The Upside to Record High Gas Prices

It’s not all doom and gloom, though. Due to stratospheric oil and gas prices, energy stocks have been the one bright spot in an otherwise dour market this year. Through the end of May, the S&P Oil & Gas Exploration & Production Index gained an incredible 60%, compared to the S&P 500, which fell about 13%.

A number of oil companies, including Shell and Exxon Mobil, reported record profits in the first quarter, and by the end of this year, they’re projected to post record annual profits. According to estimates made by Rystad Energy, publicly traded exploration and production companies are on track to generate an unheard-of $834 billion in free cash flow (FCF) in 2022. That would represent an increase of nearly 70% over last year.

Global Oil and Gas Industry on Track to Generate Record Profits in 2022

No one hopes for high gas prices, and I sincerely doubt anyone hopes they will persist indefinitely. On the other hand, think of this as an opportunity. Many investors may have missed the rally so far this year, but if Rystad’s estimates are accurate, there could be further gains to take advantage of.

Governments’ Green Energy Initiatives Have Helped Boost Fossil Fuel Profits

So how did fuel costs get this high? We could point to pandemic-era disruptions, some of which are ongoing across the globe. Then there’s the Russia-Ukraine war, which has rattled the geopolitics of the energy market.

These are but short-term disruptions. The biggest contributor to higher energy prices now and going forward are governments’ forced attempts to transition from fossil fuels to renewables before the technology is ready to scale up and meet global demand. 

That’s the takeaway from a brand new report by the Fraser Institute, a Vancouver-based think tank. In the paper, titled “Can Canada Avoid Europe’s Energy Crisis?”, the group’s analysts, led by Robert Murphy, make the case that Canada—and, by extension, the U.S.—should view Europe’s soaring energy prices as a cautionary tale against extreme climate policies. Such policies have “contributed to Europe’s energy crisis,” the authors write, adding that “Canadian policymakers should reverse course and avoid the [same] mistakes.”

It’s doubtful a reversal will happen with Justin Trudeau at the helm, of course. Despite being an oil superpower, exporting a record $13.6 billion in oil, natural gas, coal and refined petroleum in March, Canada has among the world’s highest gasoline prices. During the week ended May 30, Canadian drivers had to cough up an average of $6.50 per gallon of gas. That’s above the world average and roughly $1.70 more per gallon than what U.S. drivers paid on average during the same week.  

Average Gasoline Prices in Select Countries

And prices will likely only continue to rise over time. Late last week, all G7 countries agreed to stop funding overseas fossil fuel developments starting sometime later this year. According to the reporting by the Guardian, this agreement could shift some $33 billion every year from fossil fuels to renewable energies.

U.S. Still Number One Oil Producer

Meanwhile, the U.S. remains the world’s number one oil superpower, having surpassed Russia in 2018. That’s despite the fact that production hasn’t yet fullyrecoveredto pre-pandemic levels. 

U.S. Remains the World's Number One Oil Producer

Production is strongest in the Permian Basin, located in West Texas and parts of New Mexico. The oilfield is so prolific, in fact, that Rystad believes 2022 output there alone will surpass output from every oil-producing country except for Russia and Saudi Arabia.

As the Houston Chronicle reports, the Permian underwent explosive growth a decade ago thanks to the shale boom and ingenuity of U.S. producers. Since then, the region has been an economic powerhouse.

Rystad now expects production to reach 5.6 million barrels of crude a day this year and as much as 6.5 million barrels a day next year, which would account for close to half of total U.S. output.

This may be part of the reason why Texas has some of the cheapest gas in the country, even at today’s record high of $4.34 per gallon, according to the American Automobile Association (AAA). No wonder so many companies have relocated to the Lone Star State in recent months.

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Index Summary

  • The major market indices finished down this week. The Dow Jones Industrial Average lost 0.94%. The S&P 500 Stock Index fell 1.20%, while the Nasdaq Composite fell 0.98%. The Russell 2000 small capitalization index lost 0.26% this week.
  • The Hang Seng Composite gained 1.86% this week; while Taiwan was down 9.14% and the KOSPI fell 10.31%.
  • The 10-year Treasury bond yield rose 0.21 basis points to 2.95%.

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Energy & Natural Resources

Strengths

  • The best performing commodity for the week was DCE iron ore futures, up 7.61% on expectations that the removal of most lockdown restrictions in Shanghai will boost infrastructure spending. Gulf Coast pipelines feeding LNG export capacity continued to grow last week, as Enbridge (ENB) announced the advancement of construction on the Venice Extension and Gator Express Meter projects. At completion, the two projects will add 1.5 billion cubic feet per day (bcf/d) of capacity via ENB’s TETCO to Venture Global’s Plaquemines facility, with the Gator Express expected to be in service in 2023 and Venice Extension in 2024.
  • Brent crude topped $124 a barrel, hitting the highest level since early March. The latest round of European Union (EU) sanctions would forbid buying oil from Russia delivered by sea but includes a temporary exemption for pipelines, European Council President Charles Michel said.
  • According to Evercore ISI, demand destruction historically starts when Brent crosses above $100 per barrel. While still early, the group has not seen any change in consumer behavior in the U.S. Consumer balance sheets remain relatively healthy. In addition, after two years in a pandemic-impacted world, people are ready to hit the road this summer and spend money on experiences.
Oil Prices Continue to Edge Higher

Weaknesses

  • year. Fertilizer prices that had hit records are now plunging as buyers reel from sticker shock. The June spot price in Tampa, Florida, for the nitrogen fertilizer ammonia settled at $1,000 per metric ton, a drop of 30% from May’s $1,425 per metric ton, according to Green Markets, a Bloomberg company. Demand destruction is part of the decline. Places like Southeast Asia are seeing buyers unwilling to pay the record high prices that were posted in April and May, said Green Markets analyst Alexis Maxwell. It also reflects the declining cost of ammonia production as European natural gas prices fell in the second quarter, she said. Even with the drop, however, prices are still 87% higher than a year ago, and supply chain issues continue to wreak havoc on global markets.
  • According to Morgan Stanley, China’s imports of LNG are on track to post their first major decline this year, as high prices and weak manufacturing due to COVID-19 lockdowns crimp demand for the super-chilled fuel. China became the world’s top LNG buyer last year but surrendered the top spot back to Japan in the first four months of 2022 as imports sank 18% from a year earlier, data shows. Even for shipments arriving in July, industrial consumers are not placing orders, a Chinese trader said.
  • Iran has seized two Greek oil tankers in one of the world’s busiest shipping lanes in apparent retaliation for the capture of a Russian-flagged tanker loaded with Iranian oil last month. Iranian forces boarded the Prudent Warrior, a Greek-owned vessel, on Friday afternoon, in the Strait of Hormuz using a helicopter and a pair of speedboats in each case, according to the manager of one of the ships.  Last month Athens seized the Russian-flagged Pegas oil tanker — subsequently renamed Lana — for carrying sanctioned Iranian crude. U.S. authorities are reported to have this week taken the Iranian crude from the tanker.

Opportunities

  • According to J.P. Morgan, over the next 12-18 months, frac margins will need to rise to incentivize the reactivation/upgrade of idle equipment, which could require significant upgrade capital as the low hanging fruit from fleet reactivations has already been picked. The bank expects the market to tighten even further in 2023 as demand continues to grow, but adding useful capacity remains challenging as pumpers demonstrate capital discipline with fleet upgrade and newbuilds, and supply chain challenges delay any new equipment that is ordered.
  • Bloomberg reports that the Democratic Republic of Congo could see 10 new mines come into production that are powering the green-energy transition over the next four years. Currently there are about 500 of the nation’s mining permits in advanced development that could lead to new lithium, cobalt, copper, tin, tantalum and tungsten. The Congo’s mineral endowment of high-grade ore bodies is gaining increased attention as metal prices have risen.
  • Exempting Russia from the OPEC+ alliance’s oil-production agreements are being discussed by some members of the Organization of Petroleum Exporting Countries, the Wall Street Journal reports. Such a move would have major ramifications for global oil supply. Russia is one of the world’s top three crude producers, along with Saudi Arabia and the U.S., but it’s struggling to maintain output and exports in the face of increasing sanctions. By removing Russia from the monthly supply quota system, it could give other OPEC+ members, particularly the Saudis and United Arab Emirates, scope to pump more to stem surging oil prices that topped $120 a barrel this week. It also comes as U.S. President Joe Biden mulls a visit to Riyadh to try and repair frayed diplomatic relations.

Threats

  • A record volume of Russian oil is on board tankers, with unprecedented amounts heading to India and China, as other nations restrict imports because of the war in Ukraine. Between 74 million and 79 million barrels from the OPEC+ producer was in transit and floating storage over the past week, more than double the 27 million barrels just before the February invasion of Ukraine, according to Kpler. Asia overtook Europe as the largest buyer for the first time last month, and that gap is set to widen in May, according to the data and analytics company. Some are forecasting oil to rise with China reopening, but obviously they have stocked up on plenty of cheap Russian oil already.
  • The European Union on Monday agreed to ban most Russian oil imports by the end of the year. The embargo exempts pipeline oil from Russia as a concession to Hungary. This move is expected to result in 90% reduction in crude imports from Russia to the EU. It is estimated that close to 66% of Russian crude oil exports to Europe are seaborne. Effectively, EU countries are looking to displace 1.5 million barrels per day (MMb/d) of Russian crude by year-end. European refiners will struggle to replace these Russia seaborne barrels. 
  • Demand for oil and refined products is falling as the economy starts bracing for a recession, said Ed Morse, Citigroup Inc.’s global head of commodity research. The fair value of Brent futures is in the $70 range even though the international benchmark is trading around $120 a barrel, the well-known oil market bear said Tuesday. Analysts continue to revise their demand expectations on signs of an economic slowdown, Morse said. Citi cut its demand estimate for products to 2.2 million barrels a day, down from 3.6 million barrels at the start of the year.

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Blockchain and Digital Currencies

Strengths

  • Of the cryptocurrencies tracked by CoinMarketCap, the best performer for the week was SoldierNodes, rising 1,413.88%.
  • Fidelity Investments’ cryptocurrency-focused subsidiary is planning to hire more than 100 new technology workers as it works to expand its offering beyond Bitcoin, the Wall Street Journal reports. Fidelity Digital Asset Services wants to add engineers and developers with blockchain expertise in its hiring of 110 tech workers for cryptocurrency services outside of Bitcoin. 
  • Cryptocurrency custody firm Fireblocks hired Varun Paul, the former head of fintech at the Bank of England, as its first director of central bank digital currency and market infrastructure, writes Bloomberg. Paul will lead Firelocks’ efforts to build infrastructure for the integration of central bank digital currencies (CBDC), the firm announced Tuesday and reported by Bloomberg.

Weaknesses

  • Of the cryptocurrencies tracked by CoinMarketCap, the worst performing for the week was ERC20 down 99.76%.
  • Leading U.S. crypto exchange Coinbase is “tremendously overvalued” at current levels, warned short-selling legend Jim Chanos, predicting a collapse in fee income that will send the stock plunging. He told the Crypto Critics Corner podcast that Coinbase still gorges itself on overly favorable retail trading commissions, and his short position is based on an end to the “feasting” it enjoys relative to mature brokers like Charles Schwab, writes Bloomberg. 
  • Bitcoin has only briefly deviated from the $30,000 level since the collapse of the TerraUSD stablecoin triggered a broad crypto selloff in early May. The token could “form a cyclical low” in the second half of this year, based on previous market cycles, Bloomberg analyst Jamie Douglas said. Cryptocurrencies have been hit as the Federal Reserve and other central banks hike rates to combat stubbornly high inflation and underperforming equities.
Bitcoin Has Steadied But Remains Down Sharply in May

Opportunities

  • Singapore has begun a project to investigate potential uses of asset tokenization as the city state looks to establish itself as a hub for decentralized finance after several key crypto players left, writes Bloomberg. “Project Guardian,” a collaboration between the Monetary Authority of Singapore and the finance industry, will test the feasibility of applications in asset tokenization and DeFi while working to manage risks to financial stability and integrity.
  • Binance Labs, the venture capital arm of the world’s biggest crypto exchange, launched a $500 million fund to invest in digital asset projects, the last capital injection into an industry that’s reeling from plunging prices and the collapse of the TerraUSD stablecoin.
  • New York State lawmakers passed a bill that would trigger a two-year moratorium on new permits for certain power plants involved in Bitcoin mining, writes Bloomberg. The measure, which was approved by a vote of 36 to 27 in the state senate early Friday morning, now moves on to Governor Kathy Hochul for consideration. 

Threats

  • The billionaire Winklevoss twins’ Gemini Trust Co. was sued by the U.S. Commodity Futures Trading Commission (CFTC), which claims that the cryptocurrency business misled the regulator about a Bitcoin futures contract. In a lawsuit filed in federal court in Manhattan on Thursday, the CFTC alleged that Cameron and Tyler Winklevoss’s Gemini “made false and misleading statements” in communications with commission staff from July to December 2017 about the operations of the Gemini Exchange and Gemini Bitcoin Auction according to Bloomberg.
  • Jump Crypto, a firm involved in the defunct Terra blockchain, said that some large investors exited Terra-related positions as the TerraUSD stablecoin began to lose its peg, while small investors continued buying during the collapse writes Bloomberg. 
  • Consumers reported losing over $1 billion to fraud involving cryptocurrencies from January 2021 through March 2022, according to a new analysis from the Federal Trade Commission (FTC). The FTC’s latest consumer protection data spotlight finds that most of the losses consumers reported involved bogus cryptocurrency investment opportunities totaling $575 million in losses since January 2021. The scams often falsely promise investors that they can earn huge returns by investing in their cryptocurrency schemes, according to Bloomberg.
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Gold Market

This week gold futures closed the week at $1,853.70, down $3.60 per ounce, or 0.19%. Gold stocks, as measured by the NYSE Arca Gold Miners Index, ended the week higher by 0.23%. The S&P/TSX Venture Index came in off 0.56%. The U.S. Trade-Weighted Dollar rose 0.48%.

Date Event Survey Actual Prior
May-30 Germany CPI YoY 7.6% 7.9% 7.4%
May-31 Eurozone CPI Core YoY 3.6% 3.8% 3.5%
May-31 Conf. Board Consumer Confidence 103.6 106.4 108.6
May-31 Caixin China PMI Mfg 49.0 48.1 46.0
Jun-1 ISM Manufacturing 54.5 56.1 55.4
Jun-2 ADP Employment CHange 300k 128k 202k
Jun-2 Initial Jobless Claims 210k 200k 211k
Jun*-2 Durable Goods Orders 0.4% 0.5% 0.4%
Jun-3 Change in Nonfarm Payrolls 318k 390k 436k
Jun-9 ECB Main Refinancing Rate 0.000% 0.000%
Jun-9 Initial Jobless Claims 210k 200k
Jun-10 CPI YoY 8.2% 8.3%

Strengths

  • The best performing precious metal for the week was platinum, up 7.73% as hedge funds cut their bearish platinum outlook to the lowest in six weeks. The Reserve Bank of India boosted its gold holdings by 65 tons in the year ended March to 760.4 tons, according to the central bank’s annual report. Of the 760.4 tons, about 295.8 tons are held in India as backing for notes issued and the rest is held overseas as assets of the banking department, the Reserve Bank of India (RBI) said in the report
  • Gold advanced as investors assessed developments in the Federal Reserve’s path to monetary tightening as inflation and rising volatility weigh on economic prospects. Concerns that central bank rate hikes may induce a recession are keeping investors guessing about the outlook for the economy as rising food and energy costs squeeze consumers, and volatility in the markets has picked up. Bullion had a choppy month in May as traders weighed aggressive monetary tightening and prospects of an economic slowdown. “Fundamentals overall are supportive for gold, but not aggressively so as the markets try to figure out whether we’re in inflation, stagflation or recession,” said Rhona O’Connell, an analyst at StoneX Group. Traders are also probably waiting for the Fed’s assessment of the economy today and Friday’s job numbers, she said.
  • The demerger of Leo Lithium from Firefinch concluded on Friday with trading set to begin in Leo Lithium around June 16. Holders of Firefinch received 1 Leo Lithium share for every 1.4 Firefinch shares they held. In addition, an A$100 million raise was taken up by 90% of the Firefinch shareholder. Firefinch retained 20% of the Leo Lithium shares and is working towards producing 100,000 ounces of gold from the Morilla Mine in Mali. Based on the rerating post the spinout of Leo Lithium, their share price relative to their resource statement is significantly undervalued. Leo Lithium is partnered 50:50 with Chinese lithium mining and processing giant Ganfeng with anticipating lithium production by 2024.
Bullion Gained as the Dollar Pared Advance

Weaknesses

  • The worst performing precious metal for the week was palladium, down 4.81% on little metal specific stories. A recent Bloomberg report showed that a third Americans earning at least $250,000 annually, are faced with living paycheck to paycheck. This underscores how inflation is taking a bigger bite out of household budgets at the end of the month. The $250,000-plus income bracket represents the top 5% of earners in America. Obviously, they are not suffering the same stresses as the other 95% have experienced but seems to highlight what used to be a good income in America doesn’t cut it anymore.
  • With the banning of seaborn Russian oil by Europe, diesel prices spiked 19% to over $40 per barrel premium to crude. Russia is the biggest supplier of diesel to Europe but oil is an international market and we are likely to see knock on affects to world markets, which will impact the large open pit miners more so on cost.
  • Appian Capital Advisory LLP has filed a claim at the High Court of England and Wales seeking compensation from Sibanye Stillwater and its subsidiary Sibanye BM Brazil for Sibanye’s failure to close on a $1.2 billion transaction to acquire two mines in Brazil, according to an emailed press release. Appian says Sibanye’s termination of the deal was based on the incorrect assertion that a geotechnical instability at Atlantic Nickel’s Santa Rita mine constituted a material adverse effect Appian is seeking to recover its losses in full.

Opportunities

  • In an unexpected announcement (in part because Yamana is hosting two mine tours this week), Gold Fields and Yamana jointly announced that Gold Fields is acquiring Yamana to create a top-4 gold producer (3.4M ounces per annum) headquartered in Johannesburg. In an all-share offer by Gold Fields, the exchange ratio is 0.6 Gold Fields share for each Yamana share, implying a value of $6.7 billion for Yamana, a 31% premium to the last $5.1bn market cap. North American investors did not appreciate the offer as Gold Fields sold off 23% on the day of the announcement as they have largely ignored the South Africa gold miners, which have diminished impact on world supply in recent decades. However, Gold Fields and the other South African gold stocks have proven to have very lucrative prices moves with a strong gold market.
  • According to RBC, mergers have been driven by a few fundamental sector themes: first, the reserve replacement challenge – gold producers are having increasing difficulty replacing the reserves they mine each year; second, scale for relevance – generalist investors continue to prefer gold companies with large market capitalizations; third, scale for cost – particularly relevant in the current inflationary environment, larger producers tend to have better buying power and can better maintain costs and margins; fourth, ESG performance – gold companies with mines in more challenging jurisdictions and higher emissions intensity seek to diversify; and fifth, high industry fragmentation – the gold sector is much more fragmented relative to other mining sectors.
  • Nano One Materials has entered into a joint development agreement with BASF for evaluating Nano One’s patented M2CAM One-Pot process for BASF’s next generation of cathode active materials. BASF has a family of cathode active materials (CAM) products well suited for the drivetrains of electric vehicles (EVs). Nano One’s technology will allow BASF to have higher functionality during the crystal growing processes to increase performance and lower the costs of production.

Threats

  • The Democratic Republic of Congo was reported by Bloomberg to be considering establishing a stabilization fund to ensure its booming mining industry isn’t undermined by external events like the war in Ukraine or a future pandemic. Interesting they cite how high fuel costs have eroded government revenue. While many miners have faced higher diesel cost it is not likely the government is funding these fuel purchases for the miners. The idea appears more be a new taxation attempt.
  • The U.S. Energy Information Administration (EIA) expects wholesale electricity prices in the western U.S. electricity markets as the Northern California snowpack was at only 26% of normal levels back in April, an indicator that the reservoirs at western power plants will have enough stored water to meet power demand.
  • According to RBC, automobile sales are expected to remain challenged in 2022 given supply constraints and the impact of inflation on consumers. With supply from Russia seemingly uninterrupted so far, they expect platinum prices to stay soft through 2022.

To read the full article go to https://www.usfunds.com/resource/the-upside-to-record-high-gas-prices/

 

Author: Frank Holmes
Date Posted: June 3, 2022