Why Oil Markets Will Outperform Expectations in 2023
We believe investors are being far too complacent about oil markets. After making a 14-year high of $130 per barrel in March, prices have steadily pulled back to $80. Concerns around the security of supply following Russia’s invasion of Ukraine have given way to worries about recession and sagging demand. Oil has nearly given back its entire move higher since the attack took place on February 24th, 2022.
Despite weaker-than-expected second-half demand, we estimate that global oil markets were in structural deficit by as much as 500,000 b/d throughout 2022. Furthermore, our models tell us this deficit will worsen as we progress through 2023. In their latest Oil Market Report, the IEA implies that oil markets will be in deficit by as much as 600,000 b/d this year. It is infrequent for the IEA to predict a deficit; typically, their estimates skew toward a surplus. We cannot recall any other time, under normal market conditions, when the IEA predicted a large deficit.
Our models tell us the deficit could be even more extreme.
Investors are focusing on all of the wrong things. Stories of a near-term energy glut dominate headlines. Near-term demand is always noisy and prone to reversion. Longer-term, we believe the oil market will be dominated by the massive lack of upstream capital spending that has been chronic for nearly a decade. We expect the ongoing energy crisis will persist until inves- tors regain interest in conventional energy and encourage companies to drill. There will be volatility, as always; however, we believe crude prices are headed much higher.
Weather Presents a Natural Gas Buying Opportunity
What’s behind this collapse, and what does it mean going forward? Despite the considerable pullback, our thesis has not changed: we believe both US and global natural markets are in structural deficit. As you will see, we believe all weakness is due to one-off factors and should not repeat themselves. The underlying fundamentals remain incredibly tight, and we believe the current weakness presents long-term investors with an extremely attractive opportunity.
A lucky combination of export outages, tough choices, and warm weather helped repair the inventory situation in the United States and Europe. However, we believe long-term struc- tural problems loom large on the horizon. The Freeport LNG facility looks to be back online, increasing US export demand by two bcf/d. In Europe, the extremely warm winter offered a reprieve; however, policymakers must now figure out how to permanently replace 18 bcf/d of Russian imports, equating to one-third of total demand. There are no easy solutions. Global LNG volumes total 52 bcf/d, so the seaborne market can only replace Russian pipeline imports for a while.
In the United States, falling natural gas prices have led to a misguided sense that the worst is behind us. Over the past twelve months, Americans, in general, have felt a sense of remove from the gas crisis facing Europe. We argued that would soon change as US prices became locked into global prices through increased LNG exports. Today, the prevailing wisdom says this will not become a problem until 2025 when the next tranche of LNG export capacity comes online.
We disagree. We believe the US market could slip into deficit much sooner.
When we laid out our case for much higher gas prices last May, we warned that weather is always the wildcard. Luckily for Europe, the weather turned very favorable. However, we cannot take that for granted. The natural gas market remains exceptionally tight after a decade-long grueling bear market dramatically starved the industry of much-needed capital. The recent weakness should prove temporary.
Natural gas equities, meanwhile, represent extreme value in our view. With many gas producers having reported earnings, we can analyze their SEC PV10 values. Using the average of last year’s gas prices, Range Resources RRC 0.00%↑ announced a PV-10 of $29.6 billion, or $113 per share, after adjusting for the debt – four times today’s stock price. Even using forward strip pricing of ~$4.25 per mcf, the debt-adjusted PV10 is $52 per share – twice today’s price. EQT resources EQT 0.00%↑ has a debt-adjusted PV10 of $127 on last year’s gas prices and $65 using the forward strip – again four times and twice today’s stock price, respectively. Antero AR 0.00%↑ has not yet released its SEC PV10 value, although we expect it will be as impressive.
Base Metals: A Decade of Shortages Ahead
If metal demand exceeds supply on a sustained basis, then metal held in quickly mobilized inventory should decline, which has transpired. Below is a chart showing the base metals inventories held at the three big metal trading exchanges: the London Metals Exchange (LME), the New York Metals Exchange (COMEX), and the Shanghai Metal Exchange
Since peaking at 9 mm tonnes of inventory in Q1 2013, base metals inventories have drawn steadily and are down 90% today. Today, exchange inventories have fallen below 1 mm tonnes and are dangerously low. Adjusted for days of consumption, inventories have never been lower. In Q4 2022, exchange metal inventory covered daily consumption by only 2.7 days, surpassing 45% of the lows seen in 2005-2006 of approximately five days and reaching the lows seen 35 years ago back in 1988-1989.
Today with exchange inventories sitting slightly below 1mm tonnes, these inventories cover only 2.7 days of consumption.
We believe this is going to be the decade of shortage across multiple commodity markets. Base metals markets give investors a great example of what a looming base metals shortage looks like. We find it fascinating that investors are paying no attention to base metals inventories that have reached record lows.
Copper Demand Soars: Is a Price Surge Coming?
In our 2021Q1essay “The Problems with Copper Supply,” we stressed how falling ore grades and skyrocketing capital costs would eventually produce disappointments on a global basis. We find the Bloomberg news article cited at the beginning of this essay interesting. The authors wrote: “While Chile has the largest copper reserves, ore quality has been steadily falling. That means mines need to move more rock to produce the same amount, pushing costs.” Project development is also getting pricier, with the cost of Codelco’s new Chuqui- camata underground mine 53% above original estimates and investments in El Teniente 75% over budget.
Copper demand is now running significantly above copper mine supply, further drawing down exchange inventories. Inventories are now at levels last seen in 2005, just before copper surged nearly three-fold.
China is reopening, which will likely result in a surge in copper consumption. The copper market is in a structural deficit, and inventories are dangerously low. We believe copper could see a massive surge in 2023, -similar to the period between 2005 and 2006.
