March 2024 – Commentary from Dan Pickering

Traditional Energy Monthly Commentary

Shazam!!! March saw very strong performance as the energy sector surpassed the overall market YTD. All conventional energy subsectors were higher and beat the S&P500 during March. The S&P500 gained +3.2%, the Nasdaq added +1.8% and Diversified Energy gained +10.6% (S&P 1500 Energy, S15ENRS) with energy subsector performance as follows: Oilfield Services +13.2% (OIH), Upstream +10.9% (XOP), Midstream +4.5% (AMZ) and Clean Energy +0.5% (ICLN). Front month WTI oil rallied +6.3% (~$83.15/bbl), while front month NYMEX natural gas fell -5.2% (~$1.75/mmbtu).⁽¹⁾

The oil market gained steam during March. It wasn’t just the +6% price move, but rather the confluence of factors that mattered. On the supply side, Houthi interventions in the Red Sea have kept tanker transit times elevated versus normal, Ukrainian drone strikes on Russian refineries tightened gasoline margins, while Mexico will reduce crude exports to support internal refining goals. The US economy strengthened, which bolsters the overall oil demand outlook and moderates the pace of interest rate cuts. When US rate expectations / inflation expectations increase, oil looks better to financial players. Speculative (non-commercial) net long positions hit 12-month highs during March as money flowed toward the financial side of the commodity.

Oil has further strengthened during early April as Israel-Iranian tensions escalated. Following an Israeli strike on the Iranian embassy in Syria, Iran has vowed retribution. As of Monday, April 8^th, the retaliation has not materialized, but it is fair to say that a geopolitical risk premium has crept into WTI at the current ~$86/bbl. Like night follows day, upward crude momentum and Brent over $90/bbl have reawakened calls for triple digit oil price. The April 7^th Bloomberg home page sported an article entitled “Supply Shocks: Odds of $100 Oil Are Rising as Tensions Convulse Market”. Puhleeeze (translated as Pleeeeze or Please).

Sentiment, momentum and money flow can drive price higher. Actual supply constraints driven by geopolitical events (namely escalation of the Middle East conflict) could drive oil price much higher. BUT but but but but but but, there are 3+mmbbls/day of shut-in capacity sitting in OPEC countries (~2mmbbls/day within Saudi Arabia alone). It is 90% folly to think that OPEC would maintain status quo in a $100/bbl world. First, it is leaving cash money on the table. Second, it puts demand at risk. Long time readers of this commentary know that we adamantly believe $100/bbl oil (not $100/bbl inflation-adjusted, but $100/bbl in today’s currency) is a price at which demand contracts. OPEC doesn’t want to discourage oil consumption – it wants peak demand as far away as possible. Oil-driven inflation and economic slowdown does OPEC+ no good in the intermediate-to-long term. So they will jawbone, cheat on quotas or relax quotas if oil continues to strengthen.

There is a school of thought that believes Saudi Arabia would like to punish the Biden Administration and/or hurt its chances in the 2024 US presidential election. This means Saudi will support high oil prices and high US gasoline prices to influence US voter mindset in November. Up to a point, this resonates with us and might support status quo at $90/bbl WTI. But not $100/bbl, in our opinion. Triple digit crude bulls also think that the US might tighten sanctions on some combination of Venezuela, Russia and Iran, boosting oil prices. No way this happens if the Biden administration is worried about gasoline prices for US consumers (which we know they are).

Bottom line – a) we are thrilled at the tightening supply/demand situation in oil, b) we love the fact that oil is over $80/bbl, c) crude is getting toppy here (absent true, conflict-induced physical capacity limitations) and d) we’ll be fading $100/bbl via both stocks and commodities if it occurs.

Moving on to natural gas, this commodity is wallowing in an ugly trough. Things will improve but it is going to take time. No meaningful supply/demand changes happened in March, but the concept of AI-driven, gas-fired power demand became a very hot topic. Data centers consume huge amounts of electricity. As grid interconnects and low-carbon power are increasingly delayed or difficult to access, the market is turning toward gas-fired power as a possible solution. We’ve seen sellside research reports talking about 10-40bcf/day of incremental gas demand associated with AI/data centers by 2030-2035 (remember the current US market demand is ~100bcf/day). Not necessarily helpful to the 2024 gas market, but a shining star for the future.

After a January and February frenzy, upstream consolidation took a pause in March. The only public E&P doing a deal was EQT Corp (symbol EQT), but theirs was a vertical integration with Appalachia midstream-player Equitrans (ETRN). In the OFS space, rather than go public via IPO, private Innovex merged public with small cap DrilQuip (DRQ). In early April, SLB joined the fray with two transactions – first buying 80% of Aker Carbon Capture (~$400MM deal) and then merging with ChampionX (CHX) in a $8B combo. As E&Ps get bigger, the midstream and OFS space must follow. As we say every month, there will be more. 2024 is (another) Year of The Deal.

Energy stocks quietly went from goats to heroes in March. The sector finished Q1 as the second best in the market, lagging only Communications Services (think Magnificent Seven). We attribute the strength to several factors. 1) Oil price rally – thank you commodity gods, 2) economic strength and slower interest rate cuts making energy a defensive/rotation area for some, 3) a sloppy/down March for some of the tech darlings and 4) a catch-up trade after lagging badly for the past year. Fundamentally, energy company discipline remains good, capital return programs are firmly entrenched and valuations are supportive (albeit less cheap after the March rally). Importantly, energy has now “broken out” in technical terms, so the fundamental rally now has some chart/algorithmic tailwinds. We may not always understand charts, but we certainly respect charts. We’ll take the tailwind.

Net, net we are close to Goldilocks territory with the energy sector. Oil prices are good, but not yet too good. Fundamentals are solid. Valuation is appealing. Technicals are improving. Money flow is trending toward the sector. We must stay vigilant, particularly toward demand-destroying $100+/bbl oil and the technology sector where a reacceleration could suck some of the oxygen from the energy rally. Meanwhile, surf the current wave.‍

Decarbonization / Energy Transition Quarterly Commentary

Backsliding. Tough Q1 for clean energy as the iShares Global Clean Energy ETF (ICLN) fell −10.2% against a gain of +10.6% for the S&P500, +9.3% for the Nasdaq Composite and +13.7% for conventional energy (S&P1500 Energy, S15ENRS).⁽¹⁾

While many billions of dollars continue to be invested by governments and corporate entities around the world to further a low carbon future, public equity markets remain harsh and unforgiving. The ongoing Q1 earnings season will provide an update on near-term business conditions, which we expect will generally be gloomy. The challenges we discussed in our Q4 2023 letter continue. Electric vehicles have fallen out of vogue with customers, the solar industry is awash in excess inventory, peskily high interest rates look likely to persist longer than previously expected and even Tesla is under duress. From challenges come opportunity.

Notable Q1 items:

• ‍Layoffs - Reacting to soft market conditions, solar equipment maker Solar Edge announced layoffs. As did Tesla. And many others. In headier days, weaker financials and cash burn would have been funded by new equity at high prices. With the equity window closed (or extremely expensive), clean energy is taking another step down the maturation path - reducing costs when revenues/profits are insufficient. This is likely to be a consistent theme through 2024.‍
• An EV dry spell and tougher competition - EV demand continued to soften in Q1 as a result of higher ownership costs (interest rates) and generally high sticker prices. Simultaneously, competition intensified globally, with new models from various suppliers attacking incumbent players. In the US, market leader Tesla has responded with multiple price reductions. For now, lower prices have not jump started demand. Ford has slowed production of its flagship Lightning F150. Start-ups Lordstown and Fisker have gone through pre-packaged restructurings. While electric vehicles may be the way of the future, it is a painful present which shows no sign of turning the corner in the near-term.‍
• Autonomy getting closer or further away? Autonomy is the holy grail of automobiles, potentially allowing massive productivity and utilization gains. And like the holy grail, autonomy remains elusive. Following a serious safety event in late 2023, during Q1, GM’s driverless car division Cruise lost its license to operate in California and pulled all vehicles from the road nationwide. Capital spending in the division has been halved. Also in Q1, Apple canceled/shelved its ten-year electric (autonomous) car project. Meanwhile, Tesla appears to be going all-in on the technology, with CEO Elon Musk indicating TSLA will unveil its robotaxi this August. While acknowledging the game changing nature, we watch these developments with a skeptical eye in terms of timing. ‍
• The scorching hot topic of Artificial Intelligence (AI) data centers and electricity demand - Exactly how AI will be deployed in everyday life and business remains to be determined. However, the market has realized, that regardless of the end-use application, AI consumes power. A lot of power. Access to power does everything from lower operating costs (cheaper energy) to speed access times (faster connections to the grid = faster data center start-up = improved data center economics). Depending on the region, power demand growth is expected to accelerate from 0-1% annually to +2-5% annually. Many companies involved in AI have also made commitments to lower/eliminate carbon from their businesses. As such, AI may be an ongoing catalyst behind even faster implementation of low carbon electricity generation (wind/solar/nuclear/geothermal, etc.) and installation of batteries that can store this low carbon (but intermittent) electricity. There are literally dozens of thick research reports and daily webinars on this topic. We are working to get smarter in this area.‍
• Damn those interest rates - With business models that have hockey stick forecasts of revenue and profitability, future cash flows are significantly more meaningful than current cash flows for most clean energy companies. This makes the present value of those cash flows highly susceptible to changes in discount/interest rates. Thus, when consensus moved from five 2024 interest rate reductions by the Federal Reserve to two (or less), it created yet another headwind for clean energy equities, spooking away investors and further raising an already high cost of capital. When it rains, it pours.

As stated in every quarterly commentary since the inception of the Fund, our thematic TE&M (Technology, Energy & Mobility) views are driven by the combination of supply/demand dynamics, the status of technology development and stock/sector valuation. We are getting gradually more constructive given the ongoing washout of clean energy stocks. Many/most of the companies still have a long way to go toward consistently profitable business models. But in more and more specific instances, the stocks more accurately reflect the balance of future opportunities and challenges.  

Currently, we see the following subsectors as interesting on the long side: energy storage, carbon capture, enabling commodities, decarbonization equipment and services, wind/solar and special situations. On the avoid/short side: electric vehicle industry, hydrogen. These are unchanged from our Q4 2023 commentary. In the newly created “more work” category: AI implications.

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(1) Source: Bloomberg