Primary Vision Insights – June 15th, 2020

By Mark Rossano

Summary

Update on Global Oil Markets A Review of Oil Demand- SURPISE- IT IS WEAK! OPEC+ Deal Review Libya Update and What It Means Economic Data Doesn’t Support Current Value Export/Import Data and What it Means Unemployment Remains the Elephant in the Room Retail Sector Struggles as Consumers Don’t Show Up Port Data and Global Bellwethers A Quick Review of Credit Card Data Don’t Forget About Food Inflation/ Emerging Market Pain

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Update on Global Oil Markets

The oil markets (as well as the overall market) remains highly erratic as more data comes out and catalysts come and go. A big oil catalyst occurred this weekend with the OPEC+ agreement finalized. The initial deal signed in April created a cut of 9.7M barrels a day in May/June that was supposed to adjust to 7.7M from July to Sept. Over the weekend, OPEC+ agreed to extend cuts of 9.6M through July in an attempt to reduce the global oil glut. Mexico decided to not go along with the cut in July, which resulted in the small adjustment of 100k barrels from the April deal to June. In May, Saudi Arabia said they were going to voluntarily cut an additional 1M barrel below their allotment to “do their part” balancing the market. Between the GCC nations, an additional cut of 1.2M barrels a day is happening in June, but won’t extend past one month. An argument can be made they did this voluntary cut purely to take assets offline to fix damaged equipment, but KSA announced the additional cut would only last in June shifting back to agreed levels in July. Demand for physical crude has started to climb higher, but we are starting from a very high base and a glut that spans the whole supply chain. India has seen some growth in their demand m/m as the country struggles to restart following their nation-wide lockdown, but the ramp will be slow as industries grind back to life.

Indian Oil Corp increased utilization rates to about 83%, but will struggle to reach the target of 90% as local demand remains depressed and exports challenged as the floating/onshore refined product storage market remains oversupplied. Refinery utilization throughout the country ranges from 35% to 85% as companies contend with weak demand and getting personnel back into the facility. Indian Oil is targeting 90%, but it will be hard to obtain without forcing other refiners in the region to issue economic run cuts.

“Capacity use of its refineries had dropped to 39% in early April after India declared a nationwide lockdown from March 25 to curb virus spread Consumption of petroleum products almost doubled month-on-month in May, gasoline use gained 70% and diesel rose 59% Overall May demand is still 24%-26% less than a year earlier or the initial months of 2020 prior to lockdown Sales of diesel, the most widely used petroleum product in India, by the country’s top three retailers rose around 70% in May from April but are still down 31% from a year earlier, according to preliminary data from officials with direct knowledge of the matter. Gasoline sales jumped 82% month-on-month, but fell 36% year-on-year. “

A Review of Oil Demand- SURPISE- IT IS WEAK!

South Korea remains at or near tank tops onshore and with a huge chunk of vessels sitting just offshore, but Japan is also no different- “Japanese gasoline demand was still down 27% in May from a year earlier, while South Korean processors are operating at rates that are 5 to 10 percentage points lower than usual.” Diesel sales at India’s top three fuel retailers were around a third lower last month on a year-on-year basis.” The low demand for refined products and quick spike in crude pricing (especially OSPs) is keeping a lid on refinery margins. All regions are experiencing negative to slightly positive margins, but Europe and Asia are seeing some of the biggest impacts. Below is just an example of how refiners aren’t able to push product prices higher, and instead are left with negative crack spreads. The average across the complex can range from -$6 to $6 depending on the crude slate and refining process.

China announced imports for May, and not surprisingly- there was a big increase in crude flows. Imports of crude reached 11.34M barrels a day, which is a 15% jump from April equating to about 160k barrels above the record in November. The May surge shouldn’t be surprising given the quick slowdown issued by China- to cancel/defer April cargoes and delay all purchases of May cargoes in March. This resulted in a quick drop, but it has rebounded throughout May as OSPs fell across OPEC+ nations and pricing improved into Asia. The surge was predicted by ship-tracking data, which showed tanker arrivals rising to pre-virus levels, as cargoes bought during oil’s crash into the $20s began to land. At least two dozen tankers on China’s east coast were awaiting to discharge earlier this month. Shipping data indicates that China could import more than 14 million barrels a day in June, acording to Sean Tan, an analyst with commodity research firm Kpler. About 190 oil supertankers are expected to arrive this month, he said.” Refiners have started to slow down after peaking at about 76% and will shift closer to 70% over the next week or two as teapots slow down.

The data remains skewed given the huge increase in May to make up for April/March losses, and imports for Jan-May now average about 10.35M barrels per day, which is up 4.5% vs the same time last year. “Low prices helped boost China's crude arrivals last month. The average import price for May was $27.04/bl, less than half of 2019's average of $65.63/bl, the GAC data show.” [1] China took advantage of better pricing to lock in flow, but a large part of the crude is either in floating storage (waiting to be offloaded) or already in transit.

The Shandong province has already started refilling storage moving back to highs with about 44M in tanks and another 15 ships (and rising) waiting to unload. The amount of vessels will grow with more crude in transit, and about 18M barrels of U.S. oil heading to China. The large surge in crude heading over will slow their purchases, and limit some of the support we have seen over the last 6 weeks.

Crude Vessels Waiting Offshore Shandong Province

When we look at all of Asia, there has been another rise of oil in floating storage over the last week with shipments waiting to discharge in the region. The offshore storage numbers will remain elevated as bottlenecks persist at the coast, but also because more crude remains in transit and will convert from one metric to another. The record amount of refined product in storage will prohibit a real recovery in demand as refiners struggle with terrible margin driven by weak demand and oversupplied product.

Asia Crude Oil Floating Storage

The above chart just covers Asia, but the growth has been extended around the world- to reach a new record of 180M barrels. The total crude on the water has fallen following less oil in transit, which will continue through June as OPEC+ cuts remain in effect and KSA (with some help from GCC Countries) cut an additional 1.2M barrels a day with “voluntary” cuts that reverse in July. The Middle East and Asia have seen the largest increase in floating storage over the last week- with some declines in the US and North Sea.

OPEC+ Deal Review

The OPEC+ deal is now extended through July but slightly less vs the original- extending a cut of 9.6M into July (instead of the full 9.7M as Mexico isn’t participating in the July cut). Mexico will participate in an OPEC+ meeting this weekend, but will not extend its production cuts for any longer than what was already agreed, AMLO said Lopez Obrador said that Mexico has already shut wells to meet production cuts, and called on other countries to fulfill oil output cut pledges.” While this sounds good, Saudi (and the GCC) are reversing their voluntary cut of 1.2M barrels a day that happened in June. So a quick 30 day decline, and things will start ramping back up to replenish the barrels for next month. The deal was only possible when Nigeria and Iraq agreed to make-up for being non-compliant by extending deeper cuts longer. Iraq’s May oil production was 4.213M barrels a day with exports at about 3.633M barrels a day. The quota for May and June is supposed to be 3.592M barrels a day- a non-compliance of 621k barrels per day. “Ministers on June 6 approved a one-month rollover of their now 9.6 million b/d production cut accord through July after receiving pledges of improved compliance from Iraq, Nigeria, Angola and Kazakhstan. Under the deal, those countries will compensate by implementing deeper cuts in the amount of their overproduction for July, August and September. The hard bargain, which Iraq had resisted, according to delegates involved in the talks, came at the insistence of Saudi energy minister Prince Abdulaziz bin Salman and his Russian counterpart Alexander Novak.” [2]

Nigeria was supposed to be around 1.408M barrels a day but ended May with about 1.69M barrels a day or a non-compliance of 282k barrels a day. Angola was supposed to be around 1.176M barrels a day but closed out May at 1.270 a non-compliance of 94k barrels a day. I have used the below before- but it puts the averages in perspective vs where the target production was per the OPEC+ agreement. The deal to reduce July is being helped along with Nigeria unable to sell about 30 of their current cargoes, which totals about 55. There have been some issues between May and June numbers deferrals and floating cargoes complicated the data. Angola, which usually sells out first, has seen the pace of July sales normalize following an aggressive June offering. “West Africa up 22% w/w to 4.44m bbls, rebounding from a 40% drop a week earlier; YTD high of 6m bbl was reached on May 22.” Angola’s largest buyer is China, so the slowing pace (back to historic) indicates a normalized Chinese market after the quick buying through May.

In an effort to balance the market, OPEC+ has cut production but has also carried out OSP (official selling price) increases that are inflicting more pain across refiners. OSPs are pricing metrics that the buyers use for negotiating cargoes and directly impact refiner margins. Crack spreads were already struggling, and Saudi just hit them again with price jumps as high as $7.30. Europe is experiencing negative margins across the whole complex, which will result in economic run cuts being instituted. The additional run cuts will hurt oil demand further as refiners slow down operations across Europe, Asia, and the U.S. Refined product builds are rising globally, and putting pressure on spreads- so even with some rallies in crack spreads- it isn’t enough to get netbacks to a place that make economic sense.

Libya Update and What It Means

Another bearish development for crude pricing is the potential Cease-Fire in Libya, and the lifting of Force Majeure across several ports. “The country’s state oil firm, the Tripoli-based National Oil Corp., has lifted force majeure on exports of the Sharara grade of crude from the port of Zawiya, it said in a statement Monday. It has done the same for exports of El-Feel crude from a different port. Sharara, Libya’s largest oil deposit, and El-Feel lie in the south-west of the country. Both fields started pumping again this week, having been shut down since January as the country’s civil war worsened.” The initial flow from Sharara will be about 30k barrels a day with a goal to ramp it back to 300k barrels over a 3-month period. The Zawiyah refiner is also starting to resume operations as things start to normalize with two fields starting to get back to operation. After the GNA rejected the cease-fire, the LNA has launched a counter-attack in Sirte- which is a key city in regards to port access. At the same time the Sirte battle was ignited, soldiers stormed back into the Sharara field to stop the restarting work. This has since dissipated and restarting operations have commenced again. There will be false starts in Libya as the LNA and GNA try to get the upper hand to push negotiations in their favor. Sirte will by the linchpin for control of Sharara and the ability to restart some exports into the market.

This time frame can be sped up, but the goal is to ensure several aspects:

Security- last time a boat came close they launched mortars at it. This obviously would drive insurance costs and other uncertainties. Control of Sirte will be critical for security of the field The equipment is tested properly, and everything is functioning the way it is supposed too Buyers show up for crude GCC (Gulf Cooperation Council) decides to not pay to keep it closed or the ceasefire falls apart

A ceasefire was proposed by General Haftar (leader of the LNA) and Egypt’s President el-Sisi, which came at a time when the GNA has recaptured the airport, Sirte, and other strategic towns (especially Tarhouna). These are logistical components that are required to protect Tripoli, and essentially puts a halt to Haftar’s push to capture the capital. The GNA offensive to retake areas stalled at Al-Jufra where the LNA made a stand, and fighting has slowed as the lines are redrawn currently. The ceasefire would: "This initiative calls for respecting all international efforts and initiatives by declaring a ceasefire from 6pm [16:00 GMT] Monday, June 8, 2020," President Abdel Fattah el-Sisi told a news conference on Saturday.” “The initiative, called the "Cairo declaration", urged the withdrawal of "foreign mercenaries from all Libyan territory", he said. El-Sisi added that the declaration also called for "dismantling militias and handing over their weaponry so that Libyan National Army [led by Haftar] would be able to carry out its military and security responsibilities and duties".” [3] So far the GNA has rejected the offer, but is currently meeting Russian diplomates to discuss the deal following Russia coming out in support of the agreement. The LNA would still control Libya’s South and East- covering a huge swath of the country’s oil fields.

Energy Intelligence Group OPEC Crude Oil Libya Production Data

The GNA retaking these key areas will allow for exports to resume at two ports, and will get production back to about 300k barrels a day from the low of 87k barrels a day. The big push came with the fall of Sirte, which was a strategic target for the GNA- now Turkey and the U.S. have spoken regarding the future of Libya. “Turkish President Recep Tayyip Erdogan said a deal with the U.S. over Libya was likely after his phone call with Donald Trump on Monday. The two countries have reached “some agreements” that might open a “new era” in the war-torn country, Erdogan said in an interview with state broadcaster TRT.” This will be a fluid situation as the LNA and GNA grapple for control, but with Haftar experiencing big setbacks- Russia, Egypt, and UAE may want to close this chapter. The other option is a pull back to regroup- feel out the opposition for a deal and launch a new offensive with a different tactic and renewed backing.

Economic Data Doesn’t Support Current Value

Europe has some of the worst refining margins across the global complex, and will see the most pressure in the near term. The reduction in throughput will help pull some additional exports from the U.S. over the next few weeks. “European imports of oil products from the Americas are set to climb to a 3-month high with a surge in flows to France, fixture reports and vessel-tracking data compiled by Bloomberg show.” “23 tankers hauling about 896k tons, mainly middle distillates, are expected to arrive in Europe in June so far; highest since March.” This will help support exports at reduced levels but won’t be anywhere close to pushing exports to normal seasonal levels over the next few weeks. While re-opening economies are making headlines, it is important to look at the data and appreciate how that is or isn’t converting into economic growth.

The below PMI heat chart helps to highlight how the economy was faring as we were coming into 2020. The global economy was struggling through 2019 (which we indicated based on slowing distillate demand last May/June), and the data continues to confirm our fears that the market may be opening but not running anywhere. The export/import data across the globe remain a big headwind for market recovery as demand stays weak across the complex.

Export/Import Data and What it Means

Export/Import data is lagging the market, which points to struggles abroad as well as at home. China is the perfect example that saw exports fall 3.3% y/y even though there was a relatively easy comp given the data wasn’t great in 2019. Instead exports are trending closer to 2015-2016 levels, which sparked a massive stimulation program in China. A stimulus program of the same magnitude is near impossible given the current Chinese backdrop- we went into detail in Jan over the issues facing their banking system limiting monetary/fiscal support. The bigger issue is the fall in Chinese imports- down 16.7% y/y pointing to problems in the local markets. Regional consumption remains problematic (not just in China) as steep unemployment numbers and rising costs keep people from buying goods. The U.S. is no different with retail traffic coming off the lows, but from very depressed levels. The data will keep improving throughout the summer (at a slow pace) as more states re-open, but spending remains depressed even as some traffic recovers. The lack of buying at key importing nations- aka the U.S.- will be a huge overhang for countries, such as China that rely heavily on US markets. The below NY Fed points to PMIs remaining well below 50 as the overhangs persist in June.

PRODCO North America Retail Traffic Index YoY

The below chart represents the following: “Traditional economic indicators, such as GDP growth, are typically only available after a considerable lag and can pose challenges when assessing rapidly evolving conditions triggered by a sudden event, such as the COVID-19 outbreak. To address this issue, the WEI leverages a range of metrics, including same-store retail sales, consumer sentiment, unemployment insurance claims, temporary and contract employment, tax withholdings, steel production, fuel sales, electricity output, and railroad traffic, to offer a “real-time” gauge of U.S. economic activity.” This programs a closer to real time assessment regarding the overall economy. The pace of the collapse has been impressive- and while things have bottomed- we haven’t seen a clear shift of improvement. The data started to show some recovery, but has remained range bound near the bottom. The problem is the conflicting data points, when something starts to look better- something counteracts it by getting worse. The problem remains- the U.S. was coming into 2020 on a weak footing that was being subsidized by the Fed, and the emergence of COVID-19 helped highlight the cracks throughout the economy. This was pressured by State wide shut-downs that will take months to normalize barring a second wave of infections, which I think is likely.

US Federal Reserve Bank of New York Weekly Economic Index- The Upward Trend is Pausing as Data Remains Lackluster After a Strong Bounce Off the Lows

Unemployment Remains the Elephant in the Room

It is going to be difficult to consumers back into the store as unemployment remains problematic, and bankruptcies are now trending at 2009 levels. The consumer is sitting on a record amount of debt, while job opportunities are few and far between with new layoffs being announced. This is putting pressure on personal balance sheets and limit total spending.

As economic data struggles on an industrial and consumer level, the ability to move to different jobs is hindered with the massive unemployment throughout the U.S. The M-o-M change also reflects a miscalculation on how unemployment was measured and counted with as many as 4.5M people incorrectly marked as no longer seeking work. While the number still works out to be better vs previous, it would still be in the negative category. It is also important to put it in perspective how far we have to go in order to get back to pre-COVID levels.

U.S. Continuing Jobless Claims

The U.S. jobs growth number quoted above was subject to a misclassification driven by placing about 4.5M people in the incorrect category. This has been a problem in the past and could cause a restatement that would take the additions negative. The miscalculation is something that has been a persistent problem in the data for years, so there isn’t an underlying conspiracy- but instead highlights the importance of using a basket of data points and not just one. The chart below highlights another problem with the data over the last several months- response rate. The lack of responses is also going to skew the data as it is extrapolated on a smaller sample set vs historics. We remain in interesting times trying to quantify what a recovery looks like as people focus on getting their families to the other side of COVID-19.

Retail Sector Struggles as Consumers Don’t Show Up

The retail sector set a record for most bankruptcies last year at 9,800 stores, but given retail traffic and consumer spending at lows that number could easily double. “If the anchor tenants close stores in the mall, other tenants are likely to follow suit,” Coresight Chief Executive Officer Deborah Weinswig said in the report, which put the expected range at 20,000 to 25,000. “Department and large apparel-chain store closures in malls will therefore create a ripple effect that spells bad news for malls.” “As of June 5, retailers have planned about 4,000 permanent store closures, including hundreds by J.C. Penney, Victoria’s Secret and Pier 1 Imports. In March, before the extent and duration of the virus lockdown was clear, Coresight estimated that about 15,000 stores would shutter in 2020. Alongside the closures, the firm expects to see another spate of bankruptcies as debt-laden retailers are pushed over the edge. Fifteen major retailers have already filed this year.” The view that everything will just “turn around” as the economy opens is misleading as the consumer struggles. The below chart helps to highlight consumer debt levels and is important to remember when thinking about the unemployed and spending capacity. As we discussed in last week’s write-up, unemployment is rising and at the executive/ middle management level. This will hurt spending at levels that are typically insulated (to a point) from pullbacks in the market. As layoffs work upward through the corporate ladder, the impact will be seen across higher end retail, vacations, dining, and other discretionary spending. For example, the level of competition in the market for jobs will push people to accept lower salaries and shifting income brackets. The person making 400k will accept 300k and the individual making 300k will accept 225k, and the story continues until the lower quartile struggles to find work.

When considering the retail sector and general movement of goods, the data remains anemic across the U.S. with intermodal weakness persisting. Carloads started to shift higher, but experienced the normal seasonal slowdown driven by Memorial Day Weekend. It will be important to see it recover back into the uptrend but given industrial and retail demand it will likely hover near the bottom. The issue with carloads rising remains the drop-in industrial activity that has resulted in reduced new orders. Imports into the U.S. remain low, which means less goods need to be moved from ports to logistic points across the system. Based on leading indicators, the flow will flatten out and not continue lower- but it will remain at the bottom for a considerable amount of time. Rail capacity was falling throughout 2019- so we are even comparing against weak comps, but the problems were highlighted during Q1 calls talking about how more engines were being stacked and additional layoffs. Guidance was for another drop in carloads by 10%-15%, and even before COVID we were pacing above 15% and closer to 17%-18%. The problems in the economy are real and nothing central banks do can be sustainable without real economic support/growth.

Port Data and Global Bellwethers

Ports around the U.S. are still experiencing a decline in total flow with some increase in LA, but across the country- data remains lackluster. Consumer demand in the U.S. remains under pressure with new orders low and Merchant Wholesaler purchasing down across the complex. While some of the data goes back to April, we can project forward a bounce but nothing that would be meaningful to get us back to a “normal” level of operation. The start of the recovery remains under pressure with more layoffs coming and extended unemployment benefits running out in July. These could be extended with an act of Congress to get more fiscal stimulus into the system, but it will take time to see that realized.

Imports Into Any State Using the HS2 Commodity Name

South Korea/ Germany/ China/ Japan are great bellwethers for global market health given their export loaded economies. Each of them continues to show breakdowns in the export market, which is being confirmed in other metrics and baskets of the economy. China imports (talked about above) remain a key factor around the world with limited orders and sales. Another example- South Korea and Germany saw their unemployment rates unexpectedly climb this past week.

South Korea Exports at 2009 Levels and Showing Limited Recovery

South Korea’s businesses slashed hiring to cut costs as exports continue to fall and consumption remains sluggish. The rise in the unemployment rate comes despite the government relaxing social distancing restrictions in April, allowing freer public gatherings that unleashed some pent-up demand for services.

The middleman in the U.S. or Merchant Wholesaler saw a huge drop in purchases through April, which is by no means shocking- but the depth of collapse is important. The leading indicators that would point to a strong bounce off the bottom remain elusive. The underlying economic data remains under pressure (specifically imports/ PMI/ RR carload/ consumer spending). While retail traffic is picking up, we aren’t seeing a meaningful conversion at the register. The weak purchasing is going to leave more product throughout the supply chain as seen in the Merchant Wholesalers. The extension lower was steep due to many states going into lockdown, but the recovery will remain subpar as spending leaves goods stuck in the system. The item to watch in the PMI breakout is the change in inventories and delivery times.

Merchant Wholesalers Sales Total Monthly % Change SA

A Quick Review of Credit Card Data

Credit card and general spending on credit has fallen as people see purchasing fall by about 22%-35% depending on payment method. With many activities delayed or canceled, purchases fell across the board and have yet to see a meaningful shift higher. The concern over future employment (as we discussed in last week’s note and above) will limit the total purchasing power of the U.S. consumer.

U.S Dollar Volume Growth Y-Y in All Card Spending

U.S. Dollar Volume Growth Y-Y in Credit Card Spending

The U.S. isn’t alone in its curbed spending as Chinese consumers stay home. In China (just like the US), wealthy Chinese don’t buy Chinese made products preferring to own imported goods. Imports remain low even though the Chinese economy is technically “open” and in “full recovery mode”.” Exports also fell by 3.3%, as the recovery slows down and their key trade partners continue to struggle. This is going to lead to an extended down turn that is finally starting to get reflected in year-end expectations.

China Import Trade USD YoY

The below chart is just one example of global economists adjust GDP expectations for the new normal. GDP assumptions will remain fluid as Q2 is calculated, but the assumption of 2H growth flies in the face of unemployment and all the leading indicators. While money supply growth (central bank liquidity) and fiscal stimulus (government checks) can help pave over some of the cracks, the lack of business investments, global trade, and consumer spending will limit any type of GDP growth in 2020 and 2021. The issues have been percolating since mid-2019, and with the help of COVID-19- the central banks strategies of playing hot potato with the economy is nearing its final days. It is near impossible to effectively call a top or a bottom as the market will typically extend “too far” in both directions, but many are looking at this market recognizing the absurdity of the moves.

Don’t Forget About Food Inflation/ Emerging Market Pain

Not only do we have global growth to contend with, but food inflation is increasing globally. Spending on food has increased as the supply chain struggles to normalize and results in additional costs. I have spoken extensively on this topic, but the numbers are starting to show up in the U.S. as well driven by plant shutdowns and shortages. Some of these prices will start normalizing, but it will be at elevated levels as the import/export market contends with more shortages and price increases. When we start to measure food staples globally, we can quickly see pressure mounting in areas across Africa and Asia- specifically Africa which was hit by not 1 but 2 historic locust swarms. Crops have been decimated, and purchases of imports have started to increase and will accelerate over the coming months. Egypt has issued tenders for wheat, Kenya has run out of grain and earmarked $18M for buying, and KSA has set aside $540M for food purchases. These are just a few examples of countries moving into the market in order to lockdown orders. Senegal rejected 50 licenses for fishing vessels in their waters (most of them Chinese), which will be an interesting test to see if China respects the denial. China has invested heavily in Dakar through the Belt and Road Initiative, so they may feel they have a “right” to fishing rights.

The pressure in Emerging Markets remains even with the US Dollar falling back to $95 from near all-time highs. The debt loads, lack of foreign reserves, shrinking economies, and limited exports are weighing on all countries- but specifically impacting Emerging markets. They don’t have the same flexibility or ability to stimulate their economies through fiscal or monetary policy. “The head of the International Monetary Fund called on private creditors to join the Group of 20 in providing debt relief for the world’s poorest nations, saying that the alternative to suspension and restructuring is defaults. A debt-service suspension would provide time for restructuring debt on a case-by-case basis in countries where debt sustainability needs to be restored, Managing Director Kristalina Georgieva said in a webcast with the U.S. Chamber of Commerce Tuesday. Private investors last month said they may offer low-income countries cash to ease the burden of $140 billion in debt payments due this year to help them fight the coronavirus pandemic. Still, the voluntary nature of the proposal may mean it falls short of easing the unsustainable burden carried by some developing nations, according to Jubilee Debt Campaign, an advocacy group.” Over 90 countries have reached out to the IMF in order to receive some form of bailout whether it be new cash injections or delayed interest/ principal payments.