The ASX 200 Energy (XEJ) Index was up 4.7% this week, bringing its last 12 months’ gains to 15.42%.
This has occurred as Brent Crude edged above $84 a barrel yesterday for the first time since April, while WTI Crude also crossed $80 per barrel.
Crude has achieved four consecutive weekly gains on tightening supply from major cuts by the Organisation of the Petroleum Exporting Countries (OPEC) and its allies, known as OPEC+.
Concurrently, securities markets are signalling heightened expectations of nearing the end of rate hikes in Europe and elsewhere.
Today, we will explore whether the optimism surrounding Australia’s major oil and gas producers is indicative of longer-term growth prospects or short-term supply squeezes.
The US economy grew by 2.4% last quarter, well above the estimate of 2%. While weekly jobless claims totalled 221,000 — a decline of 7,000 and well below the 235,000 estimates.
This health is somewhat of a shock to many investors, including the Fed, who continued its rate hikes again this week to a 22-year high to a range of 5.25–5.5% — the market barely batted an eye.
A similar story came from European Central Banks overnight, who joined their US counterparts in raising rates.
Despite this, the pan-European Stoxx 600 closed up 1.4% and European blue chips near 15-year highs.
This counterintuitive market movement is a clear signal that investors believe we are nearing the end of the rate hike cycles.
It seems risk appetites in Western financial markets have grown as more indicators for a potential ‘soft landing’ have excited investors into an early hope of growth.
This could mean exciting prospects on the horizon in energy markets, but for now, the main story in town is supply.
Supply the only story for now
In late April, OPEC+ announced it had reached an agreement to extend oil cuts into next year.
The oil cartel agreed to reduce its output by 1.4 million barrels a day at a meeting in Vienna that included the big producers Saudi Arabia, Iraq, and Russia.
Saudi Arabia is said to have leant on smaller producers and forced through the agreement, despite protests from smaller producers in Africa and UAE.
In a sign to lead the charge, Saudi Arabia agreed to make a voluntary reduction of 500,000 barrels a day in its output.
Russia also announced a similar cut until the end of the year.
This news sent the price bouncing up with supply fears and then down again amid fears of weaker demand from a global slowdown.
Data from China further fanned these flames as Chinese central leaders sat on their hands while the economy sputtered.
Commerzbank analyst Carsten Fritsch said:
‘The economic recovery in China following the lifting of coronavirus restrictions has been noticeably more sluggish than anticipated, even though the data for Chinese oil demand proved robust.’
Now that markets are starting to internalise ideas of a possible path of avoiding recession, oil and gas demand projections are starting to shift.
If positive economic sentiment remains, then supply shortfalls are going to be the main driver for the medium-term growth of oil and gas.
Looking closer to home, Australia’s energy sector outlook is a bit murkier.
The Australian Department of Industry, Science and Resources’ June quarterly outlook painted a picture of short-term gains for exports that may not continue.
They estimate Australia’s crude and condensate export earnings to lift to $13.7 billion in 2023–24 as export volumes rise before falling to $11.7 billion in 2024–25 as output declines at the North West Shelf.
Meanwhile, LNG export earnings are projected to fall to $60 billion by 2024–25, with volumes also easing to 79 million tonnes over the same period.
Source: Department of Industry, Science and Resources
Domestic consumption could be a similar story of short-term gains that could face long-term challenges through decarbonisation.
Australia’s current energy consumption is dominated by coal ( ~40%), oil (34%), and gas (22%).
The dominance of these traditional carbon-intensive power sources has faced a huge amount of speculation.
Suffice it to say, the future is looking green.
Net zero policies, regulations, and subsidies are happening at the same time as the cost per unit of renewables continues to fall.
The International Energy Agency forecasts Australia’s renewable energy capacity to expand by 85% to reach 40 gigawatts by 2027.
The near future will clearly still hold a mix of the existing energy sources, but the rise of renewables can be split into three different scenarios:
- Green energy exports: Increased energy use. Large-scale growth of electrification. The use of hydrogen for local industries and natural gas becomes key green energy export in a heavily green future.
- Step change: A modest increase in total energy use. Electrification of natural gas and other fossil fuels is the most significant growth driver, while a wedge of domestic hydrogen use emerges amid the decline in gas and fossil fuel usage.
- Progressive change: Includes a lesser change in overall energy use, reflecting lower economic and population growth. Electrification represents the greatest share of the energy transformation, with minor shares in biomethane and hydrogen use across the decades to 2050.
Whatever the scenario, the Australian energy sector is going to remain in the picture as countries use natural gas to help transition from dirtier carbon-intensive power generation.
Overall, supply shortages may keep prices higher for the remainder of the year, but I would not be surprised if we see dramatic movements as news continues to push market sentiments from positive to negative…and back.
For Money Morning