Vaalco Energy: Hold On, The Industry Is Reshaping

Investment Thesis

The sanctions against Russia since the beginning of the Ukraine war have caused disruptions in the energy sector and supply shocks. Sanctions caused a worldwide oil and gas shortage, driving up demand and prices. Energy stocks soared as margins grew, and profits were astronomical due to the historically high prices. However, the good times seem to have ended as supply grows past demand forcing prices down.

Also, due to the disruption in the energy sector, there is a rapidly expanding need for green energy to address the resulting supply shortages. In addition, the situation is developing, and Russia may continue to exert influence in the energy sector even if sanctions have been imposed. Oil experienced its largest weekly loss since April due to poor liquidity fueling large price fluctuations and critical pipeline restarts easing supply concerns in December last year. I am skeptical of VAALCO Energy, Inc. (NYSE:EGY), which has already lost about 20% over the past six months due to falling demand and prices.

Company Overview

The independent energy firm VAALCO Energy, Inc. acquires, develops, and produces crude oil and natural gas. The business is the holder of an Etame production-sharing agreement for the offshore Etame Marin block in the Republic of Gabon, West Africa. A portion of its holdings also includes an untapped area off the coast of Equatorial Guinea in West Africa.

The Market: Prices, Production, and Consumption

To begin with, oil prices are declining as supply grows and demand declines. Brent crude oil prices are projected to average $83 per barrel in 2023 and $78 per barrel in 2024.

In terms of production, in 2023, it is expected that the global output of petroleum and other liquid fuels will rise by 1.1 million b/d and by 1.7 million b/d in 2024. This rise is attributable to significant growth in various non-OPEC countries and in OPEC output, which more than compensated for a fall in the Russian production of 1.5 million b/d over the anticipated period.

The US and other non-OPEC producers outside of Russia are expected to increase oil output by 2.4 million b/d in 2023 and another 1.1 million b/d in 2024. The United States accounts for the biggest share of non-OPEC production growth over the forecast period, with 40% growth in 2023 and 60% growth in 2024.

For consumption, growth in non-OECD nations like India and China is expected to be the primary factor in pushing worldwide consumption of liquid fuels to a forecasted 102.2 million b/d in 2024. Changes in oil consumption typically mirror shifts in economic growth or contraction.

Global GDP growth is expected to accelerate from 1.8% in 2023 to 3.3% in 2024, causing a slowdown in oil demand growth in 2023. Despite this, there is still a lot of doubt about the demand outlook because of worries about the global economy and the impact of loosening COVID-19 limitations and rising case counts in China.

Prices are plummeting not only for liquid oil but also for gases. Natural gas prices have dropped below $3 per million. BTUs last month for the first time since May of 2021. For a product that had recently traded above $9, the fall is startling. The warm winter in Europe and the US is the main cause of the fall since fewer people are using gas for heating, which causes more gas to accumulate in storage.

Russia is one of the world’s top natural gas producers, which is used for heating, energy generation, and industrial combustion. After it invaded Ukraine last February, prices skyrocketed. War and gas shortages are resolved, at least for now. Europe imported enough gas to get through the winter, and warm weather has lowered heating gas demand. Because of substantial domestic supply, natural-gas prices in the US are cheaper than in Europe, but demand has declined due to mild weather.

The Russia Effects: Still Evolving

Since Russia invaded Ukraine, numerous countries have committed to cutting oil and gas imports to reduce Moscow’s profits and the war effort. It appears that the sanctions on Russia are still in flux, and this will continue to impact the demand for energy prices for the foreseeable future. As of February 5th, member states of the European Union will no longer be able to import refined oil products from Russia that were previously imported by sea.

The Russian gas industry has also come under attack. The EU said in March that it would reduce its yearly Russian gas purchases by two-thirds. The UK, which only occasionally imports Russian gas, has completely stopped doing so.

Despite these sanctions, India and China are buying more Russian oil because it is now affordable due to a decision by major global economies to cap Russian oil at about $50 per barrel. By increasing their purchases of Russian oil last year, India, China, and Turkey collectively now account for 70% of all Russian crude shipments by sea. Additionally, Russia was selling its oil for much less than the Brent crude benchmark price. Russia provided fewer than 2% of India’s oil imports at the beginning of 2022, but it is currently on track to overtake Saudi Arabia as its top supplier.

Despite the EU’s sanctions against Russia, they still significantly rely on their gas supplies. Since most of Europe’s gas comes from pipelines connected to Russia, many European nations have found it extremely difficult to reduce their reliance on Russian gas imports.

In 2021, 40% of the natural gas used by EU nations came from Russia. Germany was the leading importer, followed by Italy and the Netherlands. By August 2022, that had fallen to approximately 17%.

My Assertions

Here are my conclusions based on the energy sector’s aforementioned dynamics. First, a major fall in demand for oil and gas is anticipated in 2023, which will drive prices down. In 2024, the already low prices are expected to fall even lower. Energy businesses should prepare for decreased margins, given that demand is declining and prices are falling.

Additionally, supply rises when output rises in a market where demand is falling even more, driving prices lower. The higher production was caused by last year’s high pricing, which drew additional investment to the sector. Prices will undoubtedly stay low as more supply is available in the market.

When analyzing the gas situation, it becomes clear that a lot of natural gas was stored in preparation for the expected cold weather and moderate and decreased demand for the product. As a result, petrol prices have also decreased, and I anticipate that they will continue to do so for some time, given the low demand suggests that a lot will remain in the stores, leading to an excess in the market.

Lastly, despite EU sanctions on Russia, Russia continues to sell oil to other nations, particularly China and India. Trading with Russia may impact world prices in the long run by driving them down, given that China is a significant player in the oil market. Additionally, it has been difficult for the EU to reduce its reliance on Russian gas, so it is still on the market and may continue to affect prices and demand. There might still be more to come as far as Russia’s standing in the market is concerned because this tale is still in the early stages of development. After weighing each of these factors, I advise holding investing in this business until the current turbulence has subsided.