Primary Vision Insights – September 8th, 2021

By Mark Rossano

Hurricane Ida issues are still causing problems in the U.S. with 1.7M barrels a day of Gulf of Mexico crude still offline line and about 2Bcf of natural gas. There is also about 2-2.2M barrels a day of refining capacity offline as power is still being restored to the region. This should be reduced to about 1.3M barrels offline through the weekend as power has been restored to some regions. The damage to Port Fourchon will cause Gulf of Mexico activity to be slow to return given 90% of deep-water activity is supported from this location. The U.S. has already started to address these issues with another six crude cargoes flagging the US bringing the total to 22, which is the highest since June 18th.

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U.S. completion activity is going to keep rising along a gradual path over the next few months. If we look at 2019- we are “normally” sitting at about 369 spreads and not the current 240. There is no reason to see a huge push back up to 369 for many reasons:

• We don’t have the horsepower to hit that level (the biggest one that needs to be front and center) • We are producing about 11.5M barrels a day and not 13M • The U.S. remains very heavy in oil focused crew’s vs natural gas. o This just means that the skew is much higher to oil vs 2019. • The growth of simulfrac (dual frac) in the Permian is creating some additional efficiency requiring less horsepower to achieve growth.

We still see a near term target of 254 spreads by the middle of September as activity rise steadily across both oil and natural gas basins. The U.S. operators have been very cautious on increasing natural gas completions but given the underlying economics and steep global shortage- we will see activity pick up in the Northeast and Haynesville. The Haynesville will see an increase in activity given the current break-evens, and the fact the area doesn’t have the same takeaway capacity restrictions. The whole shift in the curve opens up opportunity for a steady investment in activity with the ability to hedge some production throughout 2022 at very favorable pricing. We will see another 3 or so spreads in Appalachia and 5 in Haynesville throughout the month with another steady increase in the Williston to 20 and the Permian approaching 130. We will also see more activity in the smaller basins again with 1 or 2 spreads getting picked back up. Many of these regions are looking to manage decline curves and will increase work ahead of winter weather in some areas. We expect to see a steady increase of work through Sept and Oct with a smaller vs normal reduction in activity from Thanksgiving to Christmas. Typically, the holiday season sees the biggest reduction in completions, but several factors will limit slowdowns.

• E&Ps have managed budgets and will have capital as we close out the year • We won’t see a big surge in activity as we do in other years, so the drop won’t be as excessive • The energy space is looking for steady growth, which can be achieved at a lower activity rate

The natural gas market is also supported with 2bcf a day of Gulf of Mexico demand still offline and keeping the lower 48 states at the lowest production levels since early July.

The LNG market remains very strong with a lot of staying power as Russia is very short storage and will have to limit exports. The limitations on flow will provide a stable market for U.S. LNG into Western & Central Europe. Countries in Europe and Asia will have to supplement flow from other regions, which will support U.S. LNG movements into the global market.

The U.S. has maintained about 6 MTPA a month into the market with support at these levels. We are obviously coming into shoulder season, which sees a normal decline, but the shortage of storage globally will keep flow elevated vs previous years. The U.S. also has additional exporting capacity vs pervious cycles enabling additional volumes to move into the market.

We have been in this situation before- a bullish backdrop exiting summer and heading into winter. The last two times we had a very warm winter essentially dashing the hopes of the market. This is a big reason why there is still concern on what the demand backdrop will look like as we head into shoulder season. But, we are still in a very good position when compared to last year and the 5 year average.

When we look back through time, 2014 and 2018 had lower storage levels- BUT- we have only seen the use of natural gas expand domestically and we have brought online extensive LNG export capacity. So we are in a very different position heading into shoulder season and winter.

Early winter indications are showing a colder than normal winter- with the Farmers Almanac supporting that view. Given the Farmer’s Almanac is right 50% of the time, we are heading into a precarious situation that is supportive of current natural gas prices. The pressure from the “Green Revolution” and “Energy Transition” has taken down a lot of coal capacity over the last 5+ years leaving us with only natural gas as an option for power. So we will have power plants, homes, and LNG facilities competing for capacity at higher levels vs the previous times we were at these levels.

The above backdrop also bodes well for natural gas liquids- especially propane. Mt. Belvieu pricing is at 2017 levels as propane dips to the lowest storage levels in the last 5 years.

The U.S has expanded export capacity over the last 12 months, and the growing demand abroad for petchem feedstock, industrial consumption, and residential- exports will remain well above the 5-year average. We will easily set a new record in exports with a lot of support given the shortages around the world for LNG and LPG as countries prepare for winter. Plastic demand is also surging driven by housing and the “green” transition as many of these technologies and equipment require a large amount of plastics.

On the OPEC+ front, our base case played out with Sept/Oct numbers holding steady, while we started to hear about some concerns regarding balances heading into Nov-Dec but more importantly- 2022. Russia continues to overproduce by about 100k barrels a day, yet no one says anything. On the other hand- West Africa is producing well below their allotments given the lack of demand for their crude. The lack of Nigerian flows is concerning- especially as Russia is slating more ESPO for the spot market. It will put pressure on Nigerian barrels into Asia, but given the shortfalls in the U.S. driven by Hurricane Ida- we will see additional barrels flowing into the U.S. ESPO cargoes will pick up into PADD5, which is where we have seen cargoes flowing if Asia (China) skips purchases.

WAF UNSOLD CARGOES:

• The majority of Nigeria’s October cargoes are yet to find final buyers, with many shipments sold to date being re-offered: traders o Precise tally not immediately available; at least 42 cargoes scheduled • Angola’s crude for October loading is selling at a faster pace than the previous month; 7-8 cargoes remain to be sold, including re-offers, the people said o That’s faster than a month ago when 10-12 shipments out of 34 planned were unsold, according to estimates from Aug. 4

The problem is- even before Oct was confirmed with another increase- Middle East and West African floating storage has been rising. KSA is expected to cut OSPs in Oct as countries are struggling to sell cargoes in the market, which is going to get worse with another 400k a day in production. The JMMC has cautioned on global builds in 2022, which will be a topic of conversation as we approach the Oct 4th meeting. I still believe there is limited (no) political capital to get a full reversal on the production increases, which just means instead of increasing- agreeing to CUT additional production. If the balances get worse, I think they can come to terms on less production coming online and possibly a pause on increase, but a new cut would be very difficult to get through. This is why I think they will look to address it early to avoid the need for a new cut and try to get in front of potential builds in 2022. The underlying problem remains demand as the global economy continues to slow at a faster clip vs expectation. I have been very clear I believe economic data is worse vs what the street is expecting- which has so far been spot on.

China is taking less crude as 6 additional cargoes are heading to the U.S. brining the total to 22. This is the highest levels since June 18th, which is going to be used to replace the lost Gulf of Mexico capacity. The U.S. still has about 1.7M barrels a day offline, which will be slow to return due to the damage at Port Fourchon. The underlying issue in the market remains the elevated offshore storage market- especially in Asia- as port delays and low demand prohibit the “normal” movement of crude into onshore storage. Even at reduced rates of imports, onshore storage remains well above seasonal norms, which is limiting the purchase of crude volumes in the open market. This is leaving more WAF and Russian crude on the water and will keep pressure on spreads.

The Chinese economic data came in at the lowest print since Feb 2020 driven by a slowing economy and the Delta variant limiting local activity. Aug closed stronger vs how it began, and we expect to see some recovery in Sept. It will likely come in just above 50- showing some expansion but very limited. The issues that we have been highlighting go much deeper vs a COVID variant and will remain pervasive throughout the rest of 2021 and well into 2020.