U.S. activity continues to slow along seasonal lines with another small drop coming this week as well. The below chart helps drive home the seasonality impact, and how the pace of reductions remains fairly muted vs other years. This week normally sees another drop, but the reduction will be at a slower rate vs pervious years. We expect to see a quick recovery back to 275 spreads by the 2nd or 3rd week of January, which is what normally happens. Prices across all three streams remain supportive of activity, and will result in a swift recovery of the Holiday slowdown.

Seasonally Adjusted National Frac Spread Count

On the other hand, the Permian keeps shaking off normal reductions. We are seeing work remain robust throughout the region, but we normally see a step down this week. The rate of the decline will be less vs previous years, but still see some slowdown for the holiday. There will also be a quick snap back in activity across the country as we kick off January.

Seasonally Adjusted Permian Frac Spread Count

The big focus into next years will be liquids pricing. We expect to see a fairly stable crude price at around $65, but demand will remain robust for U.S. LNG and LPG. Exports from the U.S. are at record levels as demand remains steady from Asia but surges in Europe attracting more volumes. We have seen several cargoes indicating Asia make U-turns to come back into the European market due to the elevated prices. This will be supportive of contractual cargoes, and push U.S. producers to maximize spot capacity to capture the elevated prices. Out of 76 U.S. LNG cargoes in transit, 10 tankers carrying a combined 1.6 million cubic meters of the heating and power plant fuel have declared destinations in Europe, shipping data compiled by Bloomberg shows. Another 20 tankers carrying an estimated 3.3 million cubic meters appear to be crossing the Atlantic Ocean and are on a path to the continent.

The support from NGLs, condensate, and natural gas can’t be ignored when we look at the average production from a U.S. shale well. A large part of production in the U.S. is on the lighter side and has only gotten lighter over the last 2 years. This isn’t necessarily a bad thing when we consider that the next decade of demand growth will be driven by liquids. China has been increasing their ethylene capacity, which makes them beholden to run at least 87% ethane in the process. The U.S. has also built out more export capacity to help capture a larger share of the growing market. The rise in domestic consumption married with the increase in U.S. export capacity allows companies to capture the best price available. As the Asian markets remain hungry for liquids, we expect to see the link between liquids and WTI cushing disconnect a bit. There will always be some linkage to price, but we think that liquids pricing (condensate and NGLs) will fair better vs WTI and remain elevated. So, if we see a fall of say $8 in WTI, we don’t expect to see the equivalent drop in NGL/ condensate pricing. The consumption on the commercial and residential level has only risen over the last 5 years and is set to rise again as more assets in the Middle East and Asia (Especially China) come online.

North American Propane Mt Belvieu Index

North American Purity Ethane Mt Belvieu Index

We expect a lot of this price appreciation to remain, even as some exports slow due to the congestion at the Panama Canal. But, the demand that has come online isn’t going away in Asia, which will bring them back to our markets. This will also be supported by more liquids being consumed locally in the Middle East as they bring online their own new capacity and consume more domestically.

Another key factor that we have been highlighting to show a potential problem with global crude demand is Middle East floating storage. We expected to see floating storage to rise as OSPs rose and more consumption from West Africa, Europe, and the U.S. So far, things have played out exactly as we expected for how crude is moving around the world. Middle East floating storage has moved to a 2021 record and some stranded cargoes have moved from WAF into the open market. It will be important to see how the Middle East nations react by the rapid rise of floating cargoes. We expect to see some discounts rolled out this month, but OSPs going forward will be important to see how aggressive they get to adjust volumes.

Middle East Crude Oil Floating Storage

West Africa Crude Oil Floating Storage

As Libya volumes come into question, we expect to see Europe increase purchases of Nigerian and Russian urals to make up for any disruptions. There has already been a step up in purchases from the U.S., so those will just remain steady with the difference coming from Nigeria and Russia. LIBYA UPDATE: Election organizers want the cancelled presidential election held Jan 24, date of parliament election. Unclear if unity govt continues, or what replaces it as oil protests continue. We are also getting conflicting reports of oil production impacts – oil minister says 1.2mbd but NOC says 0.9mbd. There is enough crude in storage to meet December loadings, but we could see an impact in Jan especially if some of the ports are shut down. I don’t see any permanent impacts here, but will definitely cause some shifts in purchases and support some Nigerian cargoes.

Nigeria is facing its own issues with unplanned work being down on one of two buoys used to load Bonny causing Shell to declare force majeure in the region. There were 4 cargoes yet to load in December, so this will increase January loadings or push some into February to make room for the lost Dec cargoes. None of this is a permanent impact but will just shift the loading schedules around a bit. Angola is still selling cargoes at a wider discount (by about $1) vs previous as Asia (mostly China) remains a very sluggish buyer. We are also seeing that appear in ESPO cargoes that have been trading at about a $3.30 premium vs the $6.80 (and as high as $7.30) premiums it traded at in Oct/ Nov. Chinese buying has really slowed down after seeing some spurts in November, which is along seasonal lines. They did pick up some floating cargoes- especially from Europe/ North Sea that were trading at sizeable discounts. This will keep floating storage elevated in Asia.

We are going to see floating storage cargoes transfer from Europe and WAF and position in Asia- especially as COVID has resulted in more shutdowns/slowdowns of ports in China. This is why we have seen a big spike in crude oil on the water. We are setting a seasonally adjusted record of crude on the water driven by a seasonally adjusted record of crude in transit and near record amount in floating storage.

The biggest concern we have will be on crude demand in 2022 NOT because of COVID, but rather the deteriorating economic data that has been ignored. Many companies and news organizations just blame COVID, which creates buying pressure when the newest strain proves to be less impactful on hospitalizations and deaths. It provides a great excuse and cover for the real cracks that remain in the system as we have a global rate rising cycle. The Bank of England had a “surprise” increase in their rates and the Fed will be following suite very soon. The market is assuming that the Fed will reverse course in 2022, but as we keep trying to drive home- they have no choice as inflationary pressures remain all around us.

Many of the broader macro indicators point to a very late business cycle that will compound the problems we already face in 2022 from broad fiscal and monetary drag.

We have already seen the consumer pausing their purchases as inflation adjusted spending missed estimates and was flat month over month. #Inflation taking power away from spending … real personal spending was flat in November vs. +0.2% est. & +0.7% in prior month. Personal savings rate continuing to fall … as of November, it stands at 6.9%, the lowest since December 2017.

We are starting to see a broader slowdown in the consumer as wages don’t keep pace and prices keep rising on the cost of living. This will have broader economic implications as the U.S. consumer is the growth engine of GDP. As the U.S. consumer slows and the U.S. keeps importing inflation, it will have the biggest implications on our trade partners- especially China.

China remains a much bigger problem versus what the market expects as we head into 2022. There is a prevailing view that China will try to pick-up the economy ahead of the winter Olympics and Xi being named “president for life.” There is some truth to that as we have highlighted that China wants to increase some of the credit impulses into year end and Q1/Q2 of next year. The bigger focus is to maintain reduced liquidity, but not at the current depressed rate. It will mirror the ’11-’12 and ’13-’14 periods that saw small reductions that were very measured.

We have been adamant that another RRR cut was coming this year, and we expected it to be at the micro-SMID capital bank level. Instead, it was a sweeping cut across all three level of banks- but still cut that was timed with the expiration of medium-term facilities. The cut was also timed with a spike in bank long-term funding needs, which is due to the deadline to be fully compliant with wealth management regulations by year end.
A quick look at the interbank lending market reveals that banks are in need of some supplemental funding.

• In November, banks’ issuance of negotiable certificates of deposits (NCDs) – a niche product that banks turn to when they badly need new funding – spiked after having been fairly stable since April.
• In October and November, the total volume of outstanding NCDs increased by RMB 1.2 trillion, a 10% increase in two months.

Crucially, more than half of all newly issued NCDs mature in a year – which means banks’ funding needs are long-term, not short-term, which would be the case if these products matured in a month or two. The rise in NCDs was a signal that more liquidity was needed- not to boost the economy, but to supplement and strength bank balance sheets. This just means that a lot of the unlocked liquidity won’t make its way directly into the market, but rather, sit on the banks balance sheet to offset some underlying exposures and new capital requirements.

China’s banks needed an infusion of long-term funding in order to comply with the “new” Wealth Management Product (WMP) regulations, which are putting significant pressure on banks’ ability to fund themselves. The WMPs have been a nagging problem for many institutions as we have seen from real estate developers to banks. The government launched an initiative at the end of last year and reiterated it this year that financial institutions that utilized WMPs needed to meet more stringent criteria. This comes into effect for banks in December of this year, which required an injection of cash to help them shore up balance sheets. Plus, there is always a larger infusion of liquidity into year end to help banks close out the year and meet closing requirements. I expect to see some of the additional liquidity to be pulled from the system in January, but between Lunar New Year and the Olympics- we should see an elevated amount remain through February.

The underlying economic data left little to be desired, but there are some points where we can see some signs that the real estate sector will be able to get some funding. There is a renewed push for infrastructure projects, but so far we have seen very little uptake by local governments. The bigger issue is the MASSIVE miss in retail sales, which have been on a downward trajectory for years.

For two: Manufacturing capex and output at high-tech industrial firms increased by double digits year on year (y/y) last month.
This signals that the desired transition to “high quality” growth appears to be underway.

For three: The month also saw ongoing strong growth in exports.

A trend we expect to continue for a while at least.

OK, that all sounds pretty nice. But what about that whole gloom (and doom) part?

China’s economic officials will be most concerned with ongoing weakness in household spending.

Retail sales growth in November came in weaker than expectations, and weaker than the previous month.

What’s more, discretionary income growth is still below pre-pandemic levels.

These are the things keeping officials up at night.

Fixed investment still remains under considerable pressure, but we are starting to see a small bounce in infrastructure investment as governments roll some Special Purpose Bonds and attempt to hit their ’21 targets. They will be slow to really dive into new infrastructure investment given mane of the SPBs and Local Government Financing Vehicles (LGFVs) are underwater. But, we have seen a flatline (still negative), but at least turning the corner that also matches closely with our view on underlying credit impulses- they will stop going down with a small bounce- but not a huge move back up.

The bigger problem remains the steady decline of retail sales since the end of 2016. The government has been stepping in to reduce underlying prices for consumers that has driven the big divide between factory gate prices and PPI vs CPI/ Export prices.

The disconnect between CPI and PPI is a perfect example of “hidden” stimulus. The Chinese government has stepped in to provide relief on taxes, VAT, fees, tariffs, and other costs to help alleviate some of the price increase and keep local prices depressed. If China looks to push up credit impulses, they will have to adjust the amount of support being pushed into the market. But the consumer is already struggling so by letting prices internally rise it will push down spending even further.

The question becomes- can President Xi tolerate the “failure” of the Dual Circulation Strategy and Common Prosperity. The PBoC and CCP understand the importance of converting the local economy to be driven more by consumption and less by exports/real estate/ industrial production. Government spending is also a massive piece of the GDP calculation, and they are struggling to maintain current support as the bankruptcies increase and banks need more cash reserves for the WMP (Wealth Management Product) regulations. Local governments have required more cash infusions as tax revenues diminished and land sales dropped hurting balance sheets further. This is why the view that China will entering an “easing” cycle is difficult because they never actually left one. The law of diminishing returns is hitting hard because they didn’t “tighten” anything to generate an impact on cutting or easing. A large part of the recent “easing” metrics have been targeted at shoring up balance sheets vs generating growth on the credit side.

The cut of the 1-year prime loan rate is coming from an already depressed level that was reduced throughout 2019 and into 2020. The one-year loan prime rate (LPR) was cut from 3.85% to 3.8%, the People’s Bank of China (PBOC) said on Monday. The five-year LPR, which is the reference for mortgages, remained at 4.65%. The reduction was small, and you can see is already coming from a reduced level. The cash being released from this action isn’t going to cycle through the system, but instead sit on balance sheets to adjust for the regulation that becomes effective this month. Plus- the PBoC always increases cash availability into year-end and leaves it in the system until after Lunar New Year. So February will be a pivotal month on how much is drained from the system.

The industrial production side remains right on the 6-year trend, but it is getting harder to maintain as prices rise on input costs and gate pricing. As the government pairs back some support, how much of it will impact industrial production? As companies “near shore” or “on shore” production or diversify their supply chain- how much of that will be at the expense of Chinese growth and industrial production? This is why the government is so adamant about building out the local consumer to insulate themselves from this kind of shock as much as possible.

The consumer has been weak since 2018 and struggled throughout 2019- WELL before the outbreak of COVID. This also comes with significant support that has been rolled out since 2019 to help drum up more local spending. The failure to generate local demand is becoming a much bigger problem as we see more global CAPEX being spent on shifting supply chains. This is why the shift in stimulus or the ability for the Chinese government to do more is very limited. If prices internally are allowed to rise- it will only put more downward pressure on retail sales.

The below chart helps to highlight just how many companies are focused and spending on shifting supply chains. It is taking longer vs earlier expectations (not surprising), but that is how CAPEX is being spent going forward. The impacts will continue to be felt in China throughout the next 2-3 years as many of these deals and shifts are finalized. Nothing ever happens in a straight line, so this shows some of the additional pressure that will hit the Chinese economy on the export and industrial production side.

General global growth is also slowing on the aggregate that will limit the amount of economic strength the Chinese government can generate. As China is such a big piece of global trade, they will see an outsized impact of manufacturing slowing as it will limit the need for semi-finished and finished products.

The pressure can already be seen between Europe and China. The wealthier Chinese consumers also “don’t be Made in China”, but prefer imported items- especially from Europe (Germany). The decline in European exports to China and the lack of social financing in the area helps to highlight the weakness of local consumption. We don’t see this making a huge shift especially because the focus is on generating made in China consumption under the Dual Circulation Strategy.

China is also facing broad bond defaults that are set to accelerate again in January of 2022. Chinese firms have defaulted on a record $3.8 billion in offshore bonds so far this month, data compiled by Bloomberg show. The previous monthly high was in January when Chinese borrowers failed to repay $2.7 billion of such notes. A month that saw Evergrande and Kaisa officially labeled defaulters, December has seen a precarious rally in Chinese junk bonds threatened by heightened anxiety over the financial health of other companies such as Shimao Group Holdings Ltd. and Guangzhou R&F Properties Co., as a liquidity crisis sparked by a government crackdown on excessive borrowing by developers ripples through the sector. More credit risk is simmering, with January set to be an even busier month for maturities. Chinese developers need to repay or refinance about $6 billion dollar bonds, according to data compiled by Bloomberg. Guangzhou R&F is asking holders of a $725 million dollar note maturing Jan. 13 to extend the due date by six months, and is offering to buy back some of the debt at a discount. If the proposals aren’t backed, the company said it might not be able to fully pay off the note. We are already heading into 2022 with a potential default in the wings- with more beuind it.

Chinese construction activity remains weak, and just like credit impulses we expect to see these bottom and rally a bit. It won’t get back to growth, but will just stop going down and work closer to “0”. We have seen steel output stop going down just as credit impulses, but we don’t expect a huge surge in activity either. Instead, it will be more measured along the lines of stemming some of the bleeding, but as we described earlier- the government has limited ammo to really stimulate the economy in ways they have in previous years.

The above charts help drive home how activity has stopped going down and started to turn a bit higher. The caveat behind all of this is the turn higher is still in negative territory and just transitioning to be “less bad” vs moving instead a growth profile. A slowing U.S. and global economy will make any Chinese growth harder to obtain especially with limited abilities to ease liquidity restrictions. China faces more bankruptcies and underlying economic pressure.