Simmons Energy Industry Note- April 5, 2020CONCLUSION Notwithstanding the entreaties on the part of the WH to “work this out” and “get our energy business back,” the fundamental challenges confronting Saudi/Russia in returning to a policy of rational guardianship, with the objective of stabilizing/reviving oil markets, with a substantive intervention from on high, are daunting. As we observed last week, even in the event the Saudi/Russia/non-OPEC gaggle agreed to proactively reduce production by “at least 6 MBD” (as reported by the WSJ, with other outlets now reporting ~10-15 MBD), we viewed this as a quixotic quest given the prodigious saturation of the global crude markets due to the depth of the current economic shock (oversupplied by ~20 MBD in Q2), and the exceedingly uncertain economic normalization path on the other side of the pandemic curve.
• Moreover, given the rampant accumulation of inventory underway and storage limits likely being tested by late-May/early-June, production recalibrations, of some magnitude, irrespective of WH/Saudi/Russian declarations, were likely to be forthcoming anyway, be they voluntary or involuntary.
• In the US, as is much the case in the OECD realm, transportation demand has evaporated, gasoline prices have plummeted, refining gasoline cracks are collapsing and refining utilization is cratering. Last week’s domestic refinery average utilization of 82% contracted 500 bps w/w and 800 bps vs. the 5-yr average of 90%, and East Coast utilization dropped to a 9-yr low of ~51%. Accordingly, given the likelihood of meaningfully reduced refining runs, even from current levels, a combination of domestically produced and imported crude will become displaced. Moreover, crude exports (according to DOE Monthly data, oscillating between 3.1-3.7 MBD Sept ’19-Jan’20, and recently spiked to 4 MBD according to the DOE weekly data), which have been a meaningful outlet for domestically produced crude, will likely become severely truncated.
• While global storage capacity isn’t corroborated by translucent data, remaining headroom for onshore crude storage, according to industry sources, is currently hovering in the vicinity of ~1.5 billion barrels of nameplate capacity. Employing an 80% utilization factor, as representative of max effective capacity, implies 1.2 billion barrels of remaining onshore storage headroom. Assuming we are currently oversupplied by ~20 MBD, this results in storage limits being reached within ~60 days. The broader US physical markets have been reflecting this ominous reality more accurately, in our view, than WTI spot prices. For example, while WTI-spot (Cushing) closed at $28.34/bbl on Friday. WTI-M was recently trading at ~$11/bbl and closed at $24/bbl on Friday. Bakken closed at ~ $16-18/bbl. Thus, given rapidly growing market imbalances due to evaporating demand, there isn’t a plausible supply-driven intervention bailout for the industry given the depth of the economic and oil demand shock. Prior max OPEC spare production capacity ballooned to 10 MBD in 1985 and we believe that global spare production capacity will revisit, or exceed, these Olympian heights.
• As disconcerting as the current reality is, the forward path beyond the pandemic bunker isn’t a fount of encouragement. On Friday, the NFP print of 701K in job losses represented the most severe contraction in jobs since March 2009. The job losses in April will be far more severe. While the March unemployment rate vaulted m/m from 3.5% to 4.4%, the CBO is projecting an unemployment rate of 12% for Q2. Oxford Economics is projecting that by May, ~28M jobs will have been lost, erasing all of the job gains since 2010 and the unemployment rate will reach 16%. According to the WSJ, should this projection prove to be prescient, the ensuing loss would be more than 2x the 8.7 million job loss during the 2007-09 recession and its aftermath (which unfolded over ~25 months). The prior monthly-high unemployment rate, according to records going back to 1948, was 10.8% established in late-1982 – this will soon be usurped. Further, the CBO is projecting an unemployment rate of 9% by the end of 2021. Thus, while some continue to extoll the prospect of V-shaped recovery, the unfolding reality is far more somber given the uncertain progress of the coronavirus, the depth of the economic contraction and job losses, the uncertainty regarding the ultimate duration of the economic lockdown and the pace of the economic normalization once we are on the other side of the pandemic curve.
• In a recent interview with the NYT, Dr. Fauci, when asked to opine on when the current crisis would be over, responded that the coronavirus would remain a threat until a vaccine was widely available: “I believe that in a few months, hopefully, we’ll get it under control enough that it won’t be as frightening as it is now. But it will not be an absent threat. It will be a threat that is there.” Similarly, Bill Gates, in a recent interview, prophesied that life won’t return to normal until we have widely distributable vaccine, globally. Accordingly, the pace of the economic recovery is likely to fall considerably short of the pace of economic contraction. Moreover, it is increasingly likely that the US will be confronting waves of acute crises (NY’s exponential pandemic progression subsequently migrates to FL, LA, TX, etc. and major metropolitan area pandemics migrate into semi-rural and rural domains) and that, following our emergence from the current period of acute crisis, we’ll inhabit a state of “seminormalcy” (Ross Douthat, NYT). Conceivably, life will then be conducted at “half-capacity,” for a period of time, with limited public interaction and travel and considerably diminished consumption of oil relative to the base-line which prevailed before coronavirus. While several European countries are now beginning to discuss/debate easing restrictions, the French premier recently expressed that the challenge posed by “deconfinement” was unprecedented and would be “fearsomely complex.” (FT). Further it is widely acknowledged in Europe that a return to “normalcy” is unlikely until a vaccine becomes widely available. • And while a silver-lining is the very likely implosion in non-OPEC production, large swaths of the global energy industry are being gutted and structurally emasculated, especially the L-48 value chain. Thus, while the convergence of an eventually reflating economy and imploding non-OPEC production should, at some point, be bullish for oil and lead to a reinvestment cycle, the damage being wrought to the energy supply chain is profound. With respect to stocks, Scott Minerd, CIO of Guggenheim, is said to have stated that bottom-fishing is the most expensive sport in the world as the illusion of cheap isn’t sufficient to validate asset values without supporting fundamentals. Will energy stocks continue to embody the call option feature of risk-on/off? Yes. But given the current exceedingly high complexity factor burdening the industry, energy continues to be a precarious sector. Sources: CBO, WSJ, Platt’s, Oxford Economics, NYT, FT