Primary Vision Insights – March 30th, 2020

By Mark Rossano

Sections

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

Reduction of Frac Spreads Accelerates

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

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

WTI Cushing Spot Pricing Showing Major Pressure

Crude Spot Pricing Throughout the Americas

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

U.S. Implied Demand Across All Refined Products

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

Permian Proppant Loadings Seasonally Adjusted Below 2014 Levels

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

Storage and Economic Stimulus Will Fail to Bridge the Gap

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

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

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

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

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

Dollar Denominate Debt Abroad (Non-Bank)

Breakout of Some Emerging Market Holders of USD Denominated Debt

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

Global Economic Data Points Paint a Frightening Picture

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

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

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

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

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

Oil Demand Falling as 2.6B face lockdowns

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

Oil Demand Impacts Across Top Consumers

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

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

Here are our estimates as of March 24:

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

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

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

Teapot Storage Levels in China of Oil

Refinery Run Rates of State-Owned Enterprises by Region

Refinery Run Rates of Independent Refiners (Teapots) in Shandong

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

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

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

Singapore Complex Refinery Margins Over the Last 10 Years

India Starts Down the Lockdown Road

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

Indian Exports of Diesel

Indian Exports of Gasoline

European Lockdowns Ramp with UK Joining the Fray

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

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

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

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

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

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

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

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

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

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

Flights Around the World and Locations of Planes

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

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

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

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

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

Miles Driven (in Billions) for March 2019

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

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

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

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

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

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

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

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

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

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

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

Nigerian Previous and Planned Exports

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

Russian Previous and Planned Exports

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

Politics Drive OPEC Policy

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

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

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

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


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

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

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.

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

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

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

U.S Frac Spread Count Update + China + Exports

By Mark Rossano

The energy market closed out the year with a big drop in the frac spread count, which carried forward into the second week of January with a move down to 275. The drop was driven by the Permian, which has seen a big decline over the course of 2019. The Permian activity now resembles something closer to 2017 but will rebound back soon as activity accelerates with new spending in Q1. This should support rig activity as DUCs need to be replenished as some of the quoted drilled but uncompleted wells will maintain that “status” due to many issues making them useless at this price deck. Some of the wells were drilled for the “parent-child” which has yielded poor results, had a poor landing (fell out of zone), or is drilled in an area that isn’t economic at this strip. This will keep rigs relatively flat after the substantial decline of about 100 rigs over the last year.

The frac spread fell below 300 for the first time since 2017 as activity slowed down well ahead of normal seasonal adjustments. Typically, completion crews slow down into the holiday season, so a down move is expected- but the scale and pace were a bit surprising. The pendulum always swings too far in both directions, so there will be some support for activity as completions crews start to come back from holiday. There may be one more down move towards 270, but this should be the low (for now) as activity picks back up with new CAPEX programs. The CEO of Patterson was on CNBC talking about how the rig count bottomed in Dec, which is likely as some work picks back up in Q1’2020. It is hard to see too much growth as E&Ps look to manage portfolios as hedges increased throughout Q4 taking advantage of the rise in crude pricing. The backwardation of the curve steepened as companies looked to buy protection even as the front month ran- so the average hedging price probably averaged around $56-$58. Things have reversed considerably following the recent events with Iran (more on that below), as the fundamentals in oil play out to the downside.

There remains a large amount of marketed spreads (about 500) with many of them sitting idle as only 364 are currently active. Companies such as Patterson (Universal), Keane, BJ Services, Halliburton have a lot of capacity on the sidelines that could get redeployed to a new basin with reduced pricing (hard given current costs) to compete for work, or get scrapped or idled indefinitely. Halliburton has already talked about shifting equipment and manpower down to the Permian, so some of those assets could come back- but some capacity will be retired given the age of some fleets and increase wear and tear due to the rise in proppant and pressure reducing the useful life of assets. This will help keep a lid on U.S. production as exit 2020 falls below exit 2019, but activity will recover enough to keep total 2020 oil production for the year above 2019 oil production of about 12.4M barrels a day. The problem will remain realized prices as the world the demand for heavier crude rises around the world. API Gravity is a term everyone should get more comfortable with as “heavier” crude finds more favor- especially oil that is on the heavy/sweet end of the spectrum. API Gravity is a measure of how heavy or light a petroleum liquid is in comparison to water. China has brought online massive facilities, but many of them are complex requiring a heavier blend of crudes to operate. This has created tightness in some of the global spreads, but as the refined product market struggles under cyclical demand declines and structural oversupply- oil demand faces many headwinds as economic run cuts and extended turnarounds limit refining capacity. Oil pricing was inflated by the geo-political uncertainty (which is fluid but ebbing lower) as Iran faces growing local opposition (bearish crude) and Libyan factions discuss a ceasefire.

Even with some properly timed hedges for U.S. E&Ps, oil growth will face significant headwinds as Russia considers “life after the OPEC+ deal.” E&P companies had an opportunity to hedge some production in the first 6 months of the year at prices ranging between $56-$58 as the backwardation steepened considerably driven by the OPEC meeting and geo-political uncertainty. The above chart highlights where WTI prices went quickly allowing for some “decent” priced hedging in the first half of 2020. Russia has come out saying they are considering life after cuts as you “can’t cut forever,” which is interesting as they actively increase their condensate production. Many will point out that OPEC countries don’t include condensate production in their totals (which is true), so it makes sense for Russia to exclude those figures. On the flip side, it also frees Russia to increase their condensate production considerable as ESPO is expanded and gas is pumped into the Power of Siberia. The additional condensate can be blended into Urals as well to reduce total sulfur content, and increase flow as Ural demand has fallen due to IMO 2020 requirements. It also opens up the opportunity to “classify” something as condensate that doesn’t actually meet the API gravity standards. (We have never seen OPEC+ nations lie… I know!) Typically, Russia consumes all the condensate it produces, but with new wells coming online- Russia is facing a surge in condensate production, and the new OPEC+ quotas allow for expansion away from the eyes of the market. I will discuss in greater detail below on the geo-political situation.

The oversupply in the market will worsen now that China has increased runs across their new state-owned facilities and started pushing more refined product. China tightened the physical oil market as oil flowed in to bring new equipment online. It is important to note that China has also been slowing down the ramp of some facilities, and even at this reduced pace- continue to export a record amount of refined products. In the below chart, it is clear where the new facilities turned on with more coming over the coming months.

This is just a quick example of a facility ramping: “Zhejiang Petrochemical Company Limited continues with the trial runs on the 200,000 b/d Crude 1, 100,000 b/d Residual Hydrotreater, 40,000 b/d FCC Gasoline Hydrotreater, 9,000 b/d Alkylation and 76,000 b/d Reformer 1 at its Grassroot 400,000 b/d Zhoushan (Daishan) Refinery. The units were previously expected to come online by the end of December 2019, however, now plans are to begin commercial production by the end of February, 2020. Meanwhile, a 76,000 b/d VGO Hydrocracker, 52,000 b/d BTX 2 have successfully started up on December 18, 2019, and the 200,000 b/d Crude 2 which started up on May 21, 2019, is currently running around 80% capacity and scheduled to reach full throughput by the end of February, 2020.” “Negotiations for the January paraxylene (PX) Asia Contract Price (ACP) have fallen apart because of a wide bid-offer gap. Japan’s JXTG Nippon Oil & Energy placed its offer at $930/t cfr, while all other sellers offered at $920/t cfr. All the sellers declined to change their offers from initial levels. Bids for the January PX ACP were at $720-770/t cfr. The ACP-linked sellers are JXTG Nippon Oil & Energy, Idemitsu Kosan, SK Global Chemical, S-Oil and ExxonMobil. There are six buyers – OPTC, Capco, Yisheng Petrochemicals, Shenghong Petrochemicals, Mitsui Chemicals and BP. Negotiations for the January benchmark ACP were brought forward to 27 December because of the year-end holidays.” The additional capacity is hitting prices across petrochemicals and refined products on a global level. As margins worsen, the question remains who will be the first to cut runs?

How does this link back to the U.S.? The U.S. typically exports from the Gulf of Mexico into Lat Am and Europe, but with the new wave of products coming out of Asia the whole energy trade flow is adjusting. The new product from China is filling local demand just as other product from South Korea and India is pushed out of Asia and into other areas- such as Europe and Africa. This limits flow from the Middle East into Asia, so pushes more Middle East product into Africa, Europe, and some LatAm demand. So now you have European product that is competing into the LatAm market as well as the East Coast of the U.S. Now that we are back to the coast of the U.S.- where is the place that the product can compete? The U.S. can try to protect market share in LatAm and Europe, but it is getting harder as more refined product is moving around the world at fire sale prices. This has caused a buildup of U.S. product, which is now reverberating back through the system with rising builds in Europe and Asia. It is a key structure that is weighing on crack spreads and pricing as product can’t flow along its normal routes.

The pace of Exports will fall for refined products, but crude exports will recover as demand rises given the increase in shipping rates and the spread widening between Brent and WTI. This will keep exports elevated from the U.S. on a crude level.

To make matters worse, South Korea and China have been focused on a view that others should roll out economic run cuts- so each country has been producing products at unfavorable pricing waiting out the rest of the market. U.S. refinery utilization rates have kicked off the year near the 5-year low from 2016.

The pace of builds will increase on a seasonal level as Martin Luther King Day is the last big travel weekend before we hit the winter lull. This will result in a reduction in utilization rates, which is so far below the average and trending lower. The slowdown in exports has pushed more product into storage and keep crack spreads capped. It is already showing up in time spreads, and will struggle as the flow of product out of China accelerates.

The market is struggling with both a structural change out of Asia, and the cyclical impact of lower demand on a global level. There is a positive view that the China/US Trade deal will unlock more near term demand, but the market is saturated in light/sweet crude, and the trade war still has many steps involved to get back to a “normal” trading relationship. In the near term (aided by seasonal slow downs), WTI should trend lower towards $53, completion crews will shift back to 300, Permian back to 100, and rigs should find some support at these levels.

Geo-political Update

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.

Iran remains a key focal point, and now France/ Germany/ and the UK have triggered the dispute mechanism in the 2015 Joint Comprehensive Plan of Action. This was driven by Iran’s violaton under the agreement terms, and European leaders now have 15 days to resolve their differences or the UN sanctions snap back into place. This would be more of a symbolic gesture as many of the sanctions have already been re-instated, and will find new support given the shoot down of the Ukraine airline and rampant killing of protestors. The protests are ramping against the current regime, and chanting for the end to the current regime (which is punishable by death). This is also coming after about 1500 protestors were killed following the rallies against the rise in fuel prices. These protests occurred throughout Nov and Dec, so the anger against the regime has only been fanned with the death of their enforcer (General Soleimani) and now the killing of innocent Iranian citizens when two missiles destroyed the plane. Below is a follow-up of the Iran response to the U.S. precision strike.

Iran Fires Ballistic Missiles into Iraq as Soleimani is buried in Kerman

Iran officially launched 15 ballistic missiles (NOT ROCKETS!!!!!!!!!) into Iraq striking two Iraqi bases housing both U.S. and coalition troops.

The IRGC launched the following:

  • 10 Fateh 313 missiles at Ain al-Asad (very similar to the Fateh 110 Missile)
  • 5 Qiam-1 at Eribl
    • 3 of them failed in flight
    • 1 was shot down by a US CRAM

All relevant militaries placed assets on high alert in anticipation for a response to the killing of the high-level people listed in my previous report. The high alert allowed equipment to pick-up the launches instantly and take appropriate measures to ensure no loss of life. All personnel were able to take cover, and the sheer size of Ain al-Asad also means a “successful” strike can occur without causalities. A helicopter can be replaced… a runway can be rebuilt… a life is irreplaceable.

The attack was a way to boost morale at home or as it was quipped “funeral fireworks” as the strike was timed with the official burial of Soleimani in his hometown. Iran launched a strike against Iraq assets, as the tit-for-tat continues to take place outside of Iran borders. I mention this because Iranian assets have launched attacks on Iraqi citizens in multiple regions, which has spurred further protests. Here is just one example-“Iraqi protestors attack pro Khamenei Hashd al Shaabi militia building in Dhi Qar, #raq. The fight against Soleimani & Khamenei’s oppression continues.” The U.S. and Iraq government need to send a signal of unity at not tolerating further aggression, but Iraq must go further and focus on expelling the Iranian assets operating within their borders. The U.S. has been moving assets around the region in order to provide air support and a potential response if deemed necessary. The early indications are that the USAF at al-Dhafra (located in the UAE) and Diego Garcia are on high alert (just meaning they can launch aircraft in under 15 mins). The U.S. has moved high value assets F-35s and B-52s to Diego Garcia in order to provide support throughout the region.

It is also worth noting that the Iraq meeting held on expelling the U.S. from their sovereignty could not come to a vote or hold a quorum because all Sunni and Kurdish members held a walk out in protest. This just means that what was “officially” entered into the record books was a non-binding request. So out of 328 people only 170 remained to hear the potential timetable for U.S. withdrawing assets. It is also possible for the U.S. to remain in Iraq within the semi-autonomous region controlled by the Kurds. “The vote, he explained, was a party-line vote by Shia Iran supporters in the parliament. Kurdish and Sunni lawmakers had boycotted the session despite threats from the very same Shia militia that kicked off the current cycle of violence, leading to a barely functioning quorum in the chamber.

Of course, to admit threats of political violence from pro-Iranian militia would undermine the media narrative that the parliament, like the militia mob that attacked our embassy, represents everyday Iraqis. What these pro-Iranian lawmakers passed was no United States ouster, but a non-binding, partisan resolution that the United States should leave. The “quorum,” Abdul-Hussain writes, “was 170 of 328 (half + 4, just like Hezbollah designated a [prime minister] in Lebanese parliament with half + 4).”?”[1]

Iran has stated they will next strike Israel and Dubai if the U.S. responds to the attack, and based on the course of action- the U.S. is within its right to strike Iranian soil since the launches occurred from inside Iran. The launch sites are well documented, as well as other strategic sites that would be of importance. I find it unlikely that the U.S. will launch such a counter due to the ineffective (thankfully) nature of the ballistic missile attack resulting in no causalities. The U.S. may instead take action on Iranian assets and proxies within the Iraq borders, but most of the Iranian populace doesn’t support the current regime and it would be foolish for the U.S. to provide propaganda. Some will point to the funeral procession as saying this is false, but when you close all bases, government buildings, schools, and business and require people to show up- it is easy to show a large “outpouring of support.” I am by no means saying some of these people weren’t vehement supporters- 35 people were killed and others injured as a surge and riot occurred just to touch his coffin. It also shouldn’t be lost on the populace that he was a popular war hero from the Iran- Iraq war as well as a very savvy military strategist and leader. So some may have come out for support, others out of respect for his service in the Iran-Iraq war, and others because they had too. The generational dynamics of the country are clear, and this regime is facing a changing tide at home.

Those in power have been in power since 1979, but the younger generation doesn’t want to live under the thumb of a repressive regime. If we look throughout time, the Persian Empire (Iran) has a long history with Europe, India (other parts of Asia), and throughout the region. The current toxic relationship between Iran and the west is something (if we look at this as measured in generations and not single years) a blip in the long history of cooperation and trade between the two parties. This is coming full circle, and a U.S. response against the populace, holy sites, or important civilian assets would just galvanize the population and delay a conversion back to an open society. Nothing happens overnight- especially generational cycles- but the movements are in place and taking out one of their top assets can help speed the process. Soleimani was responsible for putting down many of the protests throughout Iran, Iraq, and Syria, and is responsible for killing, jailing, torturing, and raping 1,000’s over his reign. The Bush and Obama administrations have always considered him as a viable target, but deemed the ends didn’t justify the means. This has changed over time as protests against the Iranian government have intensified across Iran and Iraq.

An interesting point to be made- Iran carried out a precision attack against Abqaiq, but failed to strike “revenge killings” as they called it. Does this mean the remaining technology isn’t as good as perceived? (Iran has an estimated 2k ballistic missiles) Did they miss on purpose to save face and truly don’t want direct conflict with the U.S.? Was there an inside deal between multiple parties to eliminate Soleimani? Some of these are farfetched and others are plausible, but at the moment- everything points to a limited U.S. response and no escalation at this time. The assumption is additional attacks on Iranian proxies within Iraq, but not a strike on Iranian soil currently. Anything is possible as the whole remains fluid, and we will get more details over the next several days- but things will calm down over the next few hours. It doesn’t mean we tell our USAF to stand down or take anything off of high alert, but it just means this could be an exit ramp for de-escalation. Iran also shot down a Boeing 737 Ukrainian passenger jet carrying 180 people using two anti-missiles crashing near Tehran just after takeoff. The government tried to blame mechanical error and bulldozed the site, but intelligence gathered from the U.S., Europe, and Canada concluded differently.

This forced Iran to admit it’s error, and has enraged the populace launching even bigger protests throughout the country against the regime. Sadly- this wouldn’t be the first time something like this has happened, and just after the attack from Iran- China and U.S. barred passenger jets from flying anywhere near the area.

On the market front, WTI hit a high of $65.65 before turning lower to sit at about $63.63 up about 1.5% from the close today. The S&P futures reached a low of 3181, which was down about 40 handles from the close as gold future briefly spiked to over $1600. The oil markets will hold some risk premium from the initial attack while the rest of it fades into the morning, and if the EIA confirms the API report of a massive product build- oil prices will quick fall. All of this remains negative for refiners across the board, and provides a good time to fade crude. Gold remains a key holding, but timing is everything on re-entry. Even if the risk premium remains, there are many nations (Russia and KSA) that would quickly look to sell into this elevated price environment. There is a significant amount of oil supply available in the world and a massive glut of refined products around the world. The main goal is to take advantage of fear and price dislocation as fundamentals always win out in the commodity/physical world- which can’t be said for the equity markets.

The final point is on the U.S./China trade agreement that is expected to be signed this week in Washington D.C. So far the details emerging are as follows:

  • China will agree to purchase $200 Billion in U.S. goods per year
    • $75 Billion in manufactured goods
    • $50 Billion in energy
    • $40 Billion in farm products
    • Between $35 billion and $40 Billion worth of services

In exchange- the U.S. will lower the 15% tariff on $120 billion in goods imposed earlier last year to 7.5%, and delay imposing the new 25% tariffs that were initially slated to hit in December of 2019. The U.S. also took the symbolic action of removing China as a “currency manipulator”, which has no impact on operations. The deal reverts the standoff between China and the U.S. back to October, and doesn’t even scratch the surface of the real issues of bilateral tensions across IP theft, state support of Chinese firms, IP protection, state- sponsored espionage, and a litany of other bigger issues. The biggest issue for the U.S. will be designating a way to “retaliate” and “measure” if the deal is broken or if things worsen on the bigger issues. There has already been a lot of questions if China could actually absorb that amount of new goods from the U.S. or is this just another Chinese tactic of “appease” with no real desire (or ability) to honor the agreement. China (on a state and corporate level) has always signed deals and blatantly ignored every piece of the terms if they were no longer in China’s favor. They have walked from countless contracts, joint ventures, and other agreements once it no longer suited their needs- regardless of the terms everyone signed on too. The official terms will be key as the devil will be in the details, and the above is purely the “leaked” or “scooped” terms that have been put forth by China and the U.S. Each side will try to pick the details that maximize the spin on why this is a good deal, but the full information will be needed for everyone to decide if this is positive for the market.

Headline risk will remain high across the trade deal as well as Middle East tension. Iran proxies will continue to launch rocket attacks against Iraqi bases that house coalition troops and equipment. As of this writing, a rocket and mortar attack is being carried out on the Taji Military Base North of Baghdad. These attacks will continue to occur throughout the region as Iran attempts to drum up support from their proxies, while they tackle rising domestic turmoil. Headline risk remains high, but the underlying fundamentals demonstrate headwinds for crude and refined product pricing and demand. The goal will be to find the signal in the noise and focus on the underlying market fundamentals.


[1] https://thefederalist.com/2020/01/07/media-coverage-of-iraq-is-a-case-study-of-ignorance-and-manipulation/#.XhVEjROM6JE.twitter

US vs Iran

By Mark Rossano

A follow-up on the Middle East ongoing Conflicts

  • Protests have escalated in both Iran and Iraq- both against the Iranian government and the IRGC (Islamic Revolutionary Guard Corps.)
    • In Iran- protestors are demanding a change in leadership due to squandered funds on proxy wars, poor employment, and a lack of overarching civil liberties.
    • In Iraq- Iraqi Shia’s (predominantly in the southern part of the country) are protesting against the influence of Iran in the Iraq government- as well as many similar social issues.
    • There are many similarities between the two protests, and they all focus on the lack of opportunity due to high unemployment and corruption squandering oil money
  • I mentioned previously: “The key overarching theme is a rise in Middle East tensions, and while the current situations aren’t enough to lead to a broader conflict—the groundwork is being laid.” The issues have been building over the following course with some key escalation points below:
    • Iran used mines to attack a tanker
    • Gibraltar seizes an Iranian oil tanker
    • Iran seizes a British oil tanker
    • Iran shoots down Global Hawk US Drone
    • Iran has infiltrated the Iraqi government blocking operations from within, and is a key reason for Iraqi Shia protests- Iran involvement and corruption
    • Iran targets the Abqaiq-Khurais facility in Saudi Arabi
    • K1 military base in Kirkuk, Iraq comes under rocket fire killing a US Military Contractor and wounding other US Soldiers reportedly carried out by the PMU (Popular Mobilization Units.)
      • There have been other rocket attacks, but until K1 were carried out without loss of life or injury
  • Each of the attacks on US and Iraqi Military Assets were supposed to be investigated by the Iraq government, but has been slowed down by politicians tied to Iran. There was a growing view that Soleimani (and general Iran) assets have important seats in parliament, and have effectively stonewalled investigations.
  • In response to the K1 attack, the US carries out an attack in Iraq and Syria killing about 27 and destroying facilities all believed to be a part of an Iranian proxy called Kata’ib Hezbollah (Kataib Hezbollah).
  • Following this attack, the PMU and Iranian proxies attack the U.S. Embassy in Baghdad requiring the deployment of the Marine Rapid Response Team.
  • The U.S. took the attack on their sovereignty, and escalated it further by targeting a convoy near the Baghdad airport killing:
    •  Qasem Soleimani- Commander (General) of IRGC Qud Forces
    • PMU’s head of PR
    • Senior Hezbollah/ PMU leaders
      • Mohammed Redha al-Jabri, head of protocol of Iraq’s state-sponsored Popular Mobilization Forces
      • deputy head of Al-Hashed, Haj Abu Mahdi al-Muhandis
      • General Hussein Jaafari Naya
      • Colonel Shahroud Muzaffari Niya
      • Major Hadi Tarmi
      • Captain Waheed Zamanian
  • There are also unconfirmed rumors that US Special Forces have raided several buildings of Iraqi PMUs capturing Qais Khazali, leader of Asa’ib Ahl al-Haq & Hadi al-Amiri, former head of IRGC’s Badr Organization in Jadriyah, Baghdad
  • Germany has come out and placed the blame at the feet of Iran (which is a break from previous views held between the US and Iran.)
  • Response from the Cleric Muqtada al-Sadr was a bit different calling on Iran to avoid escalating and continue to criticize the pro-Iran Militia. Al-Sadr has also started talking about resurrecting his Mahdi Army.
  • Information remains fluid, and there is increasing intelligence being reported that Iran’s Soleimani was planning a bigger attack on the U.S. Based on his flight from Lebanon, the people he was traveling with, and actions at the US Embassy- there is reason to believe these were credible.
  • The U.S. has increase the Rapid Response Team in Kuwait with the deployment of 3500 troops as asset movements remain fluid across the area.
  • Impact to oil will be minimal and will fade as headwinds persist across the supply chain- especially in the refined products area.
    • This move will fade as refined product builds continue to rise globally and force economic run cuts.

Iran has been provocative in the region with consistent activity around rocket attacks and mobilizing assets in and around Syria and Iraq. Tensions have been on the rise as protests rip through Iran and Iraq all against the Iranian government, and their involvement in proxy wars spanning across the “Shia Crescent”. The U.S. has shown restraint while dealing with Iran given the fear of galvanizing the local populace against the West. The Iranian people are reaching a tipping point, and the inability of Ali Khamenei to put down the uprising is a telling sign. The IRGC and government have used violent tactics as well as turning off the internet in order to disperse the protestors. They have also taken more aggressive actions against international actors in order to project power and help isolate protestors.

The U.S. killing of so many high-level Shia assets was a calculated risk as many of them have been responsible for deaths throughout Iran, Iraq, and Syria (including US soldiers). There has been talk of “acts-of-war”, but this all took place on Iraqi soil and begs the question why such a high-level Iranian was in Iraq. A key talking point has been Soleimani’s involvement with training counter-terrorism, but the growing concern was his involvement with attacks against U.S. assets (including the embassy) and a potential bigger motive in a coup. The U.S. has tolerated a significant amount of provocation as the focus has shifted into Asia and away from the Middle East. After trillions of dollars spend in Iraq, the U.S. (as outlined below) has been pulling out assets which began in Syria and Kurdistan. As the Iranian’s attacked the KSA facility, it started to adjust the flow of US military back into the region, but with a bigger focus in Saudi Arabia, Kuwait, and Bahrain. As protests raged in Iraq, Iran sent in assets to help “control” the situation which resulted in more deaths and instead enraged people further.

As Peter Zeihan highlights, Qassem Soleimani has been the “fixer” for many of Iranians problems on the battlefield as well in politically sensitive situations. He has put down protests with an iron fist and used his skills as a military leader to carry out highly effective guerrilla attacks and battlefield logistics. The problem was- Iran overplayed its hand with an outright attack on a US Embassy… just look at the Iran Hostage Crisis where US personnel were held hostage for over a year and Benghazi. The attack in Baghadad called in the Rapid Response Team that helped deter things from getting worse, but a message was sent through a very carefully orchestrated attack. The U.S. has clearly been keeping eyes on MANY of Iranian and Iraqi high level personal. The fact so many very senior people were traveling together- highlights the U.S. caught them in a lapse of judgement as they assumed the U.S. would continue its passive nature in the region. The targeted attack means the US (and allies) has some deep intelligence penetration around Iran’s leaders, and is a wake-up call to many of those in the region. The U.S. named the IRCG a foreign terrorist organization in April, which provides legal cover to carry out attacks when provoked. This was a small cover that was widely forgotten about, and is a key reason having that many high level people in one convoy was a very risky endeavor. The only net increase in personnel into the region came after the attacks on KSA, as current troop movements are adjusting balance of man-power across the GCC (Gulf Cooperation Council). [1]

Rym Momtaz in this great thread[2] highlights that Soleimani has been a recruiting tool as his designation as “Iran’s most important military leader.” There was a growing belief that he was untouchable and could move about with ease and carry out Iran’s operations domestically and abroad. Khamenei has now vowed a response, which is possible but will need to be highly calculated because the U.S. has now shown restraint but green-lit the use of deadly force. The U.S. strikes have killed about 27 militia in 5 different locations and a convoy of high value targets. The threat will put all U.S. assets in the region at risk and on high alert, but the reach of Iran is limited given the years of sanctions, low oil prices, and extensive proxy wars.

Israel has been targeting Iranian convoys around Syria to limit the movement of equipment into key Lebanon strong holds where Iran has significant influence. Israel actions will help limit the scope of an attack on U.S. assets in Lebanon and Jordan, but by no means makes it impossible given the embedded nature of Hezbollah on a global level. The new IRGC Quds Force Commander Ismail Qani has now come out to double down on attacking Americans all over the Middle East. While these threats have to be taken seriously, the U.S. human and signal intel is very strong and any movements by Iran will be watched closely for a counterattack.

The drawdown of U.S. assets from the Middle East has adjusted to a relatively stable level with redeployment and adjustments of equipment and manpower around the area. C-17s and ship movements have been active as the pieces of the puzzle are adjusted to provide support to the Rapid Response Teams, counter terrorism Special Forces, and anti-missile defenses. Iran’s ability to close the Strait of Hormuz is now near impossible given the U.S’s willingness to use live fire and not tolerate provocation. If Iran attempts to take action in international waters or shipping lanes- they will be met with decisive action.

In terms of actions, crude should normalize lower as headwinds persist across the space with Russia posting oil production above OPEC+ levels as well as Nigeria. The bigger issue remains the growing glut of refined products on a global level, and this is not something an Iranian action will adjust. Iran has been exporting limited oil, and at the moment, there hasn’t been any real disruption to oil production and exports. The “softest” target for oil disruption would be out of Iraq’s Basrah port. This has a very specific caveat as Iran utilizes shared fields to export into the market (under the Iraq flag) through this area. This means that other areas- specifically in the GCC would be ideal locations, but have seen a heavy increase in defenses since the KSA attack. This limits the scope of a response, but by no means makes one impossible.

As the EIA data confirmed, oil barrels manage to avoid Texas when the tax man comes along to count. This pushes refiners to reduce imports, pull more crude from storage, and make more refined products. The U.S. remains with all time high gasoline in storage, which has pushed product back into Europe by shutting down flow into the US. Builds in Europe have also grown as more product enters from Asia and other markets with limited export markets. China has created short term tightness in the oil market with new imports and a rise in their quota by 10% year over year. The little talked about (but bigger issue on pricing) is the increase in refined product export quotas by 53%. There is an ever increasing amount of refined product looking for a home with very few places able to handle the new flow. Russia is raising its condensate production, and will send more into the market over the coming months just as new facilities become operational- specifically in Guyana. Saudi Arabia has strategically cut light crude pricing into Asia and Europe to try to compete against US exports, so the flow of oil isn’t abating- but as refinery run cuts accelerate demand for oil will fall precipitously as crack spreads are indicating.

The geopolitical situation will remain very fluid, but the U.S. has put itself in a position of strength in the escalation process by playing their hand very well on the geo-political front. Iran has already tried spinning this as an attack on their sovereignty, but it has been rightfully rejected by the locals. These are the same people facing 35% unemployment, social persecution, and a deteriorating quality of life. The Iraq parliament has called a special meeting where they will most likely condemn the violence and say this was an infringement of their nation. While we can play devil’s advocate, it is the host nations responsibility to secure embassies and bases at which international and local soldiers and personnel are stationed. Instead, the government (which has been wildly ineffective- more on that below) has failed to deploy troops or investigate the underlying cause of the rocket attacks. This is due to Iran’s involvement in the government, and how embedded the PMU is within the Iraq military ranks. The PMUs became embedded in the Iraqi military after fighting alongside each other to expel ISIS from the region, and instead of returning to Iran have remained in the country increasing their influence and proliferation. This may seem “frightening” but the Iraqi military (and many locals) aren’t all that happy with the presence of these entities, but lack the ability to expel them from the ranks.

Iran could also respond by increasing their uranium enrichment and going against the JCPOA on missile development and heavy-water reactor. This could be a way of retaliation in a way of saving face, while limiting the escalation process as a direct altercation with the U.S. is out of the question. Iran can also increase their missile deliveries to Palestine, Lebanon, and Yemen to increase attacks on US, Israel, and GCC nations. The overarching problem (highlighted below) is the poor economic condition that Iran finds itself, which really limits its options. Russia is happy to keep Iran involved in Syria, but wants to be sure to limit the reach and scope- so Russia is agnostic to the current situation. Turkey welcomes any weakness from Iran, so they find themselves isolated between Russia, Turkey, the US, and GCC nations. Their only help could come from China, but China has limited ability to step in and delivery any form of aid outside of continuing to purchase crude. China doesn’t have the assets to enforce or project any real strength in the region, and Russia will also look to maintain the upper hand with any of the proxy’s relationships. This leaves Iran isolated as they no longer carry favor in large parts of Iraq, have lost a “war hero” and “marketing tool” hailed as the “most valiant warrior and effective US Challenger, facing major security breaches on their inner most level, economic struggles from sanctions and low oil prices, and protests throughout the country. All of these points will keep the issue regional, with limited contagion in the area until at least the funerals have passed. Iran is very calculating and precise and don’t often make missteps, so there will be some form of saber rattling and retaliation- but the U.S. has taken the upper hand.

Previous updates on the Middle East Conflicts

The Ever-Changing Middle East Landscape:

  • The events in the Middle East won’t push lasting price increases to crude pricing
    • Outside current geo-political impacts —Heavy-light spread will tighten with heavy/sours getting a bid in the market due to both structural and cyclical changes in the market
  • Current Iraq protests will be localized with minimal impact to crude pricing.
  • Contagion of Iraq protests to other regions is unlikely.
  • Iran and the U.S. will remain at odds with little or no chance of an agreement for the foreseeable future (or at least not before elections).
  • An attack on Iran in response to the strike on the Saudi facility will be limited in scope to coastal assets and radar stations to avoid civilian casualties and turning populace views against the West.
  • The U.S. pulling out of Syria will lead to an increase in destabilizing the region as the YPG are extended and won’t be able to effectively stop an expansion of Turkish forces into Northeast Syria. It is unlikely Turkey will make it all the way to Euphrates, but will build a “buffer” zone. If Turkey gets too aggressive, it will unify the Kurds across Syria, Iraq, and potentially, Iran.
    • The Syrian situation (as it stands) will have little to no impact on crude pricing as they aren’t a key player, and the only Turkish asset is the Ceyhan pipeline originating from Kirkurk.
  • The key overarching theme is a rise in Middle East tensions, and while the current situations aren’t enough to lead to a broader conflict—the groundwork is being laid.[3]
  • The events in the Middle East won’t push lasting price increases to crude pricing
    • Outside current geo-political impacts —Heavy-light spread will tighten with heavy/sours getting a bid in the market due to both structural and cyclical changes in the market
  • Current Iraq protests will be localized with minimal impact to crude pricing.
  • Contagion of Iraq protests to other regions is unlikely.
  • Iran and the U.S. will remain at odds with little or no chance of an agreement for the foreseeable future (or at least not before elections).
  • An attack on Iran in response to the strike on the Saudi facility will be limited in scope to coastal assets and radar stations to avoid civilian casualties and turning populace views against the West.
  • The U.S. pulling out of Syria will lead to an increase in destabilizing the region as the YPG are extended and won’t be able to effectively stop an expansion of Turkish forces into Northeast Syria. It is unlikely Turkey will make it all the way to Euphrates, but will build a “buffer” zone. If Turkey gets too aggressive, it will unify the Kurds across Syria, Iraq, and potentially, Iran.
    • The Syrian situation (as it stands) will have little to no impact on crude pricing as they aren’t a key player, and the only Turkish asset is the Ceyhan pipeline originating from Kirkurk.
  • The key overarching theme is a rise in Middle East tensions, and while the current situations aren’t enough to lead to a broader conflict—the groundwork is being laid.

U.S. Company Impact Based on Current Events

The current Middle East situation won’t impact U.S. companies at the moment given the limited scope and minimal impact on supply. The demand problem on a global level is an increasing problem, which is now made worse by sanctions placed on Cosco- China Ocean Shipping Company Limited. The blacklisting of about 100 oil carrying vessels was in retaliation for transporting Iranian crude. By limiting the availability of ships, the cost to transport oil has nearly tripled across the globe- with the most recent news: “OC and HPCL book VLCCs from West Africa to India at costs of $9.5m or more, nearly triple the rate a month ago, amid widespread gains in crude shipping rates. Vitol offers Forcados on Platts window.” The fact that U.S. crude has to travel further to Asia will inherently lead to a higher cost given available vessels, which will put pressure on realized prices and spreads. In fact, rates to move crude is so high refined product tankers (clean tankers) are moving crude. This will persist as the market capitalizes on the shortage created by the Office of Foreign Assets Control’s (OFAC).

The IOCs and majors will be able to offset some of these costs by leveraging supply chain economics and reducing expenses throughout the process, but the smaller E&Ps are selling crude into a market that is experiencing rising costs (shipping) and reduced demand (crude quality, economic heads, seasonality). Some spreads are stronger in the physical market driven by location and quality of available shipments, which will persist in the market. This opens up opportunity for majors that have a broad exposure to various locations and crude qualities-especially the ones that control their own shipping fleet. The fact companies are shifting refined product tankers to move crude will also lead to tightness in the movement of products. This helps to drive home the fact—even though the U.S. is shifting around military assets, there remains a laser focus on economic impacts through sanctions on hydrocarbons and ships hitting both Iran and China.

Outside of the shipping impact, the Middle East situation won’t drive up U.S. prices as any supply disruptions will be short-lived and small in scale. While the shifts at the moment are relatively small, the area is become less stable with rising tension between Sunni and Shia factions, which is being expressed between countries and within borders. This risk helps to support U.S. flows over the long-term given the inherent stability of the U.S. infrastructure and business operations. The winners will remain the companies that are vertically integrated, while SMID cap companies will struggle to compete against larger entities with balance sheets and international cash flow. The ability for companies like- Exxon, Noble, Chevron, and BP, to extract value from abroad and funnel into operations within the U.S. and manage the process from the well-head to the dock/refiner provides valuable upside. The limited scope of Iraq disruption won’t materially impact U.S. E&P and oilfield service companies doing business in the region. The need for expertise, equipment, and continuity will also protect assets from sabotage at the moment, but these situations will consistently be monitored. The political situation will remain fluid globally driven by economic impacts, seasonality, and shifting geo-politics- so stay tuned and more below on the current Middle East problems (just naming a few).

The U.S. is in the process of shifting assets within the Kurdish (YPG: People’s Protection Unit) held locations, which make up the largest contingent of the SDF (Syrian Democratic Forces). This comes at a precarious time as tensions are rising throughout the Middle East. Turkish President Erdogan has been pushing for a safe zone that runs 20 miles deep and 300 miles along the Turkish-Syrian border east of the Euphrates.[4] Erdogan wants to place 3 million Syrian refugees back into northern Syria, which is about 75% of the current refugees believed to be in Turkey. There have been tension at the border between Turkey and Syria, with Turkish border police firing warning shots as the border remains closed and guarded by about 500 miles of fence. The area where Turkey and Free Syrian Army forces reside in Afrin has been inundated with refugees that are stretching the economic limit of the area.

I have said for several years that as ISIS falls, loose allies would turn weapons on each other as the battle for land and resources push armed groups to battle each other. President Erdogan has always had the desire to acquire land to re-establish pieces of the Ottoman Empire. This comes at a time where Russia, Iran, and al-Assad (Syrian Forces) continue to launch questionable attacks on civilians. The lack of civilian protection has driven refugees to the Turkish border incentivizing or supporting a potential need for a “safe zone”. The Kurds have done a lot to maintain control of the area, while maintaining and securing ISIS detention facilities throughout their controlled areas. The ability to properly guard these areas has already been strained, and the removal of U.S. assets could complicate the situation, especially if the Kurds (People’s Protection Units) are forced to defend against Turkey without support. Turkey has already launched initial strikes against ammunition depots targeting anti-aircraft equipment, and the Kurds currently have little help from the outside world limiting their ability to strike back. The question remains open—would Turkey and Russia join forces to carry out strikes against Kurdish held regions? Could this re-ignite a broader Syrian Civil War? The short answer is: Turkey will go at it alone in the near term, and this won’t re-ignite the Civil war at the outset.

Iran would face recourse within its own borders if they launched an offensive attack against the Kurdish populace, but the current issues will bleed over into Iraq, who is currently facing its own upheaval. The vote for Kurdistan was cut short as Iraq (and some Iran assets) moved into Northern Iraq (where most Kurds reside in Iraq) to squash the movement of freedom. The U.S. did nothing to stop these proceedings, and the same is being carried out in Northern Syria with the U.S. offering limited to no support. The Kurds have been the most effective fighting force against ISIS, and were key allies to the U.S. in its destruction—and now with a claim of “mission accomplished,” the U.S. is leaving a power vacuum that will be filled with warfare along tribal lines influenced by the whims of Russia. It is unlikely Turkey would look to fight all the way down to the Euphrates, but they will look to establish a buffer zone along their border—under the guise of creating a cushion zone. The interesting component will be if there is any movement from Iraqi Kurds into Syria, or will it be deemed a lost cause since the Kurdistan vote was split based on specific Kurdish party affiliation.

The Syrian announcement comes on the back of rising protests and violence throughout Iraq, driven by the poor economic conditions for large parts of the populace. The main grievance of protestors surrounds rampant corruption and nepotism with a failure of the government to increase economic and social services to allow jobs and oil revenue to reach all citizens of Iraq. There doesn’t appear to be one distinct leader in the protests as they continue to rip through multiple cities: Baghdad, as well as other areas in the center and south. Iraqi security forces have so far killed about 40 protesters (as of Oct 4th) with numbers expected to be closer to 100, with hundreds injured. Iraq’s parliament has tried to slow the spread of protests by promising reform. Iraqi Prime Minister Adel Abdul-Madi promised a new stipend program to poor families as well as the firing of about a thousand government employees accused of corruption. This has done little to quell the protests, as these comments and promises have been common and fleeting over the last several years.

The Shia cleric Grand Ayatollah Ali al-Sistani has condemn the use of violence, with the Shia leader Muqtada al-Sadr’s Sairoon taking it a step further and proposing his bloc will stop participating in parliament until the current government leadership resigns. The situation could spiral quickly as the split of Sunni and Shia in Iraq is about 42% to 51% respectively, with some putting the spread a bit wider. The failure of a Shia government without a quick adjustment could spring up in-fighting along religious lines making things worse. On the other hand (and more likely), this could provide an opportunity to replace Adil Abdul Mahdi in Iraq by taking advantage of the upheaval. There is always concern that Saudi Arabia is planting discontent to stir up the Sunni populace and put pressure on the Shia dominated government. Based on current reports, there hasn’t been a great deal of outside influence to the protests that appear to be more “grassroot” oriented. As I mentioned earlier, protests aren’t new to Iraq, but these are different given size and scale. The Shia Popular Mobilization Units could gain political favor as they have abstained from putting down protests and kept relatively close ties to Iran. At the moment, Iraq protests remain localized with limited wide-scale impact.

The current impact to oil will be minimal throughout Iraq as any party understands that oil revenue is paramount to maintaining peace/unity in the region. There may be disruptions as some protests take place near oil fields or, more importantly, export hubs (such as Basrah). The current protests won’t be enough to keep a premium in the oil markets as demand remains the core concern. The broad economic slow-down will be further impacted by seasonality as refiners enter their fall maintenance season. Protests will continue throughout the southern region, and the below map highlights the country’s oil regions and pipeline networks that could be impacted.

Even if ISIS or other terrorist groups look to take advantage of the situation in Iraq, it is unlikely anyone would destroy equipment, as ISIS appreciated the importance of oil infrastructure as a means of revenue. In an attempt to create more chaos, there could be some damage to infrastructure, but most would be small in scale and quickly fixed by each faction jockeying for control. The lack of formality and leadership in the protests will (at least for now) keep them from spreading or becoming more than just a disruption and display of broader displeasure. In the near term, this doesn’t seem to be the beginning of broader civil unrest turning into a civil war, but rather a move to highlight the poor economic condition of many regions. It should be of no surprise that as oil prices remain depressed, oil-based economies will see a rise in unemployment and cuts to social funding driving further unrest. Iraq won’t be the only spot to see a rise in tensions.

Iran is a perfect example of a place that has seen growing animosity as the populace failed to see the benefits of the Iran Nuclear Deal. This has led to a rise in tensions internally as the additional revenue didn’t translate into local jobs and economic uplift. There is no near-term solution to the Iran deal as the U.S. looks to put pressure on the government and The Iranian Revolutionary Guard to drive a regime change. The problem is, the 15% (or so) that support the government are also the individuals that control large parts of the military and local funding. This will limit any effective protests or civil unrest while the U.S. looks to pressure Iran. At the same time, this will restrict the U.S. military’s ability to strike targets within Iran as to limit civilian casualties and avoid turning popular opinion against the U.S. and the West in general. The populace (for the most part) has shifted their anger away from the West and focused it more on the current regime, so the goal is to apply maximum pain while limiting shifting local demand. The frequency of protests has risen in Iran, but the inability to create a cohesive unit— based on crackdowns and limited resources —will keep protests from really creating a regime adjustment.

The only thing that will allow for a new deal (outside of regime change) would be the limit and discontinued use of ballistic missiles by Iran. This was a key issue with the previous agreement, as it failed to limit the development, use, and delivery systems of ballistic missiles. The current Iran government is unwilling to even consider this as an option, which will keep sanctions in place. The limit of heavy crude in the market will keep the trade for Iran crude flowing at volumes ranging from 500k to 1M barrels per day, which the U.S. has (for the most part) turned a blind eye to. The U.S. ignores some of these barrels, as they fulfill a need for heavy sour crudes in key allied interests across South East Asia and limits some of the price premium in the open market that would impact U.S. purchases. Iran has also effectively moved crude through Iraq pipes from shared fields, with kickbacks flowing to Iran. This is a well known (but mostly ignored) part of the increase in Iraqi exports, but the shortage of heavy crude in the market has kept exports flowing. The below chart highlights the spread in Basrah vs Brent, where a large part of Iran crude finds its way to the market:

The spread of protests from Iraq to Iran will be tough as the Iranian government has much more control across the populace (though this will rapidly change as generational cycles hit Iran). As those in charge are aging and will struggle to hold on to control, the Iranian Revolutionary Guard allegiance can be bought to the highest bidder. We are still several years away from having meaningful change, but with many of those still currently in power from 1979, the generational cycle will provide a shake-up. The hope (or so it seems) by President Trump was to accelerate the adjustment, but that is highly unlikely. Iran will have to tread lightly with Syria (as they have their own Kurdish population that is already unhappy with the Iranian government), as well as Iraqi unrest in areas such as Basrah spreading. Given the lack of leadership of the Iraq protests, the spread in Iran is unlikely and anything that pops up would be fleeting.

Crude pricing will fade as refined product movements continue to fall below 5-year averages as demand wanes and refiners hit their maintenance season. The Iraq protests will remain localized given their lack of cohesive leadership, and may cause disruptions in crude exports, but not long-term outages. This will be something to watch, but nothing to be concerned about in the near term. The Iran sanctions will remain in place, with little movement between both sides—U.S./ Iran—given entrenched positions and the limit for U.S. to give ground in trade negations. The spread between heavy and light sweet crude will continue to collapse with heavy crude experiencing growing tightness. As Fernando Valle from Bloomberg has highlighted, Mexico and Venezuela are in terminal decline, with Mexico’s fields deteriorating exponentially due to age and underinvestment, while Venezuela is impacted by sanctions and mis-appropriation of funds driving the production decline. Venezuela could see production rise with proper investment and management, while Mexico has a long-term issue on source rock. Iran could bring production online relatively quickly if a U.S. deal is finalized, but there is global apprehension of investing within Iran as the global economy worsens. This means Iran could get back to 3.7M barrels from its current 500k-1M. Growth past 3.7M will be hard to achieve within 2-3 years of lifting sanctions based on the hesitancy of investment. For example, China has reportedly pulled a $5B investment in Iran due to sanctions, and the U.S. sent a message by sanctioning Cosco—a Chinese shipping company that shipped sanctioned crude—sending dayrates to 15 month highs and rising.

The Syrian situation between Turkey and the Kurds will remain fluid, but has little impact on crude given the location. If the Iraqi Kurdish population gets involved, it could cause some disruption, but the Iraqis need the cash flow through the Ceyhan pipeline that flows through Turkey. The U.S. has already said they wouldn’t stand in the way of Turkish military actions, and current reports say the Turkish airforce has destroyed a military depot with anti-aircraft weapons. The issues will be localized to Syria with limited impact to oil production and exports. The bigger problems will be actions taken against Iran for the Saudi Arabia attack. The loss and recovery of Saudi Arabia flow highlights the resilience of their underlying system, but also the glut of light crude that sits in the market.

The bigger impact could come from further loss of heavy crude in the market, which will be made worse by policy changes, such as IMO 2020. The International Maritime Organization adjustment to bunker fuel burned in ships will have impacts across diesel (ULSD/HSD), gasoline, and octane. Crude pricing remains capped to the upside due to worsening economic data, U.S./China trade deal (that won’t happen for a long time), and seasonality. This will keep a lid on Brent and WTI prices, but the changing blends and needs in the broader market will keep a persistent spread between Brent and WTI and tightness in heavy vs light. The spread between Brent and WTI will widen as shipping costs continue to move higher, as about 100 vessels were sanctioned by the U.S. The political situation across the Middle East is always fluid, but their remains growing tension across the region with any one specific move enough to create a broader conflict. Several years of weak oil prices has eaten away at cash reserves, and tempers (both internally and externally) are beginning to flare in response. A quick removal of U.S. forces could be disastrous as local assets are already stressed in Syria leaving the area vulnerable, and the lack of U.S. commentary/control in Iraq could destabilize the entire region. While all of these components impact supply, crude flows continue to rise from non-OPEC regions as the global slow-down intensifies. Cyclical pricing mixed with a structurally changing world won’t end peacefully.

Previous comments on the Saudi Attack

What the Abqaiq impact will be to the market?- Crude Quality Matters!

In the near term, crude pricing will jump in response to a shortfall in the market ($3-$4 will stay in the price after the dust settles). The $3-$4 represents the new political risk that will linger even after operations come to a normalized level globally. The spike in pricing could rise to as much as $10 depending on longevity of the downtime- but that move would be short lived. Saudi Arabia will be able to take some actions to keep oil flowing into the market: 1) Draw down from reserves to fill sold volumes; 2) reduce refinery runs (import refined products) while selling into the market; 3) cut petchem facilities utilization rates. The loss of natural gas production from the facility will require an increase of refined product burn in the power generation market, which can be found in the floating market. KSA can sell from near term storage of 50M -60M barrels, so near term disruption to supply is unlikely- but it will drive prices higher immediately due to political risk and potential extended supply risk. The country and Saudi Aramco has global storage of about 175M barrels with “quick” access to about 50M. The complex (containing 3 separate facilities within it), Abqaiq, has the capacity to process 7M barrels of oil per day of Arabian Light (32.8 API and 1.97% Sulfur) and Arabian Extra Light (API 39.4 and 1.09% Sulfur). “The Abqaiq Plants facility handles crude pumped from the Ghawar field. It is linked to the Shaybah oil field through a 395-mile pipeline and to the export terminal in Yanbu through a natural gas liquid pipeline.” The facility can also produce Arab Super Light (51 API and .09 Sulfur). The crude in the region, while sweet, has a lot of sulfur that requires processing through hydro-desulfurization units. If any of these units are lost (there are 18 in the complex)- it would cause a bigger issue in terms of crude quality. This could result in prolonged downtime if enough of the assets were damaged/destroyed but the complex has many of these assets on the premise. The lost production can be replaced by U.S., West African (Nigeria and Angola), ESPO/Urals (Russian), and Brazilian grades. There are others- but these are the most widely available flow, and many of them have spare capacity. As early as 10 days ago- Angola had 13 October shipments and Nigeria has had about 3 deferred shipments. Russia has doubled ESPO production to about 700k barrels a day as Brazil has ramped production from the coast. The below chart highlights some grades that can find additional demand in the near term- or whatever KSA can’t cover through their storage network. The problem will be logistics in the near term as many replacement barrels are in places further from the end users and will get tighter as volume is quickly purchased to make up the difference. In the near term, Nigeria, Angola, U.S., and Russia have spare cargoes to put into the market, but a prolonged disruption (over 30 days) will cause tightness in the market. As we enter shoulder season, the demand for oil always wanes as refiners enter maintenance season- which means that the loss of KSA supply technically won’t be as impactful as the call on oil producing nations always shifts lower in the shoulder months (fall and spring). “The Abqaiq Plants facility comprises three primary processing units – an oil processing unit, an NGL facility and a utilities unit. The oil processing unit consists of multiple spheroids and 18 stabilizer columns where hydrogen sulphide and light hydrocarbons are removed from the crude oil. The NGL facility contains eight compression trains, stripper columns and de-ethaniser column. The utilities unit supplies power, steam, treated water and instrument air to the oil and NGL facilities. The power needed by the facility is generated by six power generators – three steam turbines and three combustion gas turbine generators. Steam generated by 14 boilers is supplied to the oil processing unit, NGL facility, turbines and compressors. 1” The timing of the reactivation will depend on the type of equipment impacted, and some key assets were struck extending total downtime. The complex is built with triple redundancies with assets both above and below ground. The precision of the attack points to a coordinated effort with an understanding of refining/processing and the facility. The strike took out several of the desulfurization towers and spheroid storage tanks. The facility has many desulfurization units so that impact won’t be as widely impacted. The problem is- the storage tanks are required to stabilize/ process the crude (remove the light ends and impurities.) This means that even though the stabilizers were left relatively untouched- they will struggle to operate with no place to put the removed products (resulting in an extended downtime). KSA has redundancies to shift flow into unaffected storage tanks, other facilities, or by flaring some products. This will prolong downtime as the tanks are replaced, and due to the nature of their contents it will be an arduous process. By extending the repair time, this will keep a minimum of 1M barrels out of the market for an extended period. The fire will always look worse as when a facility is struck with that kind of attack (fire) protocol will shut down many of the valves (automatically to contain the fire) and to initiate flaring (burn anything being processed) to keep equipment from exploding from improper pressure/ cracking. This creates an “all-stop” in order to allow personnel to assess all the damage and begin making repairs. The equipment and redundancies will be turned on in a ramp up fashion to ensure the integrity of the equipment- for example- a high pressure line that is cracked and leaking fluid near an ignition source would be problematic to say the least. This is why many of the reports say “by Monday” because it will take several days to assess damages and adjust the flow of product to avoid damaged assets. There is a high likelihood there will be lost production of 2m barrels (including NGLs) and not the full 5.8M that is currently offline. The 3.8M or so barrels will be processed through their redundancies while the rest of the facility is fixed (which could take months) Depending on severity- I would assume the full 75% is operational within 30 days. In the meantime, Kuwait/UAE will bring on a spare 1M barrels while KSA activates idled capacity or parts of their oil complex that consists of their spare capacity. The bigger issue is what does this do to crude pricing. Based on the reports regarding the severity of the damage, about half of the production will be out of the market for an extended period of time. This will put the floor of crude pricing at a minimum of $3 uplift across the curve even after other areas, such as Kuwait/ UAE bring on spare capacity of about 1M barrels. The crude market will respond with a quick $3-$4 move based on geo-political/ military escalation risk. This will stay in the market as the damage is processed, and next steps are evaluated in retaliation. The impact to supply (if more severe) will peak at about $10- if we assume the whole facility is offline for 30 days (highly unlikely). The market is very long NGLs- so that can easily be replaced given current volumes and pricing, and the light/sweet market is also well supplied. The problem will be the loss (if any) desulfurization units as the world prepares for IMO2020. There is also a plethora of light crude available in the market- so this event will help absorb some of these spare cargoes (from Angola, Nigeria, and U.S. specifically). The U.S. has also seen their crude purchase slow as the flow stuck off the coast of China has been moved into India and South Korea- keeping them well supplied in light/sweet through the end of Oct. The extent of the facilities damage will keep about 25% of its volume out of the market. The attack on the facility most likely originated in Iraq, Basrah based on location and early reports (still the most reliable versus the Houthi nonsense). The ability to go about 1,000Km over Saudi Arabia to strike the facility with 10 drones (cruise missiles/drones) seems highly unlikely. The Abqaiq facility is close to the Persian Gulf, and would be more susceptible to an attack launched from the Gulf vs over land. The Yemen originated missiles have proven to be unsophisticated and haven’t had the ability to reach 1) that deep into KSA territory 2) deliver the kind of precision impact. The bigger question is- how did Iran (or some other entity) find the ability to strike the lifeblood to Saudi  https://www.hydrocarbons-technology.com/projects/abqaiq-aramco/ Arabia’s crude flow. If we assume KSA has the ability to pump 12.4M barrels at peak- the complex handles 7M barrels of it. This means the facility (given the location) would have multiple lines of defense regarding anti-missile/ aircraft and personnel implementations. This facility should have multiple levels of defenses especially since it was targeted in 2006 in a failed terrorist attack. I have attempted to highlight the escalating tensions throughout the world, and as the global economy slowscertain countries/regions will be worse off than others. This will lead to rising tensions and conflicts that will flare up. The bigger question will be- is this event big enough to pull everyone into a bigger conflict. Throughout history, many major wars were caused by a series of events that culminated in a broadening military action. This action also comes at a time when global GDP is struggling and a crude price shock would be detrimental for emerging markets. The US Dollar strength has already impacted countries, and now a price spike would cause more pain as additional foreign reserves are needed to keep oil and refined products flowing. On a global level, a weak economy, elevated crude pricing, and strong dollar is going to stress emerging countries and struggling markets. This is going to intensify the need to act in a way to stabilize the slide of economic growth, and given the failures of QE and Central Bank Easing- escalation of tensions will only continue to rise. The fact the attack happened now and not in July is crucial as we are currently entering refinery maintenance season, which will reduce the call on the global oil market. This will limit the upside of crude pricing, but an extensive downtime that enters into winter will drive up prices further. The focus should be further down the curve- 3 to 5 month contracts as the extent of the damage will prolong cargos. I think we are the precipice of a broadening conflict timing remains uncertain- but at the moment: buy crude and U.S. integrated/ high quality E&Ps/ and Petrobras.


[1] https://us11.campaign-archive.com/?u=de2bc41f8324e6955ef65e0c9&id=a8d843ea82

[2] https://twitter.com/RymMomtaz/status/1213045609281789952

[3] https://www.aljazeera.com/indepth/interactive/2015/05/syria-country-divided-150529144229467.html

[4] https://www.nytimes.com/2019/10/07/us/politics/trump-turkey-syria.html

PRIMARY VISION INSIGHTS MONDAY 16 December, 2019

By Mark Rossano

Domestic

The frac spread count resumed its downward trend with the national forecast coming in at 335 vs 340 last week. The trend remains on a lower path led by the Permian with the only sustained increase being the Mid-Con. Most regions have remained relatively flat with small gains over the last few weeks in the Utica, Mid-Con, and Eagle Ford while the Permian has declined each week. The OPEC+ decision (more on that below) will do little to stem the slide into year-end. Proppant loadings currently sit at 5 year lows, with little indication these will rise into year end. The WTI curve helps to highlight the OPEC+ comments on production have done little to adjust the back months, which also comes under pressure as any price increase is being used to hedge U.S. production. OPEC+ delivered a gift by allowing for better placed hedges, but the issues remain consistent with a slowing global economy and struggling crack spreads.

The below chart helps to drive home the very methodical move lower beginning in June of this year. Activity will keep following a similar trend, but will see some uplift in 2020 as budgets are renewed and hedges help protect some completions. The DUC count remains on a downward path as rigs continue to roll-off with little to stop the decline in the near term.

National Frac Spread Seasonally Adjusted

The proppant data shift in the Permian supports the decline in completion crews, and shows the extent of the slow-down. The fact that completion crews in the area continue to be released means the proppant loadings will shift lower into year-end. This will keep pressure on pricing and remain a headwind well into the middle of next year.

Permian Proppant Seasonally Adjusted

The WTI crude curve helps to highlight that supply increases and soft demand remain a problem across the next several years. The curve is far from predictive, but helps U.S. E&P companies hedge production- and after the OPEC meeting- they were able to lock in slightly better pricing.

These are the kind of activities that will keep U.S. production sticky at 13M barrels a day with exports rising driven by new infrastructure and limited U.S. demand. U.S. refiners can only handle a so much light sweet crude, which means a large portion of the oil is sent into the global market. The fact that Russia (and Nigeria) has now excluded condensate from the new OPEC+ “cuts” will allow more light-oil to enter the market and compete directly with U.S. exports. This is complicated further as chemical and refining assets facing terrible margins begin to roll-out economic run cuts.

WTI Crude Curve

As crude prices rise, it puts more pressure on refining and chemical margins unless they can pass along price increases to cover the increase in feedstock costs. Based on the declining demand in the global market, there will be little chance of an adjustment in the downstream market. Instead, margins will come under more pressure, which will put additional downside risk on oil demand as economic run cuts reduce the oil throughput. Gasoline margins have been negative for close to six month, which means that distillate has been carrying the crack but as economies struggle it has put pressure on the distillate crack. It has been balancing on razor thin margins, which have started to fall into negative territory.

Pressure is mounting on chemical plants as well for similar reasons, but new facilities continue to be brought online and many are now coming back from maintenance. So while the price spike on paper looks good, it will speed up the downstream nightmare while market share is lost and alternatives are adopted.

The most recent data on China helps to highlight the shift in their market, and the current accounts problem developing in their system as imports rise and exports decline limiting their access to U.S. dollars. Many of the margin issues across Asia all began as the two major Chinese refiners became operational as more product was pushed into the market.

The construction of world scale refining and chemical assets has flipped trading lanes as more refined products are exported. China used to be the buyer of last resort, but as the construction of advanced industrial assets are completed products are being pushed back into the open market. This is reducing margins and creating oversupply across many products in different parts of the world. China’s reasons to maintain production is two-fold:

  1. Become self-sufficient in products with a higher margin in the hydro-carbon chain
  2. Export products with elevated global pricing
  3. Employee large groups of highly trained individuals.

The last point is key, because in an oversupplied market many facilities will initiate “economic run cuts” which just means a facility will operate below their normal seasonal utilization rate. This helps to reduce the oversupply in the market and product margin. The view in China is “others” can cut, and they have already been operating at negative margins in order to force competitors to lower rates. The fact Chinese industries historically operate outside of normal economic theory will put increasing pressure on the refining and chemical space. “I think globally it’s increasingly a competitive environment for road fuels. China is already a net exporter of over 1mn b/d combined of gasoline, diesel, and jet. It’s the fastest-growing exporter of those fuels in the world. But over-supply is also percolating through into the seaborne market: Indian diesel exports are rising; everyone is trying to desperately seek out net short regions and they’re having to ship product further and further overseas. And we’re seeing a situation emerge now in China where these refineries are importing crude perhaps from Latin America and they’re exporting finished products to those same markets from which they took the crude. It’s a tricky arbitrage, one would imagine.”[1]

The OPEC Cut That Never Happened

So as this all plays out- it will be interesting to see if OPEC+ remains steady in their projections.

OPEC has “officially” highlighted what we have known all along… the slow down in demand. The bigger picture will be outlined in a coming write-up of Asia oversupply and declining demand. The “new” cuts are set off the baseline of Oct 31st, 2018. So lets clarify- what was OPEC and Russia doing on Oct 2018. In order to keep things consistent, I will use the self-reported numbers from OPEC nations. In 2018, OPEC was producing 33.1M barrels a day (and other sources like Energy Intelligence has it at 32.2M). The initial cut of 1.2M was supposed to reduce production within OPEC by 800k barrels with Russia cutting by 280k barrels. This means OPEC was set to reduce production to 32.3M barrels a day, and if we are kind and say no one cheated it brings us closer to 31.9M barrels even. So now we are ADDING 500k barrels a day in cuts, which takes OPEC (assuming they take all the cuts) down to 31.4M barrels a day. As of Nov 2019, OPEC is producing 29.7M barrels a day- so the “new” cut actually locks in something that is ABOVE current production levels. In order to offset it further, Saudi Arabia has pledged to keep the voluntary cuts of 400k barrels per day. This brings the total from 31.4M down to 31M, while OPEC is pumping at 29.7M barrels a day. The issue remains cheating because Saudi has said they will only maintain the additional 400k barrels a day as long as everyone stops cheating.

The biggest cheaters have been Iraq and Nigeria, which have pledged to adjust their production to meet the new targets. The below chart puts into context what the difference was between all the countries. Something I have highlighted in the past, the only reason the OPEC+ “cuts” had any semblance of a benefit was driven by sanctions on Venezuela and Iran. The “new cuts” haven’t even gone into effect yet and Russia/Nigeria are discussing why the numbers were “wrong,” and how adjustments to condensate will keep them in compliance while still pumping at higher levels. OPEC normally excludes the production of condensate, which is something Nigeria is looking to capitalize on by claiming Egina is not oil. Nigeria is producing about 2.2M barrels a day, with about 1.8M being considered oil. Condensate is typically an API level ranging from 45 to 70, which makes this next quote very interesting: “Country is testing Egina production in the market until end of the year; testing includes classification of Egina output as crude or condensate; “our partners are optimistic that Egina oil will fall into the condensate category”. NOTE: Egina has API gravity of 27.3 degrees, low sulfur content of 0.165%, according to Total.”

Egina started production last year, and produces about 200k barrels a day- which would be taken away from their “oil” quota and would put them in compliance with the cuts while not reducing anything. By Russia excluding condensate, the ESPO pipeline increase from 1.2M to 1.6M can be excluded from their calculation as it is being classified differently. With East Siberia ramping and gas fields increasing to fill the Power of Siberia, the amount of condensate from Russia is expected to grow by about 1M barrels a day.

OPEC Production 2019 vs 2018

Now lets shift to Russia, which was pumping 11.5M barrels a day in Oct 2018. They were supposed to reduce by 280k barrels down to 11.22M barrels a day. This total was only hit ONE TIME in 2019, and it was caused by production halts from a pipeline with the wrong specified crude shutting in 1.1M barrels a day. Even if Russia is required to take 100k barrels of the “New” 500K cut- it would just put them right back where they should be.

Russia Oil Production

Iraq is an interesting situation as protests escalate across the country, and led to the resignation of the Prime Minister and a shake-up within the government. The issue remains unemployment, lack of social welfare programs, and an end to Iranian influence. The fact that the protestors in Iraq are protesting Shia’s (and not Sunni’s) against the involvement of Iran in the local government. The protests have resulted in hundreds of deaths, the burning down of Iran consulates, and unrest throughout Southern Iraq. The shortage of cash in the country has been helped by pumping over their allotment, which has brought additional cash into the government. Iran also uses the shared fields as a way to get oil in the market under the Iraqi flag and receive kickbacks. The Iraq Oil Minister, Jabbar Alluaibi stated that Kurdistan has reduced production to come into compliance with production targets. The issue remains the shortfall of cash in Iraq, and if they are willing to remain compliant in the hopes of displacing the lost volume with additional revenue per barrel. The new restrictions will also put pressure on Iran getting paid from oil removed from shared fields, and could very well be a backhand way of tightening the screws on Iranian financials.

The country has been facing mounting pressure along the same lines as Iraq in regards to political pressure driven by unemployment and anger over corruption. These problems remain localized, but the aggressive handling of protestors is only spurring more resentment and calls for addressing rampant corruption in both countries.

The new numbers are just laughable because it also requires “no more cheating” in order for it to work. The one thing we can all agree on- cheaters are going to cheat. Iraq and Nigeria have consistently been over their allotment from 150k to 250k barrels every single month. The same can be said about Russia, leaving Saudi Arabia stuck carrying the lion share of the cuts. Saudi Arabia has also been producing BELOW their allotment, and in the “new” cuts they still have the ability to produce 10M barrels a day. The bigger issue remains demand of refined products, and as I have been stressing- it is all down across the board. Lets look at just U.S. crack spreads in order to drive home the issues.

The new structure of allowing condensate to be excluded in the production cuts brings a new twist to the “cut” as it provides Russia the ability to produce an additional 400k barrels, Nigeria 300k from Abo and Akpo, as well as from Oman, Kazakhstan, and GCC nations. The freedom to pump and classify things as condensate will help countries skirt production cuts.  Some other key developments from the recent news cycle:

  1. It is dependent on countries NO LONGER cheating and we know- “cheaters gonna cheat.” Saudi Arabia has leveled a threat that if people keep cheating they will pump at levels to crush competitors.
  2. Saudi Arabia has now priced their IPO at $8.53 at the top of the range: “The shares have been priced at 32 riyals ($8.53), with a formal announcement expected later on Thursday, according to the news agency. This means it is set to raise $25.6 billion and will likely beat Alibaba to be the world’s largest ever stock market flotation.”
  3. Brazil has formally declined to join OPEC allowing them to grow without any limitation to cuts.
  4. Russia is bringing on new gas fields, and is focused on exporting the new flow of condensate which will put pressure on prices and drive North American ethylene margins even lower.

The issues remain global as the “deal” leaves crude flowing unchanged with growth rising across Non-OPEC entities, and more condensate getting pushed into the market from OPEC+ nations. Russia has brought on new fields to supply gas as well as new oil fields in East Siberia. The growth can be seen in total as Russia has gained about 1.5M barrels a day of production (even with the cuts) while Saudi Arabia has lost anywhere from 250k-500k.

Here is an article for the refresher: https://www.spglobal.com/platts/en/market-insights/latest-news/oil/030618-russia-to-target-fading-urals-crude-oil-quality-in-2018

A Proxy for HollyFrontier’s Margin

A Proxy for Valero’s Margin on the Gulf Coast

A Proxy for Valero’s Margin on the West Coast

Refiner margins will remain under significant pressure as issues persist in the market of falling demand and slowing exports from the U.S. Crack spreads across the world remain depressed, and it is leaving more oil in the market that will remain based on this “new” deal of a cut. The issues are reverberating through the system and remain at the chemical level as well.

The rampant production of condensate (naphtha), which is now excluded from the OPEC cut calculation, means there will be growing availability of feedstock. Pressure is rising across the chemical supply chain as it hits across Asia- specifically in South Korea a core bellwether. The below chart highlights the pressure on HDPE, which is supposed to be a higher value product. As new facilities come online and chemical capacity that was down for maintenance ramps back up, pressure on prices/margin will rise. The issue also remains new facilities in China ramping up that is pumping out refined products and chemicals at a rapid pace.

China has been the buyer of last resort for the last 20 years, but as their construction of assets has shifted under Made in China 2025 and the Belt and Road Initiative- demand for products has dwindled. The pressure will remain across the board as the economy weakens, and their inability to stimulate the local market is exacerbated.

India is facing a similar problem with a slowing economy reducing domestic demand for refined and petchem products putting more on the water. The other issue (facing both countries) is an issue with current account balances as exports slow (the intake of USD) and imports rise (and outflow of USD). The limited access to foreign reserves keeps a lid on the type of stimulus and loans that can be generated to keep GDP supported. The above chart highlights just how bad the margins are regarding a high value petchem of high-density polyethylene. The stimulus China used in end of 2016 to the beginning of 2018 helped spur the market as a whole, but the chart above (and the others on refinery margins) demonstrates just how much worse things are vs 2016. This is driven by the new assets China has brought online, and they have indicated an unwillingness to cut runs as the state owned companies believe others should reduce operations in Asia and Europe. The problem is- South Korea has also responded with something similar, which will exacerbate an already difficult situation. The issues provided above will only get worse as the global economy continues to slow as demonstrated with recent economic indicators out of Germany, South Korea, Japan, and China- while the U.S. remains on a slowing trend but still the best looking house on a bad block.

[1] www.argusmedia.com/en/blog/2019/december/3/the-china-connection-new-petrochemical-refineries-impactful-or-disruptive

PRIMARY VISION INSIGHTS TUESDAY 26 November, 2019

By Mark Rossano

Where do we stand in U.S. Shale? – Week before Thanksgiving 2019

U.S activity is experiencing another step-down in activity as more completion crews and rigs are released. The issues are compounding on a global level as oil demand falls amid struggling crack spreads and a struggling economy. I don’t need to reiterate this again, as any previous reader knows I have been highlighting the weak demand environment. The softness in realized prices is putting more pressure on North American energy companies with activity dropping in every basin. E&Ps have also started to delay their filing of completed wells, but our way around that is by watching freight and proppant data. This is combined with weekly EIA information, and shipping data collected daily to understand the flow of oil and refined product.

The frac spread count is projected to fall again this week, and will be printing something closer to 330 on a national level by the end of November. The Permian, DJ, and Eagle Ford will experience the biggest roll over in activity as we head into 2020. The 345 active crews reported on 11/15/2019 is a 52-week low, but will accelerate over the next few weeks and will exit 2019 at a number closer to 300 on a national level- with another 15 crews coming from the Permian. The below chart helps to put into perspective the decline by comparing three years of data, with the following seasonality charts showing how things have changed over the last 5 years.

The shifting oil markets will make for a very interesting OPEC+ meeting as investor capital has dried up for E&Ps, oilfield service, and midstream companies. The U.S. has grown at a rapid pace for the last 5 years, and I am predicting a slowdown in U.S. production looking at exit 2019 to exit 2020. The average production levels from 2019 to 2020 will go from about 12.2M barrels per day to 12.6M barrels a day (a 400k barrel a day increase), but the move into 2021 will see production from the U.S. slowing. OPEC+ can “speed up” the downfall by not adjusting the current agreement, which will send WTI to $47 as new non-OPEC production comes online further oversupplying the world. Saudi Aramco is now talking peak oil demand, and has taken action to move further down the hydrocarbon value chain in order to protect margin. This integrated strategy will help stabilize growth as stagnate crude prices are likely to remain for the next several years driven by structural and cyclical changes in the market.

Primary Vision National Frac Spread Seasonal Chart

1

Primary Vision Permian Frac Spread Seasonal Chart

2

The frac spread count is only one metric, which is still the most important one, but by also evaluating proppant loadings into areas helps to identify the speed of completions. The below charts highlight how proppant loading into the Permian and Eagle Ford are at 5 year lows. This comes back to- how can completion crew activity also not be at a 5 year low? There are some simple answers, and others that get more complex and takes a deeper dive into the data. The easy first:

  • Crews are considered “activity” as they are being paid to wait at the site, but are actually not completing wells at a current pace.
  • Crews are active at a lower utilization rate- where instead of operating 24/7 or 12/7- it is more along the lines of 12 hours every 5 days.
  • Proppant is being used from storage either at the site or rail yards making the numbers a bit skewed to the downside.

It is most likely a weighting of all three that is creating the skew in the data, unless there has been a huge shift in the way companies are completing wells. I can say with confidence- there isn’t any less proppant going down a well than previously. It can vary well by well based on source rock and pad setup, but the below kind of drop off would mean loadings dropped by over half per well- which just wouldn’t happen. The more complex answer is a lag in the data being reported to the state agencies (which technically isn’t allowed) that creates a problem for monitoring completions. This is an interesting issue that we cover in great depth through a different report.

Primary Vision Permian Proppant Seasonal Chart

3

Primary Vision Eagle Ford Proppant Seasonal Chart

4

While rigs are released at an accelerating rate, the question turns to the drilled but uncompleted wells (DUCs) in the market. How many of them are viable at this price deck? Will some of them never be completed because they were drilled poorly? How many are related to the infill program that has failed to work and will be abandoned? There is always a natural DUC rate given the lag between drilling and completion, and the fall in rig counts- at a faster pace vs completion crews- will close that gap. The problem is- many of these numbers are overstated- and filled with wells that don’t make economic sense in the current environment. The majority of the cost in a well is at the completion stage, so as pricing is depressed across all three streams- the economics won’t work. As E&Ps focus on reducing costs and living within cash-flow, the ability to produce wells at a loss will be hard to finance. Some wells won’t work as they are old (2016 or older) and didn’t place the well properly limiting total recoveries, or were done under a drilling program that has proven ineffective- parent/child relationship. The below chart helps to highlight how the process of completing DUCs has accelerated, but will slow as we go through 2020 as the best wells are completed and brought online.

5

The cyclical data remains a core concern across the board with little to show a sign of improving. Some data points have stabilized, but only after more aggressive central bank action. This has currently stemmed the slide in the equity world, but even if you don’t read a single word of the next section and instead just look at the charts… you will get the point quickly. Refiners in Asia (specifically Singapore) have been hit by negative margins as China and India pump out more product overwhelming the area. The new flow of product has shifted the movement of refined goods and is impacting margins, which will create economic run cuts in other areas. This all leads to a decline in crude runs limiting overall demand. The 2020 crude oil demand story has been highlighted by the IEA and OPEC, but the severity of the industrial/manufacturing slowdown still isn’t fully appreciated. The new capacity coming online and no additional cuts from OPEC+ is set to push WTI below $50. I was on Bloomberg TV 11/19 reiterating the impossible nature of a China/US trade deal, and now with Congress passing the HK Human Rights Bill- a trade deal seems even less likely.

IF YOU’D LIKE TO GET THE LONGER VERSION HERE, PLEASE EMAIL MATT JOHNSON: mjohnson@pvmic.com  THIS CONTINUES THE STORY INTERNATIONALLY.

THANK YOU,

PRIMARY VISION

PRIMARY VISION INSIGHTS MONDAY 21 OCTOBER, 2019

By Mark Rossano

National Frac Spreads

In support of weak activity, proppant deliveries and loadings remain well off seasonal pace and are at 5 year lows across the U.S. This reduced activity highlights pressure on current U.S. production as we head into the end of the year, but also provides for pricing power with proppant providers and rail companies looking to sell volumes. The depressed pricing and willingness to move product will support completion activity as these levels with a small increase through year end. The cost savings will help spur some additional activity into Nov, but well off of seasonal norms and well below the typical increase in activity. It will also keep pressure across U.S production in the very near term. The bigger focus for E&Ps into year end is maintaining or reducing CAPEX, which has already started with some adjustments in production targets for 2019.

Permian Proppant Loadings

2Eagle Ford Proppant Loadings

3

Proppant loadings still remain at 5-year lows into the Permian, but there will start to be an increase in proppant deliveries as activity stabilized while remaining well off typical pace. The Eagle Ford is fairing even worse with little in terms of adjusting activity into year-end, while the Permian will see some increase in activity into Thanksgiving.

U.S. refiners remain well off seasonal averages and have utilization rates that are below depressed levels caused by Hurricane Harvey. There will be a small increase over the next two weeks as East Coast refining margins have recovered a bit, and will incentivize additional utilization as more European product moves to Lat Am. The limitation on European product will keep margin strong in the near term for PADD 1 activity.

Typically, U.S. product fills Lat Am demand, but with heavy maintenance across the U.S. complex and oversupply in European markets- refined product is still making the cross-Atlantic trip- but to Lat Am instead.  The weak U.S. activity will keep more refined product moving from storage, while limiting the demand for crude both domestically and the floating market.

Crude demand will remain under pressure driven by sky-high shipping rates, weakening global economies, and seasonality. Pressure remains across the crude complex with more expected from Angola, Nigeria, and other OPEC/non-OPEC nations even as current offerings for Nov haven’t cleared yet. We have said repeatedly that global oil demand was going to grow well below expectations, which is now being reflected in the data. The bigger problem remains demand being soft across the whole complex- oil and refined products, which will result in builds in all areas and take longer to clear even when demand picks up. Just given the nature of the headwinds- global cyclical headwinds, trade wars, and structural change based on policy and new production/refiners- not even geo-political uncertainty is enough to sustain a rise in crude pricing.

U.S. Refinery Utilization Rates

4

I still believe that global oil demand is even lower than what is posted below. I think total growth is much closer to 400k barrels a day vs the current one highlighted below. This means we will get builds across the complex unless OPEC+ cuts more, which is unlikely given their unwillingness to yield any more market share- which is demonstrated by Nigeria and Angola taking production higher (just to name a few).  These builds also come at a time when Venezuela and Iran are sanctioned limiting their flows, and the Neutral Zone is expected to come back online in 1Q’2020 (which accounts for another 500k barrels a day).

International:

The overall market rallied on the back of a potential “mini-deal” with China that would lead to a broader benefit, on top of the ever-expanding balance sheets of central banks globally. Demand continues to struggle as signified by weakening refining crack spreads across the space. Margin softness is exacerbated by the cost of shipping crude and products due to the sanctions placed on Cosco by the U.S. The “Phase 1” trade deal essentially moves us back to 2 weeks ago, but does nothing to alleviate the core issues. It is also problematic that President Xi (instead of focusing on this) is out meeting with India’s Prime Minister Modi, which just means that China is sending its JV team to a Varsity game. The proposed deal has raised more questions than answers as Chinese officials say more has to be discussed before anything can be finalized- and this is in regards to a “mini-deal”. The deal would just delay new tariffs and open up an avenue to purchase agricultural products with some small (but poorly defined) financial and intellectual property adjustments. Both of those terms appearing in a potential deal was enough to send the market higher, but they remain buzzwords with little meaning in the proposed deal. The bigger issue is how far apart both sides are on such a simple deal- with an unwillingness to adjust incoming tariffs on U.S. agriculture products without the U.S acting in-kind.

The weakness continues to appear in key growth markets- such as India- highlighted by the weakness in diesel consumption as well as oil demand.

India’s Sept oil product consumption is the lowest in 25 months across key products:

“India September Oil Product Consumption Lowest in 25 Months- India’s oil consumption fell 0.3% y/y to 16.01m tons in September, the second monthly decline in fuel demand in the financial year that started April, according to data published by the oil ministry’s Petroleum Planning & Analysis Cell.”

  • India’s gasoline consumption in September rose 6.2% y/y to 2.37m tons
  • Diesel demand declined 3.3% y/y to 5.83m tons
  • Naphtha usage down around 26% y/y to 844k tons
  • LPG consumption +5.9% y/y to 2.18m tons
  • Petcoke use +18% y/y to 1.74m tons

It is important to highlight that the demand/consumption numbers were weak even with lower prices compared year over year.

A key bellwether for oil demand has been Nigeria and Angola (West Africa in general) with Angola announcing 46 cargoes for December which is off multi-year lows and include 2 deferred cargoes from Nov. Nigeria still has more than half of their cargoes for November with an expected increase in December loadings as well (not including deferrals.) Crude movements have been impacted by refiners going into maintenance season and ships trying to minimize distances to limit total costs. U.S./China talks remain far apart on many key items, and I don’t see this adjusting in regards to the Cosco shipping sanctions. The sanctions are impacting U.S. exports- especially because large parts of our oil must travel the furthest distances. Typically, additional crude will be pulled from areas in the ME and Africa into Asia, and the U.S. would backfill into Lat Am and Europe- but slow demand across the system has brought shifting trade to a halt. Instead, countries are cutting refinery runs to operate out of storage and manage refined products from the floating market/storage.

The geopolitical landscape is very fluid at the moment with issues ranging from BREXIT to Middle East upheaval to the U.S/ China trade war and the little talked about South Korea/Japan trade war. There is a global rise of protectionism and nationalism that is driven by weakening economies and over-levered countries that are struggling to stimulate growth. While the geo-political backdrop makes great sound bites, oil pricing is driven by supply/demand economics. The current Middle East battleground won’t be enough to drive price appreciation unless the supply side is significantly impacted. The new flow of oil from Nigeria, U.S., Russia, Brazil, and North Sea and deferred cargoes from areas such as Nigeria, Angola, and the U.S. have been more than enough to fill the short-term disruptions of Middle East conflicts. The current political upheaval in the Middle East (outside of KSA) remains regional and sporadic that won’t have lasting impact on supply at the moment. This is why demand is a big focal point, because even if the trade wars go away tomorrow— the bigger issue of economic slowdown outweighs any benefits. PPI, ISM, Export/Import, Shipping, and other data points highlight the bigger overarching issue that is plaguing the market. Demand is struggling with major economies contracting, and the law of diminishing returns limits the effectiveness of any form of quantitative easing. So unless a geo-political event can really disrupt supply measured in the millions for more than a few days— demand will continue to matter more to pricing metrics.

The Iran situation will continue to impact oil pricing as the current embargoes takes about 2M-2.5M barrels a day off the market. Iran is able to put about 500k-1M barrels into the market through Iraq pipes, Iran ownedships, ship-to-ship transfers, and “ghost shipping” through turning off transponders (which led to the Cosco- a Chinese Shipping Company- sanctions.) The shortage of heavy crude in the market (a staple of Iranian flow) will help maintain tightness between light-sweet spreads. The current sanctions aren’t going away anytime soon (or at least before U.S. elections) as President Trump wants to appear tough on trade following the removal of U.S. military forces from Syria (a mistake) and putting additional pressure on China following the Cosco sanctions. The only way negotiations could begin would be a willingness for Iran to forgo the deployment, development, and testing of ballistic missile systems. This is a non-starter for the Iranian government and military limiting the ability for any deal to be brokered. The growing divide between Iran and Saudi Arabia (greater between Shia and Sunni) will continue to expand, and will result in additional attacks on both a military and economic level.

As mentioned previously, Middle East discourse is rising driven by the last 4 or so years of depressed oil prices resulting in stressed economies, reduced social subsidies, and declining foreign reserves. The region has always had tension driven by tribal and religious divide going back thousands of years, but the relationships have always ebbed and flowed over the years. The lasting wars and declining cooperation- such as Syria and Yemen or Arab Spring in general, collapse of OPEC in Nov 2014, and the GCC (Gulf Cooperation Council) under duress driven by the divide between Qatar and other Gulf nations— is highlighting how problems have continued to build over the last several years. Everyone will point to the Saudi Arabia attack as a singular event, but the discord was sown years prior and are rapidly declining now with the added stress of struggling economies with depleted currency reserves. The discord in the Middle East has been smoldering for years- limited to regional conflict, but is now reaching a point that will bring the issues to the center stage.

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PRIMARY VISION INSIGHTS TUESDAY 8 OCTOBER, 2019

Frac Spreads Falling

By Mark Rossano

The national frac spread (fsc) continues to decline as work remains slow across the U.S. with noticeable shifts in the Permian, Eagle Ford, and Williston. Realized prices will remain under pressure driven by seasonality (refinery maintenance season), oversupply of refined products, and glut of light/sweet crude in the market. This is all impacting E&P balance sheets driving them to reduce rig counts as well as frac spreads in an attempt to live within cash flow. The below is a breakdown of the slowing activity versus previous years with changes from 8/30 to 9/27 resulting in growing reductions: Permian- 14 / Eagle Ford- 7. These were key locations that should have seen stable activity as pipelines came online in the Permian, and the Eagle Ford filters into the LLS (Louisiana Light Sweet) market, which should have been strong with the Saudi Arabia attack. Instead, the Permian pipelines were filled with capacity competing for space on other lines, oil behind pipe, and current operational spreads. The U.S. exports did rise, and will be reflected in next week’s EIA report, but the total number still remains underwhelming given the expected impact of the global supply chain disruption. Typically, E&Ps will increase activity by bringing on more completion crews from now until Thanksgiving, instead- we expect a stabilization where national spreads hover around 375 versus the normal rise.

The chart below highlights how this is the longest slow period without an uptick in frac spreads since Primary Vision began collecting data. Based on the current available data, there could be a decline to about 375 before there is a bounce in activity. Either way- the data highlights the limited activity across the U.S, which will stabilize at these levels over the next two weeks. The pressure on crude, natural gas, and natural gas liquid pricing will keep activity muted across the U.S. Weak natural gas prices has already sent the Utica and Haynesville to historic lows, while the Marcellus sees the most stable activity driven by low breakeven costs. Robust NGL pricing helped support activity throughout 2018, but current pricing pressure has limited activity in several basins including the Mid-Con and Utica. There is a lot of pent-up demand for natural gas liquids in the global market, but the U.S. lacks the effective infrastructure to get it to market in a cost effective manner. This is quickly being addressed, but it will take time to bring the new coastal facilities online. LPG demand has risen globally, and the recent disruption caused by the Saudi Arabia attack has sent countries throughout the world, scrambling to replace the lost cargoes. The U.S. is in position to be the swing producer of NGLs, but that is still 24+ months away, so the rise in global NGL pricing won’t translate to rising frac spreads in the near term. As the energy financial markets struggle, there will be limitations on the available capital for struggling companies to issue equity or debt. The degrading balance sheets of many service and E&P companies will keep activity low, and as hedges roll off activity will continue to decline in an attempt to preserve cash.

Soft demand for U.S. oil will continue as domestic and international refinery utilization rates decline during typical maintenance season. The U.S. decline in utilization rates is currently below the 5-year average- per the chart below. This is on the back of slowing U.S. product demand along seasonal norms, pressure in the export market for refined products, and expected product builds. The limitations in the European markets and muted Latin American demand has kept a lid on U.S. exports, which has pushed domestic refiners to slow down activity further than normal. European refiners are also in turn around, and this is typically a time when the arb opens up for distillate from the U.S. to Europe. Instead, the European markets are being fed by a glut of distillate originating from West Africa and Asia.

International

The international market is signaling additional headwinds for U.S. crude and products that will persist throughout the remainder of the year. There was a big disruption in the market when the third largest oil producer in the world was attacked, and any premium left in the oil market from the supply shakeup has evaporated. This is driven by demand that continues to fall as indicated by economic markers globally, and an oversupply of light/sweet crude in the market that quickly backfilled the disruption. The persistent pressure on crude demand is also at the crux of Saudi Aramaco’s drive to sign on long term crude deals to solidify their placement of KSA oil in countries, such as India and China. The oversupply of light/sweet crude in the market will continue to pressure U.S. exports in a world experiencing a slow-down in total demand.

Several recent events have shifted crude movements around the world.

  • The Saudi attack has impacted their ability to upgrade/ process crude at the facility. This means that customers will either accept a “lower quality” crude (higher sulfur than initially agreed) or go out and find new shipments on the spot market. The cost to replace would be expensive so it is easier to just accept the lower grade, and blend on their side, while adjusting shipments going forward until Abqaiq can process oil to typical specifications. This will take months given the specific nature of machinery that was impacted.

  • KSA has been able to get close to normal operation and is making up any shortfall from storage. Saudi Aramco has enough spare capacity away from the facility that they can pump above exports in order to backfill storage, while meeting near term export demand. It will just take time to get the operations going and the crude to areas that have experienced draw downs. The company has announced they have currently achieved these levels and is already filling drawdowns.

  • The decline in crude quality has pulled more shipments from West Africa, the U.S., and other regions, which will persist through November as Saudi Aramco’s ability to upgrade crude remains impacted. While this move cleared some deferred Nigerian and Angolan crude into the market, purchases have slowed into November with Nigeria increasing export to a 4 year high of 2.14M barrels a day while Angola is still sitting on 40% of their initial cargoes for Nov.

    1. This points to a continued slowdown in total demand globally as builds in products continue and crude demand slows.

    2. The decline of 736,000 barrels a day in September for Persian Gulf OPEC oil exports wasn’t enough to support pricing as product draws underwhelmed, and WAF spare cargoes filled the void and responded with increases in November loadings.

    3. The weak global oil price has led many OPEC+ nations to adjust their y/y demand growth estimates.

  • The new U.S. Sanctions on Chinese Shipper Cosco: Cosco Shipping Tanker Co and Cosco Shipping Tanker Seaman & Ship Management Co have been added to the Office of Foreign Assets Control’s (OFAC) designated nationals and blocked persons list. This has blacklisted about 100 tankers in the oil trading business, which has sent countries and companies scrambling to charter other vessels to maintain operations. This pushed dayrates to 11 month highs.

  • Gasoil/Diesel in floating storage in West Africa has shifted the movement of cargoes as more flow into Europe. Even though European refiners are in turnaround- storage levels remain elevated. This has impacted the shipment of distillate from the U.S. into Europe pushing U.S. exports to seasonally adjusted lows that are below the 5-year average. This will persist and continue to pressure U.S. exports from the Gulf as Lat Am demand remains below normal.

  • Economic data globally continues to highlight a slow-down in economic activity, which will remain an overarching theme as we evaluate refined product demand. Refined products have quickly been building above seasonally adjusted averages in Singapore, Europe, and Fujairah.

  • Leading and current economy indicators point to a contraction that is being reflected across the refined product market, and is resulting in a total slow down of oil demand across the complex. The Saudi attack provided a near term bump, but it quickly faded as pressure resumes across the landscape.

  • The pressure in oil highlights some key facts following the Saudi attack:

    1. Demand for crude remains under pressure

    2. There is more than enough crude in the market to supplement, but it took time to deliver as it was originating from further distances

    3. KSA has been able to effectively fill the void created by the disruption faster than the market expected as we explained in our previous analysis.