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The Energy Report: Commitment

Published 03/04/2024, 09:38 AM
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One of the biggest challenges in the global oil market in recent years has been the commitment between OPEC and Russia to try to work together to support global oil prices. For OPEC to learn lessons, it usually takes a catastrophic mistake like a major price crash for them to get the message and change their ways.

 In the United States, a lack of commitment to US oil and gas production could teach us a lesson with a major price spike. Oil and gas industry leaders warn that US policies are planting the seeds of the next energy crisis. Even Warren Buffet is talking about the steep decline rates in US shale production that could see US oil production peak and give even more economic power to Russia and the OPEC cartel. Yet at the same time, he is making oil and gas a forever play in his portfolio as he touts the ability of the US oil and gas industry, mainly Occidental Petroleum (NYSE:OXY), to beat the odds by tapping on rock to get oil and gas.

In the 1970s, no one realized how the Arab oil embargo would backfire on them. That move and threat to the global economy forced the world into energy efficiency that never would have happened if it weren’t for the threat that OPEC would cut off their supply. Because of that, the oil demand peaked, and it took decades for global demand to surpass the glory days before the Arab oil embargo. More recently Russia and OPEC learned that if they decided to go to war together and try to outproduce each other, it could lead to a price crash as it did just a few years ago and that epic price crash saw the price of oil trade below $0 per barrel and WTI in the United States.

While those memories are fresh in mind and with the economic outlook sending mixed signals to the cartel, they have decided to act decisively and definitively to try to stay committed to their current voluntary oil output cuts of 2.2 million barrels per day and committed to reigning in their overproduction. Russia also agreed to cut oil production and exports by an additional 471k bpd for the second quarter of 2024. Iraq and Kazakhstan also vowed to compensate for their previous overproduction. In other words, they could cut production more than their quota to make up for their previous cheating. A move that will leave the globe more undersupplied and create a floor for prices going into the end of the year.

This comes against a backdrop where the head of the US industry trade group the American Petroleum Institute Mike Summers warned that, “Washington is on the cusp of spoiling the American energy advantage, undermining it with short-sighted policies and hostility toward US oil and natural gas.” This hostility, along with the fact that there is uncertainty as far as investment, is causing concerns that we could see U.S. oil and gas production top out. That of course makes it a pretty darn good investment. The Oracle (NYSE:ORCL) of Omaha Warren Buffett is making major investments in the energy space. Buffett points out that there is extreme value in the space but at the same time, is warning about the decline rate of current wells which could make the US energy production levels scarcer in the years ahead.

Buffet’s famed Berkshire Hathaway (NYSE:BRKa) owns 27.8% of Occidental Petroleum and says that, “the company is “doing the right things for both its country and its owners” by helping to free the U.S. from reliance on imported oil. He says that Berkshire plans to hold the stock in the company “indefinitely”. He said, “No one knows what oil prices will do over the next month, year, or decade,” But the Occidental CEO Vicki Hollub does know how to separate oil from rock, and that’s an uncommon talent, valuable to her shareholders and her country.”

Buffet said “Not so long ago, the U.S. was woefully dependent on foreign oil, and carbon capture had no meaningful constituency. Indeed, in 1975, U.S. production was eight million barrels of oil equivalent per day (“BOEPD”), a level far short of the country’s needs. From the favorable energy position that facilitated the U.S. mobilization in World War II, the country had retreated to become heavily dependent on foreign – potentially unstable – suppliers. Further declines in oil production were predicted along with future increases in usage.”

Buffet went on “And then – Hallelujah! – shale economics became feasible in 2011, and our energy dependency ended. Now, U.S. production is more than 13 million BOEPD, and OPEC no longer has the upper hand. Occidental itself has annual U.S. oil production that each year comes close to matching the entire inventory of the SPR. Our country would be very –very – nervous today if domestic production had remained at five million BOEPD, and it found itself hugely dependent on non-U.S. sources. At that level, the SPR would have been emptied within months if foreign oil became unavailable.”

Of course, from the larger issue, it makes you wonder why the United States is turning away from such a valuable resource. Warren Buffett realizes that the goal to reduce greenhouse gas emissions is going to be built on the backs of natural gas. There is no other energy source that can replace coal and reduce greenhouse gas emissions better than natural gas and nuclear. Alternative energies, while they are part of the solution, are in no way able to replace the volume of demand that the globe. Sometimes it takes good old-fashioned common sense like Warren Buffett’s approach to realize the best direction forward.

As far as the crude oil market, this morning they got their traditional pop and drop on the OPEC news. Yet make no mistake about it the move by OPEC is going to work prices going forward. Use the opportunity to buy breaks and make sure that you get hedged because this summer it’s going to get very interesting. There are going to be some interesting spread opportunities coming up in the next few weeks. Probably time to start looking at some options in place as well as some of the seasonal spreads.

Natural gas is getting a little bit of a bounce this morning not so much on the weather but on the growing threat to US natural gas production, and low prices. This morning it was announced that EQT Corporation (NYSE:EQT), the world’s largest producer of natural gas, is going to cut production in response to the low price environment. They expect cut gross output by one BCF a day to March in 30 to 40 BCF down the road. EBW Analytics writes that production scrapes are falling faster and—at least so far—more durably than anticipated. If supply continues to turn lower, it could set natural gas up for a notable move to the upside as the weather backdrop transitions in a less bearish direction into late March.

This comes as Qatar announces that they are going to sharply increase its liquefied natural gas production trying to take advantage of the United States’ pullback. Qatar and its desire to gain market share not only from the United States but also from coal producers as they plan to increase their LNG production by 85% in the coming years. Javier Blass at Bloomberg reports that the energy transition will eventually be a 0-sum game for one energy source to win the other one must lose. Blass says the obvious battle is between renewables and fossil fuels.

Still, he also believes that there is a bigger battle between natural gas and coal fighting for supremacy. The problem Blass points out is that coal has been dirt cheap. Countries such as Bangladesh, Pakistan and Thailand once preferred LNG. It’s a not-too-difficult and not-too-expensive way to decarbonize or have second thoughts. Qatar wants to try to squeeze out coal to get a better grip on supplying the world with energy. The reality is that natural gas is going to play a major role and Qatar is going to try to control as much of the marketplace as they can.

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