[ihc-hide-content ihc_mb_type="show" ihc_mb_who="10,13,14,16,18,19" ihc_mb_template="1"] By Mark Rossano SUMMARY US Completion ActivityCrude & Liquids PricingOPEC+ Production UpdatePhysical Crude Market BackdropAsian Weakness Across India/ChinaRefiners Foreshadowing an Ugly Start to 2021 We will provide a broader update for the US economic picture in the next report. In the meantime, we covered a large part of the inflation, stimulus, GDP, and jobs picture on our YouTube channel. US Completion Activity U.S. crews (finally) paused after the strong recovery following the Texas freeze off that sent active spreads tumbling. We had a steady increase from the low of 41 to 220 as the focus was directed at addressing decline curves and stabilizing underlying production. The U.S. oil industry has survived some huge market shocks in the last year, but even through adversity, the energy industry has persisted and remains on a path of growth for 2021. The pace of activity in 2020 was slow and steady from the low point on May 15th that saw 45 active spreads (which was briefly hit again this past February when the Texas deep freeze sent activity to zero across most of the state and surrounding areas). As we entered Q4’2020, completion activity accelerated to reach its normal seasonal peak mid-December. The beginning of 2021 started off like any other year with a steady rise throughout January, as work commenced following the holiday season. Activity ground to a halt in February, but within 3 weeks, we didn’t just close the gap, we exploded through the other side. Our initial assumptions were for a gradual recovery throughout Q1–Q2 of 2021, climbing to about 200 spreads by the middle of May as companies prepare for the typical summer push that peaks in July. Instead, we had a surge coming out of the February Texas freeze. The rally back to 200 was rapid after closing out Feb at 140: 60 spreads were brought back within 4 weeks, pushing to a near-term top of 220 crews by mid-April. This outpaced our expectations and has caused us to increase our confidence range for the rest of the year. We now expect to close out 2021 at 275 active spreads with U.S. oil production sitting at an exit rate of 11.5–11.7M barrels a day. We believe the number will be closer to 11.5M, but the speed of the recovery will provide uplift on total production. The U.S. is at a point where production will be stable with a steady increase over the next few months. There could be another reduction as some of the smaller basins see activity adjust, but 212 should be the low point as spread activity starts to increase with warmer weather. We don’t expect (or are seeing) a quick rally in the very near term, but rather a steady state between 210-220 spreads with crews moving around through the next 2 weeks of May. Some of the declines in the Permian is driven more by spreads shifting between jobs vs a decline in underlying activity. Many crews are starting to see their backlog grow and build in the summer months- so we are confident that the pause at 220 will be temporary. As we approach June, we will see a steady increase of activity bringing us to about 235-240 spreads by the end of June. The rise in activity will be driven by the Permian, Williston, and Western Gulf. Texas and North Dakota will see the largest step-up in activity- especially in the Bakken where we need to get closer to 20 spreads to stop the production decline. The political uncertainty will persist around DAPL, but E&Ps will have to act to stabilize production to avoid a steep hill to climb on the other side of the DAPL decision. The next wave of activations will start taking place as we approach the end of May/beginning of June, and we will see more activations as we head into July. We expect to exit the year at about 275 active spreads and a crude production level of 11.5-11.7M barrels a day (but much closer to 11.5M). If we look at 2017, we are already above the 4-week rolling average, and I expect us to get closer to 2019 in the area as we progress through the spring and summer. The biggest shifts in the market against 2017 are Appalachia, Western Gulf, Denver, and Williston. The gas plays don’t need the same kind of support vs oil plays given the underlying molecule. The “lighter” the molecule the easier it is to get the trapped hydrocarbon- with methane the easiest. The installed base now of producing wells and “lower” decline curves vs crude allows for less activity to generate stable production. This will keep the natural gas activity levels depressed vs 2017, but on the crude side we will start to see activations accelerate: specifically in Texas. The Williston and Denver have specific political issues that will limit growth to 2017 levels, but will at least support movements to stabilize production declines. The below chart highlights the strong pivot of the underlying capacity towards oil and away from natural gas. This will provide the support to send production higher throughout the remainder of 2021. As we look forward, we believe that 2017 “rate of change” is a better way to look at completions as we head into peak activity on a seasonal basis. We believe that the pace of activity will remain similar and peak as we approach the middle of July. At this point, we expect activity to hold within that range keeping the end of Q2 and Q3 very busy. This will lead to a normal slowdown that happens around the winter holiday season and weather impacts operations. The push-especially in Q3- will require additional DUCs in some key locations, which is why we expect to see a bigger push in Q2 to bring back rigs and build out/ replenish inventory. This will allow for a seamless transition to more spreads as we head into Q3. PVMI National Spread Count 2017 vs 2021 Crude & Liquids Pricing Crude and liquid pricing remains supportive of completions and production growth with ample opportunity to protect downside. Even a sizeable retracement in the front month, we should see the belly of the curve remain intact and not shift in a way that would be detrimental to current US production levels. The market was saturated by 13+M barrels of light sweet crude, but at a steady profile of 11-11.5M barrels a day- the market has been able to absorb a large part of it. U.S. refiners have also built additional assets to run lighter crude slates and avoid the coking units. This will allow for processing levels that have a higher API vs historic and target the lighter end of the stack. The US will still require heavy barrels for the coker and general processing, but offers up more optionality for feedstock diversification and processing. NGL prices have approached 2018 levels after taking out the highs from 2019. The support is there to maintain levels close to 2018 due to the demand for plastics and international flows. The liquids market will remain supportive of U.S. activity, and provide some additional drive to complete in the Anadarko, Eagle Ford, and other wet gas- liquids rich plays. The market is still supporting additional LPG flows, which we see remaining the case over the next few months. WTI Crude Curve NGL Basket Monthly NGL Basket Weekly BFV/EU Propane CIF NWE Cargo vs Naphtha CIF NWE Cargo Spread M1 The US crude market is still trading tight to Europe with Brent vs LLS at $1 and Brent vs MEH at $2.32. The end of month surge that the EIA reported was due to backlogs that have been clearing at the end of every month for the last 5 or so months. We expect to see some residual elevated exports this week, but head closer to the average of 2.6-2.8M barrels a day. The spreads being relatively tight will keep U.S. crude flows limited. The Dubai vs WTI has moved into negative territory as the Middle East crudes trade at a steeper discount. The competition in the physical market is heating up as COVID19 impacts Asian demand, and we see some residual slowdown in activity from China. The issues are coming at a time that is seeing an increase in OPEC+ crude production. May, June, and July are supposed to see increases from OPEC+ and KSA voluntary cut come back to market. OPEC+ Production Update OPEC closed out April with an “official” number that showed a decline of 50k barrels, which was driven by the drop in Libya. The reduction in Libya has already started to reverse as the government has deposited about $300M into the NOC bank account to lift force majeure and start the process of repairing and growing production. The goal is to hit about 1.5M barrels a day by year end after sitting at about 1.3M for the last several months. In May, OPEC+ will increase production 350k barrels a day as well as KSA adding 250k- getting to about 600k barrels entering the market. In the meantime, countries continue to “cheat” or produce well above their allotted target: “OPEC+ countries producing above their quota (The figures are derived by adding up each country's monthly production that exceeds its quota): Russia: 877kbpd Iraq: 707kbpd South Sudan: 557kbpd Kazakhstan: 425kbpd Gabon: 392kbpd Congo: 199kbpd Some of the above numbers are skewed due to the classification of condensate (not included in the deal), and it shows the aggregate amount of over production since the OPEC+ deal was struck. In the May expansion, Russia and Kazakhstan were excluded because they were allowed to increase production over the last few months. But- based on the above breakdown, it really doesn’t matter as they are already producing well above targets. Iran has also seen an increase in production levels as additional cargoes have made their way into the Asian markets (mostly China). This has shifted the import and blending at Chinese refiners. The additional Iranian crude has displaced some demand for Brazil, WAF (Angola), Norway, and Urals. Iran crude’s closest comp is Urals, and when we look at Ural flows (zero in April) and only slightly higher in May- Iran is helping to displace as maintenance and reduced run rates cut crude demand. China just came out of their labor day holiday, so we will need to see how much refining capacity returns to market vs what stays depressed following the crack down on Shandong refiners. Chinese authorities always crack down on Teapots when margins get tight in order to protect SOE refining capacity. Shandong capacity has come off quickly following a big maintenance season, but the question remains- how much will come back following the government crackdown. The State-Owned facilities have also gone down for maintenance but should start to come back online over the course of May. There have been shifts lower across the complex that has resulted in builds onshore and offshore that will keep creeping higher. The slowdown in activity has resulted in less crude purchases as China will need to work off some of their offshore storage. Flows to China fell to 361k b/d, their lowest level since at least January 2019, when Bloomberg began tracking these movements in detail Shipments to the U.S. reached their highest level in the same period, rising to 90k b/d in April from 56k b/d in MarchDeliveries to South Korea rose to their highest in 11 months, reaching 256k b/d The current data has shown that some of the flows will pick up this month, but remain well off normal pace given the shift in crude slates. The shifts are impacting more than just Russia, Brazil, and Norway flow into China. There has also been a growing reduction coming from Saudi, Kuwait, and Iraq into China. Even as flows are reduced, we have seen floating storage remain elevated throughout 2021. Asian Floating Storage Physical Crude Market Backdrop The weakness in the physical market is reflective of the Asian softness and stranded cargoes in the market. Pricing for many grades have gone between -$3.25 to -$2.20 for CPC and Urals while West Africa has seen pressure pushing spreads as low as -$1.10. The areas to watch will be West Africa and Middle East spreads as India COVID cases rise and China comes back from turnarounds. Crude flow adjustments remain robust as more is being left in the water in both regions. Urals traded in NW Europe at the lowest in a year in late April. Some margins on processing Urals crept higher last monthThe NWE hydrocracking margin ended April above the five-year seasonal average for the first time this year Vitol sold 90k tons of CPC Blend for May 27-31 to OMV at $2.70/bbl less than Dated Brent: trader monitoring Platts window Compared with -$3.25 for previous cargo OMV bought on May 4 Pace of sale of Urals crude picked up recently, and most cargoes for loading before May 20 were sold out: traders involved in the marketMost CPC cargoes for May loadings were sold with less than four yet to find buyersAsian refiners bought about 8 Suezmax cargoes of CPC for May loadings, unchanged from AprilDemand from European refiners has shown signs of recovery, partly because of easing restrictions and rollout of vaccines, they said Sonangol maintained itsoffer on its other June-loading spot cargo, price list shows Company offered 950k bbl of Gimboa crude for June 29-30 loading at 20c/bbl discount to Dated Brent; unchanged from April 26 ESPO: Russian ESPO crude loadings to rise to 13-month high in June Graded traded at premium of $2.10-$2.40/bbl to the Dubai benchmark price in mid-April, that’s up a bit from deal a month beforeEnergy Aspects commented on ESPO in report sent on April 22: “We understand that teapots are blending ESPO with Venezuelan bitumen and Iranian crudes, which explains the drop in appetite for typical teapot favorite grades like Lula and Johan Sverdrup.” Russian increased its oil output m/m in April to 10.46m b/dIf April condensate output was in line with March, then daily crude-only output would be about 180k b/d above its quota Urals traded in NW Europe at the lowest in a year in late AprilDeal on Platts at discount of $2.80/bbl to Dated Brent was the lowest since mid-April 2020APRIL TRACKINGObserved flows of Urals crude to Asia resumed in AprilVolumes remained muted as a wide Brent-Dubai spread continued to deter buyers Saudi cut OSPs to Europe and Asia in a push to protect some market share as volumes begin to rise in May. There remain around normal prices with some staying elevated vs historics. Asian Weakness Across India/China The additional pressure is coming from India’s drop in activity. We are expecting about 1.3M barrels a day less in imports, which could be pushed higher as storage is already high for crude and refined products. Exports accelerated in March, and we will see more being pushed into the water throughout May in an attempt to balance out refinery runs vs storage. Gasoline will see the biggest down move on a percentage basis because it saw the biggest recovery over the last 4 months, while diesel never got back to its 2019 levels. The pressure will remain throughout the complex because vaccine rollouts have been very slow as new cases push over 400k for several consecutive days. The Indian variant is also starting to pop up in Europe as it spreads throughout Asia resulting in additional limits on travel. Singapore, Taiwan, South Korea, and Japan all have some form of restrictions on activity following some recent spikes in cases. Japan has now expanded their state of Emergency through the end of the month, which could be extended again. Oil shipments loaded for India’s public-sector refiners hit a seven-month low of 1.78 million barrels/day in April, according to Vortexa. Indian clean-product exports -- including naphtha, gasoline, diesel and jet fuel -- seen at 1m b/d in the first week of May, on par with levels in Jan. and Feb.Product exports from India did not see an uptick in April, according to Vortexa data, partly due to inventory restocking after exports hit an 11-month high in MarchA rise in exports may be imminent if domestic demand falls further, and refiners do not pull back refinery runsFuels sales in India could have been worse in April but for the elections in some states that helped spur demand as thousands of people attended rallies and staff of political parties used vehicles for campaigning. But with those elections over and the virus still spreading, there could be a deeper impact in May.April sales of gasoline -- used in cars and motorcycles -- fell to 2.14 million tons, the lowest since August, according to preliminary data from officials with direct knowledge of the matter. Sales of diesel, a bellwether for economic activity, was a tad higher last month than February, which had two fewer days. Average daily sales of the nation’s most-used fuel in April were the lowest since October.Country’s oil imports may decline by more than 1m b/d to reach 3.1m b/d in the coming weeks as surging Covid-19 infections hit demand, consultant wrote Friday in a reportIssue is compounded by the fact India has little room to store additional oilIt could try to address the problem with floating storage, or by further diversifying suppliersIndia’s demand loss may knock 200k b/d from global consumption this year The region will see depressed demand throughout the remained of May, so the biggest question becomes June and what kind of recovery in demand will we see. So far, India has purchased their “normal” slate of Saudi Arabian crude, but KSA is also increasing production throughout May & June- leaving way more in the market. KSA cut their OSPs in order to pull through more sales, but they were also pressured to do so by the discounts in Dubai vs WTI. China storage shifted higher again this week as demand for crude stays soft within the country- even after the Labor Day holiday. Shandong refiners will remain well off pace as the government has cracked down on run rates in the region. This will keep storage very elevated across the system. China has been open now for over a year, but is still struggling to even remotely get back to business as normal. Shandong Refinery Crude Storage Shandong Fuel Oil Storage The credit impulses in China have rolled over very hard, which will be an underlying drag on the economy. The recent Labor Day holiday resulted in 3.2% more travel vs 2019 but it was over a shorter distance traveled and only generated revenue 77% of 2019. This is being driven by less big ticket items, and the rise of sales/ discounts to attract customers. It speaks to a much bigger problem for the underlying Chinese consumer that is failing to rise to the CCP Dual Circulation Strategy. The core focus has been to stimulate spending- especially in the rural community. The PboC has been pulling liquidity from the market in order to adjust their risk profiles. Credit impulses weaken again in China as liquidity and debt is pulled from the system. In 2016- China flooded the market with debt driven growth leveraging up from the village to federal govt. Now as BKs/ NPLs rise and gov'ts fund debt with up to 90% of tax revs the game is ending. Many villages and smaller cities are struggling under a huge interest expense that is pushing up to 90% of tax revenues out the door. The CCP and PBoC have constructed better ways to funnel cash down to the local governments to cover things as simple as salaries. The pressure is building across the fixed income complex that is degrading on a daily basis and is being reflected in underlying growth metrics. Infrastructure projects have either had funding pulled or projects denied as Xi tried to drive home the "Dual Circulation Strategy" by trying to stimulate local consumption (supplement the US) while cutting back on bond issuance/ liquidity into failing companies/projects. The provinces have been instructed to reduce their issuance of SPBs (Special Purpose Bonds) in order to start working down off-balance sheet risks. Provinces are struggling with SPB bonds and the PBoC has allowed only a small cut to new borrowing to insulate some slowdowns, while Chinese banks remain focused on cutting more NPLs after disposing of a record 3 trillion yuan of NPLs last year, nearly a third more than in 2019. The banks aren’t the only key target as corporations are also pushed to cut back on leverage, with support falling for bailouts. The Huarong debacle remains front and center when it comes to bad debt and how the bailout takes shape. We have covered this extensively on our YouTube channel so won’t bore you with the details here. A large set of debt comes due over the next few years and the "surprise" from Huarong provides a wake up call. China has invested trillions internally and thru the BRI that are generating cash far below expectations stressing balance sheets. China benefited from a supply recovery as the world looked to restock inventories, but companies/ nations are diversifying supply chains and that will hit China directly as they are redirected into countries such as Vietnam, SK, Japan, and other SE Asian Nations. These other countries have seen their exports increase as companies shift supply chains away from China to diversify more aggressively. The change in supply chain dynamics will remain a key headwind for China as more entities make the pivot. The limitation on internal growth is being ignored by the market even after the PBoC & CCP have been very clear on the trajectory of debt. Could they panic and paper the town- sure, but based on current leverage it seems very unlikely. As inflation rises hurting local consumption that is already well below pre-pandemic trends- the demand for commodities will hit another hiccup (Outside of just industrial). Pressure is mounting in Asia as costs and COVID limit demand further- credit impulses tell the story. The pace of activity has shifted lower throughout China falling well below Pre-Covid levels, and will add pressure to a precarious situation within the country. The limitations on stimulus will be a prominent factor as the CCP tries to find ways to drive growth. All of these factors lead to a slow down in underlying commodity purchases. The issue remains across not only China, but India as well when considering how they will try to drive the recovery on the other side of this COVID19 outbreak. So far- the RBI is holding course with an easy monetary policy with one of (if not the largest) fiscal deficit ever. The problem remains that the growth at the Emerging Market level still remains depressed even as more stimulus is pushed into the system. Refiners Foreshadowing an Ugly Start to 2021 U.S. refiners have started to post profit-warnings that foreshadow a very weak first quarter, partially due to the Texas winter storm, but also continued weakness in demand. Valero and Phillips 66 both indicated much weaker earnings than consensus expectations, with both likely to post a significant loss in the quarter and see dwindling cash balances. ExxonMobil’s own warning showed an improvement in refining earnings, but still posting a net loss. Fundamentally there are still several weak spots for U.S. refiners, and in fact globally. While the U.S. is leading the way in vaccine and bringing hope of normalization in the second-half, the rest of the world is still seeing large surges. Latin America, the key market for U.S. exports, is reeling, with Brazil setting new record for deaths and hospitalizations in early April. Europe and Asia are also seeing rapid increases, although not quite as badly as Brazil and India. That is all contributing to weak demand and elevated inventory levels in Singapore and other parts of Asia. European refiners, struggling with both Covid malaise, are shifting more of their gasoline supply to the U.S. East Coast, keeping crack spreads narrow. Crude competition is also weighing on margins, with differentials for Urals, Bonny and other bellwether grades still weak, signaling there isn’t a lot of demand from Asian refiners and that competition to place cargoes is fierce. That was exacerbated by a much slower Lunar New Year period in China and the resurgence of the virus in India. Key Crude Differentials Trading at Narrow Bands Then there are RINs, renewable fuel credits, that are eating into margins for refiners that can’t blend their sales volume at wholesale tanks or retail stations. There are plenty of studies showing that RIN prices are encapsulated in crack spreads and after a 89% increase in 2021, they could account for as much as 60% of the increase in cracks on the year. That means that refiners like Valero, PBF Energy, HollyFrontier and Delek US are not seeing an improvement in margin capture. Those that can blend, Phillips 66, Marathon Petroleum and the majors, are still passing through that cost when they tender to the EPA and not having a major tailwind from a true increase in crack spreads. PBF reported negative Adjusted Ebitda of $317 million. It also pushed off expectations for a turnaround to 2H21, as demand remains soft. PBF is perhaps a blueprint of how other merchant refiners will handle RINs. The company chose to defer most of its obligation, putting it on as a liability on its balance sheet in the hopes that further clarity from the EPA will lead to lower RIN prices in the coming months. But clarity alone may not be enough, as there needs to be some relief for small refiners to help balance the market. The Biden administration does not seem too keen on helping fossil fuel companies, and have further headwinds from judicial reviews on the legality of the small refinery exemption. RINs Account for Most of the Increase in Crack Spreads Balance Sheets Can’t Catch a Break Refiners’ balance sheets are already in weak positions and the hit from the Texas storm and RINs threatens to further delay their recovery. Even the best positioned of the group, Valero and Phillips 66, have elevated metrics that are well ahead of their mid-cycle levels. Marathon entered the downturn with a substantial debt burden, but has been able to improve its balance sheet thanks to a sharp cut in spending and contributions from its MLP, MPLX, which has exposure to natural gas basins that saw an improvement in activity in late 2020. U.S. Refiners’ Balance Sheets in Tethers, PBF Leverage Literally Off the Chart HollyFrontier stands out in the SMID space, mostly because it had a huge cash buffer at the start of the pandemic, but one that has been dwindling. It is also outspending its peers, as it converts the Cheyenne refinery to renewable diesel. But the upturn in Lubricant margins should help it offset continued refining margin weakness and RINs. PBF Energy may not be as lucky, as its balance sheet was stretched after the January 2019 purchase of Shell’s Martinez refinery. It has managed to raise a lot of cash in the bond market, although at a high interest cost that has added over $280 million to annual interest expense. For a company that does $1 billion in annual Ebitda, that could take several years of frugality to get back to pre-virus levels, especially after it shutdown part of its Paulsboro, NJ refinery. There are no buyers for PBF’s assets in the current market, so the best it can hope for is for higher margins and lower RIN costs in 2021 to stave off reorganization by 2022, in our view. Then there is the deteriorating proxy fight between Delek and Carl Icahn’s CVR Energy. There are merits on both sides, but it seems hard to believe that Delek’s Krotz Spring refinery can compete in a shrinking market going forward. While its closure would surely benefit CVR Energy’s own plants, it is a small refinery outside of the greenway in Louisiana that requires barging for its crude. Recent improvements have improved clean product yield, but Krotz has not produced positive net margins in over two years. Delek ran its refineries hard throughout 2020, even as margins were awful. It has seen leverage creep to over 8.1x 2021 Ebitda, which left it open to CVR’s unwelcomed advances. Icahn seems to smell blood in the water and will try to outlast Delek’s CEO Uzi Yermin, and with the Texas freeze likely to hit both of Delek’s best refineries, Tyler and Big Spring, the window could open wider after 1Q. Tax Rate Hike Can Help MLPs, But No-Growth Coming The proposal by the Biden administration to raise the corporate tax rate to 28% and reinstate alternative minimum tax could make the tax-free MLP structure attractive once again. But the sector itself is now likely to trade ex-growth, with most of the expansion capital being trimmed back in favor of debt reduction and share buybacks. That could mean that dividend yields remain significantly higher than the S&P 500 for most of 2021, even if risks seem to be decreasing for the sector. The old argument that the MLP sector could start trading like utilities may come to pass, but unlike utilities, midstream have substantially higher operational and regulatory risks. That will make for a much more volatile sector, especially and oil and gas takes over from coal as “woke enemy #1” (trademark pending). So maybe the sector does become the next utility, but with a dose of big tobacco thrown in. Utilities They Are Not - MLPs Dividend Yield Much More Volatile Refiner-sponsored MLPs may need to be taken out, but with their parents struggling to pay their own bills, that is likely to wait until 2022. Holly and Phillips 66 have resisted, despite very attractive relative valuations to their own stocks. Marathon likely can’t take on MPLX and it is less of a refiner-sponsored MLP than the rest of the group. Meanwhile, PBF and Delek have other worries on their plate before even considering a bid for their respective subsidiaries. [/ihc-hide-content]