On the U.S. completion front, we still have a steady move higher in activity over the next few weeks as we rise back to 275 active frac crews. We will get another rise this week of about 8-12 frac spread crews as we march right back to the highs of last year. I wanted to discuss a bit more on NGLs today as there has been some pressure on NGL pricing in the near term as naphtha pricing has fallen, but we still see longer term support in the NGL barrel.

I cover more on Russian vs Ukraine on the YouTube Channel- Econ show Seg 1 and will do a bigger write up towards the end of January. I don’t think the risk is as high there as it is in the Middle East right now- more on that below.

RECORD NGL SUPPLY EASES FEARS; BARREL STEADY NEAR $44 AS CRUDE SOARS

While domestic crude oil production struggles to recover above 12 million barrels a day, natural gas liquids fractionators continue to work full throttle, drawing on raw NGL stocks to set new production and export records for ethane, propane and other LPG’s. U.S. purity product production (ethane, propane, butanes, natural gasoline), which account for over 40% of global supply, surpassed 5.7 million barrels a day in 4Q. However, this is due in part to stock draws as 3Q inventories for all NGL products were 15% below pre-pandemic levels, signaling that raw NGL production may be struggling to recover alongside shale. Further drawing on supply, exports remain strong at over 2.3 million barrels a day, up nearly 25% from 2019, in particular for propane. Future growth could be constrained by a lack of incremental NGL production at U.S. shale and draws deplete NGL inventories well-below 5-year averages. A major buildout of fractionation capacity at the U.S. NGL hub in Mt. Belvieu, Texas, has allowed midstream companies like Enterprise Products, Targa, Energy Transfer and Oneok to process more NGL’s, clear any infrastructure gluts and continue to meet demand despite concerns over domestic shale supply.

Fractionators, Exports Draw Inventories; Provide Support Above $40 Per Barrel

While oil prices have trended closer to $85 a barrel, NGL prices have flattened near $44 a barrel. Still, rising oil, strong export demand and below-average inventories should provide support for prices at these levels. Concerns have eased over U.S. NGL supplies meeting the needs of rising global LPG demand that has held strong through the pandemic. NGL prices have nearly doubled to about $44 per barrel since year-end 2020 in anticipation of tightening markets, outpacing gains in WTI last year and indicating a maturing NGL market that is de-linking somewhat from crude. Today’s prices are a far cry from an average of under $18 a barrel in 2020 and lows below $13 in March 2020. NGL prices reached a value of 60% of the crude barrel in late 2021, but has normalized to a little over 50% as crude rises. This may provide a backdrop for stronger production growth forecasts for U.S. shale in 2022, in particular the Permian Basin, which would ease some supply concerns and inflationary pressure on prices. U.S. infrastructure bottlenecks have been cleared up with a newly built pipeline system and added processing and export facilities. A major expansion in fractionation capacity is coming to an end, though several companies are likely to add new fractionation projects or complete those stalled by the pandemic. Export capabilities appear suffice though midstream companies were clamoring to add more dock capacity prior to the slowdown in U.S. shale and several projects remain in development.

1) The Iran-backed Houthi rebels in Yemen on Monday evening attacked targets in the United Arab Emirates (UAE), including airports in Dubai and in an oil refinery in Musaffah, as well as “a number of important and sensitive Emirati sites and facilities,” with five missiles and a number of drones. It resulted in several deaths and shut down operations briefly at airports. This marks a bigger turning point in the Yemen conflict as the attack was carried out by the Houthi rebels.

The market had another round of disruptions shifting concerns in the crude market higher:

2) The Kirkuk-Ceyhan pipeline halted operation after an explosion in the southeastern Turkish province of Kahramanmaras. The fire was caused by a falling power pylon, and operations of the 450k barrel a day pipeline were already back to normal.

The bigger issue is the escalation in Yemen where attacks escalated over the last few days. The attack in the UAE was in response to the following: Early on Tuesday, warplanes from Saudi Arabia, UAE’s coalition partner, attacked Houthi camps and strongholds in Sanaa, Yemen’s capital city, including he home of a high-ranking Houthi military official, including his wife and son. About 20 people were killed, according to the Houthis. The battle over the Port Al-Hudaydah has been ongoing since the beginning of the conflict until the Houthis took complete control in November 2021. This was a huge blow for the KSA backed Yemenis, and the fall of the port has led to a renewed air attack on key high value targets- culminating in Tuesday’s attack. By the Houthi’s controlling the port, they are able to smuggle in Iranian made assets much easier ranging from drones to missiles.

This is a great summary of what has occurred thus far:

The purpose of the Houthi attack on the UAE: [1]

What is the purpose of the Houthi attack on UAE targets? Here are some possibilities:

[*] The Houthis are drunk on their success with the takeover of the Hodeidah Port, and they may think that with Iran’s backing they can defeat the Saudis and Emiratis, just as the Japanese thought they could defeat the Americans in 1941.

[*] Iran has been holding “peace talks” separately with Saudi Arabia and UAE, and the Houthis may wish to sabotage those talks.

[*] Iran may wish to send a message that it wants America and the West to end the sanctions on Iran.

Each one of these objectives is likely to backfire.

Houthi Yemeni military expert Brigadier-General Abdul Ghani Al-Zubaidi was interviewd on Monday by Russia Today TV, and said the following:

[Begin quote]”We sent a message [with the Abu Dhabi drone strike], and the UAE should take this message seriously. The UAE is not like Saudi Arabia, which is bigger in size, and which can perhaps, take the hit and absorb the shock. The UAE is a country made of cardboard and glass. …

The second thing is that we hope to receive Iranian weapons, and to have Iranian experts with us. [Our enemies] have Zionist experts, as well as American and French experts, They have gathered all of the world’s vagabonds in their command center and in the battlefield. …

We have the power, the will, and the determination to strike in the UAE and in Saudi Arabia. If it turns out that the Americans attacked in Yemen, or if they declare that they did, we will target the American interests wherever they may be. Wherever they may be!”[End quote]

Right now, there’s a bit of a lull, as both the UAE and the Houthis decide what to do next. If this is as much of a turning point as it seems, then we should see some additional military reactions soon.

I believe an escalation is likely as Iran uses their foothold in the port to keep pressure on KSA and UAE. The position of the port allows for the transfer of materials from Iran, and easy access to targets in Saudi Arabia and the UAE. The space between the port and the UAE is filled with mostly desert that is unpopulated making it easier to fly a drone/missile undetected. The UAE has reduced their involvement in Yemen, but still maintain some soldiers on the ground and support for their proxies in the region. They reduced their involvement considerable in 2019, but this may spark a more aggressive response given the broad attack again key assets in the UAE. This will be a key escalation point over the next few months, or until the port can be retaken by UAE/KSA proxies.

China data dump put in some “interesting” numbers with topline GDP beating estimates while the underlying data remained lackluster across the board. The growth rate is slowing. Household incomes are growing at a snail’s pace and domestic consumption is falling, while investment is weak on the back of a struggling property sector. The real estate sector continues to struggle under policy-driven de-risking, which remains a key focal point for Xi to make housing “more affordable.” Export growth – which has been strong, is already slowing as imports are a leading indicator and are starting to show the cracks. The recent arrival of the Omicron variant will test the leadership’s zero-COVID approach that has struck many key business centers and ports in the country.

And all this with the once-every-five-years Party leadership reshuffle, the 20th Party Congress, due to take place this fall. As we approach the 20th Congress, Xi is doubling down (again) on the anti-corruption wagon to take out bad actors or maybe potential dissenters? On Tuesday, Xi told the Central Commission for Discipline Inspection (CCDI) to maintain “zero tolerance” for corruption (SCMP):

• “There is still a long way to go to effectively tackle the more invisible, deep-rooted corruption and we still have a long way to go to eradicate it completely.”
ICYDK: The CCDI is the Party’s top disciplinary body.
• All members of the policymaking Politburo Standing Committee attended Tuesday’s meeting.
• The high-level showing suggests there shall be no rest for the watchdog, or the wicked, in 2022.

Diving into the data shows what the problem was: Secondary sector output growth slowed to 2.5% y/y in real terms in the final three months of the year.

• This was the weakest outside of Q1 2020 since at least 1992.
• The culprit: Real estate has historically been the driver of secondary sector growth, but as this has faltered, so too has industrial output.
• The fall in real estate investment also meant that gross capital formation was a big drag on GDP growth.
• It accounted for minus 11.6% of real GDP growth in Q4.
• Weaker real estate was likely contributed to slower growth in the tertiary sector as well:
• Value-added output growth here slowed from 5.4% y/y in real terms in Q3 to 4.6%.
• The main reason for the pullback in service sector activity was weak consumer spending:
• Separate data from the stats bureau shows that household discretionary income growth slipped to 5.4% y/y in Q4, down from 6.3% y/y growth in the previous quarter.
• In Q4 2019, it increased 9.1% y/y.
• Things could have been a lot worse:
• Exports contributed a much needed 26.4% of real GDP growth in Q4.
• Get smart: Overseas purchases prevented a total wipeout in economic growth at the end of the year.

Imports are a very important bellwether when evaluating future exports, and the weakening of local consumption/demand. We have been driving home the struggles of the consumer within China, and the problems Xi is facing to bring the “Dual Circulation Strategy” to fruition. Common Prosperity was the next policy to be pushed, but it has been slow going given the issues surrounding jobs and general living expenses.

The below chart is important when weighing some key GDP drivers within China: Industrial Sales vs Retail Sales.

Notice that China’s surpluses seem broadly to contract in periods in which the growth in retail sales outpaces growth in GDP, and expand in periods in which growth in GDP outpaces growth in retail sales.

This isn’t a coincidence, and investors/the market are confusing rising exports with a rising trade surplus. There are all sorts of COVID-related reasons why Chinese exports might have risen, but these don’t explain rising surpluses. We have covered countless times how COVID has created a shift in exports, and many of them aren’t sustainable over the medium term. But it is more important to look at how the cash is distributed within China- why isn’t such a big surplus driving up hiring and spending? If enough of the exports revenues were distributed to workers, the resulting increase in their consumption would have led directly or indirectly to an equivalent increase in imports. This seems to confuse a lot of people, who argue, bizarrely, that imports didn’t rise as quickly because there was “nothing” the Chinese wanted to import. This, of course, is complete nonsense. If rising exports aren’t matched with rising imports, that can only be because of the way income is distributed. The idea that China runs a surplus because Chinese don’t want to buy more Argentine beef, Swiss watches, Gibson guitars or Italian wines is idiotic at best. But the point is that China’s huge trade surpluses – as the PBoC, for one, seems to recognize, albeit discreetly – does not indicate a strong economy. It indicates the difficulty China has in rebalancing its economy. China (President Xi) wants to create a consumer driven economy, and this is a prime example of the failure they are having in converting it.

In a recent SCMP article, it notes that “President Xi Jinping has successfully cooled many of the country’s hottest property markets as part of his campaign to deliver ‘common prosperity’.” The problem is that with real estate prices so high, they have to decline by at least 50%, and probably more, relative to income if housing is to become affordable, but if that were to happen, it’d wipe out an amount of bezzle equal to well over 100% of current annual GDP. That, in turn, would sharply reduce household wealth and, with it, household consumption, which of course would not only hurt demand directly, but indirectly by undermining a great deal of previous investment. It would also put enormous collateral pressure on the banks. So it may sound good to “reduce” home prices, but the fall out is broad and impacts the economy in ways it just can’t tolerate. China’s property crisis is spilling over to its largest, strongest developers — that’s a game changer. “The best credits can last the longest, but as time goes by and the support doesn’t come, even the strongest cannot survive.”

The government is restructuring property developers’ abilities to access escrow accounts and presale money. They are doing this to provide some liquidity to struggling companies across the real estate sector, but given the problems across the leverage/debt in the country- it is unlikely they weren’t going to tighten somewhere else. We just recently got our answer: As the government/PBoC loosens some restrictions on utilizing escrow accounts and presale dollars- they removed the access for some LGFVs (Local Government Finance Vehicles). The total debt of LGFVs soared to about 53 trillion yuan ($8.3 trillion) at the end of 2020 from 16 trillion yuan in 2013, according to economists at Goldman Sachs Group Inc. That’s more than half the size of China’s gross domestic product. To help local governments beef up their spending power, Beijing has allowed them to sell some infrastructure bonds early, just as it did in past years when top policy makers were keen to get the provinces to borrow and spend as quickly as possible. China plans to keep its 2022 quota for local government special bond sales unchanged from last year at 3.65 trillion yuan, Bloomberg reported Tuesday. Several of China’s largest banks have become more selective about funding real estate projects by local government financing vehicles, concerned that some are taking on too much risk after they replaced private developers as key buyers of land, people familiar with the matter said. At least five state-run banks have imposed new restrictions this year on loans to weaker LGFVs seeking to buy land and develop new real estate projects, said the people, asking not to be identified discussing a private matter. Banks are being more stringent in assessing the financial strength of the local economy and the sales prospects of the projects, the people said.

We have been calling this out as a big problem given the amount of bad debt that is sitting at the local government level. It has become a massive problem that won’t go away. But, as the PBoC tightens in one area that loosen in another- repeating the cycle. The goal is to maintain steady credit impulses to stabilize the lending cycle.

The problem is- even though they are in a position to lend more with additional liquidity in the market as the PBoC has increased money growth; it hasn’t led to more debt issuance. Credit growth remains underwater because a large part of the liquidity measures are going to shore up bank balance sheets and not being used to generate new loans. There have been several new measures issued to increase cash on hand and help deleverage exposure at all levels of the banking sector.

The PBoC also took some additional action to increase liquidity into the market:

At a Tuesday presser, People’s Bank of China (PBoC) vice governor Liu Guoqiang said that there was still room – albeit not all that much – for proactive monetary policy.

Some context: On Monday, the PBoC cut the interest rate on the medium-term lending facility for the first time since April 2020.

More context: Over the past few months, the central bank has taken multiple, targeted measures to juice liquidity at the margins, including:

• Two respective 0.5 percentage point cuts to banks’ reserve requirement ratios in July and December
• Lowering the relending rate for agriculture and small business loans in December

Get smart: Maintaining overall liquidity volume and widening the monetary policy toolbox might seem at odds.

• They aren’t. The PBoC has said – and shown – time and again that it isn’t currently interested in large-scale stimulus.
• Instead, the central bank wants to lend targeted support to the segments of the economy that need it most – and whose development Beijing prioritizes.

If you look at the charts above, there had been ZERO tightening ahead of the recent actions taken. This runs head first into the issues of “Law of Diminishing Returns.” China is easing again after doing so at the beginning of 2020 and for the 7-day rate since 2015. The impact of these maneuvers is very limited and just helps bank liquidity ratios and won’t be able to generate a new drive-in loan growth. But, it will stabilize credit impulses at a reduced rate as the PBoC takes more leverage out of the system. This will also help stabilize the construction sector, but it will still be at a contractionary level. I have said for awhile now that the goal has shifted to pausing the move lower in impulses, but instead keep it fairly stable in a contracting backdrop.

Exports and Foreign Direct Investment (FDI) have been key drivers for the economy, but those are fading and as companies diversify away from China the pressure on FDI will increase. President Xi wants to move further away from the production/manufacturing economy and into once supported by local consumption but the consumer remains fleeting in China as retail sales missed again and by a wide margin.

The miss in retail sales is also stemming from the problems in the jobs market. The service sector was slowing down way before COVID ever burst onto the scene, which is another problem for Xi’s plan to shift the Chinese economy. The service sector is the natural progression from agriculture to manufacturing to service and consumption. Instead, they are stuck in the manufacturing gear and unable to transition further into a service driven economy. This goes far beyond just COVID, but is a more systemic problem in how the economy is structure. As exports naturally become a smaller percentage of GDP- it will be much harder to drive growth on the back of one sided trade.

China has still been able to grow when EITHER the service or industrial job growth went negative for a period of time- but they haven’t faced both moving lower in a long time. The problem also gets where when factoring the expansion of Omicron (COVID) throughout the country. There is also the underlying population crisis that keeps rearing its ugly head.

On Monday, National Bureau of Statistics Director Ning Jizhe revealed that domestic population growth was nearly flat in 2021.

• There were 10.62 million births recorded, a birth rate of 7.52 per 1,000 people – the lowest in PRC history.
• There were 10.14 million deaths recorded, a mortality rate of 7.18 per 1,000.
• That puts 2021 population growth at under 500,000 people – just 0.034%!

Get this: The last time population growth fell this low was in 1960 – amid a nationwide famine.

The stagnating population growth will give way to declines that will put increasing pressure on economic productivity. This is a long-term trend and underlying problem that will exacerbate the many issues we outlined above. It will stagnate growth and lead to more broad slowdowns within China as well as on the global stage. China has been the biggest growth driver over the last decade with many global indicators driven by their economic expansions and contractions.

My point on always referring to the credit impulse is the ability for it to be a predictive mover in the global market. The sheer size of stimulus that China has pushed into the market over the last decade has been a huge driver of growth, but as that ability wanes- what happens to the global backdrop? Do we get expansion driven by someone else or do we come to a point of stagnating growth? The China credit impulse will pause its decline, but it isn’t going to have this stiff bounce to positive growth. The PBoC is still trying to remove debt/leverage from the system and so far there hasn’t been any shift in that policy. Social financing has also paused its decline, but again at a negative rate and also in a sideways shift.

China’s problems are the world’s problems, and there is a hope in the market that as the Olympics start in a few weeks and Xi prepares to be named “President for Life” at the 20th Communist Congress later this year that they will change course and increase their stimulus. I believe they have run out of room to increase broad stimulus policies. They have only cut taxes, reduced fees, forgiven VAT and repaid companies for tariffs, while only cutting rates for the last two years. The PBoC/CCP have maintained liquidity in the market since before COVID began, and it is unlikely the latest round of cuts will do much in producing new lending. Instead- it will steam the tide of severe declines and instead be a slow reduction over the next few years.

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[1] http://generationaldynamics.com/pg/xct.gd.e220119.htm