Primary Vision Insights – August 11th, 2021

By Mark Rossano

SUMMARY

• U.S. Completions Update • OPEC+ Production for July and the Physical Crude Market • Deep Dive on the U.S. Economy: Wages, Jobs, and Inflation • Geopolitical Update: Iran Lashes Out as Local Discontent Heats Up: Droughts a Rallying Cry • Quick China, India, and Asia Recap + Brief Update on Food Scarcity

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• U.S. Completions Update

U.S. completion activity took a little breather as we had some of the smaller basins with 1 active spread go to zero and some small adjustments at the bigger basins. Unita saw a small step down, which should remain between 8-11 given the time of year. Appalachia will start to see some increases over the next few weeks as natural gas completions accelerate into Aug-Oct to prepare for the winter slowdown. The activity has been muted in Appalachia, which has led to natural gas storage falling well below historical norms and supporting gas prices (that now sit at $4.15). There will be a steady flow of activity in the Permian, Williston, and Western Gulf over the next 6 weeks. The Anadarko and TX-LA-SALT will also see steady activity with NGLs and natural gas pricing supportive of additional production. The NGL market remains robust with KSA raising prices to the highest level in years. As Korean refiners come back online, there will be some more naphtha in the market but the growth of the NGL market in Asia will still be supportive of pricing. The rise in KSA prices also provide an opportunity for U.S. flow to remain competitive even in the current pricing environment. The underlying pricing in the market (across all three streams) will keep the trend heading higher up to a national average of 255 on our way to 275 by end of Sept/ beginning of Oct.

The total amount of natural gas in storage is trending below the 15-year average and well off the 5-year average. This shortfall is increasing as we look out at the weather backdrop over the next 10 days with a heat wave hitting large parts of the U.S. Propane and natural gas storage are trending below 5 year averages, so between rising demand and lower supply- pricing will remain supportive.

US DOE Working Natural Gas Total Estimated Storage Data

Bloomberg Arab Gulf LPG Propane Monthly Posted Price

• OPEC+ Production for July and the Physical Crude Market

The spread in the market between WTI and Brent vs Dubai is keeping U.S. and European exports capped. The pressure is coming from the growth out of the Middle East with robust growth coming from Kuwait, Saudi Arabia, and UAE. Secondary sources have total production at 27M barrels a day with the current “announced” levels at about 26.54M barrels a day. Compliance is artificially strong as West Africa (Angola, Nigeria, Congo) struggle to sell crude so have been cutting total loadings to compensate. Market dynamics are a much bigger factor right now vs falling within compliance. So the fact that it is only 109% compliance with West Africa being between 175%-200% compliant is an underlying problem. It also speaks to the reduced demand out of Asia given the slow clearing of crude grades that are usually quickly absorbed into the Asian markets. “The Argus Media Opec+ July production survey is out: The 19 countries participating in the deal produced 35.82m b/d in July, up 680k b/d vs June. But 14 of those participants were under target, leaving overall compliance at 109%.” Russia maintains their lack of compliance even as Urals demand dries up into Asia (shifting more into Europe) and ESPO premiums falling quickly.

The physical market remains well supplied as differentials weaken into the beginning of August as some regions struggle to clear. Congo and Nigeria are struggling to sell their cargoes with 4-5 Djeno yet to clear and Nigeria is selling at a “normal” pace along the same lines as the last 3 months- which is historically very slow. The Middle East is shifting more crude into the market as Iraq struggles to sell cargoes- especially SOMO which normally has a backlog of buyers.

PLATTS: • Exxon Mobil offered to sell 950k bbl of Pazflor crude for Sept. 22-23 loading at $1.65/bbl less than Dated Brent: person monitoring window • Drops from -$1.10/bbl on July 30 • Exxon Mobil withdrew an offer to sell 950k bbl of Dalia crude for Sept. 20-21 loading at $1.75/bbl less than Dated Brent • Drops from -$1.50/bbl on July 30 PLATTS: • Trafigura sells 100k tons of Urals crude to Shell for Aug. 14-18 delivery at $1.80/bbl less than Dated Brent: person monitoring window • Litasco sells 100k tons of Urals crude to Shell for Aug. 23-27 delivery at $2/bbl less than Dated Brent • Grade last traded at -$2.35/bbl on July 21 • Litasco offers 95k tons of CPC Blend for Aug. 22-26 delivery at $1.90/bbl less than Dated Brent • Grade last traded at -$2.25/bbl on July 8 Observed flows of Russian Urals crude to Asia dropped to the lowest in four months in July as a wide Brent-Dubai spread continued to damp buying interest • Urals differentials in NW Europe strengthened a little in early August but are still weaker than early June levels • Russia’s Energy Ministry proposed a ban on gasoline exports to stabilize the market Saudi Arabia, Kuwait and the United Arab Emirates boosted oil shipments to multi-month highs in July, underscoring a return of their crude to an uncertain global market. West Africa’s oil for September loading is selling at a typical pace, while sales of Djeno crude are somewhat slower than normal, according to estimates compiled from a survey of three WAF traders. • Angola has yet to sell 10-12 cargoes of crude for September loading out of 34 shipments scheduled • That’s a relatively normal pace of sales for this point in the trading cycle, traders said Four to five cargoes of Republic of the Congo’s Djeno grade are still seeking final buyers out of seven shipments planned, a somewhat slower selling pace than the typical rate for the grade, which is popular among refiners in China: traders About 20 cargoes of Nigerian crude for September loading are seeking buyers out of at least 45 shipments scheduled, a similar selling rate to recent months Observed flows of Russian Urals crude to Asia dropped to the lowest in four months in July as a wide Brent-Dubai spread continued to damp buying interest • Urals differentials in NW Europe strengthened a little in early August but are still weaker than early June levels

• Deep Dive on the U.S. Economy: Wages, Jobs, and Inflation

When we talk about the future of refined product demand, or at least over the next two years, it is important to breakdown income, savings, and general consumer behavior. We have seen many shifts over the last 2 years, but many of them started well before COVID19 ever burst in to take center stage. Wage growth has been a big focus for me over the last few years, as we have seen a lot of stagnation throughout the income brackets with underlying costs grinding higher. There has been little to no respite on living costs, and with the flood of trillions of dollars into the market- it has only been exacerbated. The pressure has mounted as wages/salaries compressed, but the argument has been that CPI slowed over that time period- but the calculation was adjusted in the 80’s and adjusted total weightings. I am not saying inflation was always elevated, but it created an illusion that inflation was lower vs actual (aren’t statistics fun!)

A bigger issue was the offshoring of supply chains and exporting inflation over the last 40 years. We have now reached a point of saturation abroad, and even as supply chain bottlenecks clear- we will be left with higher prices. The underlying pressure on wages remain even when compared to 2019, and the general growth has been weighted in the “lowest paid” regions. The rise in asset prices has pushed people further down the wealth gap as money sitting in savings do nothing to keep pace. In order to even remotely keep up, it takes a portfolio of stocks, 401k, house, or other assets vs money earning nothing in savings. It promotes the irresponsible deployment of capital to YOLO creating a negative feedback loop over that time period.

If we break the wage growth into different industries, we can see the construction/mining has made the most progress since 2020. It makes sense when you consider the construction side that has seen a surge in activity- especially on the residential side of the business. When we net them all together to look at “all industries,” there has been little to no growth across that time frame with some of the worst offenders being the manufacturing and leisure/hospitality industry. There has been some recovery, but it isn’t even close to reaching 2019 levels. One of the more concerning things is the slide in wage growth in the manufacturing industry that has been subject to more automation replacing humans or at least reducing responsibilities. These adjustments reduce underlying wage growth or the need for a highly skilled individual taking the total average lower.

Private construction has seen a huge surge off the lows in 2010 but has gone parabolic again in the last 2 years. The growth in wages is supported by this big spike in activity that has driven labor costs up 20%-30% depending on the region. The rapid pace of expansion has resulted in some pause in building to let costs normalize a bit and to provide breathing room for current construction. We have seen a pick-up in “sold but not started” assets as the new construction numbers expanded.

The below data for June construction spending softened (while still expanding) to only rise by .1% vs estimates of .4%. Private residential again saw a nice bump up 1.1% with residential home improvement up .4%, nonresidential -.7% and public down 1.2%.

I would be remised to talk about wages without discussing a shift in payment to equity-based income that has been mixed into the offering backdrop. In a recent research report, the data showed that while equity income provided some benefits it didn’t offset the steady decline that has plagued the economy for the last 40 years.

https://www.nber.org/digest-202107/rise-high-skilled-workers-human-capitalists

“The researchers find that 78 percent of equity-based pay now goes to employees below the level of the executive suite and that human capitalists own a 10 percent stake in the public companies analyzed. Including equity-based compensation reduces by nearly a third the decline in wage-only income as a share of value-added since the 1980s, they calculate. For high-skilled labor, counting equity-based compensation almost eliminates the decline. Even after equity-based compensation is factored in, labor’s share of corporate earnings has shrunk in recent decades. But the gap is far more evident among lower-skilled, wage-dependent workers. Augmented by stock options, capital gains, and dividends, the high-skill share of total labor income increased from 46 percent at the start of the 1980s to 58 percent today while the employment share of high-skilled workers remained flat at 30 percent. The increased prevalence of equity-based compensation has been a win-win for high-skill employees and their employers. These workers benefit from lower tax rates on capital gains after exercising stock options, and firms use the prospect of stock grants as an incentive for retaining prized employees. Further, substituting equity pay for wages historically reduced reported labor costs and boosted annual earnings. The researchers estimate that 91 percent of equity pay has been used to replace wages rather than as compensation for increased productivity.”

The problem is not as drastic, but still shows the underlying problem of wage growth (or lack thereof) in the market as prices now go parabolic. The argument recently has shifted to savings growth, but as we have discussed constantly- it has been weighted to the top end of the income bracket and a large part has already been pulled into the market. These two charts have been passed around recently, but it is important to put them in context. I have also debunked the other countries, but for simplicity- I will just tackle the U.S. which is showing the largest surge in savings. “Stimulus checks, rising stock markets and fewer spending choices led to a massive savings boom over the past year, with Americans saving about $3.7 trillion, according to a study from Oxford Economics. Yet 70% of the gain went to the wealthiest 20% of Americans, the study found. The excess savings — or savings above and beyond the normal pre-pandemic growth levels — were even more skewed to the top. Of the $2.6 trillion in excess liquid savings, 80% went to the top 20%, and 42% went to the top 1%.”

It is important to see how the amount of personal savings has changed over the same time period when we look at the U.S. consumer. It is showing an “excess” in savings even though the total value has fallen because a large part of the pent-up levels was pushed back into the market. The remaining “excess” sits at the highest income levels, and they have already made large purchases across cars, houses, appliances, home renovations, and other big-ticket items. The remainder can be left in savings due to their spending capacity shifts as spending on goods gives way to more services. (more on that later).

It is important to look at this as a percent of disposable income because it helps put into context how much is left in the system as income levels fall with less government transfers. “Of the $2.6 trillion in excess liquid savings, 80% went to the top 20%, and 42% went to the top 1%.”

We can see it leveling off as the residual savings at the lowest end is absorbed, and the wealthier individuals sit on the excess. There will be some additional pull forward as customers look to rebuild inventories that have been drawn down to historic lows. The inherent price increase of underlying good has caused customers and companies to slow down their replenishment to avoid some of these underlying costs waiting for prices to come down. The general slowdown in consumer purchases will help some inventories to rebuild at the corporate level but it will remain fairly slow just given how steep the decline has been across the supply chain.

The prices paid remain at multi-decade highs with the pace of increases slowing, but still trending higher across the supply chain. We have supplier delays only getting worse as we come into peak demand season as orders are placed for the holiday season. The below chart helps breakdown just how skewed the supply chain is with inventories vs prices paid, and given the massive spike in prices there is a focus of replenishing inventories but in a measured way to avoid excess prices being stuck in inventory and trying to pass that on to the consumer.

Some of those prices increases have been passed on with the U.S. seeing the most pass through in comparison to other regions. The rest of the world is slowly catching up, but the U.S. (driven by government transfers and excess savings) have seen customers more willing to pay higher prices. But, not surprisingly, as government transfers slow and excess savings dwindle, the willingness to pay up has diminished and we see customers now balking at higher prices.

The delivery times have only worsened around the world with additional shocks impacting output prices remain- especially abroad. As PPI remains elevated around the world- the U.S. will be forced to pay up to keep product moving into the U.S. given our supply chain shifts over the years.

Because of these extensive supply chain shifts- the U.S. is the most vulnerable to the underlying problems that are impacting the world. This will keep our prices elevated and inflation less and less “transitory”.

The big increase in the trade deficit tells a much bigger story as we consider the outsourcing of the U.S. supply chain. It is leaving us more and more exposed to the fluctuations of the global market and price movements abroad.

The government transfers have slowed down over the last few months as stimulus checks end, extended unemployment benefits expire (rest Sept 1st), and are replaced by childcare stimulus. In total, government transfer payments still account for 19% of personal income in June, but it is a sharp drop from the peak of 33% in March- while still elevated it will drift lower. As we look at inflation, a dollar given in April 2020 and even March 2021 doesn’t buy the same thing as a dollar in Aug 2021. The ability of using that additional dollar to spend has been diminished across just everyday items from gasoline to soap.

The childcare benefit will provide some support, but when we look back over time- it doesn’t have the same impact as some of the other stimulus packages. This is due to the impacts of inflation and just the size being much smaller vs a straight $1200 check or elevated unemployment benefits. It is also important to consider the law of diminishing returns. In order to get the same or bigger impact, the size of the stimulus has to get bigger and not smaller. But, there is also a point in time that every new $1 has a net negative impact as the benefits diminish. After over a decade of some form of stimulus, we are reaching a peak period where the influx of new capital won’t translate to more spending as the cost of living shifts higher.

So now if we strip out the transfers, we can see that there has been very limited (if any) benefit to incomes. As people are pushed back into the workforce, there will be a net loss of income that will weigh on underlying spending and seeing how the consumer drives 70% of GDP- it is fair to believe their will be pressure on growth going forward.

The most recent update on employment cost actually fell: “The employment cost index measures changes in employee compensation costs (or labor costs). These costs include both direct costs (such as wages, bonuses or in-kind benefits) as well as indirect costs (such as social security contributions, training costs, medical benefits, taxes, etc.)” The underlying cost has reversed, but should stay elevated as the lower level of wage cost rises, but so far the top earning quintiles have stagnated with the “middle income” level declining which has offset some of the rise on the lowest incomes. This is why I keep saying- you can find any data set for your bullish or bearish argument, but we are looking at things holistically to get a handle on what spending will look like over the next few years.

When we look at personal income, it was fairly flat but still beat estimates. June income rose .1% vs expectations of -.3% while the previous month was revised down from -2% to -2.2%. Personal spending rose 1% vs estimates of .7%, but this is where the argument comes in on volume vs value. The “value” or “price” of goods has risen over the last 14 months so a person can buy the same number of products but see their net consumption rise. This is EXACTLY where we have seen the excess savings get pushed into the market- especially on the lower end.

The shift on consumer spending remains constant with a slowing purchase of goods and more being distributed to services. The pace of service spending will level off while still trending higher, but the purchase of goods will take a bigger leg down over the next few months. Given the underlying “value” of goods vs services- even as the volume of purchases accelerate in services- it won’t make up for the decline in total value.

The shift in consumption will provide a net negative impact on GDP growth as consumption pivots- especially with the consumer making up about 70% of U.S. GDP. The below breakdown of U.S. GDP drives home just how impactful the consumer is and has been a big reason for the surge in growth. The problem is the growth is running low now as the stimulus pulled forward a large part of spending and will now see a slow down in activity as the government reduces transfers and the consumer shifts spending patterns.

The response has been aggressive across all fronts- monetary to fiscal, which we have shown constantly through our discussion of rates/RRP, but there is always an overhang that follows so much stimulus that pulls forward consumption and general investment.

The drag on growth I think happens much sooner vs GS and other analysists- driven by the strong move on inflation and weaker wage response. The below chart I think does a great job of capturing just how excessive some of these moves will be over the coming few quarters. The big miss in Q2 real GDP growth of 6.4% vs estimates of 8.5% speaks to just the broad overhang. Just consider how much support was in the market during Q2 and the amount of spending that has taken place over that time period… now we move into Q3 with savings (still elevated) falling, wages under pressure, and prices remaining elevated.

Depending on what metric used, the level of inflation can vary, but the general trend remains up with the “stickiest” increase coming from the shift higher in rents.

Housing makes up 42% of the CPI calculation, which has significantly lagged vs other prices as the moratorium on evictions remained in place and people fled cities. Now as we near the end on the evictions moratorium and people return to apartments rents have skyrocketed with average occupancy at 96%. Rents are up 14.6% year over year in June, with more pressure coming as home prices reach new record prices each month.

It is the reason why I laugh when you can look at the different ways they can adjust the “inflation” look. There is something for everyone to quote low inflation, moderate, or elevated inflation. The biggest issue remains the direction of pricing pressure on the steady rise over the last 14 months or so.

The Fed always quotes the GDP Price Index, which put in a staggering number as inflation accelerated throughout Q2. We also know- that pricing pressures didn’t get any better in July with more issues persisting through the remainder of Q4.

There is some view that prices have stopped moving up, which is a fair push back- but it doesn’t mean they are reversing lower. Prices have a lot of staying power at these elevated levels given the broad issues ranging from supply chains to raw materials to inventories. All of the leading indicators from the local Fed banks point to either rising or remaining elevated pricing pressures across services and manufacturing. The PMIs across the board confirm the same thing, so it is unlikely we see any type of reversion lower.

Many of these price increases have been driven by demand mixed with reduced supply chain capacity, but it also has some other pieces- such as a rise in lower wages and rents. With today’s jobs number, we saw another spike in low wage jobs coming from leisure and hospitality positions. We still have about 100M people not participating in the jobs market, which should shrink significantly as we approach the expiration of the extended unemployment benefits.

This leads us to- what will jobs look like as we get to the other side of COVID19. I know there is ongoing debate on what the balance will be between WFH and in-office attendance. I don’t think the new data will shock anyone, but the pivot has grown to be focused on a flex schedule. About 30% of Americans want a full WFH schedule with another 30% desiring a flexible schedule of 2-3 days at home. I believe there will be a shift into the flexible schedule shift with this becoming a part of the “offer package” to attract talent. The next question pivots to- how much money are people willing to forgo in order to work from home?

A large sample of individuals are willing to accept a 5% reduction in salaries, which essentially equates to the money saved on commuting. So they are open to giving up their “travel savings” in order to have a broader “work-life balance.” They are UNWILLING to take any big hit to underlying earnings of 25%- so it just breaks down to passing on the underlying savings.

Businesses are spending to meet the demands described above with more IP and equipment vs structures. The shift has been into technology and other equipment that enables more WFH in industries, but also that automates more in others to reduce the roll of humans. We have covered at length the investment in machine learning, AI, and other tech innovations to reduce responsibility on the human level. This just means it will take less people and at lower wages to carry out the job. It will be a long term headwind to not only wages but normalizing the jobs market.

The jobs picture will continue to improve this year as we see more people accepting jobs and some of the 100M still on the sidelines coming forward. The issue will be inflation vs wages- the underlying “hard economic data” has weakened further. The issue stands with- inflationary drivers that are out of the companies control as we import inflation from abroad. The hard data in the U.S. remains well off the normal pace as wages remain depressed and prices rise further.

There are still an unusually high number of unemployed workers so that there were still 0.9 unemployed people for every job opening in July—or 1.1 using the realistic unemployment rate to adjust for the unusual reduction in participation. If you distinguish between temporary and permanent layoffs we’ve now undone ~all of the temporary unemployment but ~none of the permanent job losses. This is a big factor that I highlighted earlier when looking at business closures and the overhang that will have on the underlying data sets. We are seeing that play out below, which will take time to recover and cause a “leveling” off of activity as we enter into the fall/winter months.

The velocity of money remains MASSIVELY depressed as the denominator gets hit hard as the Fed keeps expanding their balance sheet. The calculation looks at the movement of $1 through the economy by looking at Price level * aggregate real value of transaction (Essentially GDP growth)/ money supply. As the growth of the economy has stagnated for over a decade (numerator) and the money supply has EXPLODED (denominator) the velocity of money has gotten destroyed. As the Fed tapers and inflation remains elevated- the money supply will stay constant (start to shrink) as the numerator stays fairly flat. This will see a pick up in the velocity of money over that time period.

• Iran Lashes Out as Local Discontent Heats Up: Droughts a Rallying Cry

Iran is ushering in a new leader today (August 5) as Ebrahim Raisi is sworn in as President. As the latest regime takes the helm, they are faced with mounting pressure—both internally and externally. Countries around the world are facing mounting pressure in response to COVID19 and struggling economies (especially in Emerging Markets). In my previous article, I covered several of them, but given the current events in the Middle East, it is important to do a deeper dive on the inner workings of Iran. President Raisi is a vocal anti-Western cleric and currently sanctioned by the U.S. for human rights abuses. His hardline political stance makes it very unlikely that protests will stop within the country; if anything, they will increase in frequency. Iran has made some headway in negotiations on a new deal with the West, but key differences remain, and given the new shift in governments, the lack of compromise and differing ideologies makes a new deal unlikely.

The U.S. and allies have maintained strategic assets in the region even as the U.S. looks to reduce personnel and equipment there. Even as some adjustments are made, the U.S. is maintaining a presence, with the USS Ronald Reagan Carrier Strike Group and USS Iwo Jima, as well as other military capabilities throughout the Middle East at strategic points. So while the numbers may diminish, the coalition’s ability to respond to threats remains in place. The elevated presence of naval capacity is meant to maintain safe passage through the Strait of Hormuz, a vital region for trade and choke point in the global supply chain. This is a place that has seen an increase in hostilities as Iran tries to flex its muscle and project power on the international stage. Recently, two maritime events took place. The IRGC (Iranian Revolutionary Guard Corps) boarded the Asphalt Princess (a Panama flagged vessel) in the Gulf of Oman, but their plan was foiled by nearby coalition forces and the ship’s crew disabling the engines. The armed men escaped on another vessel as several naval ships approached the area. This closely follows an alleged Iranian attack against a different vessel—Mercer Street (owned by a Japanese company but operated by one out of Israel)—off the coast of Oman, which was struck by a drone, killing a British and Romanian crew member. As economic pressures mount and local support wanes, the Iranian regime will face more questions from proxies regarding funding and underlying allegiance. By striking outward, it provides a show of force and a deterrent to local protests, while trying to create a unified external enemy. The problem is: the issues internally have reached a breaking point, and these actions will only serve to further rally the masses against the regime.

While ongoing issues progress outside Iran’s borders, tension is rising among locals facing an economy in shambles driven by shortages of basic necessities—most recently, water—and underlying inflationary pressures. Iran continues to be impacted by sanctions squeezing the federal balance sheet and limiting crude production and total exports. This has forced them to borrow extensively against energy assets and accept poor deal terms with countries such as China to bring in needed cash flow. The Iranian Rial has fallen 48% since the beginning of 2020, which now sits at about 257,500 IRR per $1 U.S. dollar. The sanctions against Iran prohibit the use of U.S. banks and wires, limiting the ability to receive compensation for goods sold abroad, as well as repatriating cash. It forces businesses to sell products at steep discounts to offset some of the risk of doing business with Iran. This limits the natural movement of cash, impacts normal economic operations, and influences how businesses function, creating a robust black market to try to smuggle in USD and barter.

Iran is currently doing its best to stay relevant in the Middle East, but when looking at the full picture of the region, it’s clear that their attacks are not coming from a point of strength—rather, the opposite. Iran is facing a major internal conflict between the populace and the ruling party. When the JCPOA was first enacted, sanctions were removed from Iran, which provided a cash windfall. But they spent the money on proxy support instead of on the local economy, which created a great deal of strife internally since locals didn’t see the economic or financial benefit of the deal—they believe the regime “squandered” the money. The lack of infrastructure investment is on display with the current water shortage that is starving crops and driving more animosity against the government. Their political future is nearly impossible to predict, but a major shift will most likely happen over the next 24 months. It’s doubtful that a deal with Iran will take place in 2021, but to show strength and solidarity with their proxies, attacks will remain prevalent throughout the region. A deal is possible once the regime feels more pressure from the local populace—they will try to do anything to stay in power . . . but by that point it will be too late.

The most recent pressure point is the shortage of water throughout large parts of the country, with the most recent flashpoint occurring in Khuzestan. The Ahwaz (Minority Arabs: 2% of Iran’s Population) kicked off protests in Khuzestan, which quickly spread into Lorestan and Tehran. The water shortage is just compounding existing problems and providing a spark for further protests against their living conditions. The Ahwaz sit on large parts of Iran’s Oil and Gas reserves, which is arguably some of the most mineral rich acreage in the world.

This has always been a source of contention as they live in an area facing pollution, dust storms, dried up wetlands, and extreme poverty—even though their land is worth billions. They have previously called for a separatist movement, but current protests are more focused on water shortages and underlying economic conditions. But the international sanctions (limiting foreign aid), weak harvest, and economic struggles are also a big source of anger that is culminating—the water shortage is just the rallying cry. Instead of responding with water, the regime sent military equipment and personnel that have used live fire on protestors to disperse rallies resulting in civilian deaths. The IRGC used the excuse of guns and military equipment moving across the Iraq-Iran border to bring such force into the mix. There have also been blackouts across parts of the country due to overwhelmed capacity from searing heat, but also driven by government actions to stop the protests. They have even gone so far as to cut the internet for periods of time to stop the spread of information on rallies and regime actions against protestors. But nothing seems to stem the tide of anger throughout the country. The government wants to control the narrative, but they have been losing control slowly over the last two decades, and it has only accelerated throughout the last five years.

https://mysteryofiran.multiscreensite.com/da/iran-ethnic-groups

The Ahwaz are not the only ones impacted by rampant droughts; poor water management and aging infrastructure has plagued Iran’s system for years. Now, as Lake Urmia and the Karun River dry up, the failure of managing reservoirs and groundwater becomes a huge sticking point. Some of the water has been shifted to farmland and cattle, but previous farmland in Khuzestan is facing severe drought, with other sources diverted inland and away from normal flow patterns. Opening dams would provide a short-term respite but create broader shortfalls in cities such as Isfahan and surrounding provinces.

Along with Khuzestan, Sistan and Baluchestan are also seeing an uptick in protests and riots against the current government. The Iranian people have carried out many protests over the years, but they have always been met with violent suppression (many of them led by Qasem Soleimani, the head of the IRGC’s Quds Force). The death of Soleimani has eliminated the mastermind behind terrible (and HIGHLY successful) tactics within and outside their borders. He is responsible for the deaths of many U.S. soldiers and Iranian civilians while in control. Soleimani was an enemy to many, but his whereabouts and movements were typically shrouded in mystery—the Quds Force is a clandestine unit. The brutal tactics have only built up more resentment across the region. The populace has been turning away from the regime over time, but the shooting down of the Ukraine flight in July 2020, the handling of COVID19, the new deal with China, and now severe drought have pushed people beyond their breaking point. Iran and India have been friends and allies for over a thousand years, and part of the China deal stipulated that India had to be “expelled” from current and future deals with Iran. India has built refiners specifically for their crude and has deals in place to build roads, rails, ports, and oil and gas exploration that was temporarily paused (but not stopped) when the U.S. sanctions came back into play. The U.S. even turns a blind eye to some shipments of Iranian crude heading into India. After the Ukraine plane was shot down, the local Iranians stopped walking on Israeli and U.S. flags that were painted on the ground, with some even getting rid of them all together—symbolically showing that they were no longer eager to “trample on” and disrespect these countries. The U.S. also set up humanitarian aid through the Swiss Embassy during the COVID19 pandemic to show solidarity and support for the local populace.

The attacks on international assets cost money and move them farther away from striking a deal with the U.S. and Europe. The constant funnel of money to proxies is also a drain, as coalition forces hit sensitive Iranian and proxy targets throughout the regions. This only compounds the shortfalls created by sanctions, causing the Iranian regime to run short on money (and time!) as the populace turns against them. This is on full display as intelligence leaks like a sieve from Iran and high-value targets continue to be eliminated. Most recently, Mohsen Fakhrizadeh (a top nuclear scientist) was killed by assassins using a remote machine gun. This is a man who has a constant security detail and whose movements are a state secret due to the importance of their nuclear program. There were a barrage of similar “attacks” throughout last year, which have continued throughout 2021, with fires and explosions striking various assets in Iran. All of these attacks have attempted to minimize civilian casualties but hit at regime-owned and operated companies and facilities. It’s clear that local Iranians are now emboldened to strike out against a repressive regime.

The mounting pressure internally has pushed the Iranian regime to lash out with recent attacks on coalition forces in Iraq, KSA assets, and local ship traffic. Iran’s balance sheet is under pressure, which pushed President Rouhani to sign a deal with China agreeing to inject $400B of Foreign Direct Investment over 25 years into Iranian O&G and petrochemical businesses. They also agreed to invest in their banking, telecommunications, ports, railways, and other projects (many of them already had deals with India). This new deal allows China to deepen their military cooperation through joint exercises, research, weapons development (ummm . . . JCOPA?), intelligence sharing, and other integration metrics. China has been increasing their purchase of Iranian crude at a steep discount, especially with new refiners and petrochemical facilities starting up within China that require the type of oil Iran produces. China has been given an opportunity to gain a footing in the Middle East, which is a place they have tried to increase influence through Belt and Road investments. Over the last several years, Iran has become an integral part of China’s BRI, and even after global calls to shut down travel with China due to COVID19, Iran was the last country to react. This caused Iran to be one of the hardest hit nations at the outset of the pandemic and created even more animosity between the regime and the local Iranians. The biggest concern now is the delivery of advanced ballistic missile capacity to Iran, which so far has been limited to older generation technology.

President Biden and allies must remain firm in deterring attacks against U.S. and coalition assets in the Middle East. While it is important to strike back to show force, we must avoid any civilian casualties by not striking within Iran. It would be a huge error to deter the populace’s shift away from the regime, especially as intelligence is leaking out in the U.S.’s favor. They are losing influence as the noose tightens around their borders and protests increase throughout Iranian provinces. Geopolitical moves are measured in decades, not single years, with nothing ever moving in a straight line, but the hardliners don’t have the support of the locals or the international community. We have considered Iran a friend and ally in the past, and if the Iranians continue their current path, we will again one day soon. Those from the '79 revolution are old, dead, or losing influence—now is the time to press.

• Quick China, India, and Asia Recap + Brief Update on Food Scarcity

Quick note on China and Asia in general as COVID cases throughout the region make new highs. The pressure remains throughout the area on slowing PMIs and manufacturing and general trade. China is facing renewed problems as over 150 cities and several provinces face COVID outbreaks resulting in broad restrictions on travel. This is hindering spending as well as general oil and refined product demand, which will push more exports into the market. The Politburo is very anxious about the economy, which let to a new meeting about ways to increase activity. It is important to point out that this won’t be driven by a change in monetary policy, but rather driven by an easier fiscal policy by “pushing” provinces to utilize more of the SPB capacity (Special Purpose Bonds). The underlying issue is the previous 5 years have seen SPBs issued to infrastructure projects that are grossly under earning and are being financed with tax revenue. The quality of projects has diminished considerably and with it the means to invest in a “normal” or rather fiscally responsible fashion. This is usually the time that the Chinese Government starts to panic about growth, so it will be important to watch the actions they take over the coming few weeks.

The Politburo meeting's readout reflected rising concern about the economic outlook:

• “At present, the global epidemic continues to evolve, the external environment is becoming more complex and severe, and the domestic economic recovery is still unstable and unbalanced.” • To counter this downward pressure, Beijing plans to lean more heavily on fiscal policy.

Specifically, the government wants to:

• Ensure that budgeted investment projects actually get underway • Speed up the issuance of local government bonds (SPBs) – and then put those funds to work • Some context: The central government allocated RMB 3.5 trillion for SPBs this year. But as of the end of June, local governments had issued only RMB 1.01 trillion of SPBs – a mere 27% of the annual quota.

While Beijing looks set to ramp up fiscal spending, they are going to hold the line on monetary policy.

• The readout insisted monetary policy will remain “prudent” and focus on “ensuring that liquidity is properly ample.” • The readout also pointedly stated that the government will “strengthen the autonomy of our monetary policy.” • To us, that’s a clear indication that authorities won't let the actions of other central banks disrupt efforts to maintain normalized monetary policy at home. (We’re looking at you Fed). • The bottom line: The government is worried about the outlook for H2 – that means investors should be as well.

The Chinese government remains focused on trying to drive local consumption, which is still far below expectations and what is aimed at for the “Dual Circulation Strategy.”

• The most interesting comments came from Liu Yi – Chair of the Department of Public Finance at Peking University’s School of Economics – who attended the meeting.

Liu proposed to get domestic consumption humming by:

• Improving the quality of consumption statistics and incorporating virtual and service consumption into overall retail sales statistics • Allowing local governments to keep a larger share of consumption tax revenue • Increasing investment in the development of the digital economy • Get smart: That second one is key. If cash-strapped local governments got to keep more of the tax receipts, they’d be incentivized to turbocharge local consumption.

The problem remains the drop in new orders and exports coming from China as countries look to diversify their exposure and wait for backlogged orders.

While the export and general manufacturing side slows, the social financing side is also under pressure as more money is drained from the system on the liquidity front. As liquidity is removed, the CCP is also trying to reign in real estate investment and general housing prices. They have made strong moves against real estate developers, which only got stricter following the Evergrande debacle.

As India awakes from COVID lockdowns, there has been a nice bump in gasoline demand, but diesel demand is still very weak. This should come as no surprise as the underlying economy continues to struggle even as some normalcy returns. The biggest issue (which is a global problem) is the weakness in wages across the Indian economy- hitting agriculture, rural wages, and industrial salaries. The pain has been around since 2016-2018, which speaks to a much bigger issue vs just COVID. COVID is just exacerbating an already big problem across many economies- wage growth.

Another 291 million People Won’t Have Enough to Eat This Year

• That will drive up world hunger numbers by a third, USDA says • Most of the increase is expected to come in Asia, Africa

Overall, 1.2 billion people in the 76 countries covered in the USDA report--representing 31% of their population--will be food-insecure this year. Prior to the pandemic, the USDA estimated 761 million people, or less than 20% of that population, fell into the category in those countries.

Most of the additional people the USDA expects to fall into food insecurity this year are in Asia, which accounts for 72% of the increase. Bangladesh, India, Pakistan, and Indonesia will see particularly large jumps in the number of people without enough food, according to the report. Sub-Saharan Africa accounts for 21% of the global increase in undernourished people.

The below chart puts into context just how dire some of the situations are along food and water… when people are starved of basic necessities- things devolve quickly.

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