I’m betting no one noticed. Poot. A+

 

 

Production

 

 

I predicted that for many producers in the Permian and continental United States, 2021 was going to be a weird year. While drilling will recover with prices over the course of the year, it isn’t going to be dramatic as players wait to see what the Biden administration rolls out.  More impactful however will be the fallout from 2020’s collapse in the rig count and the number of wells drilled and completed. To maintain production against its epic decline rates, the US LTO industry needs to drill and complete thousands of wells every year. This volume was not met in 2020 and the production impact was going to reverberate throughout 2021 regardless of any drilling activity over the course of the year.

 

 

In 2021, capital for new drilling programs was scarce, the pace of completions slowed to decade lows and the rig count was down 600 from the beginning of 2020. The monstrous DUC inventory has been mined and the dirty little secret of the DUC count is that probably a quarter of these were never going to completed anyway. Rig count grew modestly as companies lived within their means. Other headwinds included price volatility, Biden Building Back Better, new environmental regulations, adverse weather events, supply chain and labour issues.

 

 

All of the preceding is my long-winded way of saying that I believed that US production would decline early in the year before recovering into year end. Year end production in the US was 11 million boepd and I picked the exact same level for year end.

 

Production in the US at December 31, 2021 was estimated at 11.8 million bpd with much of that added in the fourth quarter as refiunery runs accelerated, aviation picked up steam and exports rose.

 

Grade: Close. C

 

In Canada, activity levels were expected to more closely resemble 2019 than 2020.

 

Pockets of intense conventional unconventional (tight oil, deep basin, condensate, liquids rich) activity in places like the Duvernay/Montney/Viking and the Bakken but not much in between. Rig count was also projected to pick up in British Columbia as drilling to support LNG Canada picks up. We expected continued optimization and slow-footed brownfield expansion in the oilsands, but not much more.

 

While the year was bullish for oilsands producers and investors, there was not any material expansion. Production growth was only modestly above replacement of natural declines, notwithstanding recent record production levels. With Line 3 finally filling up with beautiful diluted bitumen, the dreaded capex word is starting to circulate on the street.

 

OPEC production levels as always depended on what happens with the re-upped OPEC/NOPEC agreement at the various jump-off points throughout the year. The key to the agreement was always the Saudi/Russia collaboration and unilateral Saudi cuts which are now unwinding.

 

Our projection was that OPEC/NOPEC output would be flat year over year, with the extra Saudi cuts (implemented in 2021) unwinding as the market strengthens. The current plan to add 400,000 boepd of production appears to be a prudent market management approach, even if old Joe is concerned his ‘Vette needs cheaper unleaded.

 

It is interesting to note that while OPEC plus 1 is adding production, no one is meeting their quota, raising concerns among people who are paid to be concerned about these things that OPEC spare capacity may in fact be an urban myth.

 

In the rest of the world, we projected a limited growth scenario. New projects in the North Sea (Johan Sverdrup field) will continue to ramp up and investments in Africa will come on-line. Latin America will be sold as a growth area – look for Brazil to disappoint because that is what they do – but material growth is a couple of years out.

 

We said that the fact that global supply growth is not expected to come from a slowing US shale sector and other regions should be concerning because it now starkly exposes the lack of investment in other regions and being such a capital dependent industry, production can turn negative as quickly as it ramps up. Inventories can draw down very rapidly and we have seen over the last few years how difficult it is to reverse a trend once it starts. As the global economy continues to recover from the pandemic induced consumption decline, it would not be surprising to see consumption snapping back above 100 million barrels of oil a day by year end which would constitute a supply crisis and the resultant price spike could stick a pin in the economic recovery.

 

Goldman is calling for $100 oil and the runup in natural gas prices and coal scarcity are suggesting a fuel switching allocation of oil for power further stressing localized demand problems. It’s been so long since we had an oil bull run that no one really knows what to do. We can’t windmill our way out of this. We actually need production growth.

 

Grade: I was kind of there. B

 

Activity Levels

 

On the Canadian side, notwithstanding my relatively bullish sentiment for producers, this year was always going to be tough on exploration activity levels.

 

As I have explained previously, given Canada’s production mix, the need to drill isn’t consistent across the basin. With only about 25% of Canadian production subject to high decline rates, the incentive to drill isn’t always there because the pipes are full of heavy oil. Plus, we don’t have the intense drilling imperative that the US has, where more than half of their production has a 35% decline rate and lower production levels per well, so they have to drill like lunatics just to stay in one place.

 

Canadians are creatures of habit and in winter we drill, but breakup came early in 2021 and the recovery over the summer has been more muted than expected and now it’s so damn cold no one wants to work.

 

I predicted that activity in Western Canada would be … pretty much flat with 2019. This ironically will represent a spectacular recovery to what was an awful year.

 

My bold prediction was 4,000 – 4,250 combined oil and gas completions in 2021. Capex should be up 15%, with an upside for 20%.

 

In Alberta, to the end of September, there were 3700 wells drilled, which extrapolated out to the end of the year implies at least 5,000 at year end. Note this doesn’t include Saskatchewan or BC. Or even Manitoba. So in a year where no one was drilling, there was a huge amount of drilling. Completions data lags, but why poke the hole if you aren’t going to finish it, right?

 

Capex is on track for $23 to $25 billion which would be 15% to 20% higher than last year.

 

Rig count in Canada at the end of the year was 162 which is actually ahead of 2019. Pre-COVID winter of 2020 count was about 250, so fingers crossed for winter.

 

It’s already been discussed elsewhere but I predicted that in the US, rig count will recover, drilling activity will be flat and capex will be up 5%. True to form, a lot of rigs have been added, but still 50% below pre-pandemic levels.

 

Grade: Getting warm. B

 

M&A Activity

 

I predicted that a late 2020 robust M&A trend would continue through 2021 as property consolidation, non-core asset sales and private equity investment all pick up as the industry adjusts, yet again, to a new normal. M&A activity was predicted to be broadly based – upstream, downstream, oil, gas, services and everything in between.

 

On the Canadian side, M&A activity should pick up as portfolio rotation out of the Permian brings American and international investors back to Canada and our absurdly high Free Cash Flow yields start to attract interest.

 

Capital was predicted to become easier to access as the year progresses and the prospects for the industry firm up.

 

As always Canadian companies that are historically undervalued cash cows were expected to attract interest as investors tire of Elon Musk, Tesla, AMC and scammy ShitCoins.

 

I predicted a prominent Canadian name or two would find themselves with new foreign owners as the year progressed. This one didn’t work out.

 

On the services side, we were very bullish on energy infrastructure and related industries and see that as an area where Canada could see a fair amount of activity.

 

We did experience some pretty robust activity in Canada. Our close to $30 billion in deals so far represent 16% of global transaction value. TAQA’s assets are for sale apparently. Highlights include:

 

  • Brookfield buys Interpipe
  • Secure Energy Services buying Tervita
  • Arc Resources and Seven Generations
  • Spartan and Velvet
  • Crescent Point and Shell Duvernay assets
  • Ensign Energy Services and Nabors Drilling
  • Waterous and Ossum
  • Tourmaline and Black Swan
  • Surge Energy and Astra Oil
  • Whitecap and Kicking Horse
  • A number of Stormont deals

 

Grade: Duh. B+

 

Canadian Dollar

 

The prediction was for the Canadian dollar to reach perhaps as high as $0.80, maybe even $0.82. December 31 price $0.7849.

 

Grade: Duh. B+

 

Infrastructure

 

Finally, right? I know in the media things look bleak, what with Trudeau and Biden, ESG and the energy transition and all that jazz, but we remain of the view that we are kind if in the early to mid stages of an infrastructure supercycle in Canada which will continue well into the mid-2020s. My prediction:

 

  • Line 3 complete and operational by year end – good call there.
  • TransMountain Expansion well underway with multiple spreads operating during the year in Alberta and BC. Aside from the moronic protestors and biblical storms, yup.
  • Coastal Gas Link continuing notwithstanding challenges (see above – moronic protestors). Yup
  • Keystone XL, a Biden victim. He will give Trudeau a win on a different file, which may or may not help Alberta but is most likely to be Line 5.

 

Grade: For some reason I’m batting 1000 on infrastructure. Maybe not on heads exploding. A

 

Stock Picks

 

As per my well-established rules, each year I pick two Canadian E&P’s as well as two service-oriented companies and, finally, one non-Canadian producer and a service company. If you recall my rules for oil and gas investing, one of them was to Trust Murray and I am thematically consistent with at least a third of my picks.

 

Pick #1 was Canadian Natural Resources. One day we will all be working for Murray Edwards, but for now, Murray’s company works for my Forecast.

 

Pick #2 was Cenovus. So yeah, I’m going hard on oilsands. Deal with it. Cenovus has been dumped on for years and recently swallowed Calgary icon Husky.

 

Pick #3 was Ensign Energy Services. Ensign is one of the largest land-based drilling companies in the world and also materially owned by, you guessed it, Murray Edwards.

 

Pick #4 was my renewable play Innergex Renewable Energy. Why them? Why not.

 

Pick #5 was Phillips 66. What? That’s right. A big refiner.

 

Pick #6 was a tanker business called Scorpio Tankers Inc. based in Monaco, where Murray Edwards parks his boat.

 

Here’s how they did:

 

 

 

That’s it! Potentially staggering outperformance held back because of… my renewable pick. That tells you all you need to know about the energy transition in 2021. Wonder where Trudeau’s money is, probably bought the index.

 

Grade: WTF? Only up 38%? What a failure. D-

 

 

My time here is done. I’m all done with 2021, time to move on.

 

 

Next week is the 2022 Fearless Forecast. I am suddenly feeling less confident. Sad face.

 

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