Primary Vision Insights – June 22nd, 2020

By Mark Rossano

Summary

U.S. Frac Spread and Pricing Update The Rise of Product/Oil on a Global Level in Charts OPEC+ Shifts Won’t be Enough to Balance the Market Economic Data is Mixed in the U.S with Some Bright Spots Retail Sales Show a Consumer with Pent Up Demand- But is it Real? Industrial Production Remains Weak as Transportation (CASS Indexes) Point to Weakness Central Banks Can’t Stop Won’t Stop China/India Situation Remains Fluid- But Will Get Worse COVID Remains a Real Threat to Oil Demand Globally

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U.S. Frac Spread and Pricing Update

Global oil prices have rallied on hopes of a demand surge, but the demand remains fleeting while the U.S. looks to bring more supply back to market. The Bakken has already seen about 60k barrels of shut-ins reversed (out of our expected 100K), while the Permian continues to bring capacity online with another 250k online (out of an expected 500k). ConocoPhillips has also announced that in July the 100k barrels a day of Alaskan crude will resume flowing after shutting-in. The tropical storm Cristobal forced Gulf of Mexico shut-ins of about 500k-600k barrels a day, which is almost fully back operational. By factoring in these adjustments, the U.S. will be back to about 10.7M barrels a day of production this week and rise about another 200k over the next few weeks. As shut-ins start to reverse, we are starting to see signs of life on new activity outside of purely natural gas plays. Over the last few weeks, natural gas plays- such as Appalachia/ Haynesville/ Oklahoma Dry gas attracted some new activity as oil basins saw additional contractions on new activity. With the “rally” in crude prices, new spreads are coming back in the Bakken/ Eagle Ford/ Uinta- while the Permian saw a small decline but will most likely bottom at 20 and see a recovery this week on activity. Some companies talked about bring back shut-ins if WTI was able to rally past $30, and true to their word, as WTI held above $30 shut-ins have reversed. The flow of additional oil has been showing up in PADD 3 (Gulf of Mexico) and avoiding Cushing in an attempt to capture a better realized price at the coast. We have bottomed in frac spread count activity with a move back to 75 very likely, but it will be hard to sustain any real activity above those levels. Rig counts will remain low, and the focus will be to complete the best DUCs in specific basins to help offset some E&P decline curves. The focus will remain on managing declines through new completions of DUCs/ workovers/ refracs/ other downhole cleaning exercises to stem production loss. These activities will keep U.S. production over 10.5M barrels a day- especially in the current market given realized prices. The below price chart help to provide a view of where E&Ps are focusing time given some price recoveries. The OSP (official selling price) out of Saudi Arabia has put U.S. exports back in play from Magellan East and LLS. The rise in prices and remaining crude cargoes in the Gulf of Mexico have kept U.S. refiners from purchasing additional cargoes (so far about 1), and instead opting to increase imports from different locations, consume local oil storage, or increase runs of U.S. blends.

As U.S. refiners look to minimize losses, it is important to consider any adjustment to feedstock will be happening at significantly reduced throughput levels. U.S. utilization rates are sitting at about 73.8% vs the seasonal norm of 93.9% (or the 5-year average of 93.6%)- so we are a full 20% people normal operation. This equates to about 3.7M barrels a day less being run through the system and given the all-time high levels of refined products- the run rates won’t be adjusting all that much over the next few weeks. We remain confident that the utilization rates will sit between 70%-75% throughout the summer driving season. This is typically a time where we see draws in oil across the global complex, but instead builds continue to pile up globally in oil and refined products. There is a belief in the market that oil will be under-supplied around the world, but those views are assuming a relatively aggressive recovery in refined product demand that has yet to materialize meaningfully and ignores OPEC+ cheating, recovering Non-OPEC production, and OPEC+ production increases in line with the agreement.

DOE Refinery Utilization Rates

The Rise of Product/Oil on a Global Level in Charts

The rise in oil prices outpacing refined product demand has put pressure on refining margins/crack spreads limiting any sustainable increase in global throughputs. The weakness in crack spreads isn’t going to reverse anytime soon as global crude prices remain elevated and products demand sits under pressure. There remains a global glut in every major market/storage center that will keep a lid on pricing as storage levels struggle to normalize due to a floundering global economy. Here are some examples of elevated refined product levels:

International Enterprise Singapore Oil Products Singapore Stock Data

DOE Distillate Fuel Oil Total Inventory Data

DOE Motor Gasoline Total Inventory Data

Crude Storage in ARA (Europe)

PJK International ARA Gasoline Inventory K Tonnes

I can keep going, but I think this helps drive home what kind of oversupply we are dealing with in all corners of the world. This is covering all of the data of on land storage, but doesn’t also indicate how we remain oversupplied in the seaborne market as well. The global crude on water has started to come down, it is still elevated on a 5 year average range with little to bring it back in-line.

Global Crude Oil on Water

OECD Commercial Oil Stocks Above the 5 -Year Average and Climbing

The OECD increases are still climbing as Europe/ U.S./ Japan and other nations see crude coming onshore from offshore storage. The shift will just flip from one chart to the other as refiners/petchem keep operations well below seasonal averages throughout the summer. This is all happening at the same time as China has a record amount of crude sitting off the coast.

While China sets a record of crude offshore, the rest of Asia is facing a very similar glut in India/ South Korea and Japan.

Asia Floating Storage

OPEC+ Shifts Won’t be Enough to Balance the Market

The increases across the complex are coming at a time when many of Nigeria’s cargoes leaving the docks to go directly into Saldahana Bay for floating storage. This is being reflected in shipping data, and will keep a lid on price increases even if OSPs are technically higher. The OPEC+/IEA comments are coming at a time with sweeping oversupplies up and down the supply chain that will keep pressure on oil demand. Many countries in Europe are still reporting 20%-35% demand declines in diesel/gasoline with something similar being realized across the Americas. This comes at a time when countries are reopening and lockdowns are being lifted. While the crude export data looks good, there still remains limited buyers-especially with China now filled to the gills onshore and off. July “looks” better in this chart, but it is coming at the same time the GCC (led by Saudi) are ending the additional 1.2M barrels a day of voluntary cuts above their agreed upon flow rates under the OPEC+ agreement.

Iraq has come up with a plan to compensate for May over-production, but I continue to question the willingness of Nigeria/Iraq to compensate for over-production. Saudi and Russia have signed and continue to ink new long-term deals that leave Nigeria and Iraq behind. Angola agreed to float their crude in Chinese futures, which keeps a relatively stable flow of crude. Just for context OPEC should have been production at these levels- about 22.589M barrels.

Instead- OPEC produced at 24.195M barrels or a non-compliance of about 1.606M barrels a day. Are the worst “cheaters” going to be incentivized to cut their share of the production as crude prices have risen as their economies flounder and interest payments pile up? June will show tighter compliance vs May and get closer to 87%-90% compliant, but July things start to loosen up again as 1.2M comes back to market from KSA/ Kuwait/ UAE. This also comes at a time when non-OPEC production was taken higher, and I believe they continue to overstate total demand recovery.

Economic Data is Mixed in the U.S with Some Bright Spots

The oil markets remain in a precarious spot with a mixture of data showing some green shoots while others weighing down on the outlook. The Philly Fed Business Outlook Survey put in a very impressive beat across all its metrics- estimates were for a -21.4 and it came in at a +27.5. While that was an impressive beat, initial jobless claims increased 1.508M (above estimates of 1.29M) and continuing claims remained at 20.544M vs an expected reduction to 19.85M. We have been very adamant that continuing claims will remain over 20M as new layoffs are announced and carried out as companies shrink balance sheets/overhead limiting new jobs.

Philadelphia Fed Business Outlook Survey Diffusion Index General Conditions

As Philly Fed was strong and employment data disappointing, some Bloomberg metrics also posted very lackluster performance:

Bloomberg US Weekly Consumer Comfort Index

Bloomberg US National Economy Expectations Diffusion Index

The rise in unemployment will keep some of the key weekly economic indexes weighed down and will remain a problem for consumer spending-especially in gasoline. As these unemployed individuals face the potential lost of the increased benefits set to expire in July, spending will be reigned in even further to preserve capital and stave off personal bankruptcy. “The number of accounts that enrolled in deferment, forbearance or some other type of relief since March 1 and remain in such a state rose to 106 million at the end of May, triple the number at the end of April, according to credit-reporting firm TransUnion. The largest increase occurred for student loans, with 79 million accounts in deferment or other relief status, up from 18 million a month earlier. Auto loans in some type of deferment doubled to 7.3 million accounts. Personal loans in deferment doubled to 1.3 million accounts.” [1]

The rise in delayed payments is the key reason why last week we started talking about tightening of credit standards.

Consumer- Percent of Banks Tightening Standards for Credit

Retail Sales Show a Consumer with Pent Up Demand- But Can it Last?

The market remains a tale of two cities with data points for bulls and bears depending how you splice the data M-o-M/ Q-o-Q/ Y-o-Y. We have discussed the importance of looking across the spectrum to understand where we sit in the recovery. The move off the lows was always going to be robust given the depth of the fall and the desire for people to get out of lockdown. The pent up demand helped drive a quick rebound, but the ability to continue to trend faces headwinds ranging from new COVID outbreaks/ unemployment/ benefits running out (the additional $600 goes away in July)/ human nature of actually being outside the house. Retail sales posted an increase of 17.7% month over month, but is still down 8% from February and down 6.1% y/y. While retail posted some strong reactions following lockdowns easing, the comps will get harder as pent up demand is fulfilled. Consumers have started to show up in the Northeast-specifically NY/NJ following the move into phase 2/3 depending on locations. Things improving in the NE will be complicated as other states- Arizona, Texas, Florida, Alabama, and Georgia start to see an increase in COVID cases. These are problematic areas that could see a resurgence in cases and result in additional closures based on county. Companies continue to announce new layoffs that will span over the next few months, which will keep unemployment and continuing claims elevated.

Some have pointed to the “Control Group” retail sales bounce as a better gauge of real buying in the market. While there was a strong bounce off the bottom, we are still well out of seasonal normal range on buying behavior. The seasonality chart helps to demonstrate the depth in which we fell- taking out the lows set in 2009- and given lockdowns ending- it isn’t a surprise to see a strong recovery off the lows. With that being said, we are still outside of seasonal norms going back to 1993 and now that we have seen a strong recovery- this will level off over the next month or so as consumer pent up demand has been realized in many categories. Given the basket of data points we have covered over the last two months, there is no argument things are better- but we are far away from a normal environment as the global economy tracks at deeply negative growth across all facets of production/consumption.

Retail Sales Less Food Services Auto Dealers & Building Mat& Gas Station SA YoY (Retail sales (also referred to as retail trade) tracks the resale of new and used goods to the general public, for personal or household consumption. This concept is based on the value of goods sold.)

There has been a recovery in some areas along the home improvement/ sporting goods/ non-retail stores/ gas stations as consumers are spending in different ways in May. The time at home is being used for gardening/ backyard projects/ in-house upgrades. The shift to outdoor activities have also driven the move to hiking/camping. While these are positive spending developments, it is adjusting the consumption of not only diesel but gasoline and jet fuel. For example, if a family normal travels from NY to Hilton Head- South Carolina for a summer vacation that would require 4 airplane seats and 696 miles in the air. With the cost increase in airline flights, COVID-19 fears, or just general employment concerns, will the family choose to drive 798 miles to cover the same distance? The same family may decide to do day trips to Bear Mountain/ local beaches or other day trip drives. This will cut down on total air miles, but won’t fully dump into driving miles either. This will create a net decline across the board as some of those day trips may have already been planned and be local. The general reductions across the summer complex will result in air/driving miles to be well below seasonal norms. Our estimates put a normalized gasoline demand at about 7.8M-8.5M barrels a day, which will be about 1.5M barrels below seasonal averages. The issue will also be complicated by counties/ states experiencing a reversal in opening .

Based on the above chart, restaurants will struggle because in order to reopen they need to cut total occupancy while ensuring safety protocols that are expensive. The total cost of doing business has risen between safety to food that prices have risen that will also limit customers. The below OpenTable data points to the slow grind higher restaurants face as many have opted for outdoor seating options. The impacts of food inflation are appearing in prices, while their remains hesitancy on eating in a restaurant all together. The comps will also get a bit more difficult as seasonal restaurants that typically open this time of year may remain closed as tourists don’t materialize or general traffic are well below normal seasonal trends.

OpenTable Data- Blue Line 2020 vs White Line 2019

An interesting point here is the increase in total retail sales but the decline in total dollar value in the same period. The shift higher in retail sales M/M also led to an increase in total dollar value but at a reduced level. This is driven by the total number still being down in absolute terms, but also the amount of incentives and sales in order to move inventory. The below chart gives a snapshot of dollar volume growth incorporating all form of card payments. The shift higher is similar between dollar value and sales, but the difference remains the dollar amount. The amount of incentives offered (sales) will impact retail margins, and even with a recovery in some sales- bankruptcy is inevitable. The retail faced about 9,600 BKs last year, and at this rate we will clear about 20k.

Bankruptcies are increasing on the consumer as well as the business level. We have spoken about the consumer struggles given the leverage on personal balance sheets, but corporations are also sitting on a massive pile of debt, which limits their ability to survive the downturn. Fiscal and monetary policy has been used to stave off bankruptcy, but you can see a BKs starting to puck up in 2019 and has only accelerated throughout 2020. The below chart is showing pressure in companies that have a sizable liability claim, and sadly we are far from over due to the leverage throughout the system.

The inventory ratios remain at all-time highs as companies were stuck with product before COVID-19 struck, and after the global economy began shutting down companies didn’t have an opportunity to move inventory. Instead- it sat in warehouses/ ports/ wholesalers with little ability to get product to market. This is a perfect illustration of the damaged supply chain as product is unable to move through the system effectively. The lack of mobility in the market remains a problem across all modes of transportation.

Industrial Production Remains Weak as Transportation (CASS Indexes) Point to Weakness

We have remained cautious on transportation as our shipping trackers were showing a large decline in open water as well as at the port level. The weekly railcar data was still showing significant headwinds even though there was a bit more movement week/week. There has been limited movement on a month over month level from April into May, and while June will look better vs May- we continue to see pressure in the supply chain. The issues are driven by limited corporate and consumer purchases that is being driven by limited demand. New orders remain weak across the U.S., which is limiting buying across the complex. Even though shipping bottomed as backorders and delayed products moved to fill orders, expenditures were down 5.7% from April into May supporting what we have seen on a slowdown in new purchases. June is typically a very strong month for shipping, which will be supportive for M/M recovery- it creates a very difficult comp on a Y-Y level.

May shipments remained firmly in recessionary territory and barely recorded a change vs April which was at the peak of U.S. shutdowns. Shipment volumes while bottoming barely registered an increase.

We have already highlighted the problems that persist at the port level with limited imports across the coasts. South Korea has so far reported exports down 20.3% and imports down 16.9% with China stating exports down 3.3% and imports down 16.7%. This type of decline will reverberate through the system for the next few months, which will keep growth firmly in the negative category through May. Even though the below chart is through April, the data has gotten worse through June for both imports and exports out of Asia- which will keep the growth down- especially given how May will be a difficult comp on a year over year basis.

The rail data finally started to move in a positive direction, but with headwinds persisting in the market- we believe that the railcar data will normalize down 10%-15% over the next several weeks as companies digest inventories and try to move product to end users. With less freight appearing at the ports over the next several weeks, the movement higher will level off.

Expenditures fell again on all metrics as pressure remained in the system as many shipments were long hauls or at least had a longer than average length in movement. This reduced overall profitability and the reduction in fuel surcharges (low fuel prices) weren’t enough to offset the damage on a per-mile cost.

Trucking saw a small bounce off the lows, but still recorded a negative growth over the same time period. Movements remained relatively stable over the last few months as trucks have been a main staple to move product through the COVID lockdown. Pricing came under pressure due to an oversupply in the market, but volumes remained relatively steady.

All these data points are confirmed given the poor reading out of the industrial production index. The read through across leading indicators point to a stabilizing effect, but not a huge bounce in activity. The industrial/manufacturing side of the equation did not fare as well as utilization/production recovered off the lows but not nearly to the same degree as retail sales. There is always a delay between the two as many companies face backlogs and high inventory levels that need to be worked off. This will all take time to stretch through the supply chain, based on data across import-exports, intermodal, and port data.

Central Banks Can’t Stop Won’t Stop

All of this fun data leads us right into Central Banks, and their continuation of out-right buying in the market to support zombie companies and flood the market with liquidity. The BoJ has increase their support by $325B, but to be clear- they already own 80% of total AUM of ETFs in Japan. So I guess they can just take that to 85%?

Bank of England not one to miss the part has also increased their purchases by 100B pounds:

And just to round out the support from the ECB and Fed- what is $19.5T amongst friends?

All of this stimulus and we have stock markets that fight daily to retake the all-time highs on a foundation built with rising unemployment, terrible import-export data, weak consumers, and production indexes struggling to get out of their own way. I have already talked about U.S. unemployment, but now we can turn to Europe and see a very similar-albeit worse situation. Each country has tried to push employment, but with industries looking to shave cost and reduce headcount- many of these job seekers have no where to turn. Last week, I went through how many of these displaced workers will be forced into new industries as they are permanently displaced from their current.

There is no need to continue down this road today… I am running out of ways to say: “Things are bad but hey AT LEAST WE HAVE CENTRAL BANKS!!!!!”

China/India Situation Remains Fluid- But Will Get Worse

We have been discussing India-China for a while now, and they finally came to blows causing about 80 or so casualties with 20 Indian/ 43 Chinese deaths so far reported. Apparently, there remain several missing soldiers so these figures can trend higher over the next few days. The Line of Actual Control or LAC was the site of the clash-specifically in Galwan Valley. It has been a spot that China hasn’t particularly cared much about, but as India built a new road/infrastructure- China began to amass troops on the “wrong” side of the LAC (wrong is in the eyes of the beholder). I am on the side of China aggression knows no bounds, but that is a much longer discussion. There have been several clashes over the years in this area, as well as in Sikkim/Doklam Plateau, but years ago China/India agreed patrols were not to carry weapons to avoid an accidental/unnecessary death. I guess China thought clubs spiked with nails would only wound? Tensions have been ramping over the years as China got closer with Pakistan, and India feared encroachment on their territory as the China-PAK Economic Corridor is built through Kashmir. India/China (as well as many other countries) continue down a path of nationalistic fervor (see food hoarding) additional clashes will happen at an increasing frequency. Each side has someone to avenge, and cooler heads will struggle to prevail in a backdrop of a struggling global economy and COVID-19 decimating both countries. The blame game/rhetoric has been flying around to push the narrative, but as we know in any fight- there is his side/ her side and the truth.

The tensions will also mount as both countries build more infrastructure on their side of the only ways to get heavy machinery over the Himalayas. Each side has responded by increasing the number of troops and military equipment moving into the area. With the most recent being: “China has brought in several hundred soldiers and heavy construction equipment into the Galwan valley. Additional troops were also deployed inside Indian territory near Patrol Point 14. PLA also deployed at least 12 artillery guns on its side of the border - Economic Times.” India hasn’t been sitting still and has matched- if not led- the movement of personal and equipment into the region. It is important to consider that when the Dalai Lama escaped Tibet when China took it over- the people of Tibet were given sanctuary in India. The Indus Water Treaty covers all of the areas currently under scrutiny, and when conflicts involve Water/ Food/ Shelter- tensions can remain elevated. While India/China had tension elevated in 2017- we are in a VERY different world vs 3 years ago.

China has been looking to distract its populace/ world from the weak local economy, Hong Kong tension, and COVD so what better way than to engage India and tell North Korea to resume being North Korea. NK has now moved equipment and soldiers back near the DMZ, blown up a mutually shared building for “better relations,” and talked about launching new projectiles. 2020 isn’t short of wonders!

The U.S. has also signed into law a bill that would punish China/ Chinese Individuals for carrying out the Xinjiang re-education camps. These have been known about for some time and have been a source of contention for human rights activists and neighboring countries. China has vowed to retaliate if the U.S. moves forward with the Uighur rights bill, which has already been approved by President Trump. China is claiming the U.S. is using the law to harm China’s interests and interfere with their internal affairs- but we can span that view across Hong Kong/ Taiwan/ now India/ Uighurs.

COVID Remains a Real Threat to Oil Demand Globally

COVID-19 remains a problem around the world with a resurgence in Beijing that has now spread outside of the city and into neighboring provinces and cities. The government has moved quickly to roll out contact tracing and lockdown the impacted areas. About 2200 flights were canceled and Beijing traffic fell by 70% overnight as people stayed indoors to avoid contamination and spreading the virus. Reopening’s in the U.S. have sparked a rise of new cases in areas around the country, and show the difficulty of getting back to a normal operation. Hospitalizations have to be watched because ICU utilization rates will dictate how damaging the new hot spots will be and if any area has to go back into some form of lockdown.

Some states have seen a steady increase of confirmed cases and are outpacing the 7-day moving average- which is a better way to gauge how quickly things are rising. The focus needs to remain on ICU availability because this will dictate many decisions given the drain on normal operations caused by COVID hospital stays.

On a global level- COVID cases continue to rise each day with little break in the shifts higher. Lat Am keeps seeing a trend higher, which remains a huge headwind for refined product demand. Brazil was forced to cut their refinery throughput down to 55%, which will put more crude on the water as production remains relatively flat. The rise in cases and apparently a new strain that is more contagious but less deadly- will keep a lid on a recovery back to normal crude demand. The reduction in purchases will keep spending depressed and unemployment elevated. Fiscal and Monetary support can only provide a band-aid for so long until the economic weight of the problem drags things lower. Global economic data remains under pressure with some green shoots in the U.S.- but in total the U.S. keeps putting out mixed data that skews bearish when we layer in the negative global backdrop and overhang of COVID.

Total Confirmed World-Wide Cases

[1] https://www.wsj.com/articles/americans-skip-millions-of-loan-payments-as-coronavirus-takes-economic-toll-11592472601

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