Primary Vision Blog

By Mark Rossano

Sections

• Reduction of Frac Spreads Accelerates
• Storage and Economic Stimulus Will Fail to Bridge the Gap
• Global Economic Data Points Paint a Frightening Picture
• Oil Demand Falling as 2.6B face lockdowns
• India Starts Down the Lockdown Road
• European Lockdowns Ramp with UK Joining the Fray
• OPEC+ Politics and Flow- The Reality Tells a Different Story Versus Consensus
• Politics Drive OPEC Policy

Reduction of Frac Spreads Accelerates

The national frac spread dropped by about 18 week over week, with more reductions on the way. We have already discussed Halliburton laying people off, but they are far from the only ones with Schlumberger/ SMID Cap OFS/ E&Ps up and down the cap scale reducing work forces. Many layoffs have been announced or will be over the next several weeks as CAPEX is slashed, and the U.S. faces an uphill battle as realized prices only worsen across the country. Our assumption was for a 10% drop from 317 (3/6/2020) over the next 30 days, but the pace was faster with a total of 280 hired (no guarantee they are all operational) in under 2 weeks. The view was we would get a full 20% drop by end of April, but we are pulling that forward and assuming 253 or so by the first week of April. The Permian will remain a key driver to the decline, and will quickly hit 100 active spreads now that even the majors are reducing CAPEX and adjust spending. Completions will slow significantly and come to a near standstill as WTI Cushing prices are on their way to $15 (already sub $20 in the spot market), and the flood of naphtha in the market coming from Europe will keep a lid on condensate exports. Demand is already terrible in the region as refiners/ petchem slow utilization rates to account for the shuttering of global economies and end users. Realized prices across the U.S. complex are already below $20 with condensate approaching $0 as NGLs/Nat gas are already pushing against the negative range once you factor in shipping costs.

The collapse in pricing won’t be abating anytime soon as spot prices continue to push lower, and force shut-ins across the board. WTI Cushing spot prices are approaching the lows hit during ’98-’99 with little to protect it from taking out the bottom. WTI Midland sits at about $19.29 (as seen in the below list), which will keep DUCs from getting completed and cause a much bigger production drop as E&Ps let decline curves reduce total volume. U.S. exports fell last week to 3.85M a day, and will continue to shift lower as U.S. crude is priced out of the market or is forced to price at steeper discounts. This will shift more oil into Cushing for storage, while refiners reduce more runs across the board.

WTI Cushing Spot Pricing Showing Major Pressure

Crude Spot Pricing Throughout the Americas

Imports slowed last week, but will quickly accelerate as we start to receive shipments already in route from the Middle East. The crude coming will displace U.S. production further as more is shifted into tanks, which will push E&Ps to opt to “store it in the ground” by not completing instead of pulling it out and realizing a terrible price. Cash preservation is paramount, and the acceleration will push frac spreads down to 250 in short order. Implied demand for products is already showing the shift in total demand with a 2.078M barrels a day drop driven by gasoline- which will accelerate as 3/20 doesn’t even capture the lock down in several states/ new announcements of refinery run cuts/ reduction in Continental product pipeline.

U.S. Implied Demand Across All Refined Products

The Permian is a good place to start for how much lower can activity go, and the proppant tells the story on how much completion activity is slowing and will remain at depressed levels. The proppant levels are now below 2014:

Permian Proppant Loadings Seasonally Adjusted Below 2014 Levels

The spread activity will quickly reach 100, and with the pressure in the market with Russia, Nigerian, Angola, Iraq, and now Saudi cargoes getting canceled- the volumes will be pushed back into the U.S.

Storage and Economic Stimulus Will Fail to Bridge the Gap

The issue shifts to onshore storage and it isn’t very comforting as we see gasoline storage rising globally, and we had U.S. refiners shifting to summer blends in Feb as the demand was waning already. The crude storage in the world can fill up quickly at the type of oversupply levels, and the U.S. has seen a rise vs last year bit still has room throughout our tank system. The oversupplies is shifting around the world as Europe sends to Asia, and demand now goes through a floor with China still well off normal pace and India entering their own lockdown. The below is working storage across products that will be updated at the end of this month. Tank tops aren’t an issue yet, but we will quickly start talking about it as demand falls and production in the U.S. is slow to roll off even as refinery runs accelerate to the downside. Continental refined product pipeline is reducing flow by 20%, which will push more product into storage.

The U.S. has passed a stimulus bill that will deliver $2T in immediate aid with another $6-$7T coming from the Federal Reserve in terms of Repo/ repurchasing/ Quantitative Easing. The U.S. currently has about $25.3 Trillion in debt, and the budget deficit coming into the year was already $1.2T that assumed normal tax revenue generation and was calculated well before the COVID-19 impacts. This means the budget deficit has already widened, and we will now be adding the total amount to be raised by $2T. So before factoring in the loss in tax revenue, the U.S. will have to raise $3.2T in a market where every country is currently looking to borrow with no one looking to lend. The quick response will be- well the central banks will buy it and the can will get kicked. The problem is the dollar strength in the market as the velocity of money has come to a stand still, and the magnitude of the stimulus rises to offset the law of diminishing returns as low rates and QE policy globally has inflated bubbles to absurd levels.

Total FED Balance Sheet, Which Will Hit About $7T by Mid-April

Massive Repurchases from the Fed Reach an All-Time Record- And They Won’t be Stopping

The fact the dollar remains strong is due to several factors with dollars printed within the U.S. economy doesn’t leave the country and yet not cycling through the system, while the Fed opens up swap operations with international central banks to provide dollar liquidity. As the global economy halts to a standstill, companies and countries that issued dollar denominated debt can’t take in USD from trade operations and are forced to sell from foreign reserves to meet debt costs. As the dollar strength remains and countries/companies struggle under the weight of debt expense, default risk will widen just as in the Asian Currency Crisis when countries dropped the Dollar Peg. The debt was issued back when the value of the dollar was much lower, but as the global market sputters and USD remains strong- the debt becomes onerous and at risk of default. As the debt comes due and the entity looks to “roll” the bond and issue new debt- they will find a market that no longer will either a) even entertain a new offering b) demand a much higher interest rate already stressing a tight balance sheet. If defaults occur, companies/countries will push the dollars they have preserved back into the market as they won’t have to sit on the cash to fill the debt payments unleashing a wave of new currency. The new USD will create a tidal wave effect by sending velocity of money and paper into the market cratering the dollar and spiking inflation.

Dollar Denominate Debt Abroad (Non-Bank)

Breakout of Some Emerging Market Holders of USD Denominated Debt

This is all going to play out in months and not days, as the dollar pushes higher even as the Fed attempts to push it lower. The problem is- The ECB/ BoJ/ BOE (name your CB) is attempting to create easing policies and supporting stimulus. There have already been several failed Sovereign auctions and Germany is trying to avoid a bigger one with Italy/ France with now Italy floating the idea of “joint issuance” to maintain a safe haven. The problem is- when everyone eases- no one is easing. The below chart helps highlight when each central bank sits in the cycle of total asset purchases vs GDP. The BOJ helps highlight the failed policies that have done little to spur economic growth as monetary policy hinders investments that provide real returns. So the investment in R&D/ new factories/ general business growth comes to a stop, and central banks have to expand the purchasing program to keep up the semblance of control and growth. We are running out of buyers of last resort, and as all sovereign debt converges to 0% or below- the merry-go-round starts to come off its wheels.

Global Economic Data Points Paint a Frightening Picture

Global economic pressure has been experienced throughout the world as reflected in PMIs/ GDP/ Exports-Imports and other key leading indicators.

The employment situation globally is deteriorating quickly with little to right the ship over the next several months. Hotels, airlines, restaurants, bars, doctor offices, gig-economy employees, and many others have laid off or furloughed employees in order to adjust for the large drop-in activity. “Hyatt Hotels Corp. will furlough or significantly reduce the schedules of two-thirds of its U.S. corporate employees as the company cuts costs with the coronavirus outbreak decimating hotel revenue.” “Marriott International Inc. has said it will furlough roughly two-thirds of its corporate employees, and ask those who remain to take pay cuts. Furloughed employees will receive 20% of their usual pay to help cover health care and other costs, a spokeswoman said.” Even as things slowly normalize the economy will take time to come back, and the cost of sitting at home/ not working/ worrying about paychecks will keep people from spending. Many of these resorts/hotels are being shut down and it will be quarters before they re-open units. The next question falls too- what about Air BNB holders that have multiple mortgages on homes they can’t rent? The level of fear in the system is rising as people will focus on disinfecting assets and limiting travel due to fear as well as limited disposable income. The U.S. already sits at record consumer debt levels with delinquency well over the recent record in ’08-’09 in credit cards and auto loans:

The pressure in the market isn’t limited to just the COVID-19 impacted nations but also the nations supplying crude and other commodity products. The questioned has been asked: Will Iran strike KSA again? Will Russia or KSA attack each other’s oil infrastructure? When do the people rise up because their government subsidies stop showing up? This all sounds great in a vacuum, but war/ attacks/ uprisings all cost money and need to have some form of financing. The flow of capital has dried up as Iran battles COVID-19 at home, and the populace anger rises further which I didn’t believe to be possible. Even the Iranian Regime has recognized they need to preserve capital to tackle to mounting problems at home. It isn’t because if the “people” live or die, but rather that a large part of their aging extremists/ parliament are infected with the disease so even on a self-serving level they need to cut back on proxy financing. In Iraq, their proxies still attempt to show force with rocket attacks, but as equipment and money dry up it will be hard to maintain the offensive. Russia and KSA remain more friend vs foe at this point and would never risk an outright attack- and they have had agreements fall apart twice before this one- so we are also just seeing history repeat itself.

The loss of social subsidizes can be tolerated for a short period of time, but the fact they have been cut for years now will keep people on edge. But if they rise up, what do they get? The whole market is essentially shuttered with little to no benefit by taking out the ruling party. The only thing it would do is waste money and potential harm vital infrastructure that would be costly to fix at this point in time. Typically, the uprisings start once thing settle out- but everyone still lives in fear of COVID-19 outbreaks so rioting/ attacks will be limited. We can just hit pause on some of the social uprising chattered.

A bigger problem is the continued shutdown of the global supply chain (more on it below), but now we are having countries starting to withhold food exports. The rise of food protectionism is rising with Vietnam (Rice), Russia/Serbia (Grain/ food oils), and Kazakhstan (flour and vegetables) are being held at the border in the name of domestic food security. The disruption will ripple through the economy as countries relying on these food stuffs struggle to replace them and end up paying premiums since freight and container costs have exploded (more on that below). The commentary remains these are just the first countries to come public with the information but as force majeures rise and governments fear about ensuring food is available- stoppage of global food trade will increase. The market is failing to truly appreciate the global supply chain impacts.” The crisis has forced many governments to reevaluate their domestic food stockpiles. India says it will have enough grain stockpiles to feed its poor for at least a year-and-a-half as reserves. China, the world’s biggest producer and consumer of rice, has revamped its pricing policy for the staple, and pledged to buy a record amount from this year’s harvest.” “As UN World Food Programme Chief Economist Arif Husain put it in a recent article online, “the economic consequences of this disease could end up hurting more people than the disease itself.” “Given the problem that we are facing now, it’s not the moment to put these types of policies into place,” said Maximo Torero, chief economist at the UN’s Food and Agriculture Organization. “On the contrary, it’s the moment to cooperate and coordinate.”

Oil Demand Falling as 2.6B face lockdowns

The oil markets are facing an issue on both supply and demand, which creates pressure on all fronts pushing WTI down to $15 over the next several weeks and Brent to sub-$20. The spread will hold about $4, but start to widen as more floating crude hits the Gulf of Mexico (GoM). A wave of crude from Saudi Arabia (about 10M barrels) will start appearing off the coast of the U.S., which will either displace U.S. crude and push it into storage or will be put offloaded directly into a tank. Either way- storage levels are going to rise exponentially as pressure mounts across the global market. Russia, Iraq, Nigeria, and Angola have experienced cancellations across March and April, which compounds the problems at their coastal/storage assets. Some producers have started to reduce May volumes while slashing OSP pricing in April to help keep exports moving and production steady so things can be slowly ramped down in May. The problem many countries face- it doesn’t matter what you cut your production down too because no one is buying it anyway. The supply/demand dynamics are at work with current demand falling quickly, and more demand coming out of the market daily. India is the newest country to enter into a mandated country wide shut down. Effective 12AM 3/25/2019- India will have a full lockdown for 21 days. Demand has fallen globally by about 30M barrels a day, and reach a peak of 50M barrels a day as the lockdowns remains in-place while slowly spreading around the world. Just picking the biggest demand centers helps highlight how quickly demand can drain away overnight:

Oil Demand Impacts Across Top Consumers

China is a perfect example of peak lockdown with about 760M people in some form of quarantine saw their crude imports fall from between 4-4.5M, so about 9.5-10M barrels was still flowing into China. To get a full idea of refinery shutdowns, from end of Dec to end of Feb Chinese implied stocks rose 2.31 m barrels a day according to Reuters. This means the actual refinery utilization was MUCH lower on a demand level and actual runs were 7.2 to 7.7m barrels. China’s Jan-Feb gasoline exports also spiked by 32%, which equates to 2.72M tonnes, diesel exports up 3.5% to 3.47M tonnes, and jet kerosene up 21.1% to 2.93M tonnes. The large increase in exports was driven by managing storage tanks to keep refiners operational at reduced rates during the lockdown. Demand has yet to normalize as the country slowly lifts physical barriers throughout their roadways and ports start to mobilize.

The speed has been hindered by employees slowly trickling in as quarantines and lockdowns are lifted nationwide. Even as the country starts to normalize, their main customers are facing a shutdown that is spanning the globe hindering their own economic restart. In order to protect from additional imported cases, ports are quarantining ships and containers limiting the amount of cargo containers available to move around the world. “The availability of cargo containers at Hamburg, Rotterdam and Antwerp in Europe and Long Beach and Los Angeles in the U.S. are at the lowest levels recorded, according to a Bloomberg report.” Due to the coronavirus, many problems and delays exist throughout supply chains, and even when the “all-clear” is given it will take weeks to get everything fully operational. The world economy has shifted to “at-time” deliveries, which is great for low inventory levels and cost, but in these circumstances- extensive delays will remain in the system as all the necessary components are moved back into place. China has been facing issues with shortages of labor, capital, and raw materials- which limits the speed of recovery.

Here are our estimates as of March 24:

• The Trivium National Business Activity Index indicates that China’s economy is operating at 78.1% of typical output. That’s up from 73.6% on March 20.
• The Trivium National Large Enterprise Activity Index indicates that China’s large enterprises are operating at 78.0% of typical output. That’s up from 75.0% on March 20.
• The Trivium National SME Activity Index indicates that China’s small businesses are operating at 78.1% of typical output. That’s up from 72.7% on March 20.

While these data points are promising, normal output is still on hold as demand struggles with key trading partners. The other caveat is local demand- due to the uncertainty of jobs and lay-offs still persistent people are hesitant to go out spending until there is more comfort about the ability for work. “‘Only when employment is ensured could we have more consumption,’ said Xu Hongcai, deputy director of the Economic Policy Commission at the China Association of Policy Science.”

The storage levels now sit at all time-highs across the complex with run rates slowly ramping. The problem with any ramp is… who are you going to sell the product too? The domestic consumption still remains well below seasonal norms with the rest of the world experiencing decimated demand. The fact large parts of their storage capacity is being utilized limits the amount of speculative oil the Teapots and State Owned facilities can purchase. The options open up for floating storage, but the rise in VLCC rates has crimped some of the economics- but can still work for the right grade.

Teapot Storage Levels in China of Oil

Refinery Run Rates of State-Owned Enterprises by Region

Refinery Run Rates of Independent Refiners (Teapots) in Shandong

A key gage of growing product oversupply can be seen in Singapore. The rising tide of products will start to accelerate as India enters into its 21-day nationwide lockdown. Indian ports have started to declare Force Majeure, which will restrict the flow of products throughout the world.

Total Singapore Storage Levels of All Refined Products- on Pace to Take Out All Time Highs

The below chart highlights the global nature of the problem with Singapore complex refining margins below showing the scope of the margin pressure. This is something I have been highlighting for some time, as the problems really came to light in Sept of 2019, and have only gotten and stayed worse for differing reasons. The glut in products has been happening for some time as China was pushing out refined products as the market slowed, and now even with Chinese assets running at reduced rates there is no benefit to Singapore or other global assets.

Singapore Complex Refinery Margins Over the Last 10 Years

India Starts Down the Lockdown Road

India typically consumes about 5M barrels a day, but with the everyone being asked to stay in their homes for the full 21 days- the demand for crude will come to a screeching halt. “Top refiner Indian Oil Corp (IOC.NS) and its subsidiary Chennai Petroleum (CHPC.NS) has cut refinery runs by an average of 15% to 20%, sources familiar with the matter said.” Some refiners may continue to operate at severely depressed levels, but just using China as an example (where about 760M out of 1.4B) total crude demand fell by 4M barrels and 7M barrels if you back out crude purchased for storage. In India, all 1.3B are being asked to remain indoors- so to say India will see oil demand cut in half is a fair assessment- but will likely be much worse. India exports of gasoline in Jan were already at record lows while diesel saw a small increase, but the product will come off the water as refiners reduce total throughput. “Refiner Bharat Petroleum Corp. has suspended purchases of crude oil from the spot market for May delivery, said R. Ramachandran, the company’s refineries director. Another processor, Hindustan Petroleum Corp., may also consider similar curbs, according to its chairman Mukesh Kumar Surana. The processors are working to assess the impact of widespread travel restrictions and the movement of people in one of the world’s most populous countries. – according to Bloomberg”

Indian Exports of Diesel

Indian Exports of Gasoline

European Lockdowns Ramp with UK Joining the Fray

Europe is the next stop that consumes a total of about 15M barrels a day (includes UK which is about 1.5M). The pain can already be seen with the flow of gasoline components: “The extent of the demand collapse in Europe as people stop traveling has pushed the region’s prices to a five-year low of $40 a ton under Asian prices, making the arbitrage trade viable. That’s even as benchmark Asian pricesplunged by around half this month amid shrinking demand for everything from car interiors to home appliances.

“Weak gasoline demand is prompting Europe to send excess naphtha over to Asia and it’s bearish for the naphtha market, especially when supplies from the Middle East are increasing,” said Armaan Ashraf, an analyst at industry consultant FGE.” “An uptick in naphtha flows into Asia will only add to a glut of refined oil products in the region, particularly for aviation fuel as more non-essential travel plans are cancelled and flights are grounded. In Singapore, the region’s oil storage and trading hub, middle distillate inventories — which comprises of jet fuel, kerosene and gasoil — have expanded by 28% since early January, government data show.”

Europe Naphtha;s Discount to Asian Prices is Widest in 10 Years

• The UK was the latest to enter a lockdown for 15 days starting March 23^rd that will also require people to stay in their homes. Restrictions will remain in place until April 13^th and will be reassessed.
• Italy entered locked on March 8^th and set to expire on April 3^rd (could be extended to July 31^st) and has gradually increased the severity of the rules with the most recent banning all movement within the country. The Italian deaths had fallen for two days in a row, but had a big spike tonight. A small reprieve is the pace of new cases is slowing, while still rising but at least there are some signs the shutdown is impactful.

The below chart also highlights where the rest of Europe and the US sit in relation to Italy:

• Spain began its lockdown on March 14^th with a full stop on all travel within the country. The government is using drones to help enforce the shutdown and keep people inside. The shutdown was extended to April 11th with another week or so to go before the government reassess the situation.
• France announced a nationwide lockdown on March 17^th which expires on April 1^st but will be extended for another week.
• Germany issued social distancing measures on March 22^nd that are in place until April 6^th. The country hasn’t officially announced a lockdown, but instead opted for banning public meetings/ closing restaurants/ and some forced non-essential shop closures.
• Austria started their confinement on March 16 expiring on April 13^th
• Belgium- March 18^th to April 5^th but likely to be extended
• Portugal- declared state of emergency that will remain in place until April 2^nd

Many of these countries have closed borders with each other in order to enforce the limitations on travel, and has brought economies to a standstill. The below picture really drives home the speed in which activity has dropped off and how China is still far from its original level of operations.

The extensive loss of manufacturing/ shipping/ consumer consumption has seen Europe consumption drop in half over the last few days now with the UK joining the ranks.

Global Refined Product Demand Show The Problems Throughout the Whole Hydrocarbon Chain

Another way to assess the oil demand loss is by looking at total consumption of refined products. About 61% of total oil demand is in transportation with about 8M barrels a day going into jet fuel. On a global level, about 50 airlines are completely shuttered/ 10- 90% canceled with another 35 from 30%- 85% operational. Most of the flights have been restricted to purely domestic travel, but it is a safe assumption that jet fuel demand is down 80% (6.4M barrels a day). Due to the precipitous drop, storage is becoming a growing concern: “Only about 20% of land-based storage for the product remains — about 50 million barrels — while airlines cut flights, according to Vienna-based consultant JBC Energy GmbH. A collapse in air travel due to the coronavirus pandemic has brought with it a plunge in fuel demand and the threat of a shortage of places to keep unwanted supplies.”[1]

Flights Around the World and Locations of Planes

With about 60M barrels a day going into transport, 8M to aviation, 40M to road fuel, Marine Shipping 6.1M, 1M a day for rail, and about 5.4M for commercial/agriculture the breakdown can vary in specific countries. But as countries go into full shutdown and supply chains and travel are hindered, the demand drops off quickly. This leads directly into the U.S. predicament and large consumer of oil and refined products. “U.S. AIRLINE PASSENGER COUNTS DOWN 86% FROM LAST YEAR ON VIRUS- according to Bloomberg.”

So far, the U.S. has not rolled out a nationwide lockdown, but instead opted to have states address the local concerns with stay at home orders issued in: California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Massachusetts, Michigan, New Mexico, New York, Oregon, Washington, West Virginia, and Wisconsin. There are also some specific cities outside of the listed states following similar orders. Many of these orders were issued between March 19^th and 24^th with some of them extending for up to 8 weeks (California currently the longest at 8 weeks). This is a huge focus as many of these areas make up a large piece of refined product demand. In California, refiners have initiated economic run cuts from 20%-40%, while Continental Product Pipeline that moves 2M barrels a day of refined product from the Gulf Coast to PADD 1 is cutting flow by 20%. Many facilities have no stopped or delayed turnarounds and are rolling out run cuts. Implied demand will drop off quickly from the current levels of 21.47M barrels a day as jet fuel/ gasoline/ diesel are directly impacted by the shutdowns. Refinery run cuts will accelerate and send utilization rates down further as we are at a seasonally adjusted low:

U.S. Refinery Run Rates Rose- But Doesn’t Capture Recent Slow Downs Announced

The U.S. is far lagging behind Europe in the spread, as we quickly close the gap with Europe on our confirmed cases and death rate. The below chart helps show where the U.S. sits in comparison to countries throughout the world. The key factor for the U.S. is each state is at different levels of the spectrum with places like New York and California further along the bell curve as other areas in the U.S. catch up.

The below chart shows miles driven in March 2019 in order to keep things seasonally consistent. The West and NorthEast sector are seeing a large drop in miles driven which is being reflected with the current price of gasoline.

Miles Driven (in Billions) for March 2019

The gasoline crack is currently negative with NY 91 RBOB trading at 20 year (as far back as I can find) lows with the WTI Cushing/ US Gulf Coast Crack Spread back to levels not seen since 1995 and close to lows seen in ’08 and ’14. When we do the same seasonal exercise looking at crack spreads versus Brent 321- we are at the lowest level I can find on record (second chart below). “P66 SEES 20% U.S. DEMAND DESTRUCTION PREDOMINANTLY FOR GASOLINE- according to Bloomberg.”

Crack Spreads In the Gulf Coast (3-2-1) and Showing the Pressure on Margin

OPEC+ Politics and Flow- The Reality Tells a Different Story Versus Consensus

The significant drop in pricing won’t be reversing anytime soon, but will keep run cuts coming as refiners attempt to protect margin and focus on storage. Coastal refiners have been the ability to take some advantaged cargoes, but with the adjustments to the KSA rebate program (which just means as shipping rates spiked- KSA adjusted the rebate they gave buyers) North America buyers have renominated for less supply in April. “Freight rebates were offered to Saudi customers in the west but were slashed recently after freight rates skyrocketed- according to Bloomberg.” There is still an armada of boats heading to the U.S. carrying 10M barrels of KSA crude, but there was an adjustment lower of what NAM is willing to buy at the moment. The U.S. isn’t the only one looking to adjust crude loadings with China also looking to purchase less crude in April. “Unipec, the trading arm of state-owned Sinopec, is looking to avoid taking delivery of at least four supertankers of crude for April loading, according to people with knowledge of the company’s plans. Each very-large crude carrier has the capacity for two million barrels of oil. It may try to get out of as many as eight VLCCs worth of oil, according to one of the people.- according to Bloomberg.” The spike in freight rates have pushed people to adjust deliveries even though the KSA OSPs were cut considerably.

The move is also to address the quick fill up of Chinese storage: “China’s onshore oil inventories have risen to 796m barrels; that’s in line with a significant increase in crude imports month-to-date at 9.77m b/d, up 570k b/d from February, co. says in note to clients Wednesday.” Even though Russia and Saudi have been focused on “increasing” volume they have failed to do so as cancelations of shipments increase in April.

Crude exports from Saudia Arabia and Russian haven’t seen any “meaningful change” yet after the OPEC+ agreement collapsed earlier this month, says Alex Booth, head of market analysis with industry data provider Kpler.

• Loadings from Saudi Arabia averaged 7.692m b/d during March 7-18, vs 7.38m b/d for January-February, he says by phone from London
  • For same period, Russia’s loadings ~4.995m b/d, vs5.025m b/d in January-February

The problem with “wanting” to increase the export of oil (supply) is does anyone want to purchase the crude at any price (demand). The cancelations that have rolled through Russia, Iraq, Nigeria, and Angola suggest there is a limit for what countries/companies can tolerate as storage fills up and refiners roll out growing run cuts. Prices also fluctuate outside of the OSP, and even thought KSA was selling for prices ranging at $5-$7 discounts doesn’t mean it was crossing at those levels but rather a $1-$2 higher. Russia has struggled to sell Urals within Europe, so even though the Ural price “looked” strong the actual flow of product had to price at a steep discount to get product into the market.

Nigeria: April still remains well off of normal selling with over 50% of cargoes still available. March cargoes have slipped into April on deferrals, with still over half of April left to sell. This has resulted in a reduction in May volumes, while also cutting OSPs (official selling prices) for April cargoes in order to get volume to move. Nigeria has set pricing in April at the below discounts:

• Nigeria slashes Qua Iboe OSP to -$3.10/bbl
  • First time at a discount since Jan. 2016
• Bonny Light OSP at -$3.29/bbl

The adjustment in May is for lower Forcados (33 API) and Bonny Light crude (36.5 API- goldilocks crude), which is some of their top selling grades due to the ease it can be refined across various asset configuration. The fact Nigeria is selling at a discount that steep points to a desire to maintain market share, but also ensure product doesn’t get trapped in coastal storage tanks. The country has been trying to maintain flow of 1.8 to 2.1M barrels a day- especially as Egina ramped up. Nigeria responded to the KSA cuts, and is trying to compete and find buyers at really any price. They are currently finding that May/April is getting ugly for flow, while cancelations are coming across for April. Even though Nigeria has slated 1.97M for sale in the new offering- doesn’t mean they will even be able to sell half the allotment in the current backdrop.

Nigerian Previous and Planned Exports

Russia has focused on ramping up ESPO, which is currently on the docket for April, local energy companies are saying they will struggle to ramp oil production in this price environment. The comment shouldn’t come as a surprise as crude sales have been tough for the last 2 -3 quarters. The below chart highlights the oil exports from Russia, which have remained steady throughout much of the “OPEC+ Agreement.”

Russian Previous and Planned Exports

Even if Russia increased production it would only shift back to the highs from 2019, so there is really not much “risk” in Russia saying they have decided not to increase the cuts with Saudi Arabia and the rest of OPEC. The market is telling oil producing nations there is no market for your crude, especially as storage fills up and refiners’ ramp down. This just means- Russia might WANT to sell 4M barrels a day but doesn’t mean they will find buyers at any price.

Politics Drive OPEC Policy

It is important to address the vast amount of political back and forth between Russia and Saudi Arabia and the rest of the Middle East. Russia and Saudi are still more friend than foe at this point in time as Russia was already evaluating ways to exit the agreement, and Saudi Arabia said if countries kept cheating, they would force everyone to pay. Nigeria, Iraq, and Russia were constantly over their “allotment”, and without Russia willing to take a bigger portion of the proposed cut earlier this month- it no longer made sense for Saudi to sacrifice market share. It is important to appreciate what they did first- which was “shock” the market with an OSP cut rather than a straight spike in production. The reason for this was to test the markets as demand has been coming off hard since end of January. Why increase production pulling harder from source rock when KSA has about 160M barrels of oil in storage? They are aware that the demand for crude has fallen drastically, so they can “show” the world they are producing 12.3M barrels a day of crude, but really maintain production and if anyone calls on them for the difference between production and loadings which have been constant at Loadings from Saudi Arabia averaged 7.692m b/d during March 7-18, vs 7.38m b/d for January-February, according to Kpler. Saudi can talk a strong game but have not been called to deliver.

Libya is weighing the options of re-opening crude sales as the checks slow down from the GCC (Gulf Cooperation Council- IE Saudi Arabia and the UAE), which was helping to fund Haftar and the LNA (Libyan National Army). The LNA has blockaded about 80% of the country’s output, which equates to about 1.1M barrels a day. The LNA is working with the NOC East (main rival to the Tripoli based NOC), but will need support from key allies including Egypt, Russia, KSA, and the UAE to really get this in motion. The UN and other countries can deem the oil “stolen” and embargo the oil under that umbrella leaving it in legal embargo causing significant disruptions. Countries/companies would be taking a risk purchasing the oil in case it fell under sanctions. “Sources said Haftar’s Paris discussions focused on a mechanism to bypass the Tripoli-based Central Bank of Libya (CBL) in managing oil and gas revenues.” “NOC said it has informed the UN and the GNA and numerous other governments of this cargo, which is in “clear violation to UN resolutions and Libyan laws.” The state-owned company has regularly warned its oil buyers and shipowners to avoid “illegal” cargoes from the east.” The uncerntainty surrounding- will the EU or US sanction the shipments will keep this in the planning stage for now, but additional crude supplies hitting the market (especially 1M barrels a day) would not do this market any favors.[2]

OPEC+ nations were also seeing the same pressure across refined products and run cuts accelerating around the world. The easiest way to help promote higher refiner utilization rates is by giving a bigger discount to incentivize customers to run your blends as the margin will be higher. Brent (floating barrels) set the price for gasoline in the U.S., and is how many governments look to set their fixed petrol pricing. The recession began in Q4’19, and the emergence of COVID-19 is like dropping jet fuel onto a forest fire. The worst thing OPEC+ nations could have done was to push prices to elevated levels because they would have killed off demand and choked many sputtering economies- especially in emerging markets. If we want to really try to start the global economy, the best way to do it is with cheap refined products- gasoline/ diesel/ jet fuel/ MGO (Marine Gas Oil) in order to reduce costs and promote transportation. It provides a little extra bump to spur demand and get things jump started as everything has ground to a halt. The balancing act is not “priming the engine” to much and flooding the system with so much cheap oil that refiners produce as much product as possible for storage. The current dynamics around the world DO NOT support that setup as many countries are in lock-down and have reduced run rates to all-time lows. It would be effective for OPEC (and maybe Russia- but I think they are permanently out) to gradually support prices as the market can handle rising prices.

It is also important to understand that U.S. shale producers have been producing oil at levels that is far from economic by increasing leverage and failing to adjust break-evens to a sustainable price. U.S. crude is at the lower end of the quality spectrum- it may be light and sweet- but has other composition issues. The U.S. also produces oil well above what can be consumed locally, so the remainder has to either get exported or put into storage. Russia has been competing against U.S. shale in Europe and OPEC nations have seen more flow from the U.S. entering India, South Korea, China (now that the deal is signed), and other key markets. The current backdrop of grossly overleveraged balance sheets, a massive demand hit, investor frustration, and falling acreage valuations- it would be an opportune time to add on a supply push to make sure prices fell to unsustainable levels. OPEC+ nations can’t (or maybe don’t care too) drive all shale out of the market, because that would be very difficult to do and require a prolonged fight that would spell economic destruction for many of these countries. Instead, push some of them into bankruptcy, force take-unders, and cause drop in U.S. production. Due to the high decline rates of shale, E&P companies have to drill constantly to stay ahead of the falling production in order to achieve growth or at least keep production flat. So if you factor in a stoppage of drilling and decline curves, it would cost U.S. E&Ps billions to get back to current production let alone to a growth profile. Given the state of the global economy and leverage of E&P balance sheets, OPEC+ nations can drive down U.S. production and assume the lost production won’t appear for several years at this rate. In the meantime, the 450 or so E&P companies consolidate to become 25 and become “optimal” producers at a normalized production level well below 13M barrels a day.

---

1 https://finance.yahoo.com/news/glut-jet-fuel-brink-overwhelming-154516964.html

2 https://www.spglobal.com/platts/en/market-insights/podcasts/crude/032320-price-collapse-fragile-us-shale

By Mark Rossano

The frac spread count saw a small increase to 314 on 2/21/2020 with some upward momentum that should push it closer to 320 over the next week or two. The longer-term issue will be realized prices as global supply chains are slammed by coronavirus issues hinder trade. The Permian saw a decline of 5 spreads while most areas were either flat to slightly up over the last two weeks. The pace of additions in 2020 have slowed but will find support at around 310 over the next month. The Williston, Eagle Ford, and Permian will receive the most support over the next month, but pressure is mounting as ships pile up offshore with nowhere to take U.S. crude and more specifically condensate.

A large part of U.S. exports are condensate, NGLs, and refined products, and the overarching problem remains demand. There have been supply chain issues with refiners experiencing unplanned downtime and weather impacting ship movement- but the problems in the market are just starting to surface. Limitations on shipping are rising with Kuwait now banning all non-oil ships from every infected country: “Ships Arriving From Or Departing To China, Korea, Italy, Singapore, Thailand, Japan, Iraq Are Banned At Kuwaiti Ports – RTRS.” WTI Cushing prices have many key headwinds as storage will rise due to seasonal adjustments, reduced refinery operations, falling exports as demand is pressured, and stable supply. WTI pricing will have a quick extension down to $43, but settle out a bit higher- closer to $47 as the world digests the full impact of failing demand. The market is putting more and more hope in an OPEC+ cut, but as emerging markets face significant struggles across trade, inflation, and operating costs- a rising oil price will only destroy demand further. U.S. crude blends specifically will be impacted as refined product demand falls abruptly in Europe, and higher quality crude remains available out of Latin America (Brazil/Guyana) and West Africa (Nigeria and Angola). This also comes at a time that KSA and Kuwait are ramping the Neutral Zone to delivery heavier barrels to the market. KSA has also announced a massive gas find that will be used to replace about 800k barrels of oil demand within the country, which will see the export market over the next 5 years. This isn’t something that will be immediate but will earmark more crude to enter the global supply.

The U.S. will see oil exports decline and builds rise faster than seasonal norms, which will push realized prices lower. As COVID-19 moves into “phase 2” with clusters popping up in multiple countries, global oil demand will fall further (and not just measured by 4.5M barrels in China). The quality and distance of a U.S. barrel of crude will weigh on exports further, and push E&Ps to slow activity or delay planned increases. Production growth will be limited in Q1 with more downside revisions coming as we head into Q2 as pricing across the hydrocarbon chain is pressured. Condensate pricing is already $15 below WTI Cushing with NGL prices facing additional headwinds as refiners turn to summer gasoline blends early. This will push more butane into storage, and with the end to winter- propane stocks will rise even faster. These problems will cap the upside of completion crews at 330, but leave the rolling average at between 315-320 with downside of 300 spreads by the end of March if prices hold below $48 for an extended period of time. Since there is no uplift in natural gas, NGLs, or condensate, there is no way to offset the pain in pricing, and the steepening contango will prompt more Cushing storage. If the demand issues persist (which is my base case), E&Ps will be forced to delay completion activity into Q2 and more likely Q3 to help clear the growing supply glut across the market. Another driving factor is the weak cracking margins WTI Cushing is getting vs other blends such as Bonny Light/ Urals/ CPC/ and ESPO.

The loss of Libyan barrels has also helped support some pricing in the market, but now as Europe faces mounting headwinds those missing barrels won’t as problematic. The spread of coronavirus in Italy is just the beginning as countries take actions to limit travel. The economies in the area were already under pressure, and the spread of the virus will only strain the area further. Cracks in the global market have been forming for years, but have been kept hidden by central banks and government stimulus. The outbreak of the COVID-19 coronavirus has pulled many of the underlying economic problems to the forefront as markets face a major supply and demand disruption. On the supply side, manufacturing slowed to a standstill within China, impacting supply chains around the world. This has resulted in a huge drop in ships docking and product moving around the world. Demand has fallen for raw materials to finished goods as industrial capacity is shuttered and consumers experience some form of lockdown. These issues create a situation where demand is destroyed and not just “delayed.” Gasoline, jet fuel, and electricity consumed by factories and consumers will not be doubled up to make up for the lost demand spanning weeks: People don’t drive to work twice after taking the previous day off, and flights won’t fly extra miles to make up for a month of being grounded. Industries won’t be able to get back to normal utilization rates due to shortages across their supply chain, so the ability to just “make-up” the lost product is impossible in quick order, if ever.

The Middle East is facing mounting COVID-19 issues as Iran infections and deaths mount with other clusters is the UAE, Oman, Iraq, Kuwait, Lebanon, Syria, and Egypt. Iran was already facing a mountain of issues with protests against the regime and boycotts of the elections. The mishandling of the virus with over 12 deaths and cover-ups leading Iran to have the most deaths outside of China. Iran never stopped flights to China, and now it is spreading quickly throughout the country. It is a bit ironic that the Minister of Health was sweating and feverish on live TV during a press conference downplaying COVID-19 and officially diagnosed with the disease not even 6 hours later. This will do more to Iran’s economy than any level of sanctions the U.S. or Europe could place on the country.

Commodity pricing will be greatly impacted over the next several months, but oil (and to a lesser extent condensate and NGLs) may be the hardest hit, as the market was already facing a Q1’20 oversupply. This surplus will only grow as an estimated 4M barrels a day of demand are lost in China and other countries take action to deter the spread of COVID-19, limiting oil demand even further. The impact is growing well beyond 4M barrels as coastal cities in China are further constrained by lack of personnel. Teapot refiners (Independent Shandong Refiners) face mounting pressure as tanks fill up and operations remain under pressure. I strongly believe these numbers are grossly overstated, but even China can’t fully lie and must admit that companies are operating well off of full capacity. The market has access to satellite imagery, AIS transponders, electricity data, real time traffic, and other economic indicators that would quickly show operations are far from normal. So to say 97% of manufacturing has resumed work is fine as a worker or two might be in the facility but unable to truly operate given the limitations in freight movements, supply chain bottlenecks, and port restrictions.

342 big Chinese manufacturing companies by the China Enterprise Confederation (CEC) (see February 12 Tip Sheet).

As of February 20:

• Over 97% of manufacturers had resumed work.
• But only 66% of employees were back at their jobs.
• On average, the companies operated at around 59% of their full capacity.
• Chinese small- and medium-sized companies have resumed only 30% of production capacity, said an official from the Ministry of Industry and Information Technology
• Guangdong, Zhejiang, and Jiangsu had lower capacity utilization rates than inland provinces, mainly due to labor shortages.[1]

The global economic foundation is teetering as central banks try everything to counter the effects of coronavirus on the supply chain.

The boats never lie, and we have seen thousands of ships stranded at sea either fully ladened or empty as there isn’t a dock to take them in China. This is becoming more common in South Korea and Japan, while Austria partially closes its border with Italy. The inability to move freight throughout the system will hinder any type of economic expansion, but we know the numbers were all declining WELL BEFORE the virus struck. The supply chain will experience ripple effects for months as workers cant get back to work and supplies/ cargoes remain stranded at port or at sea.

---

Global oil demand is experiencing a growing shock as the coronavirus (COVID-19) impacts everything across the supply chain. Shipping has been severely impacted at Chinese terminals: “‘We are experiencing huge pressure at (Chinese) port terminals because there aren’t enough workers at the ports to move the containers around, not enough truck drivers to move the goods, and no one to receive them at the factories or warehouses,’ Maersk’s chief executive Soren Skou told reporters on Thursday. ‘We have lots of ships laying idle in Asia, because we have canceled many loadings out of China in the last two weeks.’ . . . Shipping consultancy Alphaliner estimated that 46% of scheduled departures on the major Asia to north Europe route had been canceled in the past four weeks.”[2] The issues are reverberating throughout the whole supply chain, which will take weeks—if not months—to get back to normal due to backlogs and roadblocks throughout China. This isn’t a situation where you snap your fingers and every facility is now operating at full tilt. This is being reflected in a slew of recent freight data within the U.S. as well as abroad.

Shipping / Freight Data Shows Worst Y/Y Shipment Volume Since 2009

Airfreight Demand Remains Weak Even Before Coronavirus Took Hold

The two charts above don’t reflect or capture COVID-19 impacts, but rather the continued slowdown in the shipping industry. The below also drives home the broad impact across the board, and still only captures a small portion of the virus impact with February data yet to come out.

Singapore Air Cargoes Are Falling (Data Precedes COVID-19 outbreak)

The demand problem will only worsen for at least the first 6 months of the year, as the slow end to 2019 is compounded with the unforeseen issues experienced in 2020. The below chart shows Japan’s quarterly GDP missing estimates and printing -6.3% for Q4’19, and it is worth noting that this is the third largest economy in the world. The BoJ has been operating quantitative easing for over a decade, with recent expansions of about $3 Trillion since 2014. China has started operations to stimulate the market with local governments releasing a list of infrastructure projects that will be sponsored, and now Hong Kong giving HK$10,000 to every person 18 years or older. The PBoC recently slated RMB 300 billion for re-lending with loan interest rates between 2%-3.15%. Companies need to apply for eligibility with 3k current on the list, which is growing by the day as firms look to capture cheap debt. Banks don’t have an incentive to be picky though because it’s the PBoC that will eat the overall cost: “To be eligible, companies need to apply to industry regulators. Banks then go and pick the companies they want to lend to from the regulators’ lists and apply for reimbursement from the PBoC.” In our bigger report, we go into great detail regarding the limitations the PBoC and government has to stimulate the economy through fiscal or monetary measures. The supply chain issues are now starting to be priced into the market as countries experience their own outbreaks, and pressure on oil demand only continues to rise. The pain is far from over.

[1] http://www.21jingji.com/2020/2-22/1MMDEzODFfMTUzNjM1Mw.html?mc_cid=0f02246626&mc_eid=21cdcdff2c

[2] https://gcaptain.com/shipping-counts-costs-as-coronavirus-hits-supply-chains/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Gcaptain+%28gCaptain.com%29&goal=0_f50174ef03-a1e3d6bb51-169893905&mc_cid=a1e3d6bb51&mc_eid=a81c61ea59

By Mark Rossano

• U.S. Completion Activity Update
• Is U.S. Production growth capped?
• What is COVID-19?
• OPEC, Russia, Venezuela, Libya and China

The completion activity has leveled off after spreads were reactivated following an extended Christmas holiday. So far, the trend of the data is mirroring 2017 in terms of direction and pace of additions, which started at a higher-level vs 2017. Oil pricing faces a significant number of headwinds in the near future as the market attempts to understand coronavirus demand impact, Libya shutdown, OPEC+ recommended cuts, and seasonal impacts as winter limits refined product demand. The IEA was already predicting an oversupply in the 1H2020 by 1M barrels per day, and this will take another 200k to 500k barrels out of the market depending on how quickly China comes back or how far this virus spreads. The reported Chinese numbers are following the same transparency as most China numbers as the country moved the goal post by “adjusting” how they report confirmed cases. These unknowns driving depressed crude pricing and capping the WTI curve limits many options for E&Ps. Airlines have extended their timelines for limiting flights into China and Hong Kong with Teapot refiner utilization falling 30%, Sinopec reducing by 15%, and CNOOC taking the refinery in Huizhou down 8%. These are just the reported numbers but doesn’t cover some sweeping reduction discussed in a previous report or other items talked about below.

The above count follows the trajectory outlined last month, with an increase across the National, Permian, and Eagle Ford completion crew. The shift lower in the Permian this past week is likely transitory as E&Ps adjust drilling plans and focus on streamlining operations for 2020’s drilling program. Realizations remain problematic in the Permian (and around the country) for natural gas and natural gas liquids (NGLs) so the focus will be to drill areas with the best takeaway pricing and limit the amount of liquids produced as a byproduct. The discount for condensate continues to widen and can range from $8-$15 as demand domestically and international is under pressure. This condensate pressure comes from shuttered demand in China as well as new flow out of Russia that has been creeping into the market. The crude curve has shifted into steepening contango as the market prices in the cost of storage- on the water and onshore. Commentary has started out of Vitol, Shell, and Litasco to research floating storage as crude demand continues to fall out of China (more below). At the moment, storing crude on a vessel wouldn’t be profitable, but given the rising U.S. crude storage numbers and global builds across OECD nations- the front month will fall further making storage profitable again.

National Frac Spread Count- Seasonally Adjusted

The builds in the U.S. are starting with the EIA reporting 7.46M addition, and to be clear- seasonally there are builds this time of year. The key will be the pace of builds as companies/countries look for ways to store crude as the U.S. has the most (and cheapest) storage levels. The below EIA report helps highlight the amount of space available in the U.S., and where some crude can find a home as contango steepens enabling for storage. The pace of builds will accelerate as China defers purchases of waterborne crude. Implied demand pared back across gasoline and distillate, while exports dipped across gasoline- which will remain off normal flow as builds in gasoline grow globally. Distillate will see a tough market abroad as builds start to rise as China’s impacts ripple through the market. The below Bloomberg chart shows how U.S. crude storage is hovering around the average over the last 10 years. As product demand abroad struggles, refiners will see a decline in runs that will be worse due to an increase in unplanned downtime. This will push refinery utilization down and help send crude storage higher.

As the U.S market faces mounting pricing pressure (across oil/ gas/ NGLs/ condensate), location options are limiting the ability for E&Ps to grow production. The expectation coming into the year was for a net increase on exit 2019 into exit 2020, but mounting pressure in the market will limit growth. The crack margins across Europe and the Mediterranean for U.S. cargoes is well below (by $3-$4 vs Urals/ Bonny/ CPC blend), which will hurt U.S. exports on top of the declining flow into China. Given current balance sheets/ hedging profiles, it will be difficult to see completion crews follow the upward momentum of 2017, but rather level off closer to 330 as pressure persists in the market. There is enough support to keep activity supported around 310-320, which will be driven by Permian, Eagle Ford, and Williston completions. But in the current environment, getting a sustained move in activity above 330 is difficult to finance with cash on hand. The Northeast (Marcellus and Utica) will see mounting headwinds as natural gas prices face a storage glut and now rising fears on LNG not flowing from the U.S. The lack of winter weather in the U.S., and now growing concerns the global LNG glut will get worse is driving fears that counterparties will “pay” and not “take” volume. The fears are a bit overblown because the question on not flowing LNG from the U.S. is a complex problem that has many competing variables including:

      • Fixed costs (tolling or penalties)
      • Variable costs- shipping/ gas pricing
      • Contract structure- DQT (Downward quantity tolerance) weighted against the annual flow total/ Take or Pay/ spot vs contracted
      • Type of contract index- oil/gas linked. Does the contract have a destination clause attached?
      • Who is the end user- is it a company selling into a wide rate base (power company) or a portfolio player?

Buyers have to elect for cargoes 30-60 days out, and some of the older contracts structured in Qatar and Australia allow for DQT movement or delayed receipt of cargoes. For example, if a cargo is deferred in March, a company can purchase their allotment in November as long as it is in the same calendar year. These differing values will be weighed when buyers look to purchase cargoes as the market is already oversupplied and has gotten worse with China declaring force majeure on several cargoes. Natural gas realized prices aren’t being helped by the pressure across the liquids space either, which will keep pressure on completion activity across wet gas throughout the Northeast. Ethane, propane, and butane pricing across the country has been and will remain under pressure as bottlenecks limit exports, and supply keeps rising out of Texas and the Mid-con.

Permian Frac Spread Count- Seasonally Adjusted

The Permian has always been the place considered for growth, but as economics come under the pace of completion activity is waning. Activity will start to pick back up, but getting back to 2019 highs is impossible without crude prices recovering by $15. Many of (if not all) E&Ps in the area struggle to break-even let alone achieve free cash flow, but as long as the bond market remains open- these companies will continue to raise capital. A key natural gas hub, Waha, is pricing gas at $.20 with WTI Midland Light pricing a discount of $1-$2 to WTI Cushing, which will start to widen if the discount in the Eagle Ford is any indication. The Eagle Ford Condensate is trading at a $15 discount to WTI Cushing as of 2/10/2020, which will only worsen as China demand for crude wanes[2]. Chinese refiners (state-owned and independent) have cut back about 2M barrels a day of runs, while Shandong crude storage reaches a one year high. The slowdown in crude demand continues to extend as activity within China remains impeded by the coronavirus. The below chart helps highlight the seasonally adjusted levels of crude in storage throughout the specific area. Large parts of the country haven’t returned to work with Shanghai traffic down 80% against daily volume, while rail traffic across the country was down well over 80% compared to days following Lunar New Year in 2019. Many people haven’t returned to the areas where they live and work, and anyone who has traveled are required to undergo a 14-day home quarantine.

“The reporter learned from the China National Railway Group Co., Ltd. (hereinafter referred to as the National Railway Group) that on February 8, the national railways sent 1.27 million passengers, a year-on-year decrease of 7.45 million, a drop of 85.4%, and the national railway transportation was smooth and safe. On February 9, the 16th day of the first lunar month, the national railway is expected to send 2 million passengers, a year-on-year decrease of 82.2%.”[3]

Total Shandong Crude Stockpiles- Seasonally Adjusted

The decline in rail traffic ranging from 80% to 99% depending on location is put in perspective by looking at the population levels throughout key locations experiencing lockdowns/ quarantines. The above chart shows the build in oil across the teapot refiners with half of them already hitting tank tops. The utilization rate has fallen to as low as 35% given the full shut down of facilities, which will get worse if refined product demand doesn’t pick up internally. Independent refiners have specific export guidelines, making it difficult to be able to just sell product straight into the open market. The below chart shows flight cancellations and the amount of populations across major cities/provinces that have seen a precipitous fall in all forms of travel.

The impacts are wide ranging across the supply chain as factories remain shuttered or have less than 15% of normal workforce present. This impact spreads across all of China with key ports still shuttered stopping the flow of product from reaching key industrial hubs. Some early estimates has been a reduction of between 1.2-2M barrels a day, which will remain until 2/18/2020 at this point given new commentary from the government. Any traveling home has to be self-quarantined for 14 days, which will keep a large majority of people out of the workforce and facilities well below normal output. The coronavirus (now named COVID-19) will remain a key factor as china adjusts the way they calculate new cases. China has announced they will no longer count individuals that test positive but don’t show symptoms. The roads in key cities, such as Beijing and Shanghai, are below normal congestion levels ranging from 35%-60%. The congestion metrics helps highlight that activity still remains well off of averages, and the world’s supply chains won’t be back to normal any time soon. While all of these fun things keep impacting the overall market, the crude curve has started to price into contango. The curve still currently doesn’t cover the cost of storing in a VLCC, but the front month faces significant headwinds given the below backdrop. As China keeps delaying March purchases, the contango will steepen in order to put crude into storage.

Crude pricing is also facing two very big unknowns: Libya and Russia.

The OPEC+ commit has recommended an additional 600k barrel a day cut, but so far, the next meeting is still scheduled for March 5th. Russia has said it will “study” the OPEC+ technical committee’s new output proposal, but the longer they delay the less likely the country will be willing to go along with the new recommendation. Russia has seen their exports rise now that the new agreement excludes condensate from the calculation. The “new” cut would be on top of the already agreed to 2.1M cut. Novak and other oil executives were set to discuss the proposal Wednesday, but Russia has been looking for ways to begin distancing themselves from the deal and after the new agreement with India this could be an opportune time. Indian Oil Corp and Rosneft are working to sign a 2 million ton a year deal for oil, which should be finalized sometime this month. This comes at an interesting time where the U.S. is talking about sanctions against Rosneft for actions in Venezuela. So far- the U.S. has turned a blind eye to flow with Venezuela crude at about 1M barrels a day heading into India and Singapore. This is also complicated by the amount the U.S. imports from Russia already- this will limit how the U.S. can levy sanctions. The U.S. has already issued sanctions against Iran/Venezuela cutting heavy crude available to U.S. assets, but also to key allies in Asia- so it will be difficult to see this gain traction.

The physical crude market keeps showing the pressure in the market impacting multiple grades of oil across the market. Nigeria is still sitting on 90% of their crude for March, while Angola has 20 cargoes unsold out of 45. The price keeps falling with the most recent offer of $.50 above dated Brent. The physical market is also complicated by the loss of Libyan flow. Saudi Arabia and Kuwait are in the process of ramping up the neutral zone with 10k barrels flowing as of Monday. The zone is capable of flowing 500k barrels a day, but the first runs will be small just to test systems that have remained unused since 2015. Libya wrapped up a meeting in Cairo, Egypt to cover some of the below key topics: The United Nations is holding a conference in Cairo on Sunday-Monday to discuss the situation because as the UN Special Rep Ghassan Salame stated- “The mission wants the oil to flow as soon as possible.” The UN continues to work with the NOC (national oil company), UN backed Government, and General Haftar’s tribal leaders in order to structure a longterm agreement. Haftar rolled out this shutdown to highlight his control of the oil infrastructure in order to strength his interests in a new government. Both sides still recognize the legitimacy of the NOC, and have done nothing to damage any assets. There remain constant discussions between all parties to create a long term action plan to unite the country. It is worth understanding why a meeting in Cairo is so important in this back and forth.

1) Who backs General Haftar (head of the LNA- Libyan National Army)
a. The UAE has been a long time backer, and rumors remain that the KSA/UAE have been providing money and assets turning this blockade
b. Russia has been on the ground for over a year now providing support through personnel, equipment, and intelligience
c. General Hafter lived in the U.S. for over 20 years and is a U.S. citizen
   i. We put him back in the country to help overthrow Gadhafi, and we recognize Haftar’s forces as the best for eradicating terrorism in the region (ISIS/Al-Qaeda and others)
   ii. The U.S. runs sorties on his behalf to strike at specific terrorist targets
d. Italy and France run sorties on General Haftar’s behalf under the same agreement as the U.S.- they also have a back-room deal- that he agrees to stop migration from Libya across the Med, and when people are picked up mid-crossing Haftar has several drop zones on the coast to keep them from entering Europe.
e. Egypt has come out in favor of Haftar, and has increased their involvement as Turkey looks to extend their interest into the region

2)Who backs the GNA- Government of National Accord
a. They are recognized by the UN as the legitimate government of the area.
b. Turkey has been increasing their support of the GNA with soldiers, equipment, intelligence, and logistics.
c. Italy has started to favor the GNA more while France plays both sides.

The key factor given Egypt’s growing involvement, and rising tension between Russia and Turkey as well as the US and Turkey- makes the location of this meeting very interesting and significant as to who is carrying more favor. There have been 3 meetings in the last month- Russia, Germany, and now Egypt- two out of 3 are openly in favor of General Haftar.

The meeting broke with “Libyan Economic Expert” studying the distribution of oil revenue across parties. The group will reconvene in early March in order to discuss findings about ways to create a lasting peace in the war-torn country. Nothing has emerged as to the resumption of crude exports from Libya even as several ships remain in port. The growing issue has been Turkey moving assets into the country, as Turkey and Russia sit on opposite sides of the table in both Syria and Libya. Turkey and Syria (AlAssad) have now exchanged fire resulting in multiple casualties as Turkey has started retaliating against aggression. The initial agreement in Syria was between Russia and Turkey with Al-Assad not present for the establishment of a “safe zone” along Turkey’s border. The fact many of the Sunni’s being attacked are Turkmen can’t be lost as Turkey looks to stem the flow of migrants into the country (currently totaling 3.6M refugees already.) Russia and Turkey also have several arms deals and bilateral/military cooperation that are at risk if things devolve. As Iran’s ability to influence Assad wanes, Russia will have to force Syria to conform to the agreement as Russia doesn’t want to lose the two military bases they received for aiding Al-Assad. In turn, I expect Turkey to make concessions in Libya for concessions in Syria. The maritime border will become a bigger focal point, which was signed between Turkey and Tripoli allowing for oil and gas exploration. Israel, Greece, and Egypt are opposed to the new borders and will be a source of negotiation as Haftar looks to keep Egypt on his side of the table.

OPEC is looking to decide on cuts over the next two weeks, as they monitor the Chinese coronavirus, Libya negotiations, and potential U.S. sanctions against Rosneft (Russia). Based on the current physical market, shipments have come to a standstill ranging from VLCCs to Baltic Cape size (chart below). The question jumps out- “why is the market still so resilient?” The answer is- the central banks continue to pour money into the market with the Fed putting an average of $30B-$50B in REPO money directly into the market each morning over the last 3 days. This also came in the backdrop of China pushing another $9.58B into the market, while also cutting interest rate on medium-term lending facilities and reducing the loan prime rate. The market remains skewed as the combination of central bank balance sheets expand across the globe (chart below). The downside risk remains very real as we head into the weekend, as economic data remains mixed across the globe- and will be directly impacted by the shuttering of Chinese industry. The below is the beginning of trying to stimulate the economy through some repo operations.

PBoC Total Reverse Repo Amount in a Week

China has also extended their focus on fiscal and tax support with the Minister of Financia Liu Kun allocating 72 Billion RMB to help fight the epidemic. The PBoC has increased their initial round of special lending with 300 billion RMB earmarked with loans made to nine national banks/ several local banks across 10 provinces. The target of the loans is for key industries focused on epidemic prevention and control with a capped interest rate of 3.15%. The government is expecting 160M people to return by Feb 18, but that doesn’t mean business as usual. Many stipulations have to be met to return to work, and it is unlikely anything normalizes ahead of March. China announced a bunch of fiscal stats and all of them missed targets by relatively wide margins (for China) as the country attempted to ease in 2019. These kind of figures and attempts to stimulate growth hinder future measures as monetary stimulus is difficult as inflation has already shifted higher and leverage within China is already problematic.

The big news: The government missed its 2019 revenue targets.
• Total revenues clocked in at RMB 19.04 trillion – up 3.8% y/y, but missing the target for 5% growth.
• Central government revenues were up 4.5% y/y – missing the 5.1% growth target.
• Local government revenues increased by 3.2% – missing the 4.9% growth target.
          Tax cuts explain a lot of the missing revenues.
• Domestic VAT increased by 1.3% in 2019 – down from 9.1% growth in 2018.
• Personal income tax revenue decreased by 25.1% – down from 16% growth in 2018.
• Meanwhile, increases in expenditures greatly outpaced revenue growth:
• In 2019, total government expenditures were RMB 23.89 trillion, an increase of 8.1% y/y.[5]

As the spread of the virus remains uncontained, the problems will span across all commodities and even the Phase 1 trade deal. There is specific language in the trade deal where a natural disaster or unforeseeable event triggers a clause to open a consultation with the US over the potential impact (coronavirus outbreak) on the ability to fulfill the agreement. Chinas has announced a 50% reduction of tariffs on $75B imports from the U.S., and has finally allowed the WHO and CDC to enter the country. The cuts (are desparetly needed at this time) are inline with the agreement signed on Jan 15th, but we will be seeing negotiations on total imports from the U.S. ongoing given the current limitations on volume. The fact they are allowed to enter now could have 2 specific implications:
1) Things have been contained, and China wants to show off how good they have done.
2) Things have gotten so out of hand they are requesting a significant amount of help.

My inherent distrust in the CCP makes any of them plausible, but the spread of the virus within the country appears to be pervasive- which leads me to below “2” is most likely. The rumor mill continues to churn out videos/ comments/ mis-information- but the actions show things remain uncontrolled on the ground. The disruptions have spread into South Korea, Taiwan, and Japan specifically on the impact on supply chains, but the problems will be broadly felt as China makes up about 1/5th of the Global Economy. The initial whistleblower Dr. Li Wenliang has passed away, which has started to create strife within the CCP and country: Li posted about concerning signs of the new virus on an online chat group for fellow doctors at the end of December. He was then detained by the police and accused of spreading “rumors.” He was released on Jan. 3 after signing a document saying he committed “illegal acts,” The Washington Post reported. Later that month, he came down with the virus himself. ” The distrust in China is growing, which is driving people to stock up on essentials in case the spread continues in other locations.