Andrew Pyle
January 12, 2024
Natural gas back in focus
For a week that started off with market participants laser-focused on U.S. inflation figures, we end up with a lot more discussion about energy developments around the world. From terrorist attacks on ships in the Red Sea, to Thursday’s news that Iran had seized a tanker in the Gulf of Oman, to another major acquisition in the U.S. natural gas space, investors have a lot of information to wade through to arrive at an outlook for the coming months.
Let’s start with crude oil. In the fourth quarter of last year, we saw a sharp pullback in WTI futures from a high of $95/barrel, down to below $70 in December. The reasons behind this decline, from what were the best levels since the summer of 2022, were primarily growth in supply and concerns over weaker growth in the U.S. and China. As much as there was an initial bump higher in the wake of the Israel-Hamas conflict, there wasn’t as much follow-through as analysts had predicted.
Things stabilized in mid-December, however, as signs of a pivot in Federal Reserve policy towards easing in 2024 reined in recession expectations that had built since the summer. At the same time, inventories began to contract and as the new year started, there were signs that demand may not necessarily be as much as a headwind as anticipated. Case in point, global traffic congestion levels picked up in most major cities around the world, according to data compiled by Bloomberg. These figures are still well below the highs in the second half of 2023.
If demand isn’t crumbling away, then what of supply. As the conflict in the Middle East has spread to include attacks on vessels in Red Sea by Iran-backed rebels. This has forced cargo ships and tankers to take detours either around the southern tip of Africa or eastbound, rather than moving shipments through the Suez Canal. The result has been an increase in shipping rates and fuel usage. Still, it is the hostility in the region that has come back to the forefront. On Thursday, the U.S. and its allies launched attacks on a number of Houthi targets in Yemen. On top of that, Iran seized a tanker off the coast of Oman, and by early Friday morning in Europe, WTI futures had gained close to $2 to re-rest $74.
While a further escalation in hostilities in the region could push crude oil prices back towards $100, the increase in production and the fact that global demand is going to remain weaker until monetary policy actually does shift into easing mode will likely keep crude in a $60-100 range in 2024. That may appear wide, but after the post-pandemic surge, it will essentially be sideways trading.
Where we believe there might be more sustainable improvement in price is natural gas. There are a number of factors on the demand side to support this. For one, as the war in Ukraine continues, European nations are going to be even more inclined to look to liquefied natural gas (LNG) imports from North America or the Middle East. Even China has seen strong growth in LNG imports, despite a much weaker than expected economy. In terms of Europe’s shift to LNG, this is one of energy independence from a sole provider that has emerged as a tyrant. Yet, there is a broader development and that is a shift in energy production away from coal to something cleaner.
As we have discussed before, the transition to a lower emission global economy is not a light switch from using fossil fuels to no fuels. Indeed, it will need to be a blend between adoption of power sources like solar and wind, alongside shifts within the traditional fuel space and increased carbon capture practices. The two main streams for this to take place, in my opinion, remains natural gas and nuclear. The latter we will look at another time, but for now it is the anticipated growth in LNG demand that is driving activity.
This week’s announced acquisition of Southern Energy Co by rival Chesapeake Energy Corp. for US$7.5 billion is expected to create the largest gas producer in the U.S. While we have seen even larger takeovers in the energy patch, this one is more focused on natural gas and so far this week, investors are rewarding the proposed deal. Ally and I have also recently started to add more of a gas concentration to the portfolio in the Canadian space, with the same rationale – that LNG demand will continue to grow and put us in a more sustained uptrend in gas prices.
Let’s be clear, however. As much as there is a lot of talk of transition from coal usage to natural gas, and the outlook for a growth move in that direction looks clear, we are approaching this from a strong trend in terms of coal production and demand as the above charts show. Total world production, according to the British Petroleum Statistical Review, reached 8.8 billion metric tonnes in 2022 – surpassing the previous peak in 2013 of 8.3 billion. Consumption has plateaued since 2014 and the 161.5 exajoules consumed in 2022 was basically back to its 2014 level. It’s no surprise therefore that we have seen coal prices nosedive in the past year and a half (the IMF world coal price index is down 68% from the high in the summer of 2022).
This drop in price could slow the transition away from coal, especially if natural gas prices continue to move higher and there is one of the key problems with black and white approach to energy transition. This is a dynamic equilibrium model at the end of the day with many variables, whether they be exogenous like geopolitical tensions, or simply the impact on demand for clean energy use due to price. Ally and I still believe that the long-term trend towards increased clean energy production continues, but have a realistic view to how the transition will also provide opportunities in cleaner traditional energy producers.
On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.
Andrew Pyle
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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.
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