By Mark Rossano [ihc-hide-content ihc_mb_type="show" ihc_mb_who="10,13,14,16,18,19" ihc_mb_template="1"] The demand for completion crews remains range bound with support in the Appalachia and Permian basins. Pricing headwinds and reduction in activity in other basins will keep the ceiling in place as the U.S. struggles to find a footing. The recent rally in the natural gas curve will provide some support for current activity, but even with the natural gas curve recovering- it will be hard to see additional activity given the storage expectations for year end. The storage levels are already trending in the all-time high levels with uncertainty surrounding LNG exports from the U.S. As we entered 2020, the expectation was for about 6bcf a day to be exported (with estimates as high as 8 Bcf a day), but COVID shook up the LNG market with cargoes being canceled or deferred. This will create persistent headwinds that will bleed into 2021 pending a very cold winter that pulls some of those deferred cargoes forward. There are many nuanced components to LNG exports, but the near-term headwinds will persist and act as an overhang for natural gas activity. The below charts show the natural gas curve and current storage levels going back to 1993 highlighting the pressure that will persist over the longer term. The weather is cooperating bringing some additional heat, and hopefully pulling down some of the storage estimates the market is anticipating as we head into shoulder season. The current rally in pricing will be enough to keep activity stable, but some of these headwinds will be persistent and act as a ceiling for new spreads to activate. This will keep Appalachia activity capped at most 20, but closer to the 17 or so 4-week rolling average. Consolidation increased in the natural gas space with Southwester buying Montage Resources in an all stock deal. MR had contiguous acres along SWN’s current operations, which will help expand inventory for SWN while also creating the 3rd largest gas producer in Appalachia at about 3bcf a day. The deal also reflects the low to zero premium being paid in the energy space, which will remain consistent given the debt loads sitting on many E&P balance sheets. Consolidation/ restructuring will remain the theme as E&Ps look to create size and scale or enter into agreements in bankruptcy to equitize debt/ restructure. These adjustments will directly impact completion crews as companies review what total activity looks like across the portfolio. It will lead to more efficient usage of crews, which is already occurring with the rise of simu-fracking wells or simultaneous fracturing two wells instead of zipper fracs. The adjustment in operations are helping to move working crews closer to 24/7 units- specifically in the Permian, which helps reduce total horsepower utilization especially when simu-frac techniques are deployed. These adjustments will keep completion crews relatively stable at the 4-week rolling average of about 75 as we expect it to drift higher from 73 over the coming few weeks with activity averaging closer to 77-80. End of August/ beginning of Sept will see additional crews added as we stay in a range of 75-85 through the middle of September. The biggest gains will remain in Texas with the Permian seeing some steady growth back above 40 as we get into September. Activity will remain relatively consistent in the Williston, Western Gulf, and TX-LA-SALT, while we get staggered activity with 1 or 2 spreads activated at different times to do some contracted work in other basins. Based on activity commentary, we will struggle to get back above 100 spreads without a marked shift in pricing, which will be difficult to achieve under the current backdrop of rising production, weak demand, and shoulder season rapidly approaching. The below charts help highlight the problems that will persist in the natural gas markets that will keep Appalachia activity relatively consistent at about 15-17 on a 4-week rolling average. Natural Gas Curve- Orange Line is Most Recent, which has Rallied Supporting Activity Total Natural Gas Storage Remains at the Top End of the Range and Pushing to All-Time Highs LNG Exports From the U.S. U.S. crude prices will remain under pressure as headwinds persist that will eventually offset the “macro” play of shorting the US dollar and buying oil/gold (or general commodities). The physical market has already been showing the pressure rising in the international markets. Urals are pricing at a rising discount (now at .80c) as pressure mounts with demand under pressure and rising crude production out of OPEC+. The U.S. blends specifically LLS- Louisiana Light Sweet and MEH- Magellan East Houston will have to price at a rising discount to be competitive in the market. This will push the spread vs Brent down to about $2 to cover the cost of shipping and the reduction in pricing. WTI Cushing has found some support in the market to counter some of this pressure from a weakening US Dollar and views that the oil markets are starting to balance. The issues with reaching a point of balance is the rising crude production, glut of refined product, and demand that is stagnate heading into shoulder season. In order to truly appreciate each part of that statement, we will look at travel in the U.S. and shift abroad to really look at the problems across the market. Vehicle miles traveled on U.S. highways in week ending August 9 unchanged from week before, -12% from same period last yr, according to data from the Department of Transportation. Travel for week estimated at 14.7 billion vehicle milesPassenger vehicle miles traveled -14% y/yTruck vehicle miles traveled on interstates +2% y/yNortheast shows biggest decline at -18% y/ySouth Atlantic -13% y/y, North Central -12% y/y, West -11% y/y, South Gulf -8% y/y Travel in the U.S. remains well below seasonal norms as more people remain cautious driven by job insecurity and COVID uncertainty. We are now in the final weeks of driving season and heading straight into the uncertainty of school and what the cold/flu season will bring families. My family received a “short” packet of 22 pages highlighting protocols for back to school and in person learning. It essentially talks about any sniffle/ fever/ cold like symptoms will be treated like COVID and you can only return to class with a negative test. There is a growing likelihood that school in-person will last a about a month before it is shifted back to online. Case counts remain elevated heading into back to school, and given how children are already little petri-dishes the spread will be difficult to stop. I know in my household the stress is real, and I am sure we aren’t the only one’s facing difficult choices as we look to get back to some form of normalcy. As the cases remain elevated, people are changing their general movements with or without mobility restrictions. Spending patterns and consumer shifts will be restrictive because the easiest answer to avoid exposure is to limit or stop a general activity. Even as states have reopened, everything remains low including restaurants, shopping, driving, and just general spending. The below drives home the limitations that remain in the market even after things “reopen” and full phases are implemented. The shifting consumer behaviors is creating a persistent glut across all refined products- gasoline with limited driving, diesel with depressed spending, and jet fuel with limited travel. Gasoline demand remains anywhere from 17%-22% (depending on data aggregation) below last year as we look at the seasonal shifts. Demand from GasBuddy shows a persistent plateau, and with weather events- East Coast and now Midwest- we will see stagnate recoveries in total demand. If we turn to the calculated number out of the EIA- things are a little bit closer down about 12% The problem with the data series by itself is it factors in exports/ imports/ storage/ refinery production and gets to a relative number. The previous week we had the East Coast preparing for a hurricane, which leads people to fill up their tanks and get gas for their generators inflating numbers as gasoline backfills the system. That is why the 4-week average is a great metric- which remains closer to our belief of 20%. Working from home remains in place, and now with new fiscal stimulus on hold as DC goes into recess until Sept 8th- spending will be anemic. August will be the first month without some sort of stimulus check to bridge the shortfalls we have seen on the personal income level. Total personal income spiked in April driven by rebate checks, $1200 stimulus, and enhanced unemployment benefits. U.S Consumer: Wages + Stimulus= Personal Income (Pink Line) Those have now expired and will directly weigh on general consumption as we have seen delinquency rates shift higher across all forms of loans/ borrowings. The below chart gives a breakdown of payouts from April to Aug, and how the drop off in payments will directly impact spending in August and September. The key months for back to school sales, where most people are assuming a resumption of at home education keeping families from conducting “normal” back to school spending. This is also being pressured by employment uncertainties and general income headwinds. This is a big hit as about 28.3M people are receiving some form of unemployment benefits, and it will directly correlate to spending levels and delayed payments. The below chart helps show how much was being distributed across April-July and how it related straight to personal income. Every week there is a new company talking about layoffs, as small businesses shutter their doors at a near record pace. The limitations of monetary policy have now been reached with bond buying, money printing, and equity purchases now fully enacted. The next stage will be direct lending/payments to people, but as we saw today with a week 30-year bond auction- there will be a limit to demand. China was the saving grave back in 2016, which gave the global economy a shot in the arm it needed to reach strong economic growth in 2018. In 2018, China backed off the stimulus train, and the Cold War between the U.S. and China really took off. As I have said countless times, COVID was jet fuel on a forest fire because when you look at the trend from 2018 into 2019 and as we prepared for 2020- the economy was moving in the wrong direction. The stock market didn’t care as liquidity poured into the global markets saturating everything and driving multiples ever higher even as earnings languished. So here we are- a global economy with a record amount of debt, saturated in liquidity, and watching the tried and true Law of Diminishing Returns take its toll on the effectiveness of stimulus. Without any real economic spark, the fiscal push highlighted below will just get us through another several months, but it won’t be a sustainable movement. This may seem bleak and drab and “Mark-why have you given up?” I respond with: I believe fully in the business cycle and the necessity of letting market forces dictate success. The next comment is: “well- the government mandated a shut-down… so it isn’t the businesses fault.” I watched 2 planes fly into towers… I was studying for my GMATs and saw the building across the street go from Lehman HQ to Barclays. My grandparents would keep money in coffee cans and stored EVERYTHING in the basement as they were children of the depression. I would ask- why are you doing that? The response: “Because you never know what tomorrow will bring, and it is always important to be prepared.” So here we sit- with 128 months of expansion and the Fed/ U.S. Government NEVER shrunk their balance sheet; Companies blindly bought back stock and issued debt because that was key to getting stock prices higher- instead of taking advantage of the good times and investing in their business or in growth… financial manipulation became the name of the game. So now- we have a black swan event, and every government, central bank, company, and consumer is sitting with records amount of leverage and no cash to spare in order to weather the storm. We are now faced with the issues created through aggressive financial manipulation, and instead of recognizing the failures- we push forward in a never-ending attempt to kill the business cycle. The invisible hand is coming back around, and companies that prepared will weather the storm and come out on top. We are ripe for innovation, and eventually the rampant fraud/white collar crime will be cleared paving the way for real growth. In the meantime, these limitations will directly lead to less driving, and as people get “back to work” after the summer lull-back to work will be dominated by WFH or limited travel to the office. We will remain well below the low end of the seasonally adjusted cloud in the chart below. This will only be exacerbated as schools shift back into remote learning protocol. DOE Gasoline Demand As we just went through above with lack of investment in business growth, distillate demand will remain a hurdle as manufacturing/ industrial production remains depressed- which also leads to a reduced need for shipping, rail, and trucking (in the U.S. in remains a bright spot). Last July- disty demand started to weaken, and we saw builds start to mount across the global market. The below chart helps drive home the level of storage in the U.S.- with areas across Singapore/ China/ India/ Europe all reflecting similar backdrops. The slowdown in demand isn’t going to turn quickly as global output stagnates with global GDP firmly negative for the year. There remains a hope that a huge surge is coming, but with the amount of leverage sitting at the country/company level- it will be difficult to see any meaningful return on stimulus. DOE Distillate Storage Trucking demand remains robust even as shipping/rail is contracting driven by low diesel prices and a plethora of available capacity. Rates remain competitive due to the sheer amount of availability and fuel prices as seen in the bottom chart. These rates make it “easier” to move spot cargoes, and the slow industrial demand means locations need “less” shipments. The ability to get affordable spot cargoes will be the driving force over the next few months vs large movements by rail/sea. Top Chart- Trucking Demand and Bottom Chart- Trucking Rates by Class The below chart helps to breakdown what we have been discussing- the average consumption hitting a plateau as “Daily Activity Indicators” and points shown above regarding mobility stagnating. These ceilings have been hit across many states, and now with the lack of stimulus- the shift lower will accelerate as we get into Sept. The general trend remains along seasonal norms, but we are starting from a massively inflated storage level with rising floating storage of refined products (again.) As storage builds in refined products and oil, it is made worse by the stagnate level of activity that is reverberating throughout many developed and emerging markets. Many companies are using COVID as an excuse to layoff works and write-down earnings, but if you follow the trail back into 2019- we were clearly on this path. Distallte demand was falling driving by declines in shipping and rail, which was a manifestation of slowing PMIs and industrial product/output. Employment opportunities will remain problematic as hiring freezes will remain in place throughout the remainder of 2020. The scale of layoffs is reaching all levels of management, which will pressure spending as those with the most discretionary income are experiencing a record amount of layoffs. The daily activity indicators are just a culmination of high frequency data points that can be aggregated to show where things are in relation to pre-COVID. Many of these negative data points are manifesting across the globe with falling crude demand just as OPEC+ production starts to pick back up in July thru Sept. India has shifted to the downside as we have seen more pressure across the distillate and gasoline space, which still remain down about 17% vs pre-COVID levels. The rise in some city restrictions is increasing some of the pressure- especially in industrial regions. There have also been several announcements of some refinery run cuts within India, which will keep pressure on oil demand through the remainder of Aug/Sept. India oil demand was supported by the rise in LPG demand, which will remain strong for the next several years due to rising adoption. As LPG/LNG finds new homes- it will displace distillate (and coal), which will lead to reductions in total oil demand. The below chart highlights the growth in COVID case in India, which is a headwind for normalization in the region. As cases trend higher, there will be growing lockdowns and limitations on movements that will directly impact driving activity and general industrial production. Oil demand headwinds will persist throughout Asia, but India was supposed to be a bright spot that is facing a decline in demand that will persist well into next year. India diesel sales down 13% in July from previous month and 21% y/yGasoline down 1% and 12% vs y/yJet down 4% m/m and 65% y/yLock downs have increased and so has flooding limiting demandFlooding remains a problem in China/India India isn’t the only one seeing the pain, as even the Chinese lies are starting to get less exaggerated as pressure builds in key manufacturing hubs. As we discussed in our Three Gorge Dam video and write-up, the Yangtze area makes up 30% of China GDP, 50% of their manufacturing, and large parts of their farming and livestock. The issues are mounting and resulting in sever limitations in government stimulus, which is also manifesting in a rise in food shortages. The consumer remains weak as we have been highlighting with massive limitations across China's fixed-asset #investment fell 1.6% y/y in Jan-Jul, in line with expectation, vs 3.1% drop in Jan-JunChina's industrial output up 4.8% y/y in Jul, vs expected 5.2% rise, in line with previousChina’s retail sales fell 1.1% in July, vs previous 1.8% fall China Recent Economic Data Points China is facing mounting pressures across at the banking and provincial levels as we have seen non-performing loans increasing and the inability of getting SPBs (Special Purpose Bonds) into the market. The above data points to a slow down across many facets that drive general GDP activity, which we already know is exaggerated. The problem is the numbers are getting hard to lie about as the Yangtze Economic Zone faces additional flooding with the area accounting for about 30% of China’s GDP, 50% of their manufacturing, and countless acres of crops and livestock. The ports remain bottlenecked with pressure across the board forming as the local consumer remains elusive. Employment and general spending will remain a problem across the China as limitations persist on manufacturing activity. We have already highlighted how this is appearing in the Daily Activity calculators, which is now showing up in even official data. Oil demand (oil imports) have already started to pare back, and the slowdown will intensify as refining activity heads lower across state owned and teapots (independents). We have seen SOEs pare back runs hitting about 76% but will move lower as we head into shoulder season- which you can see in the 5 year average. This will also impact total oil demand, which normally declines in Sept- and will create more problems at the coast with rising floating oil storage. While SOEs reduce runs, teapots activity has shifted off of all-time highs, but remains elevated even though we keep “hearing” that runs have to be reduced. Refined product storage tanks have reached limits so all of this additional product will be hitting the export market, which will keep Asia oversupplied refined product. China State Owned Refinery Run Rate Shandong Independent Refiner Run rates Oil in onshore storage is pushing back to all time seasonally adjusted highs at the independent refiners. The onshore storage is exacerbated by the amount of crude that is also sitting offshore and waiting to unload. China took advantage of cheap pricing throughout April-May, and are now sitting on a massive glut that won’t be clearing anytime soon. Shandong Crude Storage Asian Floating Storage The below breakdown of crude imports will remain under pressure as refinery runs slow down- above seasonal norms as pressure forms throughout the system. The pressure on crude will accelerate as OPEC+ increases production, and cheaters fail to meet their respective targets. Iraq is well off target with other countries also missing compliance quotas, and now while Iraq claims to “make it up this time” the exports/ boats tell a very different story. This will be a sticking point as we countries increase their total flow- specifically the GCC. “Exports from Kuwait jumped in July, rising by 294,000 barrels a day, or 18%. Shipments from the U.A.E., which include condensates that are outside the scope of the OPEC+ deal, rose by 263,000 barrels a day, or 10%, in July.” Iran promised additional reductions of 70k b/d in July, 314k b/d in August and 313k b/d in September. Iraq's crude oil exports have increased so far in July, shipping data showed and industry sources said, suggesting OPEC's second-largest producer is still undershooting its production cut target under an OPEC-led deal. OPEC seaborne exports rose 567,000 b/d m/m through July, market intelligence company Kpler said in a report. Departures “remained subdued” at 17.8m b/d, according to Kpler noteMost non-African OPEC members realized a m/m export gain through JulyU.A.E. led export gains with a 414,000 b/d increase; Saudi Arabia rose by 169,000 b/d and Kuwait 163,000 b/dConversely, Gabon exports fell by 120,000 b/d; Iran dropped by 118,000 b/d Iraq Production Numbers All these increases are also happening when Nigeria is fighting over the best way to clarify condensate as it is excluded from the OPEC+ agreement. Here are some quotes talking about the inherent problems in Nigeria: “Nigeria's oil ministry officials are asking international oil companies like Chevron and Equinor to reclassify Agbami as a condensate rather than a crude, sources close to the matter said this week.” In 2019, Nigeria was also looking to classify Egina, its newest export grade as a condensate. But NNPC now lists Egina as a medium sweet crude, boasting of 27.40 API and 0.17% sulfur. Under the latest OPEC+ deal Nigeria had committed to keeping its crude output at 1.412 million b/d in May, June and July, down 417,000 b/d from its baseline of 1.829 million b/d. From August through December it is obliged to pump 1.495 million b/d, while from January 2021 to April 2022 it will cap production at 1.579 million b/d. Since 2017, when the OPEC+ cuts first began, Nigeria has insisted that its condensate production amounted to 350,000 b/d to 400,000 b/d out of Nigeria's total production capacity of 2.2 million-2.3 million b/d. The ministry counts the Agbami, Akpo, Ima, Oso and Escravos streams as condensate.”[1] Russia is also maintaining their targeted growth inline with the OPEC+ deal- “Russia’s Rosneft raised crude production by about 6% in the first few days of August compared with July, reaching a daily average of about 536k tons (3.9m b/d), First VP Didier Casimiro said on a 2Q earnings call.” Russia has seen their production increase with more discounts being priced in throughout the Med as highlighted above. Russia crude loadings schedule isn’t fully solidified, but for Sept it will reach about 3.5M given the current trajectory- which will be above the 3M in Aug. This is coming at a time with rising floating storage and refiners going into shoulder season with a record amount of product- for this time of year. Crude Loadings for Nigeria/ Angola/ Russia Pressure will remain across all manufacturing sectors globally as unemployment, loan delinquencies, small business revenue, consume spending, and other key GDP metrics remain under pressure. The IEA and other agencies are finally taking down their oil demand estimates, and we will keep seeing revisions lower as general activity headwinds persist- and in my opinion- worsen as we go into cold/flu season. COVID cases continue to rise in key oil demand countries as we have seen with a big rise in crude storage and refined products. The glut isn’t going anywhere just based on historic as on a seasonal basis demand falls, and COVID reduced activity remains an ongoing concern. Clearing not only an oil glut but also a refined product glut isn’t achieved in the middle of shoulder season as OPEC+ reverse some of their bigger production cuts. [1] https://www.spglobal.com/platts/en/market-insights/latest-news/natural-gas/081120-nigerias-agbami-key-sticking-point-in-opec-compliance [/ihc-hide-content]