[ihc-hide-content ihc_mb_type="show" ihc_mb_who="10,13,14,16,18,19" ihc_mb_template="1"] By Mark Rossano Summary Quick US SummaryOPEC+Meeting UpdateEmerging Market Inflation Next week will be a broad look at OPEC+ (post agreement), jobs, grains, and bigger geopolitical update. Quick US Summary Elevated crude pricing, flat spreads, elevated refined products storage, and sluggish global demand for products is weighing on refinery profitability. Refiners haven’t had any issue sourcing cargoes, but as crack spreads remain negative crude demand will be muted- especially in Asia. We have seen some normalized flows, but nothing to account for the lack of buying during lockdowns. China is still sitting on about 150M barrels above pre-COVID levels, while India skipped a month of buying and have just gotten back to around normal flows. They still remain a bit depressed, but they will close that gap quickly over the remained of July. In the U.S. we are at record levels (if we take out 2020) as refiners increased gasoline runs with something similar playing out in Jet. Distillate remains at historically “normal” levels as refiners have been running a lighter grade of crude to target the top of the stack. Imports will increase into the U.S. to create a heavier cut that will provider a broader suite of products. The growing oversupply is also sending European gasoline into different regions that were initially setup to land in the NY Harbor.: “At least three tankers hauling European gasoline to New York have diverted south, according to fixture reports and ship-tracking data compiled by Bloomberg.” The shift south will take longer and prolong imports of gasoline into PADD1. U.S. Gasoline Storage U.S. Jet/Kerosene Total When we look at crude and products together, we are moving along seasonal norms as we hit peak summer demand. The crude draws have been mildly offset by builds in product, but we expect to see the pace of crude draws slow as gasoline draws accelerate- along seasonal norms. The underlying headwinds will be a slow down in exports across products and crude. Demand into LatAm and Europe will remain sluggish- especially LatAm with COVID issues remaining and Europe as additional imports are already coming from the ME and Asia. Even though Asian flow came into the Atlantic Basin, all of it (in June) was absorbed into “better” markets but there are another 3 VLCCs carrying product that will land in Europe based on current spreads. US Oil + Gasoline + Distillate+ Jet/Kerosene + Residual Fuel Product levels in Asia, Middle East, and Europe haven’t faired any better with builds holding steady across the regions. The market continues to tread water with little advancement being made in draining excess storage around the world. COVID19 remains an overhang as the delta variant spreads making up most of the new cases in the world. Global cases have stopped falling and have begun to rise again as the variant spreads. So far- the vaccines are working against the variant keeping people out of the hospital. Europe and America are seeing a rise in underlying cases, but it isn’t resulting in a pick-up at the hospital at any alarming rate, which is encouraging. OPEC+ Meeting Update So far we have had a wild week with inflationary measures going higher again around the world and OPEC+ committee recommending an increase in crude production of 400k barrels a day from Aug to Dec. The planning committee also believes the OPEC+ agreement should remain in place through 2022. The below chart provides what an equal adjustment would look like across all the participating countries in the OPEC+ agreement. Russia and KSA would still be below the amount of production prior to the 2020 deal. Saudi & Russia averaged about 10.5M barrels a day with each reaching something closer to 11.3M barrels at different points over the five or so year “tenuous” deal. So far, several of these nations have been producing well below their current allotments- let alone an expansion of the quota- yet can’t clear current loading schedules. West Africa (Congo, Angola, Nigeria) have struggled to sell current offerings, so to see them increase quotas is fine- but unlikely to be realistic. The countries can’t clear the reduced flow, so there will be limited need (or drive) to increase production to the levels allotted. I made the call back in Dec that the fight between Saudi Arabia and UAE are far from over. The UAE baseline is at the lowest level, and they want the baseline readjusted higher so they have room to increase production. The fight went into overdrive when KSA lambasted the UAE for “cheating” on their cuts. The UAE created some problems, but eventually fell in line making it clear they were going to start doing things in the best interest of their country. They officially launched a broadly traded crude futures for Murban and removed destination clauses for the physically delivered settlement. The UAE has also seen a big increase in exports between May and June with more to follow, which is the biggest driver to adjust the baseline. The UAE wants to shift their baseline up to about 3.8M barrels a day allowing for an extra 700k barrels a day of production. Exports for the UAE was already up 445k barrels a day, and puts them at 2.853M barrels a day even though in July they are only supposed to be at 2.735M. This just means- they have already blown through the June numbers. The increase in Middle East exports has been a big reason for the “discount” it has been trading vs WAF/ Brent/ WTI as more product was pushed into the market. Iraq saw crude exports drop to a seven-month low in June as purchases from China and India slowed again. Exports slumped to 3.25m b/d last month, down 125k b/d from a revised 3.38m b/d in May, according to tanker-tracking and port-agent data compiled by Bloomberg.Sales to China and India, Iraq’s largest customers, dropped for at least a third month and fell to the lowest since November and October, respectivelyA more than 50% jump in shipments to South Korea partially offset that slump. Iraq volumes added to some of the overhang out of the Middle East resulting in discounts against other crude grades throughout the world. The purchases out of Asia have been slow to materialize for others in the region as well. Observed crude exports from Saudi Arabia slipped to 5.7m b/d in June, with lower volumes to India as well as China and the U.S., preliminary tanker-tracking data compiled by Bloomberg show. Exports to India fell significantly; if the current figures hold, shipments would be the lowest since Bloomberg began tracking this route at the start of 2017, and slightly less than a low point reached in May 2020Shipments to the U.S. subsided again after reaching a 1-year high in MayFlows to Egypt, a storage hub and transit point for cargoes heading west, also declined, dropping to lowest since January 2017 We expect to see some normalized flow into India, but the unknown remains China as import quotas were cut by 35% to Teapot refiners (independents) and levies raised for light-cycle oil. The shifts in crude and product flows will be more pronounced as we get into Aug/Sept and the full effects are seen on flows. We are expecting to only see a small dip of crude flows into the region as State Owned facilities make up the difference, but refined product exports will dip and will be replaced by rising exports from South Korea, Japan, India, and Singapore. Refiners targeting the export market are already discussing small run cuts ranging between 3%-10% based on a saturated export market and some near-term uncertainties. This will mute some of the recent product builds, but also reduce some crude demand on the flip side. There was a big deal made about Libya increasing oil pricing, but when we break it down over the last 15 years. The increases are still at the very low end of OSPs- Official Selling Price. The underlying spot physical market still doesn’t carry any panic in it- with a large part of the pricing remaining near lows. Spreads have tightened in the U.S. that will put pressure on the export market as it prices itself out of the export market. Genscape reported a build in Cushing as it made more sense to reverse from the coast into Cushing or head to Cushing instead of the coast. This will reverberate through the market over the coming weeks as U.S. refiners increase imports and exports fall under more pressure. Libya, U.S., Urals, and West African grades compete into the European market, which still remains slow. North Africa Es Sider Crude Libya OSP North Africa Sharara Crude Libya OSP India demand has started to recover, but the drop-in activity wasn’t the same as the previous COVID19 restrictions. This round was state specific and was not a national lockdown, which kept activity elevated vs the previous restrictions. As we have been highlighting, the NGL basket still remains robust around the world- especially in Asia. This has been very supportive of current pricing-even above $1. The bigger issue is diesel, which is an important bellwether for underlying economic activity. India has been struggling with a COVID outbreak hitting key manufacturing regions, a sluggish global economy, and rising inflation. Pressure is mounting on the government that is sitting on an elevated amount of debt and a growing deficit. They raised taxes last year, and now factoring in those tax receipts they are still recording a record shortfall- so the ability to remove it will be difficult. It isn’t impossible, but it opens them up to a growing issue where they are already with selling debt. So far, the RBI has stepped up to purchase, but international buyers have been fleeting. The rise of COVID and concerns regarding economic recovery drove the India Consumer Confidence index to an all-time low. While a national lockdown was never put into place, there remains a broader issue of consumer activity throughout India. As we have been saying, even without a federally mandated lockdown- consumers will naturally adjust activity to limit exposure. The Indian consumer is also facing over 6% inflation with little chance of it easing based on prices across food to gasoline. This will limit underlying activity across the broader economy muting oil demand and general economic growth. Emerging Market Inflation Political instability has arisen around the world, driven by rising costs, food insecurity, and current effects of COVID19. Inflation was already hitting many emerging markets, but the pandemic has only exacerbated these dire circumstances. Sudan, Lebanon, and Iran are getting hit particularly hard, with current inflation rates that can only be described as hyperinflation. Official statistics for Sudan are recording 363.14%, Lebanon 119.83%, and Iran 46.9%. These extreme rates are affecting the people of these countries on every level. The three countries mentioned are all suffering from a lack of energy sources, but these are merely underlying causes of a larger issue: their real struggle will be in overcoming rampant inflation. As the market loses confidence in a country’s currency, a Central Bank can build up foreign reserves to “backstop” the local currency to restore faith and purchasing power for international goods like food, medicine, and fuel . . . most of which trade in USD. The U.S. Dollar is the reserve currency of the world, with over 80% of global trade transacting in dollars. If you don’t have access to USD, your country is at a disadvantage. Here is a simplified example of how trade flow and foreign exchange might work in an emerging market: A company in Lebanon uses its dollar reserves to buy raw materials (i.e. fuel). They pay workers in Lebanese Pound, who use these wages to buy “goods.”The company sells goods locally, taking in Pounds to cover costs and make a profit.They can also sell some of their products abroad in USD, which would help “replenish” their reserves to buy more raw materials.The firm can also sell 100% in Lebanese Pound and rely on the local Banks/ Central Bank to maintain a steady exchange rate against USD or EUR to keep costs manageable to convert from local to foreign FX. But what happens when the banks run low on FX reserves and can’t make the exchange? A fiat currency—or government-issued currency not backed by a commodity—is only as good as the confidence the market has in it. So, if there are fears of rampant printing, expansive debt, or government instability, people will avoid using the currency, or demand more physical dollars or higher interest on debt to cover the rising risk. As confidence is lost, companies will want to transact in a “stable” currency, but these may not always be available—whether due to sanctions (U.S. sanctions on Iran) or local foreign reserve shortfalls at the Central Bank. As costs rise, salaries must keep pace to cover bigger bills, and tax receipts fall, resulting in a government who can’t buy basic necessities. If a company can’t manage payroll or COGs (Cost of Goods Sold), how can they hire new employees or invest in facilities? Instead, they will always be reactionary. The same goes for a local consumer trying to manage a household: How can they save up for a house or car if the cost of everything around them is rising? One of the biggest causes of inflation is driven by energy and food. Lebanon has always struggled with reliable power, pushing businesses, consumers, and power companies to rely on diesel to run generators. Now, facing huge shortfalls in diesel, they are experiencing prolonged power outages and a stressed electrical grid. Since most of these assets trade in US dollars, as the USD fluctuates, the cost of diesel and gasoline cargoes explodes higher, stressing government, consumer, and corporate balance sheets. Many countries—especially Lebanon and Sudan—rely on the international market to import necessary refined products to fill local demand. A lot of emerging markets subsidize fuel to help local consumers, but as COVID costs mount and economic struggles increase, many subsidies have been reduced or abandoned all together (such is the case with Sudan). In Dec 2020, Lebanon experienced a devastating explosion at the Beirut port, resulting not only in the loss of innocent lives, but also crippling vital infrastructure and destroying many local businesses. Lebanon was already facing a slowdown, but now due to political instability and finger pointing, the rebuilding process has been moving at a snail’s pace, only to be hindered further by bottlenecks and shipping delays caused by COVID19. As local consumers and the broader market lose faith, they will avoid buying government debt needed to rebuild. Lebanon has struggled with power generation and transmission for years, and now with so much stress on an overtaxed system, generators are failing—or even exploding—due to overuse. The lack of fuel oil (diesel) also pushes consumers to utilize “other” combustible material that may not be compatible on a BTU level, resulting in misfiring and failure. An economy needs cheap, reliable, and efficient power to grow, but Lebanon faces an inability to borrow and an imploding local currency. There is already anger towards the current government, and now with power outages lasting for 22 hours a day in some spots due to fuel shortfalls, tension is mounting. The below chart breaks down how bad some currencies are faring vs the USD, and it isn’t just the Lebanese Pound. The Iranian Rial is also spiraling as U.S. sanctions remain in place, crushing the local economy. In Iran, protests are expanding nationwide with the most recent being oil and petrochemical workers demanding higher wages to compensate for the falling Rial. Salaries have remained mostly stagnant while the currency devalues as the Iranian government expands the balance sheet. The local infrastructure has also been failing due to terrorist attacks and ignored maintenance, resulting in rampant downtime and fires throughout the energy industry. Even though Iran produces millions of barrels of oil a day and has local refining capacity, they are struggling to maintain infrastructure and sell crude in the international market. If they can sell, it is at a steep discount due to sanctions, which limits Iran’s ability to tap American and European banks (SWIFT) as well as their currencies. With the failures of their refining and petchem industries, fuel shortfalls and price hikes have expanded, creating more local strife. The Iranian government has increased their use of bartering with food for oil and oil for fuel programs to avoid even worse shortfalls than already exist internally. The current sanctions are only part of the problem—the Iranian economy never firmly recovered even when former President Obama lifted them. Money was diverted to pet projects and proxy groups throughout the Middle East, leaving the locals struggling to get back on their feet. This has only increased the anger of the populace against the current regime. The U.S. started lifting sanctions against Sudan back in 2017 and accelerated their removal in 2020 following the ouster of President Omar al-Bashir. But the economy still continues to struggle, which has been made worse by the IMF pushing for more austerity measures, forcing the government to end fuel subsidies, doubling prices overnight. It has crippled local businesses and consumers as they were already reeling from a floundering economic backdrop. The transitional government has been facing shortages of foreign reserves, so without USD or EUR to back the Sudanese Pound, the market has lost confidence. This creates an inflationary spiral, and the inability to purchase goods such as fuel, food, and medicine (or service over 49 billion euros of foreign debt) is a huge anchor weighing down growth. It just takes one incident (on purpose or by accident) to set off a chain of events that can’t be contained, leading to more unrest, especially with the backdrop of a pandemic. Emerging Markets are struggling under the weight of COVID19 and a sputtering global economy that is trying to awaken. The poor are getting poorer, and the middle class is being pushed closer to the poverty line as quality of life around the world is diminished. During COVID19, hundreds of millions of people fell out of the “Middle Class” and the $1.90 a day poverty line has only grown. This causes local populaces to become disenfranchised, resulting in more protests and riots against existing governments. As COVID19 passes and people feel the sting of inflation and unemployment, pressure will mount on governments, and calls for change will rise. Each of the three governments discussed—Sudan: Transitional and Struggling, Lebanon: Fractured and Distrusted, Iran: Repressive and Suspected—will be under additional duress given the lack of local support, mounting debt, and failed policies. The shortage of necessities (food, medicine, electricity, and fuel) will make it difficult to grow, and put more pressure on local governments. We have already seen food riots and protests . . . and we aren’t even fully out of the pandemic. Pain, despair, and anger has been bubbling beneath the surface for years, and now the match has been lit. [/ihc-hide-content]