油價飆升之旅：油價見頂了嗎？

Stephen Dover:  Fred, I know you've been covering the energy markets now for 25 years, and all eyes are right now on oil prices. So, what's your reaction to the US’s ban on Russian oil and the impact on prices we've seen so far?

Frederick Fromm:  The ban on exports into the US is largely symbolic. We don't import much Russian oil, only a couple hundred thousand barrels per day versus consumption in the US of about 20 million barrels per day. The bigger impact has been from other sanctions and uncertainty about potential additional sanctions that could directly target Russian oil exports. The existing sanctions matter because they've created uncertainty. For instance, shippers don't want to take oil on and then have their ships impounded if sanctions were eventually put directly on Russian oil. There are also issues with insuring cargoes, letters of intent and things like that. And so, you know, this has led to a de facto ban on an unknown quantity of Seaborn Russian oil thought to be approximately two to three million barrels per day, which is meaningful and could serve to lower already tight inventories. Like a lot of commodities, inventories were quite low, even for things like wheat, that are being impacted by what's going on in Ukraine. This, combined with limited capacity to make up for those volumes, has led to heightened volatility in crude markets and the rise in prices, though we have seen oil prices nearly retrace all of those gains just over the past week.

Stephen Dover: So, you talked a little bit about the impact on the US. How do these changes impact other parts of the world like Europe specifically, and maybe China?

Frederick Fromm: Well, Europe is potentially the most impacted because, to the extent there is less oil coming out of Russia, much of that goes to Europe, and they'll have to find replacements for that, which they have done somewhat successfully with natural gas by redirecting LNG [liquified natural gas] imports. Some of that coming from the US that were bound for Asia into Europe and helped them get through their winter time. If they hadn't done that, it could have been a real problem. China eventually could take on more Russian barrels, but there's a situation where the refineries just aren't set up to refine large volumes of the type of Urals crude that Russia produces.

There are well over 20 grades of oil around the world. You have very light oil that comes out of the Middle East, although they also produce other grades as well. And for instance, the oil coming out of the Permian is fairly light oil, too, almost light enough to put it straight into your gas tank in some cases. And then that spans all the way to the other end of the spectrum, where you have, for instance, the oil sands out of Canada, heavier oils out of Venezuela that are very much more tar-like and a lot of them have very high sulfur content. And there are also much more heavier grades. And the issue with that is that refineries are set up to refine a certain type of oil. And typically, wherever they're getting their oil from, for instance, Maya crude out of Mexico, is a heavier oil that certain refineries in the Gulf coast are set up to refine. So, they can't just switch off and start using more Permian light crude, because it would be inefficient, and they would need to reconfigure their refineries. This can be done, but it's with quite a bit of investment. It could be several hundred million dollars, maybe even more, to do that. So, the refiners don't want to do it unless they think that that is going to be their primary grade going forward, and there is obviously time that it will take for that to happen. So, they have to be certain that they can't get that oil in the future that they're currently set up to refine before they make the investment to switch over to other grades.

Stephen Dover:  So, one of the discussions is that some of that Russian oil might be going to China. Is that something China can take on, or would China have some of these issues around how to use it and refine it?

Frederick Fromm:  Yeah, China would definitely have issues, depending on the volumes we're talking about. They might be able to run a bit more Urals crude, which is the primary grade coming out of Russia, but they can't take two to three million barrels a day of additional oil. That would just overwhelm their system. And, you know, nobody really knows exactly how these refineries are configured and some of the more modern ones, such as the ones that have been built in India, can run multiple grades and have more flexibility to change. But for the most part, the refinery system around the world is not structured that way.

Stephen Dover:  What's the solution to this in terms of perhaps producing more oil in the US or someplace else, and how does maybe that even fit in with alternative energy sources?

Frederick Fromm: Unfortunately there's no quick fix. Short-term solutions are hard to come by given the time it takes to drill and complete new wells. That's generally on the order of six to nine months in the US onshore market. Offshore, particularly deep water, can take much longer, although several companies are pursuing what they call infill drilling or step-out wells around existing platforms. So, you don't have to sink a billion dollars into a floating production platform. You can simply drill additional wells and feed them into those facilities, assuming they have excess capacity, and typically they do to some extent, as the older wells mature and their production starts to come down. So, we're seeing this pick up quite a bit off of West Africa and also in the Gulf of Mexico, and these are considered shorter cycle projects as well. And they don't cost a lot of money, but their incremental impact is also fairly so small.

The US is expected to grow fairly rapidly over this year and into next year. Depending on who you talk to, the estimates average right around 700,000 to 800,000 barrels per day. And, we're also seeing production come online in Guyana, which is a new area of production growth. Still getting something out of the North Sea; see still seeing some Brazilian barrels as well. And the US companies are growing production at a fairly rapid clip in the Permian. So, we are going to get some relief there, but it's again, not enough to replace on the order of two to three million barrels per day. Short-term, that would be very, very difficult to do.

Stephen Dover: Fred, of course, there's a difference between where prices are now and futures prices. How do you look at oil prices and where they might be going?

Frederick Fromm: So, when we look at any commodity, we use intrinsic value ranges that are based upon marginal cost of supply and obviously supply and demand balances, and then also, levels where you see demand destruction. So, our working assumption is that oil will trade between $55 and $75. Longer term, when you get up to that $75 level, there should be strong incentive to increase spending, and a lot of the private companies in the US were already spending aggressively over the past one to two years when prices were much lower than they are today. So, you get incremental supply at that higher price. And then, at the lower price, you start to lose supply because it becomes less economic. Now, most US companies can produce oil profitably, at this point, down to around $40 to $50 a barrel, but they have also committed to return capital to shareholders and pay dividends, and also through buying back stock, and that creates discipline on their spending. They're also much more committed to maintaining solid and strong balance sheets, whereas before, they would borrow money and outspend cash flow. And that era has, generally, at least gone for now, and the industry and the companies look much more attractive as a result of that. But the price never cooperates with where you think it should be. It always goes higher than you think it should, and it often goes lower, in some cases, in March of 2020, much, much lower than anybody ever thought it would, even going negative for a very short period of time. So, the big question is how long will it stay elevated above that intrinsic value range?

Because that's valuable for the companies. And theoretically, what you should be doing is, is if you could determine how long they're going to make those outsized profits, you impute that into the value of the company, while still using that long-term range to come up with intrinsic values for the equities themselves. Now, figuring out the longevity or the duration is very difficult. However, the industry had already gone through about six years of underinvestment to the pandemic, and companies had been investing at the last peak in oil prices. Their returns were still going down despite high prices. And, by and large, the industry has come around now, as a result of shareholder pressure and pressures from others to pull back spending, and the pandemic just accelerated that very strongly, and they are now committed to not spending above certain levels. And that's one of the things that will keep supply in check.

At the same time, we've got demand back already above where it was pre-pandemic without international travel being back yet, international air travel, which is a couple percent of oil demand globally. So once that comes back, we could easily be above where we were pre-pandemic levels on a demand basis and still below where we were on a supply basis. Inventories are already low. So, point being, we could see higher prices sustained for a longer period of time. And frankly, even before Russia invaded Ukraine, prices were likely to go up anyways, and we are likely to see a $100 and above oil prices. What it did was pull it forward. It happened sooner than we thought. but the expectation was, by next year, we probably were looking at elevated prices any ways.

Stephen Dover: Do you see this whole situation with Russian oil as changing policy? Is there something different that's going to occur over the next, say, three to five years than you might not have anticipated three or six months ago?

Frederick Fromm: Yes, there should be multiple changes as a result of what's happened. I mean, clearly, energy security was already an issue leading up to the invasion, particularly for European countries. And they also had issues with just shortages of natural gas because, when the wind stopped blowing in the North Sea for a period of time, their wind generation came down, and they switched over to burn natural gas and didn't have the storage that they needed given that increased demand. And so, they are going to put things in place to perhaps build more storage so that they have a bigger buffer. Germany has already announced that they are going to build LNG import terminals, what we call “regas [regasification] facilities,” which they did not have a single one, surprisingly. France does, and so do some other countries, and that could help secure supply and increase security of supply. And of course, many countries in Europe now are looking at moving away from Russia as a supplier. And that could benefit companies that have, for instance, natural gas in the Eastern Mediterranean, offshore Israel to produce more gas, and import that into the country. There's also been a big push to accelerate the use of renewables, which I'm not sure that creates security of supply necessary, given that it's an intermittent source, but at the same time, can help reduce dependence on suppliers of natural gas and eventually oil, particularly if EVs [electric vehicles] get a harder push. And we're seeing that here in the United States as well. And it’s something that could benefit the solar companies and other renewable equipment manufacturers.

Stephen Dover:  What's going to happen to prices at the pump. I just filled up my vehicle this weekend in California. It's almost $6 a gallon. Where is that going to go, forward?

Frederick Fromm:  Yes, and I did the same recently, and it was over $6 a gallon. And the national average is well over $4 a gallon now, which is a record level. This is a point when you start to think about demand destruction, and also about the potential impact on the economy in the US and globally. With oil prices pulling back, we may see some relief. I would expect gas prices to stay pretty close to where they are right now, maybe even pull back a little bit, if we can get oil to go back down closer to the $100 [per] barrel level, which, you know, it's very difficult to predict what's going to happen with Russia and Ukraine. I think the hope is that a resolution is found, and if that's the case, then I think you see oil prices pull back, and gasoline prices at least stop going up and probably come back down.

Stephen Dover:  Fred, thank you very much for spending this time with us today. It's been very interesting.

Frederick Fromm:  My pleasure.

Host:  And thank you for listening to this episode of Talking Markets with Franklin Templeton. If you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about anywhere else you get your podcasts. And we hope you’ll join us next time, when we uncover more insights from our on the ground investment professionals.