Primary Vision Insights – April 14th, 2020

By Mark Rossano

Section Breakdown

Completion Crews Fall Further with More Pain to Follow Refiners and Global Refined Product Data Highlights More Pain to Come U.S. Crude Production Has Fallen- But Will it be Enough (short-answer: NO) OPEC+ Has to Cut- But They Want to Make a Show of It. Oversupply Will Persist A Quick Overview of Russia and Saudi Arabia Sovereign Balance Sheets- Especially Emerging Markets Being Pushed to the Breaking Point Food Inflation is only Beginning

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Completion Crews Fall Further with More Pain to Follow

Frac spreads in the U.S. will continue to drop with the national forecast to break 200 this Friday as activity is slashed. The EIA adjusted production in this week’s EIA report down 600k barrels a day settling at 12.4M barrels a day with more declines to follow. We believe production will quickly go from the high of 13M barrels a day down to 11M barrels shaving off 2M a day in flow. The below breakdown highlights how all the areas are taking pain with Permian/ Anadarko/ Western Gulf/ Bakken taking the lion share (in that order). The Permian will see more declines as more E&Ps roll out CAPEX cuts, and OFS companies roll out more layoffs. Haliburton has announced 350 additional job losses in OK after furloughing 3,500 workers at the Houston headquarters. Schlumberger isn’t far behind with a focus on cutting 30% from the budget including furloughs/ layoffs/ reduced executive pay. The unfortunate toll of the massive drop in oil demand- exacerbating the over-suppled market married with over-levered balance sheets is going to result in 1500 to 3000 additional job losses.

Commentary has been thrown around regarding the shut-in of GoM assets due to their source rock- ability to be ramped down and back up in a relatively short period of time as a solution to “make a deal.” The other reason for the view that the GoM could be shut-in is related to about 90% of production resides on federal land. The below chart shows the growth in oil production over the last few years- 12/31/2014 was 1.397M barrels a day and closed out 2019 at an all time high of 1.883. Production continued to rise and now sits at 1.983M barrels a day, which is growth of 586k barrels a day from 2014. This is a number that was talked about with people in the U.S. government talking about a reduction of about 2M barrels a day. The problem with removing these barrels is the high quality of the product that PADD 3 refiners rely on to process into refined goods. The GoM oil has more distillates in it, which is even more valuable today given the gross oversupply of gasoline in the market. This crude is pivotal for maximum efficiency in PADD 3 due to the complexity of the refiner and coking capacity that needs to be weighted towards a heavier grade (sour or sweet). Supply and Demand is alive and well in the global oil markets with cuts inevitable around the world. U.S. shale is bound to carry the brunt of the declines as U.S. refiners opt for heavier barrels even while they reduce to extreme lows.

DOE EIA Federal Offshore- Gulf of Mexico (PADD 3) Crude Oil Production

Refiners and Global Refined Product Data Highlights More Pain to Come

Our view was that refinery utilization rates were going to drop to about 70% in the U.S., and so far with last week printing 75.6%. Since last week, Marathon/ PBF/ Valero/ PSX are increasing their run cuts either at specific facilities or across their whole system. This will bring us just below the 70% number we have been targeting, and if storage continues to build at these levels refiners will be left with a choice of full facility shut-downs or trying to export to keep storage fluid. There is a pressure issue on entering the facility because volumes can’t fall beneath a certain %, and if it does the process can’t be carried out causing damage to the equipment and creating sub-par product.

DOE Refinery Utilization Rate Seasonally Adjusted Dated back to 1991

This problem remains in refinery margins, which have seen some rally off the lows but remain at all time lows as gasoline demand falls to levels not seen since 1980.

Gulf Coast 3-2-1 Crack Spread Seasonally Adjusted Back to 1991

DOE Motor Gasoline Total Products Supplied- Seasonally Adjusted (back to 1980 Levels)

The precipitous drop will only get worse as more states enter into a lockdown, while no new extensions have been issued. The issue will be how much of a recovery will we get on the other side of a lockdown even as people get back to work. The view is that people are creators of habit, and things will normalize quickly- but that ignores the loss of wages and fear. As a smart person said in the BI Energy Chat: “You don’t go from buying groceries in a hazmat suit to high-fiving friends in a bar.” There is a fear of wave 2 as well as lost wages that have depleted disposable income. Most people (on a global basis) are saddled with huge debt loads that have only increased- especially in countries looking to stimulate and facing massive spikes in unemployment due to layoffs/ furloughs.

Beijing Traffic Last 7 Days- Daily Commute Slightly Down but Weekend Travel Non-existent

U.S. Federal Reserve Consumer Credit Total- Highest Going Back to 1991

The pressure on personal balance sheets will impact the way people spend over the next few months- especially for those that go from furloughed to outright laid off. How many hotels were already struggling with 65% occupancy rates or deal with seasonal travel or equipment that won’t be recovered? How many businesses will want or be able to rehire 100% of those furloughed? I would say it is fair to assume that furloughed employees are brought back in waves of 10%-15% as demand slowly picks up- but I would say throughout this year- only 60% of those come back to the office. The fear is also for a wave 2 to be ignited, which has already caused Singapore back into a lockdown for 30 days and a state of emergency declared in 7 regions within Japan. These issues globally are skewing some of the flow data as countries- Singapore/ India/ China dump a ton of refined product into the export market. We wrote last week how flows of refined products are coming into Europe and North America- but keep getting diverted as demand is hard to find.

Some of them have settled on storage in key areas, but the flow of oil into the U.S. will continue to rise. There are currently 18 crude tankers at Corpus Christi/ 64 in Houston/ 10 at the LOOP. While not all of these will be imports as we are still exporting volumes, we will see U.S. exports slow to about 2.5M barrels a day over the next two weeks as U.S. imports spike over the next 2 weeks. Shipments of crude have been waiting to offload in PADD 1 waiting to unload, while PADD 3 saw an increase of imports- but will accelerate as KSA crude begins the process of offloading. “The seven tankers that have sailed for the U.S. this month are hauling a combined 14 million barrels of crude.”

Total Singapore Storage Seasonally Adjusted at New Highs- Even as Exports Ramp

Oil Tankers in the Gulf of Mexico

U.S. Crude Production Has Fallen- But Will it be Enough (short-answer: NO)

The slow reaction to U.S. crude production declining, a massive decline in crude demand, and falling refined product demand will keep the pace of oil and refined product builds elevated. The market has baked in a 10M barrel a day cut from OPEC+ that will last about 3 months- based on what has been put into the market. The problem is oil demand is down 38M barrels a day and climbing with crude storage space running out around the globe. We are also in shoulder season for some countries that naturally see a decline in crude demand and puts more crude on the water. The physical/spot market points to more pressure in the paper market, but the futures market is holding out hopes for a surprise cut that is either “deeper” or “longer” than expectations. We just know that Russia has said- “we will only cut if the U.S. cuts as well” and we just had a recalibration with a decline of 600k barrels a day. This is still all posturing as these countries have no choice but to reduce volume as many options are being exhausted with estimates updating daily from agencies highlight the pace of crude builds. We believe the spot/physical will act as an anchor pulling crude lower- especially as tank tops become front and center and still think new lows are coming into WTI Cushing. U.S. oil inventories have filled 54% of working storage capacity, according to EIA data released Wednesday.

Nationwide working storage capacity is 653.4m barrels as of Sept. 30, 2019 Midwest inventories at 57% utilization with 172.6m barrels of total working capacity Gulf Coast inventories at 52% of utilization with 370.7m barrels of working capacity NOTE: Working storage capacity data is reported twice a year, with data through March 31 to be updated on May 29

From last week’s report:

While it is not ideal to shut-in wells, doing so in offshore- vertical assets is much easier and less reservoir damaging vs horizontal/shale. The EIA has changed the reporting structure to only show oil production monthly- instead of weekly updates- so we will see the adjustments coming up soon. Based on the below data, we can see how much how much total storage is available by product:

(as mentioned above- these are absolute figures not accounting for space required)

Oil (sum of working Capacity and Stocks in Transit) is 777.2M Oil (Strategic Petroleum Reserve- SPR) is 797M barrels (currently about 713.5M operational)- ending stock of SPR is 643.885M- spare capacity = 69.615M barrels Oil: Tank and Underground Net Available Shell Storage Capacity is 615.387M vs current 469.2M = 146.187M available storage Gasoline: 361.57M storage available vs 246.8M = 114.77M of available Distillate Fuel Oil: 212.889M vs 122.2M = 90.689M Jet Fuel= 62.595M vs 38.3M = 24.295M

OPEC+ Has to Cut- But They Want to Make a Show of It. Oversupply Will Persist

The OPEC meeting is coming together after a lot of headlines/ tweets/ phone calls to agree to a virtual meeting. Everything was delayed in order to allow for negotiations before they sit down and attempt to hammer out a short-term deal. The amount of the cut and the length of time will be paramount when analyzing if this will be effective in today’s market. Russia has offered up a cut of 1.6M barrels a day, which would require others to make up a large difference if the target is 10M. The other issue is- this oversupply also factors in Libya essentially offline and VZ-Iran under sanctions. Venezuela shipments were taken over from Rosneft by Reliance- but the lockdown in India will either push the VZ crude into storage or into a different market.

The above gives a base from what OPEC was agreeing too as we headed into 2020. In our view, the deal was already on thin ice as Russia was signing deals with India, but also facing rising competition in Europe from U.S. crude. Even though the screens showed mid $50’s Brent, Russia was realizing a price well below the screens, and was talking about breaking away from the agreement with the view that- “You Can’t Cut Forever.” As COVID-19 ripped around the world, OPEC+ came together and proposed another round of cuts, but Russia refused to carry their portion of the reduction sending oil prices into a nosedive. Thursday is meant to bring countries back together to provide some “stability” back into the oil markets, but in essence- the group is making a big show of cuts there were already being forced to make. The world economy has come to a screeching halt with lockdowns occurring in many countries and being extended for longer periods of time. A more concerning issue is the resurgence of COVID-19 in Japan and Singapore leading to Japan’s PM Shinzo Abe to declare a monthlong state of emergency for Tokyo and six other prefectures. “The announcement follows surges in new cases in Tokyo, including consecutive rises exceeding 100 over the weekend. By Tuesday there were 1,196 confirmed cases in the metropolitan region of 14 million people. Nationwide, Japan has reported 91 deaths from COVID-19 and 3,906 confirmed cases, plus another 712 cases and 11 fatalities from a cruise ship that was quarantined earlier at Yokohama port near Tokyo.” [1] Singapore wasn’t far behind with its own announcement of a month-long lockdown.

OPEC+ Sets a Date for April 9 th at 10AM EST

The OPEC+ emergency meeting is set to kick off on April 9 th at 4pm (Vienna Time), which is right at the start of the long Easter Weekend with Friday being Good Friday. The backdrop is interesting as the U.S. market won’t be able to fully react to the changes (outside of rumors and leaked or planted commentary) until futures reopen and people log back on from home on Monday. There hasn’t been mention of a press conference timing, which could provide some information, but we will know more as we get closer. The OPEC+ meeting doesn’t include the U.S. or Canada but does ask for 7 other countries to attend including Brazil and Norway. Brazil has already cut 200k barrels a day, and Norway so far hasn’t talked about cutting, but Jan was well off expectations- “The country’s preliminary oil output in January stood at 1.64 million barrels per day (bpd), down from 1.76 million bpd in December, lagging the official forecast by 6.6%, it added.” Norway expected to reach 1.76M barrels per day by July as Johan Svedrup oil field ramped and exit 2020 at 1.87M barrels a day. Norway has offered to cut a small amount, if there is a global deal- but it could already be factored in with current production at 1.75M barrels a day in February.

A Quick Overview of Russia and Saudi Arabia

Russia:

Producing 11.289M barrels a day after walking back the desire to increase production by 300k barrels a day. The big issue arises with the lack of storage across their system. In our last report, we discussed the difficulty Russia has to protect pricing due to the lack of tank space. The flood of Urals to the coast and no buyer pushed Russia to sell to China at fire sale prices (Almost $0) and Belarus at $4. “Transneft PJSC, operator of Russia’s oil pipeline network, owns the bulk of domestic storage capacity, which amounts to just over 23 million cubic meters, said spokesman Igor Dyomin. That’s 145 million barrels, or about two weeks of the country’s production. Total U.S. crude storage capacity is almost ten times larger.” “Transneft could not even take that volume of oil and store it for more than a month, Dyomin said. The operator needs to keep some of its tank capacity spare to allow flexibility in shipments and avoid bottlenecks at seaports and refineries, he said.” The shutdown of domestic demand for refined products is adding to pressure as refiners cut runs and put more crude into the export market. “Domestic fuel demand cannot shield Russian producers because the nation is also feeling the effects of the coronavirus pandemic. The Kremlin has imposed stay-at-home measures, resulting in a drop in gasoline and diesel demand in Moscow last week of 20% to 30%, Energy Minister Alexander Novak said in an interview to Ekho Moskvy radio station. He expected demand across the country to fall by as much as 40% in the coming weeks as the government introduces tighter restrictions.” New York is set to receive a rare shipment of Russian gasoil after a tanker bound for Europe’s ARA hub diverted, just as the continent is set to be flooded with diesel from Asia, according to port report and tanker tracking data compiled by Bloomberg. While the U.S. will normally receive sporadic shipments from Russia of refined products- gasoil cargoes are relatively rare. Just by looking at other lockdowns- the demand destruction will get closer to 80% at the peak. Russia has looked at storage in rail cars, but the capacity is limited and difficult on a logistics level as workers are home. “Russia still has at least a few weeks before facing hard choices. The country’s oil companies successfully marketed all of their April supply volumes, Novak said last week. Some of its producers also have their own, smaller, storage capacities at fields and refineries.” Between the lockdown (additional crude to sell) and April cargo cancellations- Russia has to reduce oil production but the issue will be by how much In 2014- right at the start of the OPEC price war- Russia was producing about 10.7M barrels a day and is now at 11.29M. So throughout the OPEC+ cuts Russia has been able to increase production by about 590k barrels a day. Production so far in April has dipped slightly to about 11.244 (nothing really significant) The assets within Russia are older and located in regions that have to deal with hostile weather conditions and can’t be so easily reduced. The complexity of the situation remains the fact Russia can’t easily shut down, but they also don’t have spare storage capacity. More importantly the country is looking to raise cash, and by “discussing” oil pricing metrics the yield has fallen extensively- and while they are in “meetings” Russia may be able to print debt at a more manageable rate.

The ministry will offer floating-rate debt due 2030 in a no-limit sale, 20 billion rubles ($265 million) of 2023 notes and almost 11 billion rubles of inflation-linked debt maturing in 2028. Something that has been simmering just beneath the surface is the growing breakdown of the supply chain within Russia. There are reports from some Russian regions of difficulties moving agricultural cargoes such as seeds and end products amid measures to curb the spread of coronavirus, the Agriculture Ministry said in an emailed statement. Minister Dmitry Patrushev calls on regional officials and law enforcement agencies to help to ensure uninterrupted operation of the industry Planting of crops must follow the usual routine, the ministry said Food security issues are rising across the globe, and Russia is no different: Russian Prime Minister Mikhail Mishustin signed a decree setting the country’s grain export quota for wheat, rye, barley and corn from April 1 to June 30 at 7m tons, according to a government website

The decree restricts exports outside the Eurasian Economic Union, a customs union including Russia, Belarus, Kazakhstan, Armenia and Kyrgyzstan NOTE: As of March 26, Russia exported 32.6m tons of grains, including 26.9m tons of wheat, in the 2019-20 season ending in June, according to an Agriculture Ministry analytics unit.

Russia Wheat Exports from Russian Seaports

It is interesting to see Russia cut who will receive wheat over the next 2 months as a big focus has been to expand wheat exports into China and other areas in Southeast Asia. Russia is also lobbying China to increase its Russian wheat imports, with Russian officials saying they expect China to increase its wheat imports in 2020 to include more Russian producing regions. [2] While major Southeast Asian countries are expected to account for 15% of total global wheat imports in 2019-20, according to USDA data, the Middle East, North and West Africa, China and Bangladesh are estimated to account for over 30% of total global imports. This is where Russian wheat would have a clear price competitiveness advantage compared with major wheat exporting regions. [3]

Saudi Arabia

KSA has announced they have reached 12.3M barrels a day, but in terms of production it is closer to 10M with the difference being moved from storage. The caveat with the “production” level is while 12.3M has been made available to the market- Saudi Aramaco is still moving additional product into storage in Germany, Egypt, and Japan. The storage is owned by Saudi Aramaco, which means even thought 12.3M was made available they struggled to sell what was being produced China has deferred shipments with the U.S. cutting deliveries for the end of April. Some North American customers of Saudi crude have renominated for less supply for loading in April following a move by state-owned Aramco to slash its freight rebates for buyers, according to people familiar with the matter. Saudi last week March boosted oil loadings to 9.64m b/d in last week of March and is on target to hit 10m b/d in April; overall March loadings 7.46m b/d Aramco building overseas inventories in Egypt and Japan Saudi Arabia ships crude from its oil terminals into the Egyptian port of Ain Sukhna in the Red Sea. From there, the crude flows via a pipeline known as the Sumed into Sidi Kerir. From Sidi Kerir, state energy company Saudi Aramco can easily reach oil customers across the Mediterranean and beyond, including refineries in Italy, southern France and Spain. Saudi crude can be shipped from Trieste, an Italian port in the Adriatic Sea, into refineries in Austria and Germany via pipeline. All of these shifts are happening as refined products get diverted away from normal flow patterns as ships are diverted into and out of Europe and the U.S. European product exports to the Americas rose to a 4-month high in March, even as several U.S.-bound ships were diverted. A rare shipment of Saudi Arabian jet fuel headed to the U.S. after it was diverted away from Europe. Saudi is also sending more crude into Germany at a time when European inventories rose by 12.34M barrels last week. It was the 9 th week of builds with the pace accelerating. Global crude storage rose 100M barrels last month, which will only get worse as large parts of the month didn’t even factor in the cuts in demand from lockdowns. Saudi Arabia is also in their shoulder season for domestic burn of oil for power generation, with more of it becoming permanent as more natural gas is used in the power/industrial sector. This naturally puts more crude on the water as KSA increases exports or reduces production to account for the slowing in demand both domestically and as global refiners typically use this time to carry out maintenance. It is important to consider where KSA was in 2014 from a production standpoint, and where they sit today: 12/31/14- produced 9.5M and 12/31/19- 9.73M- Over that 5 year period- production rose about 230k barrels a day: The U.S. produced- 9.12M on 12/31/2014 and 12.9M in 12/31/2019 a growth of 3.78M barrels a day. Canada: 12/31/2014 was 3.54M and 12/31/2019 was 4.5M a growth of 1M barrels Brazil: 12/31/2014 was 2.497M vs 12/31/2019 of 3.107M growth of 610k barrels

Iraq

The country has said they would increase capacity to about 4.8M barrels a day, and have said they have replaced buyers for the canceled shipments in April. The growing issue are the deferrals rolling through countries such as Nigeria/ KSA/ Russia/ Iraq/ Angola that is loading up a huge supply glut in May that won’t be able to clear to a buyer or will overwhelm storage. “European imports of Middle Eastern oil products are set to jump in April from the lows seen in the previous two months. Several ships are floating mid-voyage, while a Suezmax hauling ULSD is en route. 17 tankers hauling about 1.1m tons, mostly middle distillates, are under way to Europe from the Mideast region so far this month, according to ship-tracking data and port reports compiled by Bloomberg

Many of these countries face debt and currency problems as they find ways to bridge the growing gap in their budgets.

Russia and KSA will be required to cut the most, but these are cuts that were going to occur regardless to due to the supply/demand breakdown in the market. Russia lacks the necessary storage as local demand only puts more oil into the market as the lockdown intensifies. While KSA has way more global storage, the limits are finite, which is problematic as more European/ North American refiners are shut down. “Chevron El Segundo, Calif., refinery shut its largest crude unit and coker, according to person familiar with operations.

Marathon Los Angeles refinery has curtailed crude processing runs NOTE: Southern California refiners are trying to maximize diesel output and minimize gasoline production as trucks continue to deliver supplies while cars stay parked due to the coronavirus pandemic Refiners around the world are filling storage tanks as fuel demand plummets”

Across the U.S., rates have been cut by 15%-20% due to low demand and as the plunge in demand intensifies so will the economic run cuts. The below helps highlight how this is FAR from a U.S. reaction with many refiners ramping down. Every country has seen anything from 30%-40% reductions across the board. China has ramped some assets and pulled a bit from storage, but a huge chunk of the refined products is being sent into the export market as demand problems persist throughout the country. So the ramp in Chinese activity is marginal as it is helping to oversupply the already stressed refined product market and helping drive up the cost of floating storage.

MVIS Global Oil Refiners, Total Return Index (Pain Remains Global- Keeping Refiners Shut)

Gasoline/ Crude Spread

Sovereign Balance Sheets- Especially Emerging Markets Being Pushed to the Breaking Point

The impacts of the lockdowns and COVID-19 are far reaching with some new estimates on how bad GDP will get across emerging and developed countries. Each of these countries are looking to stimulate their respective economies with trillions of dollars’ worth of stimulus or asking the IMF for assistance. So far, 85 countries have reached out to the IMF for help or some for of support to fight COVID-19: “Many countries are expected to turn to the World Bank or IMF for help; 85 countries have approached the latter for short-term emergency assistance so far, double the number seeking help after the 2008 financial crisis. The multilateral institutions are expected to announce bailout deals for some at their spring meetings later this month.” [4] Many of the below countries were already facing headwinds as we entered 2020, with far more emerging markets struggling to meet debt expense. “Emerging economies’ debt servicing costs as a proportion of GDP have risen to their highest level since 2005, according to Oxford Economics. In October the IMF warned that 34 of 70 frontier economies were at “high risk” of falling into debt distress or were already distressed, up from zero as recently as 2014.”

The chart above includes some key oil producing nations, which highlights how the pain in oil prices can reverberate through the economy- especially when it makes up such a large portion of GDP. Nigeria is a perfect example that is working to suspend interest payments: “Nigeria won’t seek a suspension of interest payments from its Eurobond holders, but will seek debt relief from China as the government races for funds to battle the coronavirus pandemic.” “We will talk to the Chinese. We will negotiate multilateral loans and bilateral loans and where we get accommodation we will take it,” said Ahmed, without saying how much the government expects to save in payments this year.” Nigeria also asked for $7B from multiple creditors- including the IMF- while the World Bank Group is a top creditor already with $10.1B owed to them. “Beijing-based Export-Import Bank of China is the second largest single creditor with loans totaling $3.2 billion while Eurobonds account for $10.86 billion or 39% of external debt.” Oil makes up about 90% of foreign exchange for Nigeria, so as prices have fallen it as resulted in a large drop in dollars entering the country.

The growing problem remains the collapse of needed exports to keep dollars flowing into countries to finance debt, but some countries also lack treasures or collateral to open up a swap line with the federal reserve. The IMF is proposing the use of $1T to provide short term liquidity to “strong” countries that don’t have the necessary collateral for an “official” swap line. “Our board is going to review a proposal in the next days on creating a short-term liquidity line that is exactly targeted to countries with strong fundamentals, strong macroeconomic fundamentals, that may be experiencing short-term liquidity constraints,” Georgieva said in an online briefing for reporters on Friday.” A big focus for us has been the growth of dollar denominated debt around the world: “Emerging-market borrowers who tend to rely on the IMF for aid are particularly at risk of the lack of dollars. Encouraged by low U.S. interest rates, they’ve loaded up on dollar-denominated debt in recent years. They now face a squeeze as their exports plummet, with economies shutting down worldwide to combat the pandemic.” How does this turn back to crude- Many of these countries also rely on the imports of refined products to drive their economies. As countries look to start back up following lockdowns, they will require the necessary capital to purchase gasoline/diesel- and the lower the price the BETTER it is for them to kick start. The lack of foreign reserves is being pressured further by the strong dollar that makes the debt even more expensive to manage. Jordan has now suspended all food exports to ensure supplies at home, which is following others- Russia/ Thailand/ Turkey/ Myanmar/ Kazakhstan in having all out stops. The other issue is the failure of crops to thrive with Russia facing a difficult bumper crop due to weather implications. Between food scarcity/ slow planting/ weather implications/ supply chain disruptions- many countries will face hard times.

Food Inflation is only Beginning

2013, although that is partly explained by a long-running drought India’s food prices rose 9.5% y/y in February versus 6.6% y/y for the headline rate, although the increase predated the worst of the spread of the coronavirus

Thailand White Rice Pricing Seasonally Adjusted back to 2008

The drop in oil prices have helped offset some of the pain, but even with the fall- it is still not enough to stop the hoarding of food in specific regions around the world. Another key problem is getting food and goods to key areas and ports: “Daily movement of trucks has collapsed to less than 10% of normal levels, according to All India Motor Transport Congress, an umbrella body of goods-vehicle operators representing about 10 million truckers. Road transport accounts for about 60% of freight traffic in India and 87% of its passenger traffic, according to the Ministry of Road Transport and Highways.” “They’re enduring lengthy wait times in Europe because of restrictions that have been imposed to control the virus’s spread. In South America, local laws have at times conflicted with country-wide ordinances that deem hauling food an essential service, leaving supplies sometimes stuck in storage. In parts of Africa, the shuttering of public transportation means drivers aren’t even able to make it into work. And huge spikes in demand have caused lags for loading at some U.S. warehouses.” The below chart helps to drive home how food pricing impacts key areas around the world, and even a small increase in pricing can have a butterfly effect. Kenya has depleted its corn stocks in national stores, which is problematic as they now have to go out and purchase corn for delivery from emergence funding. The below cost impacts are also reasons countries would withhold food to secure domestic consumption and reduce pricing instead of exporting. The issue compounds on itself- between falling foreign reserves + USD strength + record amount of Dollar denominated debt + food hoarding and price ramps = disaster.

The decline in demand for exports is also impacting fuel consumption as ships are stuck at docks unable to load/offload or facing a quarantine. India is experiencing a precipitous drop in fuel demand as the market grinds to a halt. “The decline in road transport is another major setback for fuel demand in the world’s third biggest oil market, which has already been hit by the collapse in air travel. Fuel sales in March by India’s three biggest state-run retailers shrank by as much as 33%.” The complete shutdown of a country typically results to a peak drop of 60%-85% based on other countries going through something very similar. The below helps highlight how the U.S. export demand is now reaching new lows as shipping that was scheduled prior to COVID make it to international ports.

The above helps drive home the amount of stimulus some of the countries around the world are looking to print- which doesn’t include monetary policy. While stimulus will grow government spending, the problem is in the rest of the GDP calculation- consumers not spending/ companies not investing/ trade flow declining. Many of these pieces also result in a drop in tax revenue, so while stimulus sounds nice- there are also major deficits to contend with as many countries came into this year already spending well above tax revenue. The problem remains- there are a lot of borrowers in the market but lenders are hard to come by.

This is what is driving fears of inflation as exports/imports remain under significant pressure, freight-trucking can’t operate, consumers stay home, and manufacturing has no one to sell too- even when they come back to work. As governments discuss re-opening the economies- it will be a slow and arduous process in order to avoid a “wave 2” or a large spike in infection rates. The below is a gage of Chinese activity, and while on a whole it looks “good” just because the car is on… it doesn’t mean it is driving. These facilities may be active with workers in place, but are products really flowing given the fact their largest customers are either partially or completely shutdown.

Here are our calculations as of April 8:

The Trivium National Business Activity Index indicates that China’s economy is operating at 80.6% of typical output, up from 79.0% on April 3. The Trivium National Large Enterprise Activity Index indicates that China’s large enterprises are operating at 81.8% of typical output, up from 80.7% on April 3. The Trivium National SME Activity Index indicates that China’s small businesses are operating at 79.7% of typical output, up from 77.8% on April 3. [5]

The cracks in the financial keep getting bigger with larger and larger checks being written to stimulate economies and central banks printing/easing as much as possible, but the longevity of these slowdowns and massive amount of leverage/debt in the system will be the overarching problem. Many U.S. retailors and renters have fallen with more to follow. “Just 69% of U.S. apartment renters made payments through April 5. That compares with 81% who paid their rent by March 5, a new tracking tool published by the National Multifamily Housing Council shows.” This follows on the back of Staples informing landlords they won’t pay April rents. The leverage at the consumer and business level just extrapolates the already dire economic situation we face.

[1] https://apnews.com/b4c774ef3b14b923e5be6acd01613487 [2] https://blogs.platts.com/2019/12/27/russia-global-wheat-exports/ [3] https://blogs.platts.com/2019/12/27/russia-global-wheat-exports/ [4] https://www.ft.com/content/e3634816-66bd-4355-bc71-156016761dab [5] https://triviumchina.com/2020/03/07/coronavirus-getting-china-back-towork/

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Primary Vision Insights – April 27th, 2020

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