[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 ActivityPhysical Market BreakdownIran Deal and ElectionFOMC DecisionCommodity Price ShiftsInflation Across ChinaInflation Across India Bigger jobs report will be included next week looking at the disconnect between openings vs unemployment. US Completion Activity The market is moving in the direction we have highlighted for completion activity with spreads starting to pick up into the end of June. We believe that June exits at about 235 spreads with a bigger pick-up of activations in July, which will only accelerate throughout Q3. The Permian and TX-LA-SALT are either inline or well past 2017 levels with more activations coming over the next few months. The Bakken remains temperamental with current spreads, but rail activity into the region indicates we will start to see a pick-up in the region. On the natural gas side, we don’t need the same type of activity to generate the level of natural gas demanded in the U.S. Between associated gas, producing wells, and new activity- completions in natural gas regions will remain measured and increase along seasonal patterns vs running at levels we have seen over previous years. The Permian (and Texas in general) remains the growth engine but given the move in NGLs and liquids- we will start to see a pick-up in Oklahoma activity. The rise in coal prices globally is pulling a maximum of LNG off the U.S. coast, and with various heat waves in the U.S.- natural gas prices will find some near term support. The closer to the Gulf of Mexico the better and OK/LA has a lot of spare pipeline capacity to get the natural gas to the coast. There remains an equipment and labor shortage in the OFS market and as more spreads are pulled out of cold stacked status- it will cost more money to bring the horsepower back to life. A rise in prices is only natural as more horsepower requires new parts or a tune-up to bring it fully back to life. Some spreads have had parts cannibalized to keep working spreads in the field and running at near 24/7. We heard from companies such as CAT and NOV talk about how their backlog was growing as some OFS tries to get in front of the ramp by jumping in the queue. Due to vast supply chain disruptions and rising steel (and other raw material prices), companies that booked early will reap the rewards over the long term. Frac’ing isn’t going away today, tomorrow, or 10 years from now because the world requires natural gas, liquids (plastic demand surging), and crude to maintain daily life. The U.S. ran well ahead of global light/sweet demand at 13.2M barrels a day with a large part of that flow being exported into a saturated market. The U.S. refiners have a lot of complexity that requires a heavy cut of crude, but have added some lighter processes to capitalize on the steady flow of light-sweet crude and liquids in the U.S. The U.S. is well placed in the global market producing between 11.5-11.7M barrels a day because it provides a steady flow to regional refiners while exporting the remaining into the global market. The U.S. exit rate will remain at about 11.5-11.7 and based on next year’s projection maybe we get to about 12M barrels a day. The spread out of the U.S. have come under pressure, which will limit near term exports as Brent vs LLS waffles between a -.30 to +.30 that will pause new purchases. We already had some previous buys, so the current export levels are filling orders already in place. The next several weeks will see these flows tail off- especially with the shift in WTI vs Dubai. The shift in pricing out of the Middle East has put pressure on spreads and flows around the world- especially out of West Africa. I know I sound like a broken record, but the physical/forward physical market doesn’t support the current pricing of the paper market. Physical Market Breakdown The physical market diffs tightened briefly, but quickly reversed back to levels that we have become accustomed too over the last few months. Nigeria sales have started to pick-up a bit, but Angola and Congo headwinds persist with China buying still very much subdued. The slow Angola sales is also coming at a time they are exporting the least amount in over a decade. They were hit with another deferral from June into July as Nigeria is trying to clear the deferrals languishing since April in July. Sales of Nigeria’s crude for loading next month have begun to pick up, while demand for Angola’s remaining July cargoes is more sluggish, according to traders familiar with the matter. Nigeria has yet to sell 13-20 of 49 planned cargoes of July-loading crude; more than half were unsold as of June 11Sales have improved to Europe and the U.S. in the past week, one of the people saidAngola has yet to sell 6-7 of 32 planned shipments for July loading; drops from more than 10 on June 11Sales for the outstanding July shipments have remained somewhat subdued in the past week as sellers are offering cargoes at too-high prices for potential buyers, traders said Glencore offered 100k tons of Urals for June 28-July 2 at Dated -$1.75/bbl: trader monitoring Platts windowGlencore yesterday sold a cargo at -$1.40Gunvor offered 100k tons of Urals for June 29-July 3 delivery at1.60/bblMitsui offered 94k tons of CPC Blend for June 28-July 2 at -$1.60/bbl ESPO still remains tight as buying remains firm from China and the U.S., but China’s purchases remain under pressure with India- while back- still well off of normal pace. Both countries are sitting on massive storage that they are focused on working through over the next few months. Ships signaling China/India slipped again this past week, which has resulted in some remaining softness across North Sea/ Urals/ West Africa. Asia is also facing pressure with the spread of the India (D variant) across other Southeast Asian nations that will slow normalizing crude demand in the near term. India Demand So far in June The lack of local Indian demand and refiners maintaining a steady utilization rate of 85% during the second wave of COVID- has pushed more product into the market. Exports have accelerated over that time period and have shown up in Singapore/ Fujairah storage and Atlantic basin. China has also increased their total exports in May, but will see a bit of slowdown in June as the country adjusts taxes and levies at teapots. China May Gasoline Exports 1.55M Tons, +129.5% Y/y General Administration of Customs says on website. YTD gasoline exports rose 13.9% y/y to 8.11m tonsMay jet fuel exports 570,000 tons, +0.3% y/yYTD jet fuel exports fell 59.8% y/y to 2.81m tonsMay diesel exports 1.68m tons, +16.5% y/yYTD diesel exports rose 3.3% y/y to 10.65m tons Exports of diesel from China hit a five-month low in May as refiners kept more supplies at home, betting a new tax may spur a shortage. China exported 1.68 million tons of diesel last month, about 404,300 barrels a day, according to Bloomberg calculations based General Administration of Customs data. That’s 40% less than April, and the lowest since December. There will be a consumption tax on inflows of light-cycle oil, which makes low-quality diesel. The shift comes as the pressure mounts on teapot refiners: “In April, officials from China’s economic planning agency began probing teapots for suspected violations of tax and environmental rules. The investigation has recently escalated in Panjin with the arrival of senior officials from national tax and prosecution departments, according to people familiar with the matter. Some refiners may face significant punishments such as losing access to imported crude, the people said, asking not to be identified discussing a sensitive matter.” Teapot refiners are big buyers of crude and have risen over the last 5 years to become a bigger part of imports. As China brings on more State Owned Facilities, they will try to make room for the additional utilization by forcing the issue by “investigating” private operations. This has become a common practice within China every time a new wave of refiners opens in the country. “Teapots, which account for a quarter of processing capacity in the world’s biggest crude importer, are still waiting for details on how much oil they’ll be able to purchase in the second half of this year amid the government investigation. The equivalent quotas last year were allocated in April.” “The ripple effects could extend beyond energy markets, given teapots can be an important source of local tax revenue and employment. Local government financing vehicles in Liaoning province, which encompasses Panjin, are among those that have faced the heaviest refinancing pressure in recent months. Plagued by slow growth and an aging population, the area is home to a several prominent defaulters, including state-owned carmaker Brilliance Auto Group Holdings Co.” As we talk about later, China is struggling under a growing debt load that will need to be addressed over the coming 12 months. Many provinces are sitting under a mountain of growing debt that will cap near term growth and put additional pressure on the PBoC. The loss of teapot operations won’t cut total throughout as any loss will be replaced by the SOEs taking run rates higher. This is a game that China is playing, but it will shift the way semi-finished oil and refined products are traded by pushing product back into Singapore/ Japan/ South Korea. They typically send it into China and more specifically Teapots. China Apparent Oil Demand I know the mantra has been that the U.S. is running short with broad based draws, but we have seen a swap from oil builds and product draws to oil draws and product builds. As we sit in peak summer demand, it is important to understand where we sit on a storage level as imports remain robust from Asia into the U.S. market: US Gasoline Storage US Jet/Kerosene Total US Distillate Storage The U.S. is sitting on a near record (only 2020 was higher) in jet and gasoline as distillate has room to spare. U.S. imports will continue to rise as refiners look to fill the middle and lower ends of the stack to try to bump gasoline production a bit more but also increase runs. U.S. refiners have maxed out a large part of the top end of the stack, and in order to increase thruput- they will need to increase heavy crude runs. This will pull in more imports over the next few months and push distillate storage higher, which is still have the long-term average. But, it still has space to expand inventories, and based on seasonality- it normally starts to build this time of year. The bigger issue is the counter seasonal builds that have occurred in other refined products weighing on crack spreads. Global crack spreads have shifted negative over the last 10 days, and pressure is mounting in the system as refined products remain well supplied in the global market. Even with recent crude draws, the U.S. market is sitting on an excessive amount of crude oil days of supply. Days of Crude Oil Supply When we factor in the normal splits, the underlying price still remains well ahead of what we have in storage. Typically, at this days to cover level, we are average around $50-$55 crude, but the market is pricing in a strong acceleration of draws that will balance the market faster. The problem will arise as we head into the end of June and beginning of July with a shift in exports falling and imports rising as U.S. refiners increase run rates. While refiners increase runs, we still have a steady flow of refined product imports coming into PADD 1 from Europe and Asia with PADD 5 taking in more Asian product. Iran Deal and Election The Iranian deal remains in the headlines as the country approaches the presidential election tomorrow. I have said from the very beginning- a deal had zero chance of crossing the finish line ahead of June 18th. Right now- the hardliner Seyyed Ebrahim Raeisi has a 68.9% chance of winning with his closest competition Mohsen Rezaei having an 8.1% chance of victory. This will ensure a hardliner remains in power, but the election was a foregone conclusion given that many in the Iranian populace were planning to boycott the vote. The government is facing rising pressure internally with “random” explosions taking out vital assets within the country. We have highlighted that intelligence was exiting the country like a sieve providing an opportunity for subterfuge on a grand scale. Israel has been able to strike their proxies (and Iranian assets directly) across the ME, and the local populace has been emboldened to act against the regime. This pressure on a political front is compounded by the pain on an economic front from sanctions U.S. sanctions. China offers some relief valve, but as their buying has been curtailed it is leaving more product trapped on the coast and slowing exports. The lack of new cash is pushing Iran to be more “amenable” to a nuclear deal, which would unlock about 70M barrels of crude floating offshore. According to TankerTrackers: “Iran's Crude Oil & Gas Condensate exports are now trending back down again due to a logistical constraint caused by a lack of spare VLCC supertankers. NITC's own fleet is currently storing 70 million barrels of gas condensate due to insufficient demand from China.” The type of crude that Iran produces is in growing demand- especially as China brings on new coking capacity. China has slowed down their purchases (especially teapots) as new import quotas haven’t been released yet and storage within the country (and offshore) remains well supplied. South Pars condensate is also well suited for South Korean petchem, and once sanctions are lifted the purchases would kick back up quickly. The question remains- will the U.S. lift sanctions given how effective they have been in putting more pressure on the local government. Even though China has slowed, the “pie” for NGLs and liquids continues to grow with petrochemical demand growing around the world- especially in Asia and the ME. This has provided a solid base for pricing not only in the U.S. but also other areas around the world. So even if (when), Iranian condensate and LPG hits the market, the U.S. prices will fall a bit- but demand will remain robust due to the size of the market growing. China has been buying more and more of U.S. LPG and ethane along with other Asian buyers. We already have Iranian LPG hitting the market, so a big pick up is unlikely- it would just make Iranian prices rise and compete more directly with the U.S. Right now- Iran is selling at a steep discount due to the sanctions- so we would see prices rise and some volume as well. But by opening up the buyer pool, China would face more competition from India, Singapore, Japan, South Korea, and other Southeast Asian nations. It would just be another knock to China’s underlying commodity exposure and pressure prices further in a country trying to manage the rise in commodity prices. FOMC Decision The market was taken off guard (I guess) by the Fed starting to react to the rising inflation pressure by “talking” about increasing rates in 2022… you heard that correct- not 2021 but end of 2022. So we have another full year of 0% interest rates and so far- $120B a month in quantitative easing. We have the Reverse Repo Purchases hitting $735B on their way to $1T by quarter end, which just signifies those banks are fully saturated and have no where to place the excess capital. The “reflation” trade has come under pressure as the long end rates have come under, but long-term rates are just back to 2019 levels with some very important things yet to come. Inflation pressures still across the supply chain with pressure in China remainingDelays in the supply chain are growing with more Chinese congestion resulting in prolonged issues across the complexUS Fiscal stimulus on per child payments start in JulyThe U.S. still has monetary & fiscal policy pushing what will end up being $15T into the market in stimulus. U.S. economy will grow at an accelerated rate on the back of the liquidity pushing more money though the system The underlying premise that inflation is behind us or is under control ignores the full supply chain price increases that still remain across the system. U.S. export/import prices continue their upward trend with more pressure sitting behind it. Because the U.S. has a record inventory shortfall, companies are price takers and have to accept whatever the going rate is especially with delivery delays expanding. Many of the delivery delays are impacting key components to the underlying process- for example- if you are missing a key semiconductor or some widget- the whole production line has to either cut utilization or wait for the part to arrive. This is keeping U.S. employment depressed as there remains a misalignment of skills vs openings. So between: delivery delays, inventory shortfalls, and rising costs- costs and underlying prices will remain elevated. Commodity Price Shifts Commodity prices in the market have run well ahead of the underlying fundamentals on the belief that the future will be bright, which in some cases it is true- but the underlying supply vs demand is a key consideration. Some commodities are facing broad droughts, shortages, strikes, shipping delays, political pressure (IE- Coal- Australia vs China), and other underlying fundamental issues. Oil is not one of them- the underlying mantra remains: “Well in 4-6 weeks things will be different,” which is something I have heard since March. The underlying commodities have moved well ahead of fundamentals, which has been correcting a bit over the last few days. The drive higher in raw materials increases the underlying cost of goods driving inflation, and we are seeing consumers reject some of the rise in prices across different areas. The drop in grains is extended at this point because the underlying physical market remains supportive of price appreciation, but some of the other speculative prices- IE Lumber- have come down from all time highs. Even though prices have fallen, they still remain at massively elevated prices, and it will stay that way over the next few quarters. Not all countries have the ability to pass through cost depending on wealth and underlying local mechanisms. Some Emerging Markets have price controls and other subsidizes that limit how it shows up in the data. The pass through of cost has accelerated in the U.S. where we have seen some of the housing data cool off with builders waiting for some prices to normalize driving up raw material price. There has also been a change in the way consumers are viewing buying homes saying that right now is the “worst time” to purchase a car, home, or appliance. This is an example of customers rejecting prices and waiting for some cost adjustments. The problem is- inventories are at record lows and companies remain price takers, which will keep price increases sticky across the board. Inflation Across China The inflation/ cost data that has come out from around the world keeps the party going as we import more inflation from abroad. The two biggest ones remain China and India, while other smaller Asian countries see a steady rise in underlying costs. Because it is the biggest, I will kick off with the China update to take us through the underlying problems in the region. China is facing a problem at home with economic growth given the target of reducing liquidity (monetary policy) while consumer spending remains elusive. The Dual Circulation Strategy is pivotal to provide an outlet for local industries as pressure builds abroad. The China-EU trade deal has been put on “hold” due to some big elections in Europe and pressure on China regarding human rights violations. The US-China has been at odds for years now (I would argue decades) and now things are getting worse again with a renewed push as US regulators proposed a ban on products from Huawei Technologies Co. and four other Chinese electronics companies, including surveillance cameras widely used by schools but linked to oppression in western China, stepping up pressure on tech suppliers alleged to be security risks. “US FCC says it proposes ban on devices deemed a threat to national security.” Anyone who thinks the US-China trade war is over or the Cold War Trajectory has changed- hasn’t been paying attention. As I laid out on May 29th, 2020: I go back to Tiananmen Square and the slow disintegration of relations that proceeded it. Nothing dies in a straight line- especially on a geopolitical front, but the damage was done, and public support quickly turned away from the CCP. There have been peaks and valleys along the way, but the trend has been moving in the wrong direction since this pivotal event. Fast forward to today, and we can see how President Xi came in with a splash by ending the Japan-China tension (lifting ban on rare earth exports). He also wanted to push China into the center stage with Made in China 2025/ Belt and Road Initiative/ Attracting more Foreign Investment/ Investing in local infrastructure. But the expansion kept getting more aggressive in the worst way possible, and things started to sour with our "Pivot to Asia" shifting military resources and focusing on building more relationships in Southeast Asia. China began to get aggressive across the false 9-Dash Line by claiming islands/ fishing grounds/ oil and gas resources. When President Obama pressed the issue in the Rose Garden, President Xi claimed they were only for scientific purposes, but within 6 months they had air strips, advanced radar, satellite interlinks, all forms of missile protection, and military barracks. The goal was to push the U.S. Navy further away from the Chinese Coast and protect their false claims of the 9-dash line that was unanimously defeated in UN arbitration. President Obama launched a review of stolen IP and overall damage through the IP Commission Reports-identifying the true economic cost and passing laws to protect U.S. assets. The stage has been set for a ramp in tensions- especially as it came out the terrible structure and debt loads created through the BRI. The documents were leaked out of Africa early last year. The depth of espionage was finally appreciated with the Huawei backdoors installed in all the hardware they created/supported. In my opinion, a trade war/cold war was the next logical step in the process of mounting pressure against China. I fear the cold war is going to quickly escalate into a "hot war" as China starts to make moves against- Hong Kong, Taiwan, and India. This is just a quick summary of the progression of China-US on the world stage... Just remember- China will enforce a contract if it is in their favor- the moment that stops... so does the contract terms in their eyes. The pressure is mounting, which is why China is pushing to expand their local consumption. May was deemed “Consumer Spending Month” and the CCP rolled out a variety of initiative and incentives to get people spending. There were rampant sales and company led discounts to get people out and buying. It was supposed to culminate with the Dragon Boat Festival. “That’s why data from the Dragon Boat Festival holiday are so disappointing. According to the Ministry of Culture and Tourism: Total tourism revenue over the three-day holiday was RMB 29.43 billion.That’s a mere 74.8% of pre-pandemic levels.It gets worse: Those numbers are particularly bad when you remember that international travel is basically verboten. With everybody stuck in the country, you would expect domestic tourism numbers to be higher than normal.China's recorded 89.136 mln tourist trips in the Dragon Boat holiday (Jun 12-14), up 94.1% from a year ago and recovering to 98.7% of pre-pandemic level, said Ministry of Culture and Tourism. Tourism revenue rose 139.7% y/y to 29.43 bn yuan, about 74.8% of pre-pandemic level.China recorded 462.8 mln yuan #BoxOffice sales in Dragon Boat holiday (Jun 12-14), a multi-year low, said an industry commission. According to ticketing platform Maoyan, box office on Jun 12 was 136 mln yuan, about half of that in the same period in 2019, marking an 8-year low. Not only was the Dragon Boat Festival a failure, but May retail sales missed estimates by a wide margin and remain well below pre-COVID levels. It is important to factor in how important May was to start off strong, but travel has been subdued and the Chinese consumer remains more willing to save vs spend. There is also a cultural difference where many Asian consumers are more “saver” oriented vs the U.S. model of spend blindly. The CCP and more importantly Xi has made this a TOP PRIORITY starting last year, and the local market has essentially ignored any driver to increase spending. The problem is now spreading into other facets of their economic growth (which we called for) as investments slow and general industrial production comes under pressure with exports (new orders) slowing. The bullish side of the equation is that the Chinese economy has “Stabilized”, but based on their own data points it has continued to slow down- and slow well below their target of “At least 6% GDP growth.” Many key drivers of China GDP are trending well below the 6% target rate and given the issues on bond yields and borrowing- there will be a limitation on bond rolls. It will result in elevated interest rates and higher interest expense, which is a key reason the PBoC has yet to “ease” on their tightening strategy. “Industrial production rose 6.6% in May on a two-year average basis -- which strips out the impact of last year’s pandemic -- while retail sales grew 4.5%, about half of its pre-pandemic rate. Investment in fixed assets such as property and land was 4.2% on that basis in the five months through May, according to the National Bureau of Statistics. All of the figures were roughly in line with the previous month, suggesting the economy’s growth has stabilized.” Based on estimates and 2-year pace, China is now stabilizing but slowing. The aggregate financing side remains fairly stable at this point with as the credit impulses remain on a downward trajectory and the PBoC manages near term liquidity. We had a small pause this past month in M2 reductions, but it was balanced as several holidays took place in May/June and spending was expected to be stronger. The path hasn’t adjusted, it is just difficult to take something down consistently especially given the underlying economic stress that remains in the system. The CCP has also announced selling commodities from strategic reserves in order to cool off pricing and underlying inflation. The spread between PPI and CPI within China is at the widest since 1993 as the government tries to insulate the local consumer… again to drive local consumption. The problem is- the country is in a very different place vs where it was over the past cycles as Debt to GDP has only grinded higher over the same time period. The pressure has grown with PPI moving higher again as import prices drive higher and underlying costs. Companies have been passing on these cost increases internationally, while trying to insulate the local layer. The cost of maintaining these levels keeps growing, and as borrowing gets tighter- the CCP will be forced to yield and allow some pass thru down to the Consumer Goods/ Durable Goods side. This is why we look so closely on the internals of Chinese debt levels: The growth of debt went exponential in 2008, which is why when we layer that in with the spread between CPI and PPI at 1993 levels- we can see the spread between debt levels. Instead of being at 10ox (still not good), they are at over 250x- and depending how it is calculated- at 327x. This also highlights how “poorly” China has invested in their economic growth because if a company, bank, or government (local or federal) invests in a project yielding a return of over a multiple of 1- it will result in general economic expansion. For example, if a company invests in a new facility and has a multiplier of 3- for every $1 invested the company is earning $3. This is more than enough to not only cover interest expense but also drive a healthy return on capital. As the Debt to GDP grows, it means that less and less of the debt is yielding actual economic growth bringing more pressure on tax revenue. In China, some provinces and local governments are struggling under the weight of their debt with close to 100% of tax revenue going to interest expense, which is why a lifeline has been thrown in from the PBoC/CCP to provide a line of “credit” to governments just to cover payroll and basic programs. The issue is compounded as China’s external debt has grown and continues to drive higher because it is no longer a “closed” system. The problems get moved into the global market, and given the level of debt at home and expanding debt abroad (most of it with Emerging Markets or Frontier Markets) the pressure mounts on bad debt expense. China has about $3.3T in foreign reserves, but we have seen time and time again that many companies/banks have used collateral to cover multiple projects and not just one. These issues are playing out with Huarong as the company looks to sell assets in order to carry out the rescue plan. They are looking to sell stakes in 7 areas, but the current offerings will fall short of covering the underlying debt commitments. The sheer size of the liabilities (both onshore and offshore) keeps growing as the regulators uncover additional investments and “side pockets” leaving a potentially massive insolvency. The PBoC has tried to address this in several ways- two of which being to require a broader holding of foreign reserves and offering an exchange for bank perpetual bonds converted into PBoC backed 10-year bonds. Many banks issued perpetual bonds, which were purchased by other banks that also turned around and issued their own similar instruments. This has brought up the fears of underlying contagion, which they are trying to get in front of by offering the conversion to a different asset. “Foreign currency deposits in Chinese commercial banks have surged over the past year. By increasing the reserve requirements on foreign exchange deposits, the central bank forces commercial banks to hold forex on their balance sheet, which could ease upward pressure on the renminbi, according to Alpine Macro.” The pressure in China’s markets has expanded into investment and production as builders and other lower rated bonds. “Builders rated AA- or below, levels broadly considered as junk debt by onshore investors, have sold about 13.2 billion yuan ($2.1 billion) of local notes so far this year, according to data compiled by Bloomberg. That accounted for just 4.7% of total Chinese developers’ yuan bond sales during the period, the smallest share since 2008. The lack of new sales, coming as China’s “three red lines” policy to curb excessive debt expansion in the sector takes hold, could mean trouble ahead. Developers rated AA- or below by Chinese ratings firms have some 31 billion yuan of bonds maturing in 2021’s second half, according to Bloomberg-compiled data. Property firms overall have made up about one-third of this year’s record pace of onshore bond defaults.” These key stress levels are EXACTLY what we have been discussing for months now as the bond fears grow, and local companies have an inability to issue new debt or roll existing. The fear of missing payments keeps growing as State Owned Enterprises (SOEs) are coming under pressure and setting record on defaults. These were supposed to be “safe” investments, which is only increasing pressure on the riskier assets… the pain is just beginning. China is also facing another issue in Guandong- a key manufacturing powerhouse and one of the wealthiest provinces. The region has experienced a severe drought that caused many of the local hydro dams limiting power generation resulting in rolling brown outs. The region was also hit with a COVID cluster that forced several areas into quarantine and broad testing. Many of these restrictions compounded the problems already faced by COVID restrictions. The area was also facing supply chain disruptions at the port given the shortage of containers and orders going unfilled. This is also the area that has the Taishan nuclear power plant in it that has seen a spike in Xenon releases above normal levels. The reactors are high pressure water that utilize ceramic pieces within the fuel rod to provide an extra layer of protection. As the ceramic heats up, it can start to crack and releases radioactive particles and other elements into the fuel rod. The fuel rod is meant to keep those releases contained, and so far while the release is something to watch- it so far hasn’t been followed with other more concerning radioactive elements. Xenon is called a “noble” element because it doesn’t react with many other elements in the environment- especially within humans or other organic material. So the risk to human life is very limited, but a released of Xenon could be an early warning sign of a bigger breech but so far nothing has been detected. The issue will be corrected when there is a fuel change and the rods are removed, but this will be something to keep an eye on regardless as water has been a huge problem across the region. Here is a breakdown on how bad the current congestion really is: showing how bad the situation is at Yantian. 28-30% of all PRC exports comes from just a few ports in South China. The impact of this port closure will be more disruptive to global trade over the next 3-6 months than the Suez Canal blockage was. Congestion levels appear to be getting even worse as neighboring ports get overwhelmed by the redirected traffic from Yantian. This image from 10:45am Singapore time on June 12. Taiwan has been facing a similar drought situation resulting in huge drop offs in reservoir totals: “That has plunged Taiwan into its worst drought in 56 years. Many of its reservoirs are at less than 20% capacity, with water levels at some falling below 10%. In dry areas, high-volume industrial users including semiconductor manufacturers have been asked to reduce water usage by 13%, and non-industrial users, such as hair salons and car wash businesses, by 20%.” Taiwan is the largest producer of semiconductors and the shortage in water is hindering an already troubled market. Guangdong has over 60k factories and is a major contributor to the Chinese economy, so as the issues persist it will become even more of an international problem. At this rate, it will make the mess at the Suez Canal look like a non-event. We have already seen a huge increase in ship congestion across China, and it has resulted in another leg higher in freight rates. The above shifts have resulted in a move lower across credit impulses (again) even after a small increase in M2 flows. It was nominal and the net target is to reduce total liquidity in the system. This will also keep a lid on underlying commodity prices, which will also face pressure from China selling from their reserves. The pressure will keep growing as factories face higher prices as well and limited ways to pass on the rising costs. Even thought new export orders have been steady, they are coming under pressure as backlogs expand with little end in site given the port delays. The shift in purchasing will leave more product on the water and at least pause some of the recent run up in the commodity space. China has already been a slow buyer of crude as more cargoes are left with Angola and WAF in general. China credit impulses have always been strong drivers of the underlying market from commodity prices to export orders to general global growth. Some of the correlations have been delayed because of shifting supply chains, but the underlying connections still remain firm in the market. China is still the 2nd largest economy in the world and is a massive manufacturing hub for the rest of the world. They are involved in the supply chain somewhere along the line, and as the PBoC tries to adjust the liquidity profile- the macro economy will feel the impacts. Credit impulses are falling rapidly, and so far the market has completely ignored the underlying problems emerging from China. It is even hard to call them “Emerging” because the issues have been pronounced for two quarters now with more pain on the horizon as many underlying fundamentals have overshot to the upside. It will be anchored lower by the persist slowdowns we have seen out of Asia- this relates to everything from crude demand to exports. If new export orders get pulled lower and you have Chinese local demand struggling, the country will require less materials, which they are trying to promote in order to bring down underlying prices. The bigger issue that reverberates into the global market is the drop off in PMI new export orders. We highlighted a few weeks ago that export orders were slowing, and that decline has increased as backorders expand and customers go elsewhere to find products. This has driven up pricing in other regions- South Korea/ Japan/ India as China faces a growing problem at home. Exports can remain elevated for a period as some backlogs are met, but a broader slowdown is afoot- also calling attention (again) to the importance of local consumption. A fall in exports will also leave companies sitting on additional cost that won’t be able to quickly get pushed through the system. This will leave the corporations limited choice, but to push through as much pricing as possible to try to buffer some of the cost increases. A drop in exports is also a broader signal to the rest of the market, but this time it won’t be as much of a read through because of the shift in supply chains. Many companies (especially in the US) started shifting and diversifying suppliers during the Trump administration and that has only accelerated during COVID19. This will provide broader support for exports out of India, Taiwan, South Korea, Japan, and Vietnam- but China is still our largest trading partner by a wide margin. The increase from the other countries can only last for so long because some of their raw materials/ semi-finished goods. Many inventories are already running at the bottom of the barrel, and as the issues within China expand it will pull down global PMI levels. It will just take “longer” this time due to shifts in the supply chain overall. We have been cautious on global economic growth, and this is another signal that things are stagnating. Inflation Across India India is facing their own issues on an economic level as they start to exit their second round of COVID19 travel restrictions. We predicted that the inflation rate would spike above the top of the RBI range, but the more important question is- will it stay above for a prolonged period? Short answer- yes. Inflation spiked across all components with little in the way of those product prices easing in the near term. The country is facing its own supply chain issues that will keep prices elevated across the board, which has brought into question the increases in fuel taxes. The government raised fuel taxes by roughly 20% on domestic fuel prices in May 2020. A 10% increase in fuel prices raises CPI inflation directly by roughly 25 bps and indirectly by around 50-60bps. India is running the steepest budget deficit in history (or close to it) and that is including the additional revenue from the fuel tax. It is unlikely (in the near term) they cut those prices. As states lift some of the restrictions, we will also see a round of buying as households and companies try to replenish following the lockdowns. This time around- the lockdowns were more locally based and not as restrictive vs the national one rolled out a few months ago. This will limit the surge, but still provide a bump that will provide a boost to prices. The country was already facing widespread shortages, so the increase in pricing is only going to remain across the complex. Consumer price inflation jumped to 6.3% year on year in May from 4.2% in April. Consensus called for a 5.4% reading.The increase was broad-based with food and fuel prices climbing. The core rate also rose sharply. Food inflation reached 5%, up from 2.6% in April. Higher transport costs and fuel prices probably contributed to the increase.Core inflation hit 6.2%, up from 5.2% in April. This probably reflects companies passing on higher costs to consumers from rising fuel prices and virus-related expenses. On a month-on-month basis core prices increased 1.4% in May, up from 0.5% in April. While commodity prices have fallen, they still remain elevated across their historical norms, and when you factor in shipping/freight rates- the cost is still elevated on a local delivered level. Monetary and Fiscal policy remain very loose in India, and it has increased the fears of inflation in the country. Unlike the US and other developed markets, India faces rising uncertainty on inflation and their ability to manage their debt loads. The RBI has been very active in buying up excess bonds being issued as foreign and local buyers have been absent. The below chart gives a breakdown of how much slack is in the monetary system right now, which will keep pressuring inflation higher in the region. On the positive side, Trade balances were better as exports surprised to the upside as imports maintained their strong growth. Exports will remain strong as international companies are relying more on India, but imports remain elevated as prices rise and costs are slow to pass on- the total level will remain negative. Crude imports account for about $120B each year making them very sensitive to pricing. Refiners maintained utilization rates at around 85% vs the previous lockdown resulting in cuts down to about 60%. As demand collapsed locally, more product was slated to the export markets- which has shown up in Singapore, Fujairah, and the Atlantic Basin. We discuss some of those demand profiles previously. [/ihc-hide-content]