Economic Reconnaissance

Picture of  Chris Kuehl

Chris Kuehl

Managing Director • Armada

This edition of the NACM Connect report is a little different. Given the importance of the energy market I thought a deep dive would be useful. These are some observations on the sector and the influence this all has on the overall economy.

As is usually the case there is volatility in the sector. Some critical elements have altered and there are potentially significant developments on the horizon. The most important is that the US position in the oil and gas world has changed. The US has resumed its position as the world’s largest oil producer with an average of 16.6 million barrels a day. Saudi Arabia is second at 11 million barrels a day and Russia was once number three but has been fading fast. This has changed the way the world reacts to OPEC statements. The decision by Saudi Arabia to reduce production barely moved the needle as far as per barrel price. It has remained in the low 70s and that level is expected to be maintained through most of this year (barring weather events and maintenance issues). Although there is considerable interest in expanding electric vehicle usage the Energy Information Agency still predicts a 70% dependence on fossil fuels by the year 2070. Investment has been returning to oil and gas as the experiences of last year’s global energy shortage shifted attitudes.

Stability is expected in the oil sector but continued volatility in gas. The reduction in investment that marked the last decade has faded as it is apparent that renewable projects will not meet demand in the short (or even medium term). The limitations on oil and gas development have generally been more political and financial than anything connected to demand and supply. US consumption of oil has declined from around 24 million barrels a day to approximately 20 million barrels a day. This has been attributed to the reduction in the daily commute for millions of workers who are choosing the remote option. Most of the new development has been in the middle of the country (from Texas to North Dakota). The slower pace of development is expected to reverse in the coming months.

The production level is close to normal levels and the conversation has shifted to what is going on with consumption. The US level is down from what it had been prior to the pandemic. Consumption in Europe has been likewise down due to the reduced commute and the arrival of recessionary conditions. The big question revolves around China. The expectation had been that there would be dramatic recovery after the nation ended the lockdown but that has not transpired and China may be hard pressed to achieve their goal of 5.0% growth this year. The oil companies had been shifting resources to alternate energy projects but this has slowed as it has become more obvious that fossil fuel development has to continue. Profits surged in 2022 to historic levels – $219 billion. This is twice the profits the year before but 2021 was a slow year given the impact of the pandemic. This was in stark contrast to the doldrums experienced in 2020 when oil prices cratered. The oil company profits are determined by market volatility and the driver in much of 2022 was the impact of sanctions on Russian oil output. This has driven prices very high for a period of time before they settled.

Oil prices averaged in the 70s over the last few months. This came as something of a surprise given the announcement by OPEC that it intended to cut production through 2024. In early June WTI was sitting at just over $70 and Brent crude was at about $75. The very brief increase after the OPEC announcement was followed by a series of price drops as it became obvious that consumption was still falling and that the US was capable of offsetting the OPEC reduction with stepped up development activity. The US has even started to replenish the strategic petroleum reserve without affecting the per barrel price. The expectation is that oil prices will remain in the 70s through this year and into next. That is affected by potential weather issues as well as potential geopolitical issues.

Price declines have been seen in most of the energy sector. Gas prices through mid-March 2023, are $.30 lower on average compared to the same time as last year. Diesel prices through mid-March 2023 are averaging $.24 lower and are $.13 higher on average compared to the same time as last year. The expectation for gas and diesel prices in 2023 will be a decrease on average compared to the average over 2022. The prediction for diesel pricing has dropped considerably—down by over a dollar a gallon to $4.22 this year and perhaps $3.69 in 2024. As of mid-March the E.I.A. raised their forecast for U.S. gasoline consumption in 2023 and 2024 by about 2% compared with February’s outlook.