Energy, Politics & Money - 01 September 2022
News curated from the ever evolving worlds of energy, geopolitics, and money just for you!
In this roundup, we hypothesize, had a position been taken in oil that aligned to the economic outlook we articulated this past July, it is possible that the profits would have been handsome.
Additionally, we discuss:
Why the oil futures market is broken and what this means for analysts
Why we fear the US proposal to cap the price of Russian oil on the international market is more likely to reduce supply
Why China’s economic problems are likely to be much worse than official statistics suggest
Why we believe buying in to the “Energy Transition will fail” narrative would be bad for your business
Why some experts are becoming more convinced a major stock market correction is on its way
General Energy News
CRUDE OIL
In our Tuesday update we said trader sentiment was turning bearish due to a focus on the coming economic recession. By the end of trading on Tuesday, this had caused oil to drop nearly $6 a barrel, the steepest decline in about a month. The decline continued during trading on Wednesday and early morning Thursday, when Brent crude futures were trading at $95.27 a barrel by 0006 GMT, while WTI traded at $89.23 a barrel according to Reuters.
Bloomberg highlights the fact that with August now over, oil has declined for 3 consecutive months, the longest losing streak since April 2020. This is primarily driven by the outlook for the economy.
In our view, early summer the investment community grossly underestimated the implications the “triple whammy” general inflation, Russia sanctions, and monetary policy tightening would have on the economy. Consequently, they have had to adjust their view on the future downward in steps, pushing oil down slowly but steadily. If you go back to our work from July, you will notice that at EPM we highlighted the “dark clouds gathering” right from the beginning.
SAUDI – ANALYSIS OF ITS REMARKS ON OIL FUTURES
Bloomberg also delves deeper into the statement originally made by the Saudi Energy Minister Prince Abdulaziz, that the oil futures market - where the prices are set that usually get quoted - is not properly functioning. On Wednesday, hedge fund manager and oil futures specialist Pierre Andurand said the futures market is “completely broken”. On Twitter he complained that futures can now move $10 a barrel lower a day “for no apparent reason”. In part this is due to interest in oil futures being at a seven-year low. Combined open interest on the four main Brent and WTI contracts fell below 4 billion barrels for the first time since June 2015 last week, Standard Chartered said in a note. Here at EPM, we have previously discussed our fundamental issues with the futures market and remain of the view that one must always focus on spot market prices for a comprehensive understanding of what is going on. And, what is likely to happen next.
US MOVES TO CAP RUSSIAN OIL PRICES
Looking slightly ahead, Bloomberg reports that the upcoming G7 meeting will feature a discussion on the US proposal to cap the price of Russian oil on international markets. The thinking behind this US proposed massive intrusion in the free market (oh, the irony…) is that it will ease supply shortages while slashing overall Russian revenues from crude. From EPM’s perspective, we fear the proposal might make things far worse than they already are. As reported by Javier Blas of Bloomberg, Russian oil - disguised in a number of different shapes and form - is currently finding its way to the market. For example as Malaysian crude – which is the only way to explaine China importing 800,000 barrels per day of Malaysian crude more than Malaysia actually produces. At the same time, Russia threatened that any country going along with the proposed US price cap, will be completely cut off from Russian energy. In other words, the US proposal is more likely to decrease supplies to the market than it is to increase them!
OPEC – PRODUCTION NUMBER ANALYSIS
OPEC’s Joint Technical Committee (JTC) met on Wednesday and said the oil market will have a small surplus of just 0.4 million bpd in 2022, much less than forecast earlier, due to underproduction of OPEC+ members, writes Reuters. This highlights that the OPEC+ discussing on whether or not to reduce the production quota in support of the oil price is largely artificial, as underproduction is running in the millions of barrels.
ULTRA DEEP-WATER OIL – A COME BACK
A few years back, we at EPM thought ultra deep-water would be suffering the worst consequences of US Shale. We also thought that shale-technology was more likely to go global than resuscitating ultra deep-water drilling. According to Reuters, we might well have been wrong in that assessment. Shale technology has not gone international nearly as fast as we expected. While we could brush that forecasting failure off by saying “COVID”, Reuters is saying that post COVID it is ultra deep-water that is attracting most attention of oil companies globally. Global offshore investment should rise 27% from 2021 levels to $173 billion in 2024, reversing a decade of decline and growing slightly faster than onshore investment, based on data from Rystad. Mea culpa…
Macro-Economics
EUROPEAN INFLATION
Eurozone inflation rose to a record 9.1 per cent in the year to August, writes The Financial Times, which makes a 0.50 to 0.75% rate hike in September essentially a certainty.
CHINESE CARBON EMISSIONS
China’s carbon emissions fell almost 8 per cent in the April-to-June quarter compared with the same period last year, writes The Financial Times based on analysis by climate research service Carbon Brief. At EPM we believe this is probably on the best indicator of actual economic activity in China, much better than official statistics. Carbon Brief said it was the fourth consecutive quarter in which emissions have fallen in China, due to “falls in steel and cement output due to the real estate slump, fall in transport oil consumption caused by Covid-19 control measures, slow electricity consumption growth and strong increases in renewable power generation”.
Geopolitics
FURTHER US RESTRICTIONS ON CHINA
The US is further restricting shipments to China of high-end graphics processors and AI accelerators used in high-performance computing, writes Nikkei Asia. Washington's move marks the latest escalation in the U.S.-China tech battle. In August, the U.S. restricted exports of the most advanced chip design software to curb Chinese efforts to produce cutting-edge chips locally. We at EPM are reminded of the US sanctions on oil purchases by Japan in the 1930s, which eventually led Japan to invade South East Asia to capture its oil producing regions. Will the US sanctions policy around semiconductors similarly push China to war over Taiwan for TSMC?
JAPAN INCREASES MILITARY SPENDING
Japan is not taking any chances, it seems. The Financial Times reports its defence ministry on Wednesday made a record ¥5.6tn ($40bn) budget request for the year to March 2024, compared with ¥5.4tn in planned spending for the current fiscal year. But, people with knowledge of internal ministerial discussions said the final budget would top at least ¥6tn after the inclusion of additional requests for military equipment to be made at the end of 2022, when Japan will release a new national security strategy and defence guidelines. This would make the figure one of the biggest increases in the country’s military spending in the postwar period. FT further says Japan was considering developing homegrown cruise missiles that would have a range of more than 1,000km, which would allow Japan to strike targets within North Korea or China from ships and fighter jets. Our EPM commentary is that, from a strategic perspective, developing a domestic defense industry is critical for real security. Therefore, while we expect the US to strongly support Japan’s increased expenditure on defense, it will push back on any plans to build out a Japanese defense industry. Germany and its new $100 billion budget will experience the same US response, we foresee.
Energy Transition & Technology News
OPINIONS ON THE ENERGY TRANSITION
In the Wall Street Journal an opinion piece with the title “Why the Energy Transition Will Fail”. This is likely to be jumped upon by people with an emotional attachment to the oil and gas industry. Because emotion is a very bad strategic advisor, we share a couple of thoughts in response.
First, no credible forecast says the Energy Transition will cut oil and gas demand to zero. Even the most aggressive transition scenarios, such as the Net Zero scenario of the IEA, leave 20 million barrels per day of oil demand by 2050, and its authors recognize it is an extremely unlikely scenario.
Second, and this is linked to the first point, whether or not the Energy Transition will succeed is strategically irrelevant.
What is important is that the world will try to move towards an Energy Transition, enabled by advancements in technology (electrification of transport) and public policy (e.g. Paris Climate Accord, US climate bill, etc.). The effort itself will have an impact on oil and gas demand. At best, it will end the growth in demand. At worst, it will take a significant bite out of current demand levels. Both will change the oil and gas business, either significantly (best case) or dramatically (worst case)! This what energy strategists need to focus on, not whether or not the political project Energy Transition will succeed or not.
JAPAN – HYDROGEN INFRASTRUCTURE DEVELOPMENTS
Nikkei Asia reports Japanese trading house will start opening year-round hydrogen stations Itochu in 2024. It will undertake the project with French gas supplier Air Liquide. The first 365-day hydrogen station will be in Fukushima, to be followed by other locations along major highways. While this may get some people exited, we at EPM see it as evidence that hydrogen will not be playing a major role in transportation. The necessary infrastructure is not only exceptionally expensive due to the characteristics of hydrogen, its development also lags significantly behind the infrastructure supporting battery EVs. This will not change anytime soon, as Japan, the country pushing hydrogen for transportation the most, so far has only 160 hydrogen fueling stations, with a goal of opening 1,000 by 2030. These small numbers are unlikely to make hydrogen cars a competitive alternative to battery EVs.
As one would expect from a National Oil Company managing one of the world’s largest natural gas resources in the world, QatarEnergy will build 1.2 million tonnes per year blue ammonia facility, reports Reuters. The cost of the Ammonia-7 project is approximately $1.1 billion and production scheduled to start 1st quarter 2026.
The Electrification of Transport
HONDA PLANS EV CATCH-UP
Similar to its Japanese peers, Honda has been slow to embrace electric vehicles. But it plans to catch up quickly, reports Nikkei Asia. On Monday the company announced it will team with South Korean battery maker LG Energy Solution to build a $4.4 billion EV battery plant in the U.S. In addition, the company intends to establish a competitive advantage during the latter half of the 2020s, through development of solid-state batteries. The company will spend $310 million to launch a pilot production line that produces all-solid-state batteries at Honda's research center in Sakura, north of Tokyo.
INDONESIA AND NICKLE (ITS GONNA BE HUGE)
The Financial Times reports on Indonesia, which is poised to take “pole position” on nickel, an element that is critical for the electrification of transport. But, the report notes, Indonesia’s nickel needs significant processing and in the country which has the highest carbon emissions per KWh of electricity, this is leading to significant CO2 emission. Those with an interest in investing in the country, which has an ambition to develop along the EV value chain from mineral development all the way to the actual manufacturing of the vehicle, would be wise to push the country to greening its electricity network.
The Global Energy Crisis
RUSSIA HALTS GAS FLOW TO EUROPE
As previously announced, Russia indeed halted gas supplies via Nord stream 1 to Europe on Wednesday. According to Russia the interruption of flows is necessary for maintenance, and will last until September 3, reports Reuters.
On Tuesday Gazprom also said it would fully suspend gas deliveries to major European utility Engie from Thursday, writes Reuters. According to Gazprom, Engie had not paid in full for July deliveries of gas.
EUROPE - ENERGY PRICE PROTESTS
The increase in energy prices that has resulted from the reduced flow of Russian gas to Europe is triggering protests in the UK, writes The Financial Times. The “Don’t Pay” campaign is hoping to amass a million supporters who will cancel their direct debit payments to energy companies en masse on October 1. Since mid-June it has attracted more than 130,000 supporters.
The EU is looking at options to bring energy prices down for consumers in a sustainable manner, and The Financial Times has a deepdive looking at how, possibly, if at all, it could achieve this.
ESG
The International Sustainabilty Standards Board (ISSB) called upon the European Union to slow down the efforts of the EU's standards writing body EFRAG to develop standards for reporting on climate change, writes Reuters. ISSB argues alignment between the two bodies would be more beneficial, as it would reduce complexities facing international organizations that will have to do the reporting.
Other
STOCK MARKET MELTDOWN - PREDICTIONS
Bloomberg reports on Jeremy Grantham, co-founder of GMO and worldwide celebrity in investment circles for his work on market bubbles. He became for famous spotting and profiting from bubbles in Japan in the late 1980s, tech stocks at the turn of the century and in US housing before the 2008 financial crisis. According to Grantham, the collapse of a super bubble comes in several stages: there’s a setback, then a slight rally follows, and, finally, the fundamentals break down and the market reaches its low point.
In a note on Wednesday, Grantham says the surge in US equities from mid-June to mid-August fits this pattern of bear market rallies common after an initial sharp decline — and before the economy truly begins to deteriorate. Grantham sees more trouble ahead because of a “dangerous mix” of overvalued stocks, bonds and housing, combined with a commodity shock and hawkishness from the Federal Reserve. Echoing the sentiment we have regularly aired here at EPM, Grantham points to near-term problems such as the impact of Russia’s invasion of Ukraine on Europe, food and energy crises, along with fiscal tightening and China’s persistent Covid issues. “My bet is that we're going to have a fairly tough time of it economically and financially before this is washed through the system”, Grantham said. “What I don't know is: Does that get out of hand like it did in the ‘30s, is it pretty well contained as it was in 2000 or is it somewhere in the middle?”.