Energy Musings - January 2, 2024
2023 was a good year for stock investors - not good for energy investors. The year failed to unfold as predicted by forecasters, but everyone is back offering thoughts about 2024? Just more chaos?
Thoughts About 2023 and 2024
The 2023 financial year ended at 4 pm ET last Friday when trading on the New York Stock Exchange stopped for the day. For investors, 2023 was a very good year. The S&P 500 Stock Index gained 24.2%. More than half the year’s gain came from the price performance of the Magnificent Seven tech stocks – Apple (+48.2%), Alphabet (+58.3%), Microsoft (+56.8%), Amazon (+80.9%), Meta (+194.1%), Tesla (+101.7%), and Nvidia (+238.9%).
Although the final trading day of 2023 was a downer, Friday ended the ninth consecutive week of gains for the S&P 500, the longest winning streak since late January 2004. Inquiring minds want to know: Will 2024 be a repeat of 2023?
Much of the market’s gain came in 2023’s final quarter when the “everything rally” took off. The S&P 500 climbed 11.2%, but gold, bitcoin, risky bonds, and depressed stock sectors all rose. With the Federal Reserve done hiking interest rates, and expected to soon be cutting them, the goldilocks market environment, known as the “soft landing,” is in place. Only curmudgeons doubt it and that the Fed will be cutting rates multiple times in 2024.
Haven’t they heard? The inflation battle is over. The Fed won - and won decisively. After one of the most rapid increases in interest rates in monetary history during 2023’s first half, the Fed stopped dead this summer. Federal Reserve Chairman Jerome Powell’s commentary became increasingly dovish, and the Board followed his lead. Dissents are unwelcome in his boardroom.
We are heading back to normal – whatever that means. Should we prepare to welcome back TINA? For those who forgot, it means “there is no alternative” but stocks when interest rates were at zero. With inflation heading to the Fed’s 2% target or below, can zero interest rates be far behind?
Interest Rate Chaos In 2023
Few people expected the chaos of 2023. Then again, does anyone forecast chaos in their year-ahead outlooks? As the Fed cranked up interest rates in 2023, forecasters predicted something would break – they just didn’t know what. It turned out to be Silicon Valley Bank. Bank management failed to read the interest rate tea leaves and positioned the bank’s balance sheet for a continuation of zero interest rates. A four percent Fed funds rate crashed SVB’s levered balance sheet forcing the FDIC to seize the bank. The fate of several similarly levered regional banks was questioned, with several quickly finding new owners.
Even Europe’s financial sector was devastated by rising interest rates. Switzerland’s government and financial regulators stepped in to force UBS Group AG to buy Credit Suisse to prevent its collapse. Fears of another Great Financial Crisis emerged, forcing governments and central banks around the globe to step forward to assure their citizens that a new financial crisis would not happen ‒ no matter how much money it took.
However, rising interest rates created other problems. Consumers struggled as rates on credit card borrowing soared above 20%. Auto loan rates climbed, credit became tighter, and defaults rose. The worst example of high-interest rates was the U.S. government budget. Higher rates pushed projections for debt service spending in FY24 to $745 billion, nearly as much as we spend on Defense and non-defense categories. Debt and deficit spending are hidden economic curses.
As 2023 opened, forecasters focused on whether there would be a recession. They also wondered about the fate of another commodity super-cycle. Underpinning these fears was doubt that inflation could be tamed. They were also worried about who would win the Super Bowl, the World Series, the NCAA basketball tournament, and how successful Taylor Swift’s Eras Tour would be.
Patrick Mahomes led the Kansas City Chiefs to his team’s third Super Bowl win. The lowly-seeded Texas Rangers (#5) beat an even lower-seeded Arizona Diamondbacks (#6) to win the World Series. A #4 seed from the West Region, UConn swept through the NCAA Men’s Basketball Tournament, winning every game by 13 points or more for the first time in tournament history, to claim the school’s fifth title in 25 years.
Taylor Swift – Time magazine’s Person of the Year – had the highest-grossing tour of all time according to Pollstar. She earned $1.04 billion by selling 4.35 million tickets across 60 tour dates, but equally impressive was the $200 million earned from the sale of tour merchandise. Pollstar calculated that Swift’s merchandise sales outearned the year’s number 10 music tour. Now the media is fascinated with the romance(?) between Swift and Kansas City Chiefs tight end Travis Kelce.
What forecasters predicted for 2023 was a recession or certainly slower economic growth. Neither happened. U.S. GDP grew 2.2% in the first quarter, 2.1% in the second, and 5.2% in the third quarter. Labor markets continued adding jobs and remained tight, helping to boost workers’ wages. The tight labor market is becoming a concern for some forecasters worried about wage-driven inflation appearing in 2024.
Last fall saw the United Auto Workers launch a triumvirate strike against Detroit’s three auto manufacturers for the first time in history. The strike, the longest in the last 25 years, produced huge wage gains, work rule adjustments, and organizing rights for the new electric vehicle and battery plants. For Ford Motor Company, the strike will add $850-$900 to its average vehicle cost and will cut profit margins by 60-70 basis points. Cost adjustments will be needed and likely hurt 2024 activity, just as every other car manufacturer will have to adjust.
This year begins with nearly half the states (22) raising minimum wages, in some cases forcing fast food and other low-wage employers to lay off workers. Federal workers will receive a 4.7% salary hike, the largest wage increase since President Jimmy Carter hiked them by 9.1% in the 1970s. The military is scheduled for a 5.2% annual salary hike later this year. Federal workers who live and work in one of the 53 locality pay areas across the nation will see higher salary boosts as their areas adjust to higher cost-of-living adjustments. There are little to no productivity offsets to government wage increases, so there is a little more inflation pressure this year.
Forecasters predicted inflation would cool faster in 2023 than it did. The Consumer Price Index posted a 6.4% rate in January, but its last data point (November) was at 3.1%. While the rate dropped sharply, it wasn’t until the second half of 2023 that the decline accelerated. Victory over inflation is propelling the stock market higher – maybe too high too fast. Market strategists are already revising their 2024 year-end targets higher because of the market’s fourth-quarter performance, but is this premature?
Other noteworthy events dogged the economic and financial outlooks for 2023. The Russia/Ukraine war entered its second year, with no sign of ending. On October 7, the horrific attack on Israeli civilians by Hamas, sponsored by Iran, set off the latest Middle East conflict. This conflict is having geopolitical and economic repercussions. Recently, the Iranian-sponsored Houthis in Yemen have attacked Red Sea shipping, forcing the maritime industry to abandon using that trade route. Instead, ships have to travel around Africa, adding two weeks to voyages and substantial costs. This shift, unless ended quickly, will hurt the fight against global inflation. Tensions between China and the U.S. remain high, although the two are once again communicating. But Southeast Asia could become another geopolitical flashpoint with economic and financial implications.
The year and stock market were dominated by the explosion of Artificial Intelligence into society, business operations, and the financial results of technology companies. Separating real from fake messages and pictures could also become a flashpoint in 2024. Covid-19 vaccines disappeared from the political discussion, as well as from pharmaceutical earnings. Other health advances such as weight-control drugs could alter lifespans.
For energy investors, the record performance of 2022 became a bust in 2023. Last year, WTI fell $5.28 a barrel to settle at $71.65, while Brent declined 10% to end at $77.04. That was the reverse of 2022 when both WTI and Brent rose by slightly over $4 per barrel. What is the future of the commodity cycle and oil prices in 2024? Will Saudi Arabia remain as committed to supporting global oil prices in a world where non-OPEC suppliers are growing production rapidly?
Expectations that Chinese oil demand in 2023 would soar as its economy reopened failed to materialize. While all eyes are on China’s economy, surprisingly global oil demand continues growing to the consternation of environmentalists and the International Energy Agency. Repeated predictions of a peak in oil consumption, just like peaks in coal and natural gas use are swatted down by the data.
But the big story of 2023 was the soaring U.S. oil output. The Energy Information Administration estimates domestic production at 13.3 million barrels a day at the end of December, an increase of 10% or 1.3 million barrels per day over December 2022. Domestic output, combined with growing supplies from Guyana, Brazil, and Venezuela, and increasing exports from Iran and Russia, overwhelmed global demand growth. Saudi Arabia led the OPEC+ group in cutting exports in what was thought to be only a short-term move but appears to have become a permanent feature of the global oil market.
Most forecasters call for oil prices to remain at the low end of a $70-$95 trading range. Others expect prices not only to fall below the range’s low end but possibly collapse to the $30s a barrel. While they see a price collapse as the demise of the industry, it might stimulate economic activity and oil use. Such a price collapse would bring pain to the industry, but in contrast to the 2014 bust, the oil industry today has less debt, has shunned drilling at any cost, is grudgingly reinvesting, and has become a dividend machine for shareholders. Industry consolidation is also leading to stronger companies dominating the sector. Their interests and investing patterns are different from those of the multitude of private companies that drove the oil shale revolution of the 2010s and became bankruptcy fodder in the downturn. Indications are that industry reinvestment will be low in 2024. However, industry bears remain convinced we are on the cusp of another down-cycle like 2014-2020. Only time will tell who is right about these trends.
A Repeat Of 2014-2020 Oil Market?
While we cannot dismiss an oil-price collapse scenario, geopolitical conditions in the Middle East add a wildcard for how the oil industry cycle plays out. An examination of the 2014 collapse is instructive when considering a potential repeat. A detail that never received much attention was the radical shift by the European Union towards Canada’s oil sands resource. After years of fighting to prevent this heavy and “dirty” oil from coming into Europe, the EU made a 180-degree turn in August 2014. Rather than banning oil sands use, the EU voted to allow it. The vote convinced Saudi Arabia it needed to make a move to protect its market share in Europe. At the Thanksgiving Day OPEC meeting, Saudi Arabia abandoned its support for the OPEC marker price that was already under pressure from growing global oil supplies. Prices plummeted, as did the fortunes of the global oil industry. “Lower for longer” became the guiding light for managing in the industry.
Saudi Arabia had already lost its U.S. market position. With the EU voting to allow Canada’s oil sands into Europe, Saudi Arabia saw its global power shrinking. It would have to become more aggressive to protect and grow its Asian market share. And frankly, Asia was more likely to be a growth market than either North America or Europe.
The chart below shows the amount of heavy oil that arrived in the European Union countries from Canada and Saudi Arabia along with their total oil shipments and the respective shares of total EU oil imports each represented during 2013-2016.
Canada’s oil sands output being allowed into EU helped upset the global oil market balance and forced Saudi Arabia to act in 2014.
Following the August 2014 EU vote, Canadian heavy oil volumes began climbing. At the same time, Saudi Arabia’s heavy oil volumes began falling. Even lower oil prices failed to change the volume trends.
What was going on in the EU concerning heavy oil volumes needs to be seen within the context of overall oil supply/demand balances during this period. The following chart shows U.S. and world oil production and consumption, as well as the annual volume changes for 2013-2017. We have also posted the annual spot oil price for those years for West Texas Intermediate and Brent.
World oil market consumption rather than U.S. consumption is what led to the oil price recovery in 2017.
What we see is that oil production in the U.S. and globally was growing strongly in 2014 and 2015, but after the collapse in oil prices and curtailed investment, U.S. production fell in 2016 before rebounding in 2017. Global production also collapsed in 2016 but grew slightly in 2017, driven by the strong U.S. production increase. On the consumption side of the equation, demand barely grew in the U.S. and globally in 2014, but rebounded in 2015 spurred by the collapse in oil prices. However, U.S. consumption barely increased in 2016 and 2017, although global demand was nearly stable at around two million barrels per day.
What this period shows is how quickly the supply/demand fulcrum can be upset. Even small market share moves can upset the market balance, leading to oil prices being cut in half during 2013-2016. Could a repeat be about to happen?
There is certainly a risk of repeating the last non-pandemic-related oil price crash. A recession in 2024 could unbalance the global oil supply/demand balance sufficiently to force Saudi Arabia’s hand. What are the odds of a recession? According to the Wall Street Journal:
“In the past 11 Fed rate-hiking cycles, recessions have typically started about two years after the central bank begins raising interest rates, according to Deutsche Bank. This hiking cycle started in March 2022.”
Countering the interest rate and recession history is the reality that we are in an election year and the Fed will likely make sure there won’t be a recession. That means cutting rates early and aggressively, along with injecting substantial liquidity into the financial system. While creating a benign economic environment and a healthy financial market, such moves will increase the odds of inflation returning with economic and financial repercussions in 2025 and beyond. We don’t know the odds of such a scenario unfolding. The only thing we are confident about is that whatever economic scenario we set forth; it will be wrong. Welcome to 2024 – another year of chaos.