Ty's Take January 2019
Last month, I sent you all my outlook and market predictions for 2019. In that analysis, I spent a great deal of time focused on the supply side of the equation. In short, I predicted that continued growth in U.S. Shale production, coupled with OPEC+ (referring to OPEC members + Russia and others who had agreed to production cuts) rapidly rising production had once again thrown supply and demand out of balance with the world awash in oil.Nevertheless, I indicated my firm belief that, based on the information then available, we would see some softening of demand for oilfield services, but not to expect the kind of downturn we saw in 2016.
I think from the supply side that remains true. OPEC + Russia begrudgingly reached an accord to continue production cuts in order to bring markets back into balance.It should be noted that historically, Russia is not the best at complying with their agreed cuts. And early indications are that they may not this time.Yet, Saudi Arabia took the laboring ore – and they have every incentive, as long as they do not perceive a loss of market share, to insure that oil markets re-balance. Remember: their long-term play is to drive up the value of their reserves, sell a small portion of Saudi Aramco through an IPO, and diversify their economy. How far will Saudi Arabia go to balance markets? No one knows.
But I believe my bigger concern, over the long term, rests in my growing concern that the U.S. and world economies are flashing warning signs, and a recession may be more imminent than we believe.
First, let's note our base.The U.S. economy for most of last year was firing on all cylinders.Unemployment was low, manufacturing up, stock markets soaring (or at least giving the impression that they were soaring), and overall sentiment among economists and consumers alike was good.
But, as we have noted in our article this month, global growth appears to be slowing. Consumer confidence is down, manufacturing appears to be down, and business sentiment is falling under pressure from higher borrowing costs and falling equity prices.Global expansion has been losing momentum since the middle of last year, and every indication is that consumption of middle distillates such as diesel, is likely to grow more slowly in 2019 than previously forecast.
The United States is currently running a mix of expansionary fiscal policy (tax cuts and increased spending on the military) and a less accommodating or contractionary financial policy (rising interest rates). Indeed, the U.S. Federal Reserve has raised interest rates nine times since 2015.
However, both of those policies seem to be running their course: tax cuts and other incentives boasted the U.S. economy but growth attributed thereto is now starting to end or slow. The Federal Reserve has indicated a more wait and see policy to further interest rate increases.And as recently as this week, seemed to signal that they were not going to raise rates again.The net positive is that the dollar cycle may be about to turn supporting oil prices.
So, whereas at the end of 2018 I was primarily concerned with supply side and the ability of OPEC+ to adjust to market conditions and alleviate the glut, my new concern is the rising risk of slowing global oil demand due to downward corrections across global economies and slowing economic growth. As we noted last year, oil demand forecasts continue to grow. And always, present in our assumptions of whether markets are in balance is a premise that demand growth will continue which is obviously tied to economic growth.OPEC+ has indicated and proven their willingness to work on the supply side, but there is only so much correction they can do in the face of decreasing demand (or rather, a deceleration of the previously forecast demand growth).
But the 800 lbs guerilla in the room is the trade dispute between the U.S. and China.I will argue below, that also presents an opportunity. Nevertheless, on the short-term energy outlook: the overall threat of a trade war between two of the World's biggest economy is having an effect.Already, Apple reported this week its first revenue decline in a decade. Other key economic indicators have dropped as concerns increase over the possibility of a prolonged trade war.But regardless, the concern I have over 2019, now that OPEC+ appears ready and willing to balance the supply side, is that there is only so much they can do if the World economy hits the brakes.
As we see from E&P budgets, there is a mix of optimism and concern with all companies falling reasonably close to neutral. Larger companies, that perhaps have more room to gamble, seem to be increasing their budgets while smaller operators are contracting.
The article this week that I enjoyed writing the most is America's Light Sweet Problem. I am elated that the EIA now projects the U.S. to become a net energy exporter. Setting aside my obvious self-interest, I have always advocated for a growth in energy related jobs. Just looking at the more narrow job classification of oil and gas extraction, according to the Bureau of Labor Statistics, in December 2018, 154,700 people were employed. Of non-supervisory employees, the average hourly earning was $36.56 with the lowest annual 2017 average wages being $43,660.I would note in Texas it is lower than the national average.
I have always advocated that America's strength is tied to a strong middle class who have more discretionary income. That discretionary income of the middle class is what drives our economy: they eat out more, they consume more goods and services. In short, I will only eat dinner once so even if I wanted to, I can only eat out for dinner 7 nights a week. But if the middle class has more discretionary income, they will eat out more and the aggregate effect is substantially greater. Which helps the restaurant, helps the waitress, and generally drives economic growth.
And therefore, I believe that building critical infrastructure to support America's oil and gas industry is strongly in our national interests. We can fight with China over manufacturing and trade deficit. But in reality: we are probably fighting a losing battle.But the solution may well lie in our energy industry.Energy jobs cannot be exported: they are at the field where the oil is extracted. China needs energy. We have it. In abundance.Let's build the infrastructure we need to fully utilize our resources. Perhaps we can solve some of our trade problems by creating these high-paying, non-exportable jobs rather than trying to bring back minimum wage factory jobs.
In the short term, I maintain my prior guidance: I believe this year will be relatively flat, with a modest risk of some downside exposure. However, whereas in December I was cautioning to maintain a vigilant eye on the supply side (and I still think we should), I now believe we all need to watch key economic indicators for signs of a weakening global economy, and in particular, any signs that the heretofore immune U.S. starts to slow. While many U.S. indicators remain strong (such as job growth and low unemployment), there are sufficient warning signs to be cautious. Moreover, it should be noted, economists have missed calling every major recession. So when warning signs appear, woe to you who does not pay attention.
In the long term, I'm excited that the U.S. is now expected to become a net energy exporter. I see this as not only excellent news for our industry but also for our economy as a whole. I just hope that we invest in the infrastructure necessary to fully take advantage of that opportunity.
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