Primary Vision Insights – May 11th, 2020

Primary Vision Insights – May 11th, 2020

By Mark Rossano


  • National Frac Spread Overview
  • A Deeper Dive into the EIA Data
  • FED Actions and What it Means for Distillate
  • Distillate a Key Bellwether for Economic Growth
  • Europe’s Economy to Struggle for a Long Time
  • Non-OECD (Emerging Markets) To Add Additional Pressure Across the Oil Supply Chain
  • The Belt and Road Initiative and The Fall Out
  • Chinese Data Shows More Pain to Come Through May
  • Seaborne Market Highlights A Persistent Oversupply
  • Leading Economic Indicators Point to No V-Shape Recovery
  • A Summary of Builds in Key Locations
  • Quick View of Chemical Margins and Lasting Pain
  • Geo-Political Roundup

National Frac Spread Overview

The national frac spread hit 55 last week and will fall below 50 this Friday. The pace of decline will slow as some of the activity left is relatively sticky. My view is that we will bottom around 40, supported by the Permian and one or two spreads remaining active in the Eagle Ford/ Williston/ Appalachian. The Permian will likely touch around 25 spreads with most companies announcing a slash to new completions on recent conference calls for Q2’20. The bear case takes Permian activity to about 17, but it would be hard to see the area hang around these lows let alone go to zero. Most of the other regions could operate with 1-3 spreads depending on the operator and if it has an operational electric spread. So far through earnings, we have most companies cutting production by about 8%, but Parsley and Diamondback have said they would only need $30 to bring some shut-ins back online. Based on the current crude curve, $30 is now back in play as early as Aug if they decide to hedge here and bring capacity back online in Aug-Sept (depending on the cost of hedges).

WTI Cushing Curve

E&Ps have slashed drilling programs and completions with some going so far as to say they won’t be doing any new fracs in 2020. Instead, we will likely see workovers or other low-cost methods to preserve production and fill some of the decline gap. We hold the opinion that U.S. oil production will fall to about 8.5M barrels a day, which will take time to achieve as companies have been slow to cut production. Shut-ins will accelerate and reflect quickly in parts of the system- specifically the Bakken/ DJ/ SCOOP/STACK. The EIA estimates of 11.9M barrels a day is a bit slow to reflect the magnitude of change taken place as we are producing about 10.8M per day right now. I still believe there is another 2M to come out of the U.S. market- especially as refined products and crude builds rise. Refinery activity shifted a bit higher to 70.5%, but it will average closer to 65%-70% as some pieces of equipment are either slowed or turned off. Slowing U.S. refiners and headwinds in the export market will keep U.S. crude stuck onshore and push back up the supply chain. The other problem is- the decline in activity will remain relatively sticky given the oversupply in refined products.

U.S. Refinery Runs Seasonally Adjusted- Lowest on Record

Refiners typically increase runs from the end of April into May-June to cover the summer driving season as we come out of shoulder season (spring). During shoulder seasons, refiners will carry out maintenance and other upgrades ending in May or Oct (depending on the side of the shoulder). Due to the slow end/start to the year, refiners were already slowing down as demand was soft due to a warm winter and slowing industries. Given the current storage levels, it is unlikely we see any meaningful shift higher in throughput- especially with refiners guiding to system wide reductions on recent conference calls.

A Deeper Dive into the EIA Data

When looking at the total oil build, we need to include the SPR (Strategic Petroleum Reserve) because the government has leased out space to nine companies to add storage space to the system. This means the build was actually 6.31M barrels and will keep shifting higher as U.S. crude is pushed into storage and PADD 3/5 floating storage is transferred to onshore tanks. The timing of the move has been slow due to logistical restrictions with lightering and congestion in each port. There is also more KSA crude heading into these two locations that took the long way around in order to stagger loadings and relieve some of the congestion. It is also a cheap way to store crude by leaving it in transit longer. The pace of the builds will start to slow as U.S. producers slow/stop completions and continue to shut-in wells, but the trend remains higher. This is why we believe WTI Cushing prices will fall back below $20 and bring Brent back to about $27. Elevated crude levels will remain a major issue, and the biggest focus now is Cushing- where we are approaching the all-time highs initially hit in 2016-2017. The problem is the current backdrop is far worse vs the issues facing the crude market in those years.

Total Seasonally Adjusted U.S. Oil in Storage (including the SPR)- Only Two Years that were higher 2016/2017

Seasonally Adjusted Crude Storage in Cushing- Only 2016/2017 Were Higher

The data this week points to another 1.8M being pumped into Cushing so next week the EIA will confirm something in that ballpark setting a record of crude in storage. The estimated limit of crude that can be stored in Cushing is about 76M. Saudi Arabia has now decreased their discount to all markets by about $5 sending oil higher. Each country still has a lot of work to do in order to bring levels back inline with the agreed upon cuts. It should also be no surprise that Iraq has been slow to comply with the cuts, and it is likely Iraq and Nigeria fail to meet these production limitations- especially given these countries are experiencing the most stress on their balance sheets. The GCC nations are in a much better situation to weather the storm vs Nigeria/Iraq- Nigeria has already asked for an interest payment holiday and received new IMF funds.

So now we have WTI Cushing futures moving to the same spreads we had in March except we now have an additional 30M barrels in storage. While higher OSP pricing is a positive move as it will slow purchases and pull more crude out of storage, the OSP takes away margin from refiners- so we will see additional run cuts as refiners opt to pull product from storage and avoid the higher cost barrel. Russian Urals are also finding some strength: “Russia’s Urals crude has strengthened sharply in northwest Europe following a sharp reduction in cargoes from the nation’s western ports that has tightened the market.” With many European refiners well off seasonally adjusted runs, Russia has been targeting more flow into China. CPC remains at a premium, which is why Russia has maintained the grade at elevated exports. (more on that below)

Gasoline has been driving crude prices (even though it should be distillate), but people are driving more to get out of the house and as states start to loosen travel restrictions. PADD 2 and PADD 5 are now back within the average range of storage- with PADDs 1/ 3/ 4 maintaining all time high levels. The rise in prices and demand has also attracted new shipments from Europe with about 11 new tankers coming into the US on top of the 6 already on the way. “European product exports to the Americas will start to edge higher in May after falling last month to the lowest since the start of 2017 and possibly longer.” More flow will turn towards the U.S. (specifically PADD 1) as flow to Africa falls across the board: “European shipments of oil products to West Africa, mostly gasoline, plunged to the lowest in about 2 1/2 years, vessel-tracking and fixture data compiled by Bloomberg show.” Off the coast of Nigeria there will be about 16 vessels floating holding a combined 8M barrels of road fuel waiting to discharge (or just find a home). “The number of gasoline tankers anchored off the coast of Lagos, Nigeria, has swelled with more vessels from East of Suez adding to the fleet of ships that has been floating there for weeks, port reports and ship-tracking data compiled by Bloomberg show.” Some of these ships have been redirected away from Europe and sent to Africa (2 that were supposed to go from KSA to Europe). The glut in Europe will keep flows moving to PADD 1 in the U.S.- especially as some space opens in storage and demand creeps higher in gasoline. The below charts help highlight the storage limitations in other areas and in this case Singapore. I discuss storage in other areas lower, but the builds in Singapore highlight the struggle within Asia for demand and the limitations in the export market to clear the glut as it rises.

Singapore Light Distillate Storage at All Time Highs and Rising

Singapore Total Refined Product in Storage at All Time Highs

Singapore Middle Distillate in Storage at All Time Highs- It is still maintaining all time Highs

Demand in the U.S remains a core problem specifically in gasoline and distillate. Gasoline numbers have bounced from all time lows, and is now closer to the lows established in 1994- but given the rise in miles driven over the last 26 years- it is much better to look at the 5 year average to compare apples to apples. The below chart drives home just how far we have fallen, but as states continue to reopen demand will keep trending higher. People are also looking to get out of the house so gasoline demand will always be the first to recover- the question then turns too: 1) are these individuals going out to spend money 2) are they driving to work? We got some answers over the last few days with unemployment now shifting to 33M with continuing jobless claims going to 22.647M and new claims at 3.169M. Companies are now shifting employee designations from furloughed to “let-go”, and people who were operating on reduced salaries are now unemployed at a growing rate. The spending of these individuals will be hindered, and the fact states must borrow from the federal government just to meet unemployment benefits speaks to a bigger problem at the government levels. Municipalities and states will struggle to balance the budget without borrowing, and the Federal Government will have to issue about $3T worth of treasuries this quarter to cover stimulus and the deficit. The Fed balance sheet will be pushed to about $8.8T over the same time frame in order to stimulate the market and “purchase” new and old treasuries. The above backdrop will create a huge overhang in demand- some will say employment data is “lagging” but with companies pulling yearly guidance and the uncertainty of job prospects- the data is indicative of a much bigger problem that will persist. This isn’t like 100k additional people are out of work, we are breaking records set by the great depression with limited prospects for employment. This will keep people tight with money and limit any sustainable rally in pricing. Gasoline prices hit lows not seen since the late 90’s, so the cost also helped people go fill up- but as prices rise demand will also be capped in the near term.

U.S. DOE Motor Gasoline Implied Demand- Seasonally Adjusted over the Last 5 years

FED Actions and What it Means for Distillate

The Fed has already taken aggressive action to purchase all types of assets- MBS/ Treasuries/ High Yield to provide what they call liquidity. I discuss this more later, but just to introduce the issue of real wages vs asset prices. Now that over 30 million people will be competing for jobs- wages will fall as people are willing to except less money in order to generate income but asset prices (especially food) is being driven higher (or kept from falling)- so even if these individuals get jobs- their ability to spend will be hindered across the board. Disposable income will be limited due to real wages and total spending power being limited.

The remaining issue will be across the distillate cut when it comes to demand and overall storage. Distillate is the driving engine of the economy across the supply chain (trucks and ships) as well as industrial/manufacturing. Disty demand has fallen, and after a bounce off the bottom it has leveled off and started to turn lower as industries struggle to restart. China is a perfect example of a country facing backlogs (exports increasing- surprise to the upside) while imports fell by 14%. Local demand post COVID-19 remains weak, and the U.S. won’t be any different as people lack jobs and concern over money grows. This is made worse by the fact many homes are levered through credit card, mortgage, and home equity lines. Household debt has hit a new record at $14.3T… so YAY!!!!!!!! Distillate storage space remains plentiful, which is another reason that refiners have been focusing on this cut of the oil barrel. It is also a place refiners can put kerosene (jet fuel) as jet storage remains saturated with little to no demand recovery as planes remain grounded. This has led to the pace of disty builds accelerating even as demand has faltered and exports decline.

The other growing overhang for both gasoline and distillate is the falling exports as more Latin American country cancel purchases through June. Ecuador was another country (after Mexico) to cut imports through June following high storage levels and demand down about 67% for gasoline and 50% for other fuels. There is also Brazil to contend with that has reversed production cuts and kept refiners operating at about 79% pumping out refined product. Due to low refined product demand domestically, it will be pushed into the floating market and likely purchased in the local Lat Am markets. Europe continues to receive shipments from the Middle East, which will further displace U.S. flow of disty into Europe. 13 tankers have already discharged into Europe with “26 tankers hauling about 1.44m tons, mostly middle distillates, are under way toward Europe and are expected to arrive in the continent this month, according to fixture reports and tanker-tracking data compiled by Bloomberg.” This will keep storage levels moving higher in the region as industries struggle to restart as seen in leading indicators.

Distillate a Key Bellwether for Economic Growth

The bellwether to watch for in crude demand going forward will be distillates, which represents the underlying strength of the economy. The long-term implications show up in distillate storage- this is what will dictate the speed at which refining ramps back up. Gasoline demand has bounced off the lows driven by more people looking to escape their homes for a random drive, but aimless driving doesn’t move the needle on economic recovery. It does represent some normalcy, but the levels of gasoline/blending components point to a glut that will remain throughout the summer. The leading indicators across the economic complex show the contraction is only getting worse for the largest buyers of distillate. European countries are key buyers of U.S. distillate originating from PADD 3 (Gulf of Mexico), but with a backlog of ships waiting to discharge and new product showing up from Asia/ME pressure will remain on U.S. exports. China has allotted more cargoes for export, which will keep Singapore storage well stocked (charts above) and shipments heading into Europe. There is some easing in France, Italy, and Spain on travel restrictions so gasoline demand will increases, but economic drivers such as manufacturing/industrial use will remain limited keeping a lid on economic growth and distillate demand. Key exports into Latin America from the U.S. will face additional challenges as several countries have canceled refined product shipments through June- specifically in Ecuador and Mexico. Brazil has also decided to reverse course on production cuts and set a record of new exports in April of 1 million barrels per day as domestic demand plunged. China remains Brazil’s largest buyer with about 60% of exports sailing to Asia. “In a Monday securities filing with first-quarter production figures, Petroleo Brasileiro SA, as the firm is formally known, noted that it initially decided to cut April oil production to 2.07 million barrels per day (bpd). But it said it decided later in the month to increase production to 2.26 million bpd. It also increased utilization rates at its refineries to 79% after cutting them to 60%.” Due to the surge in domestic COVID cases, local demand will remain depressed keeping a large portion of products slated for export. “Petrobras says jet fuel demand declined 90% from normal levels in April, gasoline demand fell 65% early April, recovered to -50%, diesel fell 40% early April, recovered to -30%.” The lack of local demand will keep tanks full and slated for the international markets- likely local Latin American countries- a key market for PADD 3 exports.

The Russian Health Minister has also said that “restrictive measures in Russia will continue until the vaccine is found”, which has already resulted in more diesel exports. The problem in the market is the focus purely on oil, and not weighing the balance between oil production/ oil exports/ refinery utilization rates/ refined product storage/ product exports. The lack of jet fuel demand will push kerosene into the diesel stream, so it will keep diesel well supplied and weigh on the overall crack spread. Russia currently has about 200k active wells that range in age from the Cold War to the recent activation of the Power of Siberia. Drilling activity in key locations has increased to fill the pipeline, and due to the nature of the super-rich gas- Russia now has more condensate to export, which is why it has been exclude from the OPEC+ agreement. This gives Russia the freedom to blend Urals with extra condensate helping to adjust the overall cut of the crude in an attempt to get a better price. China has been a large buyer of Urals with flows remaining relatively stable with a focus on ESPO exports. “Urals crude oil shipments to Asia more than doubled to a record 3.55m tons in April.” Some cargoes have been reduced across the Russian complex, but so far loadings of oil have dipped about 1M barrels for May after April’s ramp. While some areas have seen a decline in oil loadings, refined product- specifically diesel- has maintained well above seasonal flows. Crude flows are back towards 2018 levels, but the flow of natural gas has increased through the Power of Siberia while more condensate remains relatively stable.

Total Russian Crude Loadings by Location

Russian Total Diesel Production Seasonally Adjusted for the Last 10 Years

Diesel production remains constant out of Russia even as refiners run at lower utilization rates due to the blending of kerosene and re-cracking of heavier fuels. The lack of gasoline and jet demand will keep the focus on diesel and overall disty production. The loadings remain elevated out of Russia from two key areas of ESPO and CPC (as seen in the line chart above).

Russian Primorsk Diesel Loading Seasonally Adjusted for the Last 5 years

Europe’s Economy to Struggle for a Long Time

Europe is a key market for Russia and the U.S, and the below indicators bring to light issues across the EU market regarding economic recovery. Industries remain shuttered or operating well below capacity due to COVID-19. The problem here is the slowdown was happening BEFORE COVID-19 showed up across the continent. These cracks were present in PMI/ Exports/ GDP well before COVID took center stage.  The issues are much deeper vs COVID, which also points to a much longer recovery as economic health was already challenged. The underlying problems were never addressed during the Financial crisis or the resurgence of defaults in 2011. PIIGS (Portugal, Italy, Ireland, Greece, and Spain) became synonymous of overleverage and financially unstable countries. While the problems were temporarily relieved with ECB printing, backstopping debt, and pushing negative rates, the underlying mechanisms of economic growth have yet to be cleared. Germany has been the strongest country in the group driving the stability in the debt and currency, but now with its problems mounting- little stands in the way of a much bigger financial collapse.

German PMI is a bellwether given its status as an exporting economy, so the below helps drive home the issues even further when considering the key PMI components and the fact corporations aren’t spending. Exports will remain a headwind as industrial manufacturing orders face headwinds due to stress across their customer base.

All of these problems will lead to depressed oil consumptions as demand for refined products stay well off seasonal norms. Spain’s road fuel sales fell 25% y/y to 1.7m tons in March, lowest for any month since January 1999, according to preliminary statistics from national agency CORES. Gasoline consumption fell -35% y/y to 276k tons, 74k b/d, lowest since February 1973, Diesel sales declined 23.2% y/y to 1.5m tons, 359k b/d, and Jet fuel sales -44% y/y to 297k tons, 75k b/d.” “Madderson said fuel demand was currently down between 55% and 60% compared with pre-crisis levels, an improvement from two weeks ago when it was down by 65%-70%” There has been pick up in gasoline consumption with Spain, Italy, and France recording a 10%-15% increase in consumption while jet fuel and diesel remain on the lows. Some gasoline shipments have started to become profitable again into the U.S. after posting the lowest level in April. “Provisional bookings for the transatlantic trade route rose to 11 tankers, or 430k tons, so far in May; more cargoes to emerge for the month.” “U.S. imports of European gasoline rose by more than three times w/w in the week through April 30. Shell sold a jet fuel cargo again after selling two on Friday.” The new flow was helped by a decline in gasoline storage in PADD 1 with the Colonial pipelines still operating 20% below normal capacity. This positive development is being offset by a large drop in total shipments of product into Africa. The issue is exacerbated by a huge chunk of refined product floating offshore in ships waiting to offload. “The number of gasoline tankers anchored off the coast of Lagos, Nigeria, has swelled with more vessels from East of Suez adding to the fleet of ships that has been floating there for weeks, port reports and ship-tracking data compiled by Bloomberg show. This will add to at least 16 tankers hauling a combined total of about 8m bbl of the road fuel that have been awaiting discharge operations off the Nigerian Coast for a month or more- Includes gasoline shipments from Europe, the Middle East and China.” “A total of 25 tankers with combined cargoes of 1.14m tons sailed to West Africa from European ports in April- Equates to 37.8k tons/day, lowest since October 2017.” The flow continues to amass on the coast, and the limitations in demand will push exports back on Europe and either get directed to the U.S. or sit in a storage tank.

Non-OECD (Emerging Markets) To Add Additional Pressure Across the Oil Supply Chain

There is a growing view that non-OECD gasoline demand will recover and grow over the coming months and over the next several years. Many of these nations are facing an uphill battle against leverage, falling exports, and commodity reliant economies. Nations face depressed pricing for commodities they rely on, which will limit the investment process in building necessary infrastructure locally. The chart from the FT highlighting China BRI loan recipients believed that a cooperation with Chinese entities would lead to a prosperous relationship, but instead- required countries to borrow in Yuan, only purchase materials and equipment from Chinese manufacturing, and hire Chinese labor.

China uses the typical “teaser” rate on the first tranche of debt, but by the time the last bond is purchased the debt load is massive. Many countries complain about racism against local workers/ poor working conditions/ and negative economic attributes from projects. The leverage leaves little money left for economic investment, instead it is used to cover interest expense because the revenue assumptions on projects always seem to be grossly overstated. Now with China falling on hard times, many projects have been furloughed with work being paused for extended periods of time.

A key area for delivery of diesel and distillate has been emerging markets- as many of them import diesel in order to operate. Debt problems have been exacerbated as the US dollar has strengthened and exports have come under pressure. The below chart helps drive home the drop in new export orders as the weakness persists across key regions with little change expected throughout May.

The above weak economic data is also made worse by investors pulling capital from key regions, which also pushes investors to convert the currency. When you sell the local stocks/ index, an investor will sell local currency and repatriate back to their native fiat. This creates a problem for the central banks that are trying to manage inflation and currency levels (either through a direct peg or a pegged range- typically to USD). So Central Banks are forced to purchase local currency and sell foreign reserves to help protect against adverse inflation and protect their local fiat. The complexity of the situation remains fluid, and in order to keep these countries from driving the USD higher- the Fed has opened up swap lines to allow for purchases at a fixed rate away from the FX markets. These types of arrangements require the receiving country to have posted collateral, but if the nation doesn’t meet the requirements but are deemed “solvent” – they can go to the IMF for necessary funding. Nigeria was issued another $3.4B from the IMF, while the country also looks to defer some debt payments till 2021- once oil revenues increase. ““When revenues improve, and we hope by 2021 they should improve, we will be able to resume regular repayment of that debt,” Ahmed said, without specifying what type of debt obligations the government would seek deferral on. She spoke a day after President Muhammadu Buhari urged international financial institutions to cancel the debt obligations of member states to help them withstand the fallout from the virus.” The issues aren’t only occurring in Nigeria, as Saudi Arabia battles their own issues to get to the other side of the price route.

Saudi Arabia has been dealing with a collapse in central bank reserves, which Goldman Sachs estimates to be $27B in march alone. “Last week, Finance Minister Mohammed Al-Jadaan said the kingdom would only draw down reserves by up to 120 billion riyals over the whole year. The government used none of its reserves to cover the fiscal shortfall of 34.1 billion riyals in the first quarter, but tapped its current account with the central bank for 9 billion riyals, according to the Finance Ministry.” The country is looking to plug the deficits and social spending required in the country through a record amount of new debt issued. KSA has also slated about $540M to be used to import agriculture products and secure food supplies. These issues are propping up around the world- as more negative data hits oil producing and non-food secure countries.

  • The Egypt PMI slumped to 29.7, down from 44.2 in March and the lowest since the series began in April 2011, according to IHS Markit; activity, new business and exports all dropped at record rates
  • Saudi Arabia’s PMI was at 44.4, compared with 42.4 in March; new orders and employment levels continued to decline
  • IHS Markit’s gauge for the U.A.E. dropped for the sixth month running to a record low 44.1 in April; export demand collapsed amid global lockdown

This is data impacting one of the strongest entities within OPEC+, but when we shift away from KSA (and generally GCC Nations) the quality of the balance sheet degrades quickly- with some closely tied to China. The below chart helps to put into perspective who has the most debt tied to China. The below Russia exposure helps to highlight the relationship between China and Russia.

  • Urals flows to Asia in April represented 41% of total loading volumes of Urals from three main ports
  • China was the biggest buyer, receiving at least 2.16m tons of April-loading Urals

The Belt and Road Initiative and The Fall Out

Russia has been increasing their flow of oil into China, which has been a big driver of the KSA OSP cuts into Asia. The price war remains alive and well across the physical market as each country jockeys for control.  The below chart also highlights just how much trouble China is in across their investment portfolio of $8T throughout about 90 countries. The below is just a drop in the bucket as some have already defaulted on the projects, especially since China has a total of $35T in debt outstanding. Each project- faces its own issues has revenue remains well below even the most conservative estimates. Made in China 2025 and Belt and Road initiative are guy focal points used to drive policy and economic growth. Made in China 2025 is a policy to create more robust local manufacturing, technology sector, and ultimately attract talent. The long-term goal is to become inventors and through leaders in the creation of major advancements in technology. The Belt and Road Initiative or BRI is a move to diversify supply chains, control multiple outlets over land/seas, export the Yuan economy, and Chinese workers. The below is just a small sample of the loans/bonds that have been issued under the program and has resulted in countries defaulting on the projects allowing China to take over.

Complexity of the BRI- Connecting the String of Pearls

The goal is to create diversity across the Maritime Silk Road while also maintaining land bridges to avoid the bottleneck at the Strait of Malacca. Many of the countries have avoided taking loans from China in that area, and the U.S. has been focused on building alliances in the region- specifically Vietnam, Malaysia, Indonesia, and Singapore and the U.S. Navy practices shutting down the Strait on a yearly basis. This choke point is an area that sees the lion share (80% of Chinese trade) and would cripple the country in terms of receiving needed supplies. The focus of the 9-dash line has been to bridge some of those needs by claiming oil/natural gas reserves while also taking fishing grounds. In these manmade islands, China has constructed anti-ship missile batteries and advanced/early detection radar to deter the sailing of vessels near their shore. China has also focused on connecting Gwadar through the Pakistan-China Economic Corridor to provide a way around the Strait. The other area of interest is Sri Lanka and Bangladesh where China can connect from the Doklam plateau through Bhutan. “China’s Maritime Silk Road, also known as the “String of Pearls,” is a sea-based network of shipping lanes and port developments throughout the Pacific and Indian oceans to the Mediterranean Sea and Europe. The port in Sri Lanka adds to ports that China controls in Myanmar, Bangladesh, Maldives, Pakistan, and Djibouti. China even has a controlling stake in Greece’s port of Piraeus on the Mediterranean Sea.”  The problem remains that many of these locations haven’t seen any new work as COVID-19 travels around the world, and China struggles under the weight of economic pressure that is only going to remain.

The below chart provides some visual of where the fight over the islands/ fishing/ natural resources is taking place. China has now sunk two Vietnamese fishing vessels and harassed countless other vessels including Rosneft assets and Malaysian seismic groups. The U.N. tribunal unanimously rejected China’s claims over any of these areas, but it has stopped China from annexing land and natural resources that rightfully belong to other nations under accepted International and Maritime Law.

Under the Chinese policies, a key drive was to create their own refining and petchem assets to drive local manufacturing and capture a better margin. The U.S. for decades has been importing oil, and converting it into higher value products to either be consumed locally or exported into the market. China has increased total throughput capacity to about 17.2M barrels a day and is looking to increase another 3.1% in 2020. It is highly likely the additions will be kicked to the right given how unprofitable refining was for China in 2019, and the fact most facilities operate between 65%-85% at the state owned level and 45%-72% at the Teapot level. Right now- activity is starting to slow down as teapots are pushed down to about 68% and SOE’s maintain around 70% utilization rates. The below chart highlights how the shift in policy and construction of new assets is shifting the global refined product landscape. China has been pushing a growing amount of gasoline into the market, but more importantly just dumping diesel into the market. This diesel has flowed into Africa/ Europe/ Asia and resulted in a huge amount of pressure on crack spreads and pricing. China has only increased exports as local demand has been far below expectations and remains hindered for the near future. Between the rise in KSA OSPs and glut of refined products- refiners will struggle to operate at a profitable margin in specific regions.

China Export of Gasoline and Diesel Since 2003

Chinese Data Shows More Pain to Come Through May

The data out of China yesterday was mixed with the PMI Composite printing 47.6 and China Services PMI missing estimates and hitting 44.4. On the flip side, exports in dollar terms increased 3.5% y/y, which topped estimates of -11%. Imports were below expectations of -10% coming in at -14.2%. The above refined product and trade data drives home just how poor domestic consumption remains after the spread of COVID-19. While exports rose due to terrible domestic demand and pent up shipments, new export orders shrank further in April, and fell at the 2nd fastest rate on record behind February’s collapse. The data is more of a blip and less of a trend, which will weigh on the local economy as China attempts to stimulate. The China vs U.S. trade war is something to keep an eye on because it will start heating up again over the next 2 weeks. Countries are now demanding China answer questions about COVID-19, and the issues are starting to concern the CCP with more leaked data highlighting some interesting intelligence reports. Based on the “wide” availability of these reports, it is likely they were released on purpose to show the world they are aware of the issues, but also don’t tread too closely. The below report could be nothing but given the current backdrop the world faces with failing economies and nationalism every new piece of information has to be vetted.

“In case you haven’t noticed – US-China tensions are heating up.
That’s why China’s top spy agency (MSS) has told Xi Jinping to be prepared for a new Cold War.
The China Institutes of Contemporary International Relations (CICIR), which is overseen by MSS, presented a report to Xi Jinping in early April (Reuters):

“The report… concluded that global anti-China sentiment is at its highest since the 1989 Tiananmen Square crackdown.”

“Beijing faces a wave of anti-China sentiment led by the United States in the aftermath of the pandemic and needs to be prepared in a worst-case scenario for armed confrontation between the two global powers, according to people familiar with the report’s content.”

This could be historic:

“One of those with knowledge of the report said it was regarded by some in the Chinese intelligence community as China’s version of the ‘Novikov Telegram’, a 1946 dispatch by the Soviet ambassador to Washington, Nikolai Novikov, that stressed the dangers of U.S. economic and military ambition in the wake of World War Two.”

“Novikov’s missive was a response to U.S. diplomat George Kennan’s ‘Long Telegram’ from Moscow that said the Soviet Union did not see the possibility for peaceful coexistence with the West.”

“The two documents helped set the stage for the strategic thinking that defined both sides of the Cold War.”[2]

There are now growing reports of new clusters in Harbin, Heilongjiang that I discussed in the last report. More leaked documents are coming out saying that new infections have been grossly underreported. The focus will remain on wave 2, which will impede any kind of momentum as the data remains lackluster throughout China.

Seaborne Market Highlights A Persistent Oversupply

We have focused significantly on exports as it is a much better indication for the global market, and seaborne exports remain at last year’s levels. There is also a growing problem with the crude quality available in the market. This is probably a reason Brazil decided to shift their cuts as demand for medium sweet and heavy sour is rising with a glut of light sweet in the market. The disconnect between crude slates and refinery runs will cause some wide spreads to form between different crude grades and locations. It is also a key reason Angola can sell well into China, but Nigeria is struggling to send crude into Europe as Russia pushes more blended Ural barrels into the region. There will be clear winners and losers in this scenario, but it is still early in the shifts to get a clear indicator of who benefits the most over the long term. But- the reactivation of the Neutral Zone between KSA and Kuwait enables both countries to send more heavy sour into the market. There was a big increase in April cargoes following the surge of production hitting just over 30M barrels a day. Saudi hit about 11.3M barrels a day but fell short of their quoted 12.4M production target. I have stressed that KSA tops out at about 11.7M, so it is unlikely they can hit the quoted max target without drawing down from their storage. The fact that exports remain the same y/y is a problem given the huge hit to demand and helps show that the glut isn’t going anywhere quickly especially as refined product storage keeps rising.

Crude demand remains a problem on a global level as Nigeria posted pricing that pegs some key grades at discounts not seen since 2001, and in some cases- all-time lows. “Two of Nigeria’s banner grades — Qua Iboe and Bonny Light — will sell at discounts of $3.92 and $3.95 respectively to Dated Brent in May, according to a price list seen by Bloomberg. Both are more deeply discounted than they were in April, when prices were already staggeringly cheap by historical standards. The majority of the country’s grades will be sold for at least $3 a barrel below the benchmark next month.” Nigeria and Angola (West Africa in General) are bellwethers for how well the current oil demand situation is and based on pricing and crude movements it remains abysmal. The discount Nigeria is pricing vs dated Brent is going to widen as the current record discount will not be enough. This comes at a time where about 4.5M barrels of Nigerian crude is floating off the coast of Gibraltar and Ceuta. The system is already choking on volumes stuck in the market that cannot clear due to a lack of refiner demand. Another parking lot for Nigerian crude (and UAE/US grades) is Saldanha Bay where about 9M barrels of crude is sitting outside of South Africa’s storage terminal.

Japan has increased their lockdown by 1 month across the country, which will remain an overhang in the global economy. Japan is the third largest economy and 4th largest buyer of oil in the market. India has also increased some lockdowns in areas with some regions banned from going to the supermarket for a week. It is an odd backdrop, but something to watch as evidence of a bigger spread in parts of the country.[3] Saudi Arabia has put oil in storage across Japan where the country either outright owns or shares storage capacity. Russia has seen local gasoline demand fall by 40%-50% so far and will likely bottom out in the 50% range. This will put more crude on the water as local storage has reached max capacity and refiners have cut runs to accommodate the fall in demand. The lack of throughput will be destined for the water, which is why Russia is looking to cut up to 2M barrels a day in production. The issue will be the ability to hit the mark given the infrastructure in place and the aged equipment that was never built to operate at lower flow rates. The issue comes down not only to the age of the assets but the bitter cold in which they operate: “The country faces considerable obstacles, from the frigid Siberian climate where pipelines can burst without oil in them, to low-yielding Soviet-era fields that are expensive to maintain and restart.”[4] Another issue is the price war that continues to rage away from the oil futures market where Belarus purchased its first ever Saudi crude after Russia raised prices. “Moscow and Minsk have clashed in past months on issues such as energy prices and integration, forcing Belarus to look for alternative supplies or pay what it says are unfair prices. Nearly a quarter of the 2 million tons of oil it bought in April came from other sources, including Norway and Azerbaijan. Belarus has been in talks with Saudi Arabia over supplies since January.” These are issues that are plaguing the system as global demand recovers at an awfully slow pace. India is an area that has seen storage reach tank tops across their system including the SPR. “Indian refiners are taking advantage of cheap oil to bulk up its supplies even as every corner of the nation’s onshore storage tanks fill to the brim, according to Oil Minister Dharmendra Pradhan. State-run and private processors are now holding seven million tons — equivalent to more than 50 million barrels — on-board tankers out at sea, the minister said in a Facebook post. The refiners are doing so amid a collapse in crude prices that saw the world’s top benchmark lose more than 60% of its value this year and U.S. West Texas Intermediate plunge below zero.” India’s use of floating storage comes as all its onshore options run out. The country’s 25 million tons of crude and fuel storage at refineries, pipelines and inland depots are at capacity, partly due to lower demand, said Pradhan. Even the nation’s strategic reserve tanks are full, he added.” India’s total demand has now fallen by about 70%, which is well above early expectations. These are some key reasons why we believe crude demand remains down by 25-28M barrels a day as gasoline, distillate, and jet fuel struggle to move through the system. Many tankers filled with refined product are also floating around the world given congestion and limited demand.

Leading Economic Indicators Point to No V-Shape Recovery

The below charts drive home the struggle across freight volumes specifically in air and shipping. These key data points highlight problems across the global economy. They also show the slowdown was happening in 2019, which is why the down move in economic data will be sticky. Key metrics flashed  warning signals of slowing demand, which has only been exacerbated by the pandemic. Consumer demand was already slipping and now the prolonged unemployment/underemployment will keep a lid on spending. Many ships are facing delays in port due to congestion created by limited port operation and quarantine protocols that slow down the unloading/loading process. Companies are also deploying slow steaming methods and avoiding canals to save money on both fuel and fees, while also trying to space out deliveries. The problem arises with the new data showing continued weakness across the export and industrial sectors recorded by the Institute for Supply Management. The Cass Index release will be the next focus in terms of how low April was and what does May look like over the next few weeks.

South Korea is a key Asian exporting entity and has been a bellwether for the health of the global market. It has been flashing warning signs across the trading world- especially with the issues arising from the Japan vs South Korea trade war. The consumer buying power has been severely impacted by furloughed and unemployed, which is indicated in the recent data releases.

South Korean Exports YoY Change Seasonally Adjusted- New Low Going back to 1991 (takes out the previous low of 2009)

Chinese data highlights that it is clearing backlogs but lacks new orders to keep the recent surge in exports sustainable. The issues are much worse when we factor in global demand with countries remaining in lockdown, but also struggling with domestic demand- which was falling last year.

China New Export Orders at 2008 Lows- Driven by Trading Partners Shutting Down 

The below chart on global PMI rankings demonstrates the magnitude the markets have contracted, and this isn’t something that just restarts as we face a second wave/ new clusters of COVID. It is important to highlight that many of the below countries were already showing slowdowns in 2019, so the current backdrop is just fuel on a raging fire. The lack of exports has hindered the market beginning in the middle of 2019 and accelerated into Q4’19, and now with importing nations (such as the U.S.) sitting with massive unemployment spending will pull back keeping international markets stunted. During this time frame, each country will have to finance debt at the expense of foreign reserves while contending with food inflation.

The Chinese data is reflective of the limited imports across their trade partners given the weight of economic slowdowns and supply chain disruptions. China is a decent indicator of what things will look like post COVID, and even in a communist country the data is underwhelming. “Data from the Ministry of Culture and Tourism of China: 115 million people(-41.1% Y/Y) went out for travel and spent¥47.56 bln Yuan($6.7 billion USD, -59.6% Y/Y) in the five-day-vacation of May Labor Day.” Consumers have been hurt due to lockdowns. People who have lost jobs are forced to liquidate savings to purchase necessities, which leads to less spending on items or trips deemed non-essential. While Chinese facilities are “operating” it doesn’t mean the goods or services are being transferred to clients. A key customer has been the U.S., but the below data shows the magnitude of the economic pain in exports/ employment/ business activity.

  • Business Activity: 26 vs 48
  • New orders fell to 32.9 vs 52.9; a record low
  • New export orders fell to 36.3 vs 45.9
  • Employment fell to 30.0 vs 47.0

The headline number “beat” driven by supplier delivery timing issues, but all the underlying data looks forward highlighting more pain to come across May. March trade deficit widened to $44.4B vs. $44.2B est. & $39.8B in Feb; as the COVID19 pandemic stymied trade, causing imports to fall most in 11 years (-6.2%) & exports to fall most on record (-9.6%).

The data was not any better with the US April Composite PMI at 27 with new orders falling to 26.4 vs 40.9. which shows the continued degradation across the economic backdrop of the U.S. The weakness of the consumer is exacerbated by household debt climbing to $14.3 trillion through Q1’20- which  is now $1.6T above the recent high.[5] This comes at a time when states are borrowing from the federal government to cover unemployment expenses, while the Treasury has to borrow $3T in Q2 (the largest number in a quarter ever). [6] This comes at a time when all countries are in the process of borrowing, which leads to the natural question of: Who is the buyer?

Total U.S. Debt Outstanding Ending March 2020

The normal comment has been- well the Federal Reserve is the natural buyer. It will get passed directly from banks straight to the Fed, as the availability of buyers dwindles with nations/investors facing similar challenges. By purchasing more treasuries, it would spike the amount of dollars in circulation, and during a lockdown the velocity of money remains under relatively control. But- as things accelerate- inflation becomes a problem on the back end. Fed Chariman Powell has been clear on the direction he will carry monetary policy: “As you know, our credit policies are not subject to specific dollar limit. They can be expanded as appropriate, and we can do new ones. We can continue to be part of the answer.” Powell is willing to print blindly to support asset prices- as he states- there is no specific dollar limit. There is only a demand limit as to when will people no longer demand USD. Powell goes further to highlight the levels of degradation to the system he is willing to inflict: “They do raise asset prices, including the value of your home. If your saver owns a home or has a 401k, your saver will benefit from that. But, for people who were really, just relying on their bank savings account earnings, you are not going to benefit from low interest rates. But we must look out for the overall economy. If needed, we will use them, and I would just say we have a number of dimensions on which we can still provide support to the economy.” So now we have 22M people unemployed/ consumer debt at $14.3T/ wages going to be under pressure as unemployed compete for jobs/ inflation driving prices higher…. This all leads to a quick recovery to an economy I guess. Especially when you have people increasing their savings (as shown below) but are told by Powell- unless you buy a home or invest in stocks- good luck.

US National Debt as % of GDP is BEFORE the New $3T to Be Issued

A Summary of Builds in Key Locations

The builds in the U.S. continue to climb with total product inventories taking out seasonally adjusted highs. Distillate as shown below between U.S./ Fujairah/ Singapore remain well above seasonal highs with more builds coming as refiners create more product and economic sluggishness destroys demand.

ARA Fuel Oil Inventories-
Fuel oil inventories in Europe’s ARA hub region surged to the highest in more than a decade due to low bunker demand and a shortage of vessels to handle exports to Asia, according to Insights Global. There were builds this week for all main oil products.

The above examples of builds is being reflected in real time with spot and futures prices weighing down the crack spreads. Gasoline has seen some increases over the last few days, but diesel/gasoil hasn’t followed suite to the same degree.

NY Harbor ULSD Spot Pricing at Lows (Gulf Spot Chart Looks the Same)

Another key bellwether for growth is the gasoil crack vs Brent- especially as we have crude prices rising with OSPs increasing. Refinery margins are going to get hit hard as OSPs take money directly from the refiner as they evaluate creating new refined goods. The pain in the crude supply chain keeps moving all around the supply chain, and now OPEC+ has pushed the issues back to the refiner- and will push margin pressure and run cuts will remain sticky. OPEC+ is likely hoping to force refiners to pull more product from storage, while refiners have purchased enough crude they can hold out until prices come back in their favor given the level of crude in the market.

Another key bellwether for growth is the gasoil crack vs Brent- especially as we have crude prices rising with OSPs increasing. Refinery margins are going to get hit hard as OSPs take money directly from the refiner as they evaluate creating new refined goods. The pain in the crude supply chain keeps moving all around the supply chain, and now OPEC+ has pushed the issues back to the refiner- and will push margin pressure and run cuts will remain sticky. OPEC+ is likely hoping to force refiners to pull more product from storage, while refiners have purchased enough crude they can hold out until prices come back in their favor given the level of crude in the market.

ICE Gasoil Futures Minus Brent Futures- Lowest since 2007 (furthest I can go)

Quick View of Chemical Margins and Lasting Pain

Another bellwether of growth are chemical margins- specifically High Density Polyethylene, which is significantly impacted due to no demand in the market.

High Density Polyethylene Margins- Gulf Coast Seasonally Adjusted

High Density Polyethylene Margins

The chemical stream was facing oversupply already which was only exacerbated last year as China brought 2 new facilities on last year, weighing on the global chemical crack. Margins have been depressed starting in 2018, and the pain has only increased through 2019 as the global market slowed down. As the global economy remains capped, chemical companies will have to maintain economic run cuts as they face a market saturated by new supply and a terrible demand world. GDP expectations that are in the -7% and higher globally (especially in OECD countries) will keep any type of earnings power capped for the next several years. The below is a quick sample set of countries facing prolonged pain, not to forget the PMIs listed above.

Each of these negative PMIs/GDP/ Export-Import/ New orders/ Inventory has to contend with the surge in new debt being used to stimulate the economies at already highly levered ratios. The U.S. is now at $25T and over 100% levered with the EU right with us. The issues across the US/ EU/ Emerging Markets limits the end buyer for chemicals/ refined products- which forces each petchem and refinery to cut runs leading to a huge amount of pressure on oil demand. There is no V-shape recovery at this point in time as storage remains full up and down the energy complex.

Geo-Political Roundup

Israel struck Damascus in the early morning hours hitting several Iran Revolutionary Guard, Hezbollah, and Syrian Army assets and positions. The cruise missiles were launched from Israeli jets that struck in the early morning hours, which was a bit more brazen as the attacks typically come in the dead of night. Israel has had free reign to strike convoys and equipment deliveries throughout Syria, which has some specific implications.

  1. If Russian assets are left alone- they won’t do anything to defend or deter the attacks.
  2. Russia does not really care if Iran is weakened further, as it gives Russia more power in the Syrian fight and direction of the battle/spoils.
  3. Iran keeps depleting resources into Syria and Iraq, but the IRCG still has to show support or else they will lose clout with proxies.
  4. Iran is starting to face a round of defections in Iraq with some loyalists now turning away from Iranian control:[7]
    • The four militias associated with al-Sistani had even previously stated that they wanted to start operating under the auspices of the Ministry of Defence.
    • A turning point in this divisive group came after US forces targeted pro-Iranian militias, after they were alleged to have bombed US camps inside Iraq. One of the US raids was aimed at militias stationed in Karbala.
    • While al-Sistani condemned the US attack on Iraqi soil, fighters loyal to him began to feel how dangerous it was going to get, to be associated with the Iran-loyalist militias. Again they expressed intentions to leave the larger PMF group and to have the Ministry of Defence as their new bosses.
    • This attempt was not successful, apparently for technical and administrative reasons. Apparently, the fighters in the militias had not been trained to the same standards as regular Iraqi army soldiers, nor been subject to the same standards, with regard to age, professionalism and length of training. This apparently made it too difficult to integrate them.
    • But a solution was eventually found: The militias could work under the office of the prime minister, after Adel Abdul Mahdi, who has resigned but not yet left office, was persuaded to take them on. The counter terrorism unit is also associated with the prime minister’s office.
  5. The U.S. has also increased flights of drones and spy equipment over Iranian assets (early detection radar and missile launch sites) to analyze readiness as well as activity.
    • The U.S. will not (or at least shouldn’t) attack ANY site that isn’t deemed a hard target, so any U.S. strike on the regime would be coastal (docks/early warning) or radar stations.
    • It is important to appreciate many in Iran welcomed the death of Qasem Soleimani
  6. It is also important to highlight the quality of intelligence the U.S./ Israel is getting should point to some high-level leaks and aggressive data collection. The weakness in the regime is growing, which would be a benefit overall as to stability in the region and new crude flows into the market.

In Iran popular support is already at all-time lows and the issues only get worse with the loss of proxy influence within the region. The potential for regime change continues to rise, as public support hovers just below 15%. The IRGC still maintains control, but the desire to get paid will always outweigh “loyalties.” The current administration has bungled everything from the downing of the Ukraine aircraft to COVID-19. The U.S. has been sending aid into Iran through the Swiss consulate, so we can demonstrate local support while finding ways to surpass the Iranian regime.

The reason we will continue focusing on Iran in the region is based on their military size and influence in the region, but also the amount of oil locked behind the wall of sanctions and underinvestment. Iran is (Persian Empire) has always been integrated into the European and Asian markets for thousands of years, and the cultural implications will push us back to the same status. This will unlock a huge flow of oil (which is desired given the heavy nature) back into to market, but it will take time as more pressure is put on the regime.

Another focus remains Kashmir- between India and Pakistan. This has always been a hot spot, but over the last 2-3 years the violence has escalated with the PAK and Indian armies exchanging fire- through mortar/ artillery/ sorties. India has reported to have killed the top Kashmir militant- Riyaz Naikoo, which will lead to more protests as violence as about 76 militants (including Riyaz) have been killed since January. This also resulted in the death of 20 Indian solider, so the blood shed continues top rise on both sides of the LoC line. Raids have been increasing across the region, which will only intensify as we head into the summer months. The reason this is an area of interest is due to the importance of Kashmir to India/ PAK/ China, and the tensions have been flaring in accordance with Generational Dynamics. This will be a source of concern as a flashpoint for a bigger conflict.

Libya has seen a spark the last few days with the UAE and Egypt carrying out airstrikes against Turkey. On behalf of the LNA, the UAE air force (leaving Egyptian military bases) carried out airstrikes against Turkish assets including drones and equipment. The LNA and GNA remain in a standoff with the LNA losing some strategic positions recently to the UN recognized GNA. Oil flow remains negligible from Libya, and the intensifying of strikes will keep oil behind a curtain of conflict. This is not a place Turkey is looking to spend a large amount of their time but are using it as a leverage tool to get Syria under control. It will all be one big trade-off between: Russia, Turkey, and Egypt.