We had a prospective client management and executive team in the office the other day and we got into a high level top down discussion as it regards commodity prices and the future price direction of everyone’s favourite toxic substance – oil. It was an interesting dialogue because at this stage in the cycle, it is safe to say that no one really knows and, if we are going to be completely honest, the people that claim to know the most generally have the least accuracy and a dart board may be in order.
The upshot of this is that we end up with a lot of generic statements like “range-bound” or “it depends on OPEC” or “let’s see how the Trump tariffs shake-out” or “the risk premium isn’t in play anymore”.
And I’m as guilty of that as the next guy, since that paragraph above is pretty much what I told them. And sadly, it is all true. No one knows and there are a myriad of factors that affect the price of oil, just as there are a myriad of slightly different ones that affect the price of natural gas. And quantifying them individually is a mug’s game. It can’t be done.
As an energy industry participant, investor, lover and hater I spend a lot of my time immersed in the minutiae of the energy industry, the oil price, its movements, the price of natural gas and its irrational gyrations (including perpetually free AECO gas) and all the factors that push and pull these magnificent commodities in often infuriating and counter-intuitive directions on a daily if not hourly basis.
It is not uncommon for my business partner to have to mute BNN because I am unhingedly yelling at yet another of the procession of uninformed talking heads they bring on to discuss the energy sector and pontificate and theorize why the price of oil is headed to $40 or $140.
Regardless, the oil price is, as always, topical. And as discussed above, the price of oil is subject to many influences that tend to pull and push it in many directions at once.
So, I thought we should take a look at some of these. A lot of people like to use the terms “bearish” and “bullish”. They are indeed handy market terms, but their connotation is largely a positive vs negative one while in the case of oil and natural gas, for may reasons and for different parties, low prices can be just as good as high prices, but for different parties. Especially in a world where inflation, the rising cost of living and income disparity are such potent forces.
For this reason, I am more interested in looking at the qualitative factors that can move prices in either direction. At some point there must be equilibrium, right? Right? A sweet spot? A place where there is tension but stasis.
For oil, that’s $68.29 if everything is in balance. You heard it here first.
All kidding aside, when I think of the market on a qualitative basis, price direction is often dependent on the interplay between the price makers (those who control the supply) and the price takers (those who don’t). Sometimes it’s as simple as OPEC and everyone else, sometimes not.
Regardless, here are, in my view, some of the main qualitative influences affecting oil and/or natural gas prices in the current environment and an assessment (where I can) how that influence is affecting the direction of prices.
Note that if you are expecting a deep dive on data, you are in the wrong place, there are other people who do that way better than I ever could (Rory Johnston – commodity context). Me? I’m all about the qualitative.
OPEC
OPEC, plus or otherwise, or as I like to call it “Saudi Arabia and the not ready for prime-time producers” is, as always, the largest single influence on the price of oil. They account for close to 30% of production and supply and have the ability to either flood the market with product to squeeze competitors out or withhold exports to force prices up. They are a price-maker.
In the current pricing environment, Saudi Arabia and its partners have been gradually reducing voluntary cuts in quotas to try to rebalance the market without swamping inventories and to deal with the rampant cheating that the smaller, less predictable and controllable (read poorer) members have been doing. For the past while, OPEC+ has been assiduously unwinding their committed cuts to quota to ensure a stable amount of supply for the world and offset rising prices. Ironically, they have consistently failed to collectively and individually hit their quotas which has led many to opine that the myth of OPEC spare capacity is indeed a myth. It’s hard to argue this as there is a difference between quota, exports and actual production. Many members continue to underperform the recent increases in the amounts they are allowed to produce.
In the coming weeks, OPEC+++ will have their annual meeting and consensus is that they will scrap the last of their voluntary cuts. At least then the drama will mercifully be over.
Russia
Ah Russia. What the actual F are you doing. Russia is in the top three producers of oil in the world, typically behind only the United States and Saudi Arabia. Since the invasion of Ukraine, Russian oil production and exports have suffered. The US and the EU have sanctioned or avoided Russian oil and established a “price cap” on Russian oil exports. Still, many of their barrels are going to China and India but a fair amount are also backdooring their way into Europe via ship transfers (smuggling).
Meanwhile, Ukraine has perfected the art of bombing Russian oil and gas infrastructure. So successfully in fact that the third largest producer of oil in the world is in the midst of a domestic fuel supply crisis. If Ukraine can continue to press this advantage, it will continue to weaken the Russian economy. Another irony of course is that Russia, as part of OPEC+ is going to be unwinding its voluntary cuts in production, even though it is severely restricted its ability to do anything with that production.
On the gas side, Russia is in a much different position. The massive pipelines it is building to access the Chinese market remain years away so their biggest customer remains whatever gas makes its way into Europe. But now that the Euro region has settled its supply issues with LNG imports (mostly from Qatar and the United States), Russia will become increasingly reliant on China, which would like nothing better than to have Russia as a commercial vassal state – nifty parades and dictator bro-hugs notwithstanding.
Russia used to be a price maker, but given their domestic issues are now a price taker.
Iran
Iran is constantly in the news, especially since it provides an Axis of Evil distraction and easy target for a Trump admin focused on being tough on the nuclear and sanctions file. Where the Biden admin turned a blind eye to the flood of Iranian barrels going to China, the Trump admin has been much tougher, forcing the smugglers to get even more clever with their grey market sales to China, India and anyone else with a chequebook. Meanwhile, Iran is selling drones to Russia to assist its war efforts and continues to sponsor terrorists and militias in locations ranging from Lebanon to Yemen to Iraq. Iran is decades away from any form of normalization and needs to produce and sell oil to fund its ambitions and economy. While there is no shortage of bad actors willing to scoop up their barrels, it will cost literal billions of dollars and years to get its market up to the point where they can significantly affect the market. They are for the time being, a price taker.
America and The Permian
In 2007-2008, the last time energy prices went bananas, the shale revolution rode to the rescue with cheap and abundant natural gas being extracted in economy saving amounts from porous rocks from Texas to Arkansas to Pennsylvania while similar technology was used to suck billions of barrels of super light crude from horizontal seams across Texas, North Dakota and Canada. At the same time, the largest infrastructure spending frenzy ever seen in Canada took the oilsands from expensive curiosity to low decline factory style mega output. In the 2010’s the majority of oil production growth came from the United States and most of the balance came from Canada. That made the Permian a price maker. They were the “swing producer”.
In today’s price and physical environment that type of growth is impossible. I don’t care what anyone says. There isn’t enough money or will. The billions have been spent – in many cases vaporized and producers are in harvest mode. While US production bounces along at record highs the rig count is falling. At the same time, US oil majors, fresh off their mega-merger frenzy are retrenching capex and laying off in some cases up to 25% of their work force.
Yet still production remains persistently high. It’s a bit puzzling, but this is a testament to both technical proficiency, production optimization and high-grading of drilling prospects. Even if rig count is down, the number of wells being drilled is high and time to completion is shrinking.
That said, the Jenga tower has to collapse eventually. The runner on the treadmill will eventually trip on their shoelaces. I thought it was going to be this year and evident by now. My timing is off, but the physics and geology say that the direction is inevitable given the facts on the ground. Absent any significant change of circumstance with OPEC, the Permian is a price taker.
Tariffs and Trump
A little segue here. We all know that Donald Trump campaigned on the whole “Drill Baby Drill” mantra and how he was going to make the US an energy superpower. Look – election slogans are fun and they make for great press, but production was already high but Carry On Carrying On wasn’t going to win Texas. But can we be serious for second? Rig counts are down since he took office because a politician can’t alter the physical market – he can only influence it in the short term. Donald Trump wants low gas prices (to reduce inflation) and massive drilling activity (to keep the dumb energy promise which needs high prices). He can’t have both. It’s just not possible. He needs to pick a lane. And even if prices warranted, the activity might not pick up – Trump tariffs on steel and aluminum are making key inputs in the drilling process (steel and aluminum) massively more expensive. Break evens are rising. Which means capex will be held back, which means production should decline and prices will rise, contributing to increased inflation. Fun.
In a nutshell – Donald Trump can’t beat the physical market. His talk about lowering gas prices and cozying up to the Saudis and Venezuela hurts the US oil industry. His tariffs hurt the oil industry. His attacks on Canada hurt the oil industry. On the other hand, his deregulatory moves will help the industry. It’s a mess, prevents price discovery and has the industry electing to sit on its hands until it all sorts itself out. Donald Trump is a price-taker.
Canada
Canada is the hard done-by cousin of the United States. Our many issues are out there for all to see. An energy sector and resource base that is the envy of the world. An egress problem that is only finally beginning to be solved. A customer that takes us for granted. A federal government that is perceived as hostile and uncooperative to the industry – “Scaring away investment since 2015” is the LPC campaign slogan corollary to “Drill Baby Drill”. The major producing province that doesn’t trust anyone and wants to go it alone.
Yet against this backdrop we have record production of both oil and gas. Activity levels are steady. There is a cautious optimism in the space.
It’s downright weird, but we will roll with it.
Are we going to see a capex boom? No. We have the same issues as the Permian – we are currently producing as much as we can given the price deck. More egress will allow us to squeeze out a bit more but can we all take a deep breath on how much and when? If I hear Pierre Poilievre talk about how Germany built an LNG (regassification) plant in 192 days so we should be able to do the same in Canada for a liquefaction facility, I’m going to pull my hair out – it ain’t the same Pete. On the other hand, I am just about all done with the smug LPC sycophants yammering on about how if projects made sense the private sector would simply step up as if they have spent any significant amount of time working spreadsheets, calculating IRRs, risking capital, navigating regulatory roadblocks and answering to boards and shareholders over multi-billion dollar projects. STOP IT. Canada is a price taker.
Rest of World Production.
Mexico? Declining. Africa? Years away and barely material. South America? Brazil always disappoints. The rest are minor players. Meh. While the non-OPEC growth of the Permian and Canadian oilsands were game-changers for production, none of the other non-OPEC players has the chance to affect prices on the supply-side, the rest of the game is demand related.
Renewables and electrification
The ongoing electrification of everything in the world and the advent of electric vehicles is of course an unstoppable force (as long as battery tech keeps improving and, well, we can still get all the cheap minerals needed to make said batteries). In addition, the relentless expansion of solar and wind energy will surely change the generation mix from 80% fossil fuel and 20% renewable to something closer to 75% fossil fuel and 25% renewable sometime around 2050 if not sooner. So, the writing is on the wall for energy dense, cheap and abundant fossil fuels. Who needs to burn oil and gas when there is the sun, the wind and the forests to generate heat and electricity. Look, I’m being tongue in cheek. As long as governments are willing to spend the trillions required to upgrade the grid around the world, I am just fine with companies building as much renewable generation as possible, especially if it is subsidized and I don’t have to pay for it… directly. The long and short of it of course is that eventually, the cheap, yet dirty, energy dense power from fossil fuels will be replaced. If it’s from acres and acres of landscape destroying solar and super expensive batteries, so be it. I am down for that. In the meantime, that pesky 80/20 world prevails but if when it changes they will be a price maker.
Powering the AI Revolution
The last few years have seen the rise of Artificial Intelligence as a major force in the energy demand universe as giant data centres created to satisfy our insatiable appetite for making ever-more impressive memes, creating online “partners” and AI videos of cats performing in the Olympics seem to be popping up all over the world putting increased strain on already overtaxed electrical grids and drawing as much power (and water) as a small cities. To satisfy this rapidly exploding demand for electricity, power plants are now being built at a rapid rate with the predominant fuel source being natural gas leading to significant growth in production. Some of this demand is targeted to be met by solar and wind, but in the US at least, Donald Trump is changing the playing field on that front which means that gas is where it is at.
The ultimate solution here is nuclear – the most dense power source available – but with lead times measured in decades, I ain’t holding my breath.
On the plus side – this is long term bullish for Canadian natural gas. Demand growth is always a price-maker.
Ch-Ch-Ch-China (and India)
Last on the list and a veritable elephant in the room. China, for want of a better term, has been a pain in the ass for energy markets for the better part of the last two years. What they do going forward matters for the energy industry, both oil and gas. The largest investor in renewable energy in the world is also the largest emitter of CO2 and the largest and fastest growing consumer of coal. After the US they are the largest consumer of oil and natural gas on earth (I don’t consider the EU as a singularity BTW), so what they do matters. And the Chinese economy is, for want of a better term, challenged. Real estate is a mess, youth unemployment is rising, population is declining and tariffs are a major drag on growth. But they consume A LOT of energy and that isn’t going to change. While it would be nice if they bought more Canadian oil and less Iranian and Russian oil, we should be happy we are selling what we do to them and figure out how to get them more, maybe at a discount so they can lay off on the canola tariff nonsense.
Hey – I almost forgot I said India. Did you know that India is the fastest growing buyer of oil on the planet and is projected to catch up to or pass China within a decade for consumption? Russia does. So they sell them oil. Cheap. And now India gets tariffed 50% by the US on whatever they refine and resell into the global market, which can’t be that much… because they are the fastest growing buyer of oil on the planet and they use a lot of it. Pay attention to India. What India does matters. These two giants are price makers.
Recession and Stagflation
We shouldn’t be having this conversation, yet here we are. It is becoming increasingly clear with every economic data release that the sclerotic tariff war initiated by Donald Trump is causing the economy of the United States to slam on the brakes and sending Canada off a cliff. The contagion cannot help but spread to China, which is already teetering. The most recent employment numbers are at levels not seen since the Great Financial Crisis (I know people like to say since COVID) and should be a five-alarm fire to policy-makers instead of an excuse to fire the person who counts the beans. Meanwhile, inflation is coming in hot and central banks are reluctant to cut interest rates and feed to fire. Governments already bereft of substantive fiscal room are thus forced to continue borrowing and running deficits, fuelling the inflation beast even more. The end result of high inflation and high unemployment is called stagflation and the recession will be the cherry on top. And, it needs to be pointed out again and again, it is an own goal. It didn’t have to be this way. But what do I know, right? Depending on the depth of the slowdown and how long it lasts, this reduced consumption (demand) is a price-maker.
In conclusion…
As always, I think it is apparent from the preceding where I sit. On a bit of a fence. There are contrarian forces pushing and pulling the market all over the place, which can either lead to volatility or, if all these forces are in temporary balance – a trading range and stagnation. Which is where I feel we are now, just waiting for one of these factors to make a break.
My own spidey sense still posits that OPEC is unwinding their quota positions into demand strength. They are seeing demand where the rest of the pundit class doesn’t and may feel that the Permian roll-over is going to come sooner than many of us, certainly the EIA and IEA, think. Coupled with energy insecurity, demand growth in emerging economies (especially China and India) and the time to transition to the ongoing electrification of the global economy, many signs point to prices headed higher.
Which is a good thing for the sector, even if it isn’t for my pocketbook.
On the other hand, the “check engine” light in the US economy and OPEC increasing production into a slowing global economy may create a glut and crater prices.
Which is ultimately a good thing for consumers and will fuel the eventual turnaround.
As always, be optimistic but informed. It usually works.
