Weekly Hard Assets Insights
By David McAlvany

Infrastructure Bill and Oil Supply—Both in Doubt? 

This past week provided headlines on the much discussed and anticipated infrastructure fiscal stimulus bill. On Thursday, President Biden announced “We have a deal” on an infrastructure bill “framework” following a meeting with a bipartisan group of senators. Much like a snow leopard sighting, the announcement offered a rare glimpse of an elusive animal—bipartisanship in Washington.

The $1.2 trillion eight-year framework includes $579 billion in new spending and constitutes a compromise proposal aimed primarily at repairing roads and bridges, increasing the resilience of the electricity grid, and building new, resilient transmission lines to facilitate the expansion of renewable energy. The overall proposal is significantly smaller than previous initial proposals, but as soon as victory was declared, issues arose anew. It was a “moment” (and only that) of bipartisanship indeed.

At a White House press briefing, Biden confirmed to reporters that the “deal” would be contingent upon linking the passing of the bipartisan “infrastructure” bill with a second measure funding what Democrats call “human infrastructure.” This second measure would be passed through a Senate procedure called reconciliation, a maneuver that would allow it to take effect without Republican votes. Biden told reporters that unless there was swift action in passing both measures, neither would survive.

Not surprisingly, Republicans were none too pleased. It didn’t take long for Senate Minority Leader Mitch McConnell to speak up, saying on the Senate floor, “Less than two hours after publicly commending our colleagues and actually endorsing the bipartisan agreement, the President took the extraordinary step of threatening to veto it….” McConnell added that, “It almost makes your head spin.” Lindsey Graham, one of 21 senators who had negotiated the bipartisan deal, commented that, “If reports are accurate that President Biden is refusing to sign a bipartisan deal unless reconciliation is also passed, that would be the ultimate deal breaker for me.”

So, despite the fleeting moment of bipartisan progress, the future of the infrastructure bill remains as clouded as ever. One of the interesting developments that came from negotiations had to do with the means of funding. In addition to at least a dozen other funding mechanisms, the use of proceeds from a possible $6 billion sale of oil from the U.S. Strategic Petroleum Reserve was proposed. A $6 billion sale from the SPR, at around current prices would roughly translate to 82 million barrels, or 13 percent, of crude held in the U.S. reserve.

Oil inventories had a big 7.6 million barrel drawdown this week, with a total drawdown of 8.2 million barrels including the SPR. Gasoline had a 2.9 million barrel drawdown, while distillate inventories saw a build of 1.75 million. This is the second straight week of large drawdowns in crude inventories, and may be the initial signs of demand pressure from the combination of the typical high-demand summer season accentuated by the added impact of a reopening economy and increasingly realized pent-up demand. If significant drawdowns continue throughout the summer months, it would be in line with the bullish expectations of Goldman Sachs and several other banks, and add a strong wind to the back of an ongoing rise in crude prices.

Continued strength in oil prices will likely hold great significance to the stocks of oil-related companies. This is a sector that legendary money manager David Tepper recently stated held “the cheapest equities by every measure….” Tepper also commented on recent developments that have seen activist investors successfully making inroads into big oil companies by claiming board seats. According to Tepper, this is a catalyst to buy oil stocks, as the activist pressure means that new drilling “will eventually decrease over time,” taking supply down with it. The combination of decreasing capital expenditures reducing new supply while oil demand remains steady introduces the risk of a supply crunch that could put powerful upward pressure on prices.

A survey out this week from the Federal Reserve Bank of Dallas also highlights concerns of an oil supply crunch. According to three-quarters of U.S. oil and natural gas executives surveyed by the Fed, the group now expects a global oil supply gap by 2025. The survey finds that underinvestment and a focus on the energy transition is expected to create a global oil supply shortage in two to four years. The Hellenic Shipping News reported that, “One upstream executive said policies focused on limiting oil and gas growth, restrained capital budgets in favor of free-cash-flow generation, and continued consolidation could lead to an undersupply for growing demand.” The report continued that another oil executive respondent said, “only one of 400 institutional investors their company has worked with is currently willing to give new capital to the oil and gas sector. And the same is true for public companies and international exploration….” The same respondent added that, “This underinvestment coupled with steep shale declines will cause prices to rocket in the next two to three years…. I don’t think anyone is really prepared for it, but US producers cannot increase capital expenditures.”

Elsewhere in the oil patch, Iran missed a deadline to renew its temporary atomic-monitoring pact with international inspectors. This development is not likely to make negotiations to revive a nuclear accord with global powers and the U.S any easier for the Iranians. Without an agreement, it will be extremely unlikely the U.S. will lift its current sanctions prohibiting Iranian oil exports from hitting the global market. Next week, attention will turn to the OPEC+ meeting, where the group is expected to discuss the possibility of increasing supply to curb the rapid rise in crude prices. According to analysts at ING, “The group will likely continue to take a cautious approach, and so we believe that there will be reluctance from some members to increase supply by more than the previously agreed 500 million barrels per day monthly limit.” The analysts believe that an increase in production by anything less than that amount would be a near-term catalyst for higher prices.

Natural gas also made news this week as prices surged 9.49% and increased to their highest level since early 2019. The U.S. Energy Information Administration released its report on natural gas inventories, and said utilities added 55 billion cubic feet (bcf) of gas into storage last week. The number is much lower than the 66 bcf build analysts forecast in a Reuters poll. The primary culprit for the low storage build among utilities is that power generators are burning a tremendous amount of gas to keep Americans’ air conditioners on as a series of heat waves and a megadrought have plagued the western half of the U.S. Liquefied natural gas exports have been soaring in the last couple of months, with a record 11.5 billion cubic feet per day average in April and an average 10.8 bcfd in May. Supply disruptions, shipping delays, and strong demand are driving prices, and near-term market projections continue to anticipate further demand increases.

Friday was also a big day in the small cap universe as the Russell 2000 Index underwent component rebalancing. This index rebalancing is perhaps a fitting sign of the times, as, according to Bloomberg, “today’s reshuffle will mean a further deterioration in quality of the Russell 2000 Index’s components.” The underlying quality of the index, on balance, is taking a notable hit. Frothy speculative story stocks have been given an increased weighting, while actual positive cash-flowing enterprises have received a diminished role within the index. As Jefferies’s Steve DeSanctis points out, “the proportion of money-making companies in the index will fall to the lowest since 2000.” In addition to the deterioration of fundamental underlying component mix, “meme” stock AMC is the Russell’s largest member now, boasting an extended consecutive quarterly losing streak and a fascinating enterprise value/revenue multiple of 87.6x. While the following disclosure might not surprise the reader, it is important to make clear that AMC is not an MWM holding.

As for weekly performance: The S&P 500 rebounded sharply from last week’s sell-off to make new all-time highs and close the week up 2.75%. Gold was up modestly by 0.50%. Silver was up 0.46%. Platinum and palladium recovered nicely on the week, up 6.01% and 6.77%, respectively. The HUI gold miners index was down 0.77%. The IFRA iShares U.S. Infrastructure ETF was up 3.27%. Energy commodities were up on the week. Oil was up 3.87%, while natural gas prices surged 9.49%. The OIH Oil Services Index added 5.60%. The CRB Commodity Index gained 2.22%. Copper was higher by 3.20%. The Dow Jones US Real Estate Index ended the week up 1.67%, while the Dow Jones Utilities Index gained 0.48%. The dollar weakened by 0.40%. The yield on the 10-year Treasury jumped 9 bps to 1.54%.

Have a great weekend!

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC