Primary Vision Insights – February 17th, 2020

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.

PRIMARY VISION INSIGHTS MONDAY 3 February, 2020

By Mark Rossano

  • U.S. Frac Spreads increase, but consumables remain soft
  • Oil and Gas Demand issues accelerate globally; all eyes on consumption
  • Coronavirus Update: We need another month to evaluate
  • Libya, Russia and Nigeria Output Updates

U.S. activity rebounded throughout January as crews returned to work following a prolonged holiday vacation. Activity will trend higher over the next two weeks as completions are accelerated in the Permian and Eagle Ford specifically, but it will remain seasonally slow in comparison to the last three years. In 2017, while pricing was comparable, the market was still driving forward to prove out acreage and optimism arose from the OPEC+ agreement struck in Dec of 2016. These components pushed activity up, but the market is structurally different at this point of the cycle in 2020. Seasonality will factor into the recovery, but the movement of proppant has been slow to follow limiting the speed of completions. The pace of additions will remain slow over the next few weeks based on the growing issues across the supply chain- product demand/ coronavirus/ realized prices.

The front half of 2020 will be supportive of moderate activity as the spike in crude pricing allowed for hedging, but the steep backwardation in the curve only provided enough room to get “favorable” terms through about June of this year. The rejuvenated CAPEX budgets and favorable hedges will keep activity front loaded in the first 6 months of the year. The below seasonality chart and WTI curve helps highlight the shift higher in the front months while the rest of the curve remained depressed. This is driven by the overarching issue of slowing demand across the supply chain driven by a refined product glut. The outbreak of the coronavirus (more on that below) will act as a massive headwind as industries remain shut throughout China. Refined product exports have already been surging, and now with this large slowdown in domestic demand- there will be an even bigger surge into the open market.

The below shows the seasonally adjusted national frac spread and based on normalizing the chart- there is support for activity to get back to the average of about 315.

The increase in the national spread count will be driven mostly by the Permian and Eagle Ford as the rest of the areas see a slower response in activity. The Bakken (Williston) has already seen an increase but will level off as the economics (while still weak) support activity geographically closer to refiners/export terminals. The reason I believe there will be a muted recovery in these areas is driven off the following:

  1. Oilfield Service commentary surrounding NAM activity
  2. E&P commentary regarding US activity
  3. Proppant deliveries/loadings into key basins
  4. Headwinds persisting on realized prices as refined products grow (more on that below)

The canary in the coal mine will remain the proppant loadings- below is a look at the Permian and Eagle Ford (Seasonally adjusted).

Permian Seasonally Adjusted Frac Spread Count

Permian Seasonally Adjusted Proppant Loadings

Eagle Ford Seasonally adjusted Proppant Loadings

The above breakdown of proppant helps drive home the typical decline in year-end loadings as equipment is idled and everyone heads home for the holidays. But, the turnaround is quick once everyone gets back to work in January. The current backdrop is bucking the trend with proppant loadings remaining at seasonal lows as completion work increases but at a much slower pace. Rig activations have started to creep higher, but at a very controlled rate with little reason to increase it too quickly. Many of the SMID Cap E&Ps are facing significant headwinds as investors focus on living within cash flow, and it will come at the expense of production. The market faces an alarming amount of demand issues, but supply is also facing headwinds as General Haftar has cut supply coming out of Libya. OPEC+ has talked about maintaining cuts (recent commentary from Russia and UAE) through June at their next meeting scheduled for March. The rumors have started to grow stating a March cut is possible but given current physical loading schedules it doesn’t seem likely. Nigeria has already sold about 2M barrels a day worth of oil (above their OPEC+ target) in March, and Russia has maintained a strong export presence above OPEC+ targets. Demand issues are going to accelerate (more on that below) that has already resulted in shipments being deferred, and I expect some of these future loadings to be canceled as refined product builds grow globally.

What does the Coronavirus mean for us all?

It is always a black swan that causes the cracks we have been discussing to truly be pulled front and center. The virus is an event that has pulled center stage- and to be clear- it isn’t because this has a massive casualty rate (2.3 vs normal flu of .114), but rather the infectious rate that it carries. This happens to be highly contagious- and just like a cold or flu- contagious when no symptoms are showing. With an incubation period of 1-14 days (average of 10-14 days), it is proving to have an infection rate of 2.6-3.8 (average is closer to 2.6-2.9), which is huge and makes quarantining nearly impossible. By the time the Chinese government reacted, the virus already spread well outside the initial city limits of Wuhan. The virus wasn’t treated seriously for several weeks, and of the initial people diagnosed many of them never went to the seafood market. This is just an example of the prolific nature of the virus, which effectively doubles every 6 days. The panic is being compared to SARS/ Bird-Flu but the timing is vastly different. Ground zero- Wuhan- is now attached to the rest of China through high speed- rail, roads, and airports that have only been completed over the last 10 years. The infectious nature, interconnective China, and fear are leading to a mass slowdown across all of China. A new estimate for China’s Q1 GDP has been shifted to 5% (still seems high) and will continue to shift lower the longer facilities remain shuttered.

The following is a summary of commentary from several experts that have put together some fantastic commentary that is simple enough for even me to understand. The coronavirus is an RNA virus that mutates rapidly with an example given of a single family that had 6 different versions of the virus among all the infected. The virus mutates in a volatile sense making vaccines near impossible because by the time one is ready- it could be utterly useless by the time it reaches the populace estimated at 9-12 months. The focus has shifted to anti-viral treatments, such as things used to treat AIDS (another RNA virus) that stops the mutation process and effectively destroys replication enabling the body to defeat the infection. There is now a wider spread of the coronavirus outside of Wuhan versus inside, which is indicative that the quarantine came too little too late. The spread of the virus is now outside the walls of the attempted isolation, which means there will be a ramp of infections through at least February. The death rate remains low and is only problematic for those with weakened or compromised immune systems and can be viewed as a really bad flu. It doesn’t mean a continued mutation can’t make it worse- just that the current setup makes it highly contagious but not a death sentence. The contagion is being hypothesized to grow as it is proving to now be airborne or spread within a 1-2 meter radius. The underlying problem remains a person is contagious even when no symptoms are present- which can vary from 1-14 days making it very difficult to track. With an infection rate of 2.6-2.9, the spread will continue to get worse and cases won’t stop until the number falls to 1 or below.[1][2]

China has effectively cordoned off 26 provinces with about 65 million people isolated to their region with no ability to travel. This is still only about 5% of the Chinese population of roughly 1.3 billion, but as people can be walking around infected with no symptoms the expectation is for this to get worse through February. As the cases grow, China’s industrial sector will be directly impacted as people are told to stay indoors and away from crowded places. These are industries that don’t function with a “work from home” option. The below gives a breakdown of the expansion rate, which won’t stop expanding until it falls below 1. To put this into context:  Seasonal flu has reproductive number of 1.3; Spanish flu was 1.8; SARS was 2.5-3, after quarantine was 1. For a value > 2, you need to quarantine at least 50% of all case to contain the virus, but according to experts this level of containment is not possible at this point. This makes the below a likely trajectory over the coming days.

None of this is meant to be an alarmist view or reason to live in a bunker for the next three months, but rather to highlight the damage it will due to crude, refined products, and Chinese GDP. China is expanding the Lunar Holiday to February 3rd-8th (depending on location), which will keep industrial facilities and other GDP accretive regions down for an extended period. This will directly impact everything from oil demand (consumption), refined product demand, internal consumption, and total travel. Based on the quarantine, miles driven will fall drastically as travel is impossible in key industrial regions, factories remain shuttered limiting the demand of diesel/fuel oil, flights have been canceled limiting jet fuel, and chemical/refining facilities operating at reduced utilization rates. Either way- this will directly impact China’s GDP, which expands into the global economy based on their exports and consumption.

Our target for the crude move was $52, which was reached and now starting to rally a bit off the lows. As my old boss used to say- “too much too fast” – so a bounce was going to happen as the market normalizes. Some commentary has highlights by extrapolating the SARS oil shock into today’s China results in a reduction of about 260,000 barrels a day according to Goldman Sachs. This is a grossly misstated number based on current Chinese run rates on a refining and petrochemical metric. China has seen refined product exports increase over 53% after reaching a record of about 12M barrels a day of crude imports. This flows into both refining and petrochemicals, and just based on the current oversupply of refined products in the global market Chinese exports were already struggling to find a home. Local demand was already softening with guidance of a 2020 GDP targeted at 6%- so we already had a slowing economy, mixed with falling local demand for refined goods, and now a quarantine across 26 provinces. It is safe to say that 260k barrels a day will prove to be a low estimate for crude demand with something closer to 500,000 barrels and likely rises towards 750k-1M as the virus spreads limiting activity. So as the virus spreads, other regions will experience a slowdown in travel- not an all stop quarantine- but a means of limiting trips and travel. The ripple effect will cause additional gluts in refined product, so between the glut and limited workers at facilities- run cuts will strike across the Chinese system. This will directly impact crude demand by redirecting cargoes through re-sale, deferral, or heading into storage.

There have been a bunch of new events outlined below:

  • The Iraq US Embassy was attacked with 5 rockets- 3 hitting the intended target and one striking the cafeteria. It is unknown how many injuries occurred, but it is clear some impact occurred which will result in a ramp in activity against Hezbollah in the region.
  • There have been a ton of protests across the region against the Iraqi and Iranian governments that are increasing the uncertainty in the region. They have been put down with brutality (live ammo) against relatively peaceful protestors, and it will only lead to more animosity and the continuation/ increase of protests.
  • Libya has walked away from the cease-fire without anything formal signed, and General Haftar maintains his closure of the oil facilities. Libyan production is heading to 72k barrels a day from its current 262,000 barrels. These facilities are offshore and insulated from the issues on land.  General Haftar is demonstrating his control of the key Libyan revenue source, and while this is a large disruption- it is temporary.
    • The issues remain fluid as now tankers are sailing away empty as the blockade is still holding firm based on the shutdown led by General Haftar. It has resulted in about 1.18M barrels being pulled off the market. This came by way of shuttered facilities in the Gulf of Sirte, Hariga Terminal, as well as Mellitah and Zawiya terminals following the loss of oil flow. The issues remain temporary as this is a clear show of force, but isn’t causing any lasting damage to the facilities or source rock. The issues can be resolved quickly on a physical movement level- the political side is vastly different. (a summary of earlier comments are below).
  • A USAF plan has crashed in Afghanistan, and so far, it looks to be a plane crash. This means it wasn’t shot down by the Taliban, but right now, all information is fluid.
  • The news is playing up the concussions from the Iranian ballistic missile attack, but when a missile explodes a few yards away- there is bound to be a residual effect on those in the area. These consequences won’t be enough for the U.S. to strike Iran directly, but the continued attack on the Iraq green-zone will keep the U.S. engaged with Iranian proxies.
  • The biggest issue is and will remain the massive glut in refined products. OPEC+ nations have already commented (specifically UAE and KSA) regarding a potential additional cut in March if oil continues to drop. We already have canceled shipments out of Russia and Nigeria, and I believe their will be additional cancellations.
  • Houthis attempted a missile/drone attack on Jazan- a city on the coast of the Red Sea and close to the border of Yemen- but was unsuccessful as all incoming assets were intercepted. The area hosts a 400k barrel a day refiner (not fully operational), a military base, and several other important facilities. The refined products are slated for domestic consumption and some local export but doesn’t have any oil producing/exporting assets. The attack is an escalation, but not unexpected following an escalation of tensions in Yemen.

Nigeria and Russia have increased total output in March based on the combined loading programs across oil and condensate. Nigeria is expected to export about 2.02M barrels a day, which is up 6.4% m/m. This is going to be problematic as more crude is left on the water due to the shutdown of China, refinery turnarounds in March, and seasonal weakness. Russia has also announced something similar for January by reaching an output level (so far in Jan) of 11.283M barrels a day- which is a five-month high. This comes on the back of the new agreement excluding condensate from the total- but it is unclear how much of the growth is driven by condensate growth. Russia failed to meet its 2019 OPEC+ deal throughout most of the year, so it isn’t much of a surprise to see a continued non-compliance setup from the region. Supply in the market remains relatively stable with Venezuela exporting about 1M barrels a day, Guyana operational, Norway at about 1.55M barrels a day, Russia, Nigeria, Angola, and the U.S. are keeping the world amply supplied- which is limiting geo-political fears throughout the Middle East. Even with fog and a shutdown Houston ship channel for a day or so, the U.S. still exported about 3.5M barrels a day last week.

The bigger issue has been refined product builds on a global level, and the impact that will have on total crude demand. Q1’2020 was already supposed to be a tough period for builds and crude demand, and the Chinese coronavirus is just making that worse. So while people say- “China demand will be short-lived and not that bad”- which could be true, but it is happening at the worst possible moment from the perspective of the oil supply chain. Below is a quick snapshot of U.S. refined product demand:

Finished Motor Gasoline- Seasonally Adjusted

Distillate Fuel Oil- Seasonally Adjusted

Singapore builds have been following a normal seasonal trend of builds across the facilities, but it will start to increase this week and accelerate driven by issues throughout China. Singapore/ Fujairah/ Europe are other key places that builds should start to rise as China slows consumption of refined products and maintains some exports. As utilization rates fall, exports have the potential to remain stable/if not elevated as product is turned abroad making up for lower rates of throughput. Crude pricing will remain stable here as support is generated by OPEC+ talks, and the fall from $65 back to $53 in WTI. Oil prices will remain range bound in the near term, but the risk remains to the downside as product builds weigh heavily on the near to medium term pricing structures.

Libya Commentary from Previous report

Libya is moving front and center as the Libyan National Army and the Government of National Accord (UN Recognized) failed to come to an agreement after General Hafter (leader of the LNA) refused to sign the truce. The cease-fire still remains in place after being brokered between Russia, Turkey, and all Libyan parties. The next attempt at coming to a “longer-term” agreement will be in Berlin later this week. Saber rattling has increased as Egypt demonstrated “readiness” drills in response to Turkey sending proxy troops to Libya. General Hafter holds the upper hand currently based on the areas under his control- essentially cornering Tripoli. So far, the LNA have held off on a new offensive in Tripoli and Misrata. The cease-fire took effect Jan 12th, and so far- crude production hasn’t been impacted and should remain relatively stable. Both sides NEED the oil revenue to survive going forward, so all infrastructure and assets will be spared. There could be some near-term stoppages if fighting gets too close, but NO ONE and I mean NO ONE is going to target anything oil related. This is something to watch for near term disruptions, but little in terms of long-term impacts.


[1] https://www.biorxiv.org/content/10.1101/2020.01.26.920249v1

[2] https://twitter.com/DrEricDing