As Gold & Silver Rip, is OIL the Next Commodity to Go BALLISTIC? Josh Young

Key Concepts

• Contrarian Investing: Investing against prevailing market sentiment, often buying when assets are undervalued and out of favor.
• OPEC+: An alliance of oil-producing countries, including OPEC members and other major producers, that coordinates production levels to influence global oil prices.
• US Oil Production: The output of crude oil from the United States, a significant factor in global supply.
• Natural Gas Demand (AI): The increasing consumption of natural gas to power data centers for artificial intelligence operations.
• Geopolitical Risk: The impact of political events and international relations on commodity markets, particularly oil supply.
• Spare Capacity: The ability of oil producers to quickly increase output to meet demand or offset supply disruptions.
• Fiscal Break-Even Oil Price: The oil price required for a country to balance its government budget.
• Shale Oil: Oil extracted from shale rock formations, typically through hydraulic fracturing and horizontal drilling.
• Natural Gas Liquids (NGLs): Hydrocarbons that are extracted from natural gas, such as ethane, propane, and butane.
• Liquefied Natural Gas (LNG): Natural gas that has been cooled to a liquid state for easier transportation and storage.

Oil and Gas Sector Outlook and Contrarian Investment Thesis

Josh Young, CIO of Bison Interests, argues that despite recent negative sentiment and price dips in the oil and gas sector, it presents a prime opportunity for contrarian investors. He draws a parallel to gold and silver, which have recently reached all-time highs, suggesting oil could be the next commodity to experience a significant rally when least expected.

Key Points:

• Market Reaction to Tariffs: The oil and gas sector experienced a sharp decline following tariff threats, with WTI dipping below $60. Young notes that while the broad market recovered, oil stocks and prices remained depressed.
• OPEC+ Production Increases: A significant factor contributing to the current oil market situation is OPEC+ ramping up export volumes, with an increase of over 2 million barrels per day since the start of the year.
• Price Resilience: Despite this measured oversupply, oil prices remain around $58, leading Young to question why they aren't lower and suggesting underlying dynamics are supporting the price.
• Contrarian Opportunity: Young believes that the market is anticipating further declines in oil prices, making it an opportune time for investors to consider buying the dip.

The Gold-Silver-Oil Correlation and Fundamental Demand Drivers

Young elaborates on his thesis that gold and silver's ascent could precede a similar surge in oil prices, citing both historical technical patterns and emerging fundamental demand drivers.

Key Points:

• Historical Correlation: Over the past 100+ years, gold and other precious metal prices have historically risen either concurrently with oil or with a 12-18 month lead. This pattern has been particularly pronounced since the late 1960s, when gold prices were unpegged.
• Fundamental Demand from Mining: A significant, often overlooked, fundamental driver for oil demand is the mining sector, especially for commodities like gold, silver, and platinum group metals (PGMs).
  • AI-Assisted Demand Estimate: Young used AI (Grock) to estimate incremental oil demand in a commodities bull market, receiving an estimate of around 800,000 barrels per day for sustaining natural resources extraction.
  • Oil Intensity of Mining: Mining these precious metals is highly oil-intensive, requiring significant energy for extraction and processing. As prices rise, more energy investment is needed, thus increasing oil demand.
  • Evidence in Equity Markets: The surge in share issuance activity among mining companies (one to two offerings per day) indicates increased investment in exploration, mine development, and expansion, which will translate to higher oil demand.
• Missing Line Item in Forecasts: Young observes that mainstream financial reports from banks and consultants often fail to explicitly account for this "natural resources extraction" demand wedge, suggesting a potential blind spot in consensus oil demand forecasts.

OPEC+ Role in the Oil Market

Young provides a nuanced perspective on OPEC+'s role, emphasizing the shifting dynamics and their strategic objectives.

Key Points:

• Initial Production Quota Increases: When OPEC+ initially announced increased production quotas for a group of eight countries that had voluntarily reduced output, it contributed to a price dip, exacerbated by trade war announcements.
• Production Lagging Quotas: For a period, actual production did not match the announced quota increases. However, production now appears to be catching up.
• Strategic Objective: Young believes OPEC+'s current strategy is to increase production to test market demand limits and potentially trigger a disorderly price sell-off. Simultaneously, they aim to reset quota levels to align with actual production capacity.
• Spare Capacity Skepticism: There is warranted skepticism regarding OPEC+'s claimed spare capacity, especially given past price wars where production increases were accompanied by significant inventory drawdowns. Spare capacity is a dynamic target due to varying investment levels in member countries.
• Fiscal Needs of Member States: The fiscal break-even oil prices for key OPEC+ countries like Saudi Arabia (requiring over $90/barrel) highlight their need for higher prices to fund social welfare states and growing populations.
• Volume vs. Price Strategy: Young argues that producing less oil and achieving a higher price is more profitable for these nations than increasing volumes at the expense of price, as the net increase in profits is greater.

US Oil Production Outlook

Young expresses skepticism about current US oil production figures, suggesting that official data may be overstating output and that production is likely declining.

Key Points:

• Data Discrepancies: There is debate about current US oil production levels, with different data providers showing conflicting numbers. Young points to TGS, a seismic and subsurface data analysis company, as showing significantly different figures than government data.
• Reliability of Government Data: Young questions the reliability of government data on oil production, suggesting it may be modeled or subject to revisions, and potentially politically motivated.
• Shale Production Decline: Contrary to the belief that shale development has led to sustained growth at lower prices, Young believes efficiency gains are largely in the past. CEOs of pressure pumper companies, who are at the forefront of shale stimulation, are actively forecasting production declines and disputing EIA figures.
• Rig Count and Fracking Activity: A rapid decline in drilling rig counts and pressure pumping (fracking) activity further supports the argument for declining shale production.
• Potential Over-Reporting: Young suggests that shale production might be over-reported, and that the market is not experiencing the significant growth that some data implies.

Venezuela and Oil Reserves

Young offers a cautious perspective on the geopolitical situation in Venezuela and its potential impact on oil markets.

Key Points:

• Limited Expertise: Young acknowledges that Venezuela is outside his core area of expertise but offers insights based on his general understanding of the oil market.
• Geopolitical Motivations: He believes oil is a contributing factor to US interest in Venezuela, alongside a desire to reassert American hegemony in the Western Hemisphere, potentially linked to the Monroe Doctrine.
• Logistical Challenges: Significant environmental issues and the need for massive investment in infrastructure repair (pipelines, etc.) make materially increasing Venezuelan oil production a long and costly process.
• Demand Surge Potential: In the event of a successful regime change and economic turnaround in Venezuela, Young anticipates a significant surge in domestic oil demand as citizens' quality of life improves. This could lead to a short-to-medium-term bullish impact on oil prices.
• Long-Term Bearish Potential: In the long run, the vast untapped reserves in Venezuela would be bearish for oil prices, but the immediate years following a turnaround would be oil-intensive with limited incremental production.

Impact of Global Conflict on Oil Demand

Young downplays the direct impact of global conflict on oil demand, particularly in the context of modern warfare.

Key Points:

• Shift to Drone Warfare: Modern warfare, with its increasing reliance on drones, is far less oil-intensive than historical large-scale tank warfare.
• Reduced Civilian Activity: Generally, war leads to less civilian activity, which is a primary driver of oil demand.
• Holiday Weekend Analogy: Young draws a parallel to holiday weekends in the US, where reduced commuting to work, despite increased travel, can lead to a net decrease in overall oil demand.
• Limited Material Impact: Fortunately, large-scale tank warfare has been rare, and the current nature of conflicts is not a significant driver of oil demand compared to civilian consumption.

Geopolitical Risk and Oil Supply Disruptions

Young highlights that geopolitical risk is currently underpriced in the oil market, with potential for future supply disruptions.

Key Points:

• Underpriced Risk: The head of a major energy institution recently stated that geopolitical risk is too low in oil prices, with some suggesting it's even negative.
• Historical Disruptions: Over the past 20 years, an average of 2 million barrels per day of oil production has been offline due to geopolitical reasons. Currently, this figure is closer to 1 million barrels per day.
• Current Supply Factors: Libya is near record highs in production, and Iranian exports are at seven or eight-year highs, contributing to the current low level of geopolitical disruption.
• Potential Disruptions:
  • Iran: Iran is seen as a potential source of disruption, either through direct sanctions enforcement or through its funding of various activities that can unpredictably impact supply.
  • Russia: Ukraine's repeated attacks on Russia's energy infrastructure have impacted processed oil product exports (diesel, gasoline), though overall oil exports have seen some recovery.
• Magnitude of Impact: While significant disruptions can cause sharp price increases (e.g., $50/barrel in a month in March/April 2022), current geopolitical disruptions are relatively small.

Natural Gas Demand Driven by AI

Young believes the AI race will be a significant tailwind for natural gas markets, despite current low prices.

Key Points:

• Astronomical Demand Growth: The demand for natural gas from AI data centers is projected to be astronomical, with current estimates likely being low. Demand growth for AI data centers is nearly 50% higher than at the start of the year.
• Scaling of Projects: The size and speed of AI data center announcements and expansions (e.g., from 1 GW to 2 GW projects) are driving this demand.
• Chip Energy Intensity: The increasing energy intensity of AI chips further fuels this demand.
• Mitigating Constraints: While there were initial constraints on gas turbines, manufacturers are ramping up production. Older, less efficient power generation technologies are also being utilized to meet immediate demand.
• Increased Utilization Rates: Existing power plants are running at higher utilization rates, and new data centers are pulling electricity, increasing the demand intensity for gas.
• Global Impact: This trend is not limited to the US; China's energy-intensive chips will also contribute to demand, potentially absorbing their existing spare electric capacity.
• Current Price Disconnect: Despite the strong demand outlook, US natural gas prices remain low ($3/MCF) due to seasonality and weather. Moderate weather in recent months has suppressed prices.
• Forward Curve vs. Spot Price: The forward curve for natural gas prices reflects the anticipated demand, but the spot price is still low.
• Equity Market Discrepancies: There is a wide variation in how natural gas-related equities are pricing in future gas prices, with some large companies pricing in $5/MCF and others as low as $2/MCF, indicating potential opportunities.

Bison Interests and Bison Insights

Josh Young outlines his professional endeavors.

Key Points:

• Bison Interests: A decade-old firm that invests in publicly traded small-cap oil and gas producers, as well as services and infrastructure companies.
• Bison Insights: Launched earlier in 2024, this media company and newsletter serves as a platform to share investment ideas and research on the oil and gas sector in a compliant and organized manner. It also features expert interviews.

Conclusion

Josh Young presents a compelling case for a contrarian approach to investing in the oil and gas sector. He argues that while current market sentiment may be bearish, historical patterns, emerging fundamental demand drivers (particularly from mining and AI data centers), and the fiscal needs of major oil producers suggest a potential for a significant oil price rally. He also expresses skepticism about current US production figures and highlights the underpriced geopolitical risk in the oil market. The AI race is identified as a key catalyst for natural gas demand, despite current low prices, creating potential opportunities in both oil and natural gas equities.