Displaying items by tag: China

This year has seen some big swings in crude oil prices given a variety of developments. These include rising US oil production, OPEC production cuts, the ongoing war in Ukraine, rising tensions in the MIddle East following Hamas’ attack, and a slowing global economy. As a result, crude oil prices ended the year down 10%. 

Entering 2024, these will continue to be major themes that need to be monitored. At its last meeting, OPEC reduced its production by 2.2 million barrels per day and said that more cuts may be necessary to support the price. But, there is increasing skepticism whether countries will actually abide given that many are reliant on oil revenue. 

Another challenge for OPEC is that US oil production continues to rise. Next year, it’s forecast to be 13.3 million barrels per day, an increase from this year’s average of 13 million barrels per day. Companies like Exxon Mobil and Chevron recently made major acquisitions of domestic producers and are also increasing capital expenditures. Unlike smaller producers, these majors are able to take advantage of economies of scale to push their costs lower and remain profitable with lower prices. 

OPEC now only has control of 51% of the crude oil market which is the lowest in decades. This raises the possibility that Saudi Arabia could choose to increase the supply to temporarily crash the price of oil in order to punish these producers and take back market share, although most analysts believe this is unlikely. 

On the other side, demand is projected to grow at the smallest rate in a year - 1.3 million barrels per day. In 2023, oil demand increased by 1.8 million barrels per day.  In part, this is due to a slowing global economy especially in China. 

Finsum: Oil has been quite weak to end the year despite several bullish catalysts. In hindsight, the most important development has been rising US oil production which is expected to hit a new record next year. 

On a shorter timeframe, oil has been enjoying a nice rally as it’s up nearly 30% since late-June. It’s largely being driven by the same catalyst that is affecting the stock market and bond market - recession risk in 2023 and early 2024 is being priced out, at least in the United States. 

While the worst-case scenario for the economy has been taken off the table in the last couple of months, it’s also clear that the best-case scenario of a re-acceleration of growth is also unlikely given the spate of weaker than expected economic data released this week. The other major factor supporting prices is production cuts from OPEC+ countries who are looking to push prices higher. And, there are rumors that Russia and Saudi Arabia are expected to announce further cuts in the coming weeks. 

On the bearish side, the major development is the deluge of data showing that China’s economy is much weaker than expected. Some of the weak data points include a drop in exports, consumption, and a nascent crisis in its real estate market. China is the world’s second-largest consumer of crude oil so this has major implications for its supply/demand dynamic.

Overall, oil is in a similar place to stocks and bonds. Amid a mix of bullish and bearish factors, it’s tough to determine whether this is a resumption of its bull market or simply an oversold bounce. 

Finsum: Crude oil prices are up nearly 30% since late June. However, it’s tough to be confident about its long-term direction given the mix of bullish and bearish factors. 

One of the biggest long-term issues affecting the energy sector is the growth of electric vehicles. According to the IEA, 50% of new vehicles sold will be EVs by 2030 with EV sales completely displacing traditional internal combustion engines (ICE) by 2050. 

In Q2 of 2023, there was a new record in terms of sales in the US with nearly 300,000 EVs bought which comprises about 7% of the total sold. A big contributing factor is the Inflation Relief Act which offered subsidies for up to $7,500 for select EVs with many states offering additional subsidies.  

Of course, this has major implications for gasoline demand which is a major component of crude oil use. And, it’s one reason why many are betting that global oil demand is peaking and set to decline over the coming decades.

This narrative is even affecting the supply side as many producers are using excess cash flow to pay off debt, distribute dividends, and strengthen their balance sheet rather than invest in new production. However, if this narrative turns out to be preemptive or incorrect, then there is likely going to be major upside for the energy sector.

Finsum: EV sales hit new record highs in Q2 of 2023 in part due to subsidies from the Inflation Relief Act. Whether EV sales keep rising is a major storyline in the energy market. 

Energy stocks have underperformed in 2023 following a year of massive outperformance. YTD, the sector is up 5%, while the S&P 500 is up 15%. However, the sector continues to attract interest from value investors due to its low valuations and high dividend payments. The Energy Select SPDR (XLE) has a P/E of 8.2 and a dividend yield of 3.7% vs a P/E of 25 and yield of 1.5%.

Recent 13-F filings show that prominent value investors continue to build a position in the sector. Warren Buffett’s Berkshire Hathaway boosted its stake in Occidental Petroleum by 5% and now owns 25% of the company. Despite his appetite for the stock and approval from the SEC to buy up to 50% of the company, Buffett has dismissed speculation that he is looking to buy the whole company, remarking that “We’re not going to buy control. We wouldn’t know what to do with it.” 

Carl Icahn also owns Occidental albeit a much smaller stake at 1.5%. He also owns positions in Southwestern Oil & Gas and CVR Energy. Like Buffett, his career has been defined by buying into industries that are unloved with compelling valuations that are being ignored by the broader market in favor of ‘hotter’ sectors. 

Many see a looming catalyst for energy in that oil producers have reduced production in the second-half of the year which should provide a healthy tailwind for prices the rest of the year.  

Finsum: The energy sector is one of the cheaper parts of the market. So, it’s not surprising to see that many value investors are making big bets on the sector.

The first-half of the year saw the energy sector underperform due to various headwinds such as the crisis in regional banks, concerns of a recession, high rates, tight monetary policy, stubborn inflation, etc. The second-half of the year has seen energy outperform as economic data continues to come stronger than expected and inflation has moderated, leading to more confidence that a soft landing outcome is likely.

For instance, crude oil started the year at around $80 per barrel but spent most of the first-half, trading between $60 and $70. In the second-half of the year, oil has traded between $70 and $80 for the most part. 

In terms of the outlook for crude oil for the rest of the year, the major bullish catalysts are reduced output due to OPEC+ cuts while demand should remain resilient especially if a recession is avoided. However, there is a bearish catalyst on the horizon due to increasing concerns that China could already be in a recession. 

Recent data coming out of the country has been quite poor. This has been underscored by the 8.5% decline in property investments and defaults from some high-profile developers. Retail sales data also missed badly at 2.5% growth vs expectations of 5.3%. Another concerning datapoint is the 14.5% decline in the country’s exports. These trends could undermine the nascent rally in crude oil given that it’s a major source of demand.

Finsum: Crude oil prices have enjoyed a nice rally in the second-half of the year, however a weakening Chinese economy could result in the rally fizzling out.