Primary Vision Insights – March 2nd, 2020

Primary Vision Insights – March 2nd, 2020

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.