Crude Observations

May Number Day

What day of May is it, I’m confused. 6th8th? Too many numbers.


Or is it Cinco de Mayo? A celebration of Mexico defeating France in some war that no one in Mexico really cares about? But that has been coopted in the United States as a super convenient numerical excuse to drink margaritas and eat mass-produced tacos? Sign me up!



Or May the 4th, the day when we celebrate the force and Yoda and 3, maybe 4 good Star Wars movies out of 10 (Empire Strikes Back is the best BTW, I will fight you on this).



All these days show one thing in common. An obsession with numbers. Which is of course a good thing since our society runs on numbers. Or is it a bad thing, to be too obsessed with numbers? Especially when we take them out of context.



Like 3. Three is a magic number. Yesterday morning when I got to work, the Dow Jones was down 3%. I saw that 3-year mortgage rates in Canada were above 3%, the highest they’ve been in 3 years and almost 3 times (actually 2, but I have a theme here) what they were for prime borrowers just a year ago.



Or the 3-2-1 crack spread which measures the difference between the purchase price of crude oil and the selling price of finished products, like gasoline or diesel, that a refinery produces from the crude oil they bring in.



Currently, margins are awesome, because diesel and gasoline are so expensive. So, you can buy 3 barrels of oil for about $330 and sell the 2 barrels of gasoline for $290 and 1 barrel of fuel oil for $168 and make a boatload of money! Except now that natural gas, which you burn to generate the heat to run your refinery and crack the oil, is at its highest price ($8/mcf) since 2008, that margin will be eroded.



Of course, that’s here in North America where the energy market still makes sense. Imagine Europe, where natural gas prices are 3 times higher than here. That’s industry shutdown levels of cost.



Aren’t numbers fun? Let’s take a gander at some other numbers that are out there and what they are up to.



Did you know that numbers can lie? Some also reveal some pretty ugly truths.



I know I pick on Tesla a lot. And Elon Musk. Why? Because he is a good example of both statements above.


Take Tesla Q1 results. Or better yet, don’t. In Q1, Tesla reported earnings of $3.3 billion, deliveries of 305,000 units and said their results were impacted by rising costs due to supply chain and increased materials costs. But their costs were way down. While they were opening 2 new factories. What numerical voodoo was that? Well, you see, buried in the numbers are $675 million of government transfers. Plus, they are charging now for certain accessories that used to be free. Goosing revenue. And no analyst really buys their delivery numbers. The next 3 months will be interesting.



Yet despite this, Tesla’s market cap remains higher than the combined market cap of the rest of the auto industry. VW alone reported earnings 3 times Tesla’s yet its market cap is 15% Tesla’s. Why? A market that refuses to look at numbers.



More on Elon. How about some Twitter numbers?



He is buying Twitter for $44 billion. Hooray right? Free speech and all that jazz. Let’s unpack it.



Twitter has about $1.5 billion in cash flow and negligible debt, so he is paying close to 30 times cash flow. Crazy right?



The $44 billion price presumably includes the $4 billion in shares he already owns, and he’s talking $21 in total equity. So that means he needs $17 more in equity and the rest is debt.



So, $23 billion in debt. $12.5 of that is loans secured by Tesla shares. The balance – $10.5, is coming from conventional LBO lenders in a mix of secured and unsecured loans.



Or is it? It’s not clear.



Anyway, let’s call it $23 billion in debt. And guess that he got a special “Elon deal” blended interest rate of 5%. (Market would be 8% or higher, but he’s rich, so he gets a break.)



To service that debt will require $1.15 billion. That is skinny. If the cost of debt rises with, say, the fed funds rate, this deal is underwater.



Someone enterprising did the math on the share pledge (according to formulas set by the Tesla board for pledging shares) and found he would need to put up close to $60 billion in shares to secure his loan. And that $570/share was the price at which Elon would receive a margin call. The last time Tesla shares were at that level? 1 year ago.



Look, I may or may not do this for a living and I’m sure not as rich as Elon. But this deal is dumb. It makes no financial sense in a market that is stable and requires infinite growth to make money.



In a world of volatility, 8% inflation and rising interest rates? It’s a vanity project.



And given that the 1 year standard deviation on Tesla shares is $177, the price today is $870 and the trajectory for tech stocks is down, it’s an incredibly risky share pledge.



My call? 50/50 Elon eats the $1 billion break fee and walks away before his 6 month closing time frame.



Phew, right? Let’s look at some other numbers.



In a recent blog, I had some ideas for energy companies that were reporting their numbers on how to spend their cash. Let’s look at some actuals. They are staggering.



CNRL ($3.1 Billion!?!?!?! WTF Murray!), Tourmaline ($260 million), Imperial Oil ($1.2 billion) and Cenovus ($1.6 billion), all delivered substantial net earnings and cash flow without the use of gimmicks, revenue pumping, government handouts or celebrity CEO variety show appearances. Suncor reports next week, but let’s put them down for $1.5 billion.



And what was their reward?



At close of business today they had, combined, close to $7.5 billion in earnings, more than 2 times what Tesla “earned”.



And a combined market cap of $285 billion or about a third of Tesla’s $900 billion.



To be fair, the gap last year was wider, but the math here is broken.



Speaking of broken math, how’s 7%-8% inflation going for everyone? The price of everything continues to go up. Gas, food, lodging. Everything is more expensive. It’s moving so quickly we are at the “stickers in menus” part of the “transitory” phase. Restaurants probably can’t even source menu printing due to supply chain issues in the ink industry.



This week, Jerome Powell raised rates 50 basis points in the United States and said more is on the table. Some people project interest rates need to hit 5% to slow the inflationary cycle. And that’s the Fed Funds rate people. Our costs are above that.



In Canada, we expect the Bank of Canada to follow suit. Not because we are followers, but because we have similar problems. 50 basis points. That is the likely next move in the Bank of Canada rate.



Here’s another number. -27%. That’s the change in home sales in April 2022 vs April 2021 in the formerly red-hot Toronto housing market. Let me be the 1 to tell people this. The bubble has burst. Make sure your seatbelt is firmly fastened because it’s going to be a rocky ride for quite a few people who are on the wrong side of the market top.



Canada’s real estate market has been broken for some time. Hopefully this can fix it while the LPC continues scrambling for bandaid solutions that won’t work, such as doubling housing starts in a constrained market (can’t be done). Or blaming immigrants for the price of housing in Brantford (good lord).



My expectation is for a correction in overheated fringe markets of as much as 20%. Tell me I’m wrong and let’s check in at the end of the year.



Meanwhile, food prices are up 10% or more. Gas prices are up 10% or more. The spot price of lumber heaves around like classic bitcoin, not the shitcoin it is now.



Chip scarcity means that soon the price of anything that uses a chip has increased in price or is simply no longer available. You know, things like cars and electronics.



I feel central banks waited way 1 year too long to address what was a self-evident problem to anyone who lives in what I like to call the real world. Inflation wasn’t transitory, it was persistent and now it feels like its permanent.



Here’s a number. 50%. That is my odds of a recession call for end of 2022 into 2023.



Thanks Vlad. (It’s not really his fault, but why not blame him?).



On the plus side, you know what’s not broken?



The price of oil. It’s been great. How do I know that? Well aside from the results posted by all those lousy Canadian oil and gas companies, at US$95 for WCS, and our currency in the dumper, we are making bank on royalties here in Alberta. Good bye deficit!



Let’s hope all the crazies in the Permian don’t go rushing back to work too fast (more on that below).



Here’s some numbers – today versus a year ago.



  • WTI Crude: $110.48 ($64.89)
  • Western Canada Select: $97.73 ($52.35)
  • AECO Spot: $8.26 ($2.749)
  • NYMEX Gas: $8.10 ($2.986)
  • US/Canadian Dollar: $0.778 ($0.82)



Holy moly. By any objective measure, this is a market that is materially improved from a year ago and really, cause for celebration.



Sure, you could quibble that the dollar needs to show up and help tame inflation, but in all reality, this is about as bullish a picture we have seen for the energy sector in Canada for years. Which makes me sad that we may find ourselves in a recession in 2023 even as energy prices remain elevated.



Want more numbers?



As of May 1, 2022, US crude oil supplies were at 415.7 million barrels, a decrease from the previous week and well below the 485.1 million barrels they were at last year at this time. This puts the US 40 million barrels below pre-pandemic levels. That is a massive drawdown in inventories (this is a good thing).



Production was 11.900 million barrels per day. Production last year at the same time was 10.900 million barrels per day.



Refinery inputs are at 15.598 million barrels per day compared to 15.293 million barrels per day this time last year.



Distillate inventories are 22% below the five year average.



Natty is equally tight.


As of May 1, 2022, US natural gas in storage was 1,490 billion cubic feet (Bcf), which is 17% below the 5-year average and about 21% lower than last year’s level of 1,958 Bcf. Production was pretty much flat with the prior year – demand for gas remains strong.



Welcome to $8 gas.



Think prices may settle down eventually for natural gas? Think again. Summer usage of gas is just as robust as in winter. Only a super-deep recession stops this train.



More price support.



The US now exports close to 20 Bcf of gas a day. This is close to 20% of production. It is expected that another 5-10 Bcf of exports are in the works. That would be a whopping 30% of domestic production. Conventional production has long been in terminal decline. Now some of the most prolific shale fields may be approaching the same fate. We’ve all seen the tight oil curves. These are similar.



Many of the older fields in the US (Barnett, Haynesville) have peaked. Close to 85% of US gas production comes from shale. Close to half from 2 fields (Permian and Marcellus) and about a third from the Marcellus. This is a dependency issue. 5 Bcf comes into the US from Canada.



Gas prices aren’t coming down. The US has 1 big problem on their hands.



How about drilling activity levels? Surely, they will overwhelm the market at these prices?



As of today, the Canadian rig count was 91. Seems low, right? Except this is breakup. Last year at this time it was 55. Ouch. Same time in 2019 it was 58.



US Onshore Oil rig count at May 8, 2021 was at 342, this year it has recovered significantly and is at 688, which seems like a lot, but…



Peak rig count was October 10, 2014 at 1,609 and just as recently as May 2019 it was at 831.



The implications of this are clear – there are not enough rigs currently drilling in North America to significantly increase production in the short to medium term.



And producers aren’t in a hurry. Remember those profit numbers??? All the market wants them to do is maintain production, not grow. For most of the past two years, at least in the United States, they’ve done this by using up DUCs.



Everyone likes to talk about DUCs, but not the ones you eat, shoot, breed. No, these DUCs are drilled but uncompleted wells or untapped production. And with the frantic drilling of the free-for all days, there used to be a massive overhang of these that you could grow production from. Now? Not so much.



Currently (latest data is end of March), there are about 4,300 DUCs, with about 800 of them in natural gas producing regions. Last year, there were 7,000 and about 1,000 of them were natural gas wells. This means that for oily purposes, there are 2,700 fewer DUCs meaning the excess inventory has been eliminated. Want another data point? In May 2019, the number of DUCs that were oily was just under 8,000.



But with 3500 oily DUCs still around surely they can add a lot of production, right?



Maybe, maybe not.



First off, there is typically a base level of DUCs at any given time – dry holes, inventory, secondary property, child wells, whatever. In other words, a LOT of garbage. Estimates are around 1/4.



Secondly, who is completing these wells anyway? That is an excellent question. People. But a lot less people. To get an idea about this, you need to look at the number of frac spreads – the crews that are out there completing all these DUCs and bringing them online.



On April 30, there were 273 Frac Spreads working. Seems like a lot, right? Wrong. While at the same time last year, there were only 217 working (something about a pandemic I think), in the first week of May 2019, there were 384 crews out completing wells. And even if they wanted to put more crews out, it’s hard. Labour is in scarce supply.



So, half the rigs working, a few more frac crews working with labour constraints and a dwindling inventory of wells to bring online.



While activity levels in the US have recovered, they are nowhere near enough to significantly expand US light tight oil or gas production in the short to medium term.



Looks like the price deck is pretty safe.



It’s the same situation in Canada.



Just for fun, let’s circle back to inflation.



Think CPI is frightening? Try wage inflation in the patch (10% plus) and oil-field service PPI – up another 10% year over year – and this is with restrained spending on capex and production growth! If the producers decide to get busy, that 10% OFS PPI is rising 20%, easy. It will finally be the service companies’ turn to participate in the profit party.



But what about demand you say? Isn’t that declining? EV’s and all that? Good question. As you can tell by the refinery runs still being a couple of million barrels per day below pre-pandemic levels, it seems like US demand hasn’t completely recovered. But that’s not entirely accurate. Remember the inventory numbers? Down. And the DUCs? Used up. What has been happening is that the demand recovery has been satiated by existing over-supply and now that has turned around completely.



Demand sits at around 100 million barrels per day and that isn’t going anywhere anytime soon. And if China releases its lockdowns, pay attention. An already tight market will get tighter. And China likes diesel, which is in short supply. And American refineries need to start switching over to summer gas in anticipation of summer driving. And make lots of money. Remember 3-2-1?



Not to mention, demand in the rest of the world isn’t showing much sign of slowing. Do you think India is poking the rest of the world in the eye with respect to Russian crude for fun? No. They are desperate for oil and realize that they can’t get it anywhere else.



The thirst for oil isn’t likely to be assuaged anytime soon.



Consider transportation. In 2020, vehicle miles travelled per day in the United States was about 7.9 billion. In 2021 that number was 8.8 billion and expected to be 9.1 billion in 2022, which is above 2019. This means that by the end of 2022, fuel demand in the US should have basically recovered to pre-pandemic levels.



Another number I saw was 80%. That is where flight volumes sit relative to the same time in 2019. And the recovery is continuing even in the face of rising jet fuel prices and despite the current lockdown in China.



The demand for finished products shows no sign of slowing down.



Demand for oil, gas and energy is in full post pandemic recovery, the numbers bear it out. It’s part of why inflation is so high.



One final set of numbers.



0.75 to 1.5. This is the estimate of the millions of barrels per day that it is expected that Russia will end up having to take offline, potentially causing extreme damage to the wells they would have to shut in and exacerbating the already tight energy market. Some of this production will be permanently lost. Well played Vlad.



10,000. The amount of barrels added by OPEC+ in April. Well shy of their 270,000 target. OPEC+ continues to lag in adding production despite raising their quotas. Now they have raised their target another 430,000. Which they won’t meet. Because they actually can’t.



Something is amiss here.



The supply response isn’t coming.



This is extremely bullish for Canada and for Alberta if we can take hold of it.



Now if only we could get Elon to acknowledge this and buy Suncor, it would all be unicorns and sunshine.



For me at least, as a shareholder.

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