Energy Prospectus

Read this carefully, especially the last few sentences.
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Note from Adam Rozencwajg 2-23-2024

Oil investors turned extremely bearish during the fourth quarter. Worries over perceived
strength in US shale production and fears of potential recession-related demand weakness
drove prices lower. West Texas Intermediate and Brent fell by 21 and 17%, respectively.
Oil-related equities fell, albeit less than the commodity. The XLE ETF, dominated by
large-capitalization integrated energy companies, fell by 6.4%. In comparison, the
smaller-cap S&P Exploration and Production Index fell by 6.7%, and the OIH, which tracks
oilfield service stocks, fell by 9.1%.

Throughout the second half of 2023, the Energy Information Agency (EIA) released bearish
data suggesting US production again surged after several consecutive years of disappointing
growth. As of November 2023, the EIA claims that US production was still growing by a
robust 1 m b/d year-on-year. Our models tell us these figures are simply incorrect, resulting
from a subtle change in the EIA’s methodology rolled out last July. Although rarely commented
upon, adjusting for this change, US production growth appears to have slowed dramatically
throughout 2023, just as we predicted. We dissect the recent change and its impact on US
production trends in the oil section of this letter.

Although few people care to admit it, global oil markets slipped into a “structural deficit”
in the summer of 2020, causing OECD crude and refined product inventories to fall by 600
mm bbl over the next twenty-four months – a record. To prevent a price spike, OECD
governments arranged a coordinated release of 320 mm barrels from their strategic
petroleum reserves (SPR). In response to the government’s SPR releases, commercial
inventories rose.

Since March of 2022, when SPR releases commenced, OECD commercial stocks have risen
by almost 175 mm barrels. Many analysts, including the International Energy Agency
(IEA), have failed to comment on the true reasoning why commercial inventories have
risen—SPR releases. Instead the IEA has implied inventories rose simply because supply
exceeded demand. However, if one adjusts for SPR liquidations, inventories are unchanged,
suggesting a market that is not in surplus—but balanced. Given our models of both supply
and demand, we firmly believe oil markets will once again fall into a sustained deficit in
2024. Although few people agree, we believe the deficit could prove so acute as to require
further SPR liquidation later this year. The last period of structural deficit, between 2020
and 2022, saw crude prices advance three-fold from $40 to $120 per barrel. Could we
experience the same again now? We recommend investors position themselves accordingly.
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As I have posted here many times, demand for oil-based products is "seasonal". The annual demand spike for transportation fuels begins mid-March and accelerates into June. My forecast models are based on WTI averaging $75/bbl during Q1 and then rising to average $82.50/bbl in 2H 2024. The global oil market is much tighter than most people believe. As the paradigm changes from an Oil Surplus to an Oil Deficit oil prices should increase and a lot more money will rotate in the high-quality companies of our Sweet 16. It has already started. Our Sweet 16 Growth Portfolio has gained 9.34% over the two weeks ending February 23rd.

More from Adam's quarterly report:

Over the last twelve months, oil markets have been broadly balanced. OECD commercial
inventories drew a modest 100,000 b/d throughout the year. Looking forward, the IEA
expects a surplus of nearly 800,000 b/d; however, we disagree. First, we believe the IEA is
again underestimating demand, as evidenced by the return of the “missing barrels.” As our
readers know, “missing barrels” occur when, according to the IEA, liquids that are neither
consumed nor added to inventory are produced. Over the past twenty years, “missing barrels”
have often predicted future upward revisions to demand. Last year, the IEA’s missing barrels
averaged 400,000 b/d. In the fourth quarter, they reached a very large 700,000 b/d. We
believe the IEA is underreporting demand again, especially as we enter 2024. Even if the US
shales moderate from 4Q23 levels to an average of 500,000 b/d, the IEA’s expected surplus
will fall to only 300,000 b/d.

Moreover, as discussed, the IEA expects US liquids production to grow by 800,000 b/d,
whereas our analysis suggests production may be flat in 2024 compared with 2023. If we are
even halfway right, oil markets will be in deficit for the fourth consecutive year. Both
commercial and government inventories remain below average, leaving markets vulnerable
to an unexpected move higher. Speculators hold nearly the lowest level of net-length in twenty
years.

We previously predicted privately that if oil markets became tight, governments would
release vast quantities from their strategic petroleum reserves to keep prices low. Although
we never wrote about our predictions, they were proven correct in 2022 and the first half of
2023. Given the upcoming election, we would not be surprised if the Biden Administration
considered releasing further barrels from the SPR – something we would consider a massive mistake.
Although this action might depress prices in the near term, we would use further SPR releases
to prove the oil market is tighter than expected and exploit the weakness as a buying opportunity.

The only source of non-OPEC supply growth is grinding to a halt; we believe demand will again
surprise the upside in 2024, and inventories, artificially boosted by SPR releases over the last
two years, will begin to draw again strongly. Investors will be forced to take notice.