U.S. completion activity is having its seasonal dip in March, which will start to shift higher as we approach April. The spring is a period of accelerating activity that will carry us through the Summer until we start to see a slow down in September/October. We have seen activity remain strong in the Anadarko while the Haynesville has slowed down a bit, which is 100% normal for this time of year. The energy markets are facing some severe supply chain constraints that will remain when it comes to everything from pipe to casings to available horsepower. We have been discussing the supply constraints since the beginning of last year, and it has only become more prevalent over the last few months as activity ramped up. Even as the Permian slows, you can see it remains right inline with ’18-’19 just helping to support our view that the dip is normal. E&Ps typically make a bit of a push to kick off the year, and slow down on the completion side while keeping rigs active to ensure there are enough DUCs to carry is through the summer months. The slowdown also helps the supply chain “catch-up” when we consider all of the components that go into completions- from friction reducers (general chemicals) to pipe. The average cost of a truckload of pipe has surged from $42K in 2019 to over $160k in today’s market. A large part of these costs have been/ will be passed through to the E&Ps, which is one key reason we are seeing CAPEX get pushed higher. There will be production growth, but the inflation hitting the oil patch from labor to equipment is just increasing costs exponentially. Given the shortfalls, it is unlikely we see any softness in costs as we progress throughout the rest of the year. This will also cap how aggressive we can get on production growth in the U.S.- even though the politicians keep saying- JUST PRODUCE MORE!!!!! Anyone reading this report is fully aware of the vast limitations the energy market faces and the uphill battle we are facing to address a stretched supply chain.

We expect to see activity stay between the 270-285 realm as we head into the end of April, and as we said at the beginning of the month- we were going to pull back from the 290 active spreads. As we get into the first 2 weeks of April, we will quickly get back to the 290 number- but getting to 300 will be a slow grind. It will be achieved by the end of April supported by price and the current lull enabling logistics to catch-up with the E&P drilling programs. The below chart helps to show the either slow-down or “pause” that occurs during March and typically we either see a pivot higher starting this week or next- when you look at 2017/ 218. Some other years- 2014/2019 we held constant at these levels until we got further into April/May. We will be a mixture of the years and have a very controlled move higher because hydrocarbon prices support a spike in activity, but the many limitations we have seen throughout the industry will cap how fast activity picks up. The smaller basins will get more active in April while the normal cast of characters- Permian, Anadarko, Appalachia, Haynesville, Eagle Ford- keep us busy throughout the spring/summer.

The biggest issue will remain available horsepower and underlying labor shortages. A lot of the warm/cold stacked equipment was used for spare parts in ’20 and to some degree in ’21. As the market normalized for activity, OFS companies were waiting to see about pricing power and the desire for E&Ps to bring back stacked equipment. Many of the oilfield service companies weren’t in a hurry to spend money on equipment and parts without an E&P on contract for extended work before they went about repairing horsepower or purchasing new equipment. Once the decision was made, the massive issues across the global supply chain hindered the speed in which these orders can be completed. All the while- the current deployed spreads need their normal maintenance to remain in the field. The issues in the market will prohibit the OFS and E&Ps from getting “ahead” of the shortfalls, and instead we expect more scrambling to keep things functional/active. This will make the industry more reactive instead of proactive, which will prohibit a big step change in underlying completion activity and underlying U.S. production. We still expect production levels of 12.2M barrels a day on an exit rate- but given pricing- it should be higher… we just won’t be able to get there.

Rig activity has picked up with a focus on stemming the decline in DUCs and increase inventory as we head into the pivotal spring/summer months. In 2020, we said that the focus was going to pivot hard to limit decline curves to about 11%-13% because if an E&P approached 20%+ the hill to overcome would be massive and very expensive. So as we progressed through 2021- Completion crews remained very active as rigs were slow to react as E&Ps wanted to work through excess DUCs and build back their production profiles. Our call in Aug ’21 was that the pivot was starting where rig additions would outpace completion crews, and so far- we have seen that hold true. This is something we believe will remain in place throughout the spring months and balance out a bit more as we get closer to summer with more spreads activating. We are in for a wild ride!

The physical crude market remains balanced with some excess when we look at West Africa and the Middle East, but on the LNG and NGL front things are much different and tighter. The LNG market remains white hot as Europe looks to build up storage capacity in preparation for the summer demand and making sure they are “better” positioned for the winter. Europe and Japan are in negotiations to purchase more cargoes to help close the gap on storage in the continent as the Russia-Ukraine war remains ongoing. European gas storage is off the lows as the weather moderated limiting the total burn for heating while LNG cargoes (supply) increased to meet the shortfalls. It will take a lot of work and a mild summer to help move this back to the normal 5-year average.

Germany relies significantly on Russian natural gas, and they are working quickly in an attempt to increase the “other” of that gas dependency which is from the floating market. The tightness on the water will help keep prices very elevated for LNG and returns strong for U.S. exports. This will also support additional activity in natural gas basins in the U.S.- especially the Haynesville.

We expect to see more slowdowns in the European markets as they are now firmly in a recession as prices surge, and their local consumers struggle on dropping real wages and weak spending. The huge spike in gasoline and diesel prices will limit mobility, and we are likely to see an increase in WFH in order for families to limit spending.

Russia accounts for a huge amount of oil imports into European countries. This is where we will see demand destruction strike first as wages and spending never got back to pre-COVID levels, and were already falling before COVID even struck. The impacts will be broad, and we expect to see a bigger slowdown in the continent as we are already seeing a change in spending and activity patters.

We are already starting to see a bigger dip in Europe, and we will want to see if this trend continues as prices show zero signs of abating. We have seen activity cool off around the world, but Europe and China have been the most severe declines. China is caused by the broad lockdowns, while Europe is driven more by the cost of doing business.

The natural gas liquids basket remains just off record highs, but as the Panama Canal adjusts their preferential treatment for some cargoes- we expect to see more LPG/condy cargoes heading to Asia. The Asian markets are struggling with shortfalls driven by limited Russian cargoes, and the Iranian sanctions remaining in place. U.S. ethane exports are at record levels with little in the way of taking that lower- we expect ethane to be at record setting levels throughout the rest of the year. LPG prices will hold at these elevated levels as companies balance their purchases from the U.S. and Middle East. The Middle East should be able to increase their supply as they add additional production in March with the OPEC+ deal technically expiring in April. All of these surging costs are key feedstocks for petrochemicals where we will continue to see inflation pushing higher.

When we look at the crude market, the paper market is still signaling a big shortfall being in steep backwardation but there still isn’t much (if any) panic in the physical world. Urals have been offered at steep discounts of over $30 below dated brent that has enticed some buying from India and China, but it still remains fleeting. We have seen an increase in floating storage around West Africa and the Middle East while Asian floating storage remains elevated. China activity is slowing down again as lockdowns expand as they address broad COVID19 outbreaks. We have seen some declines in WAF floating storage, but things remain at seasonally adjusted all time highs even as less Russian crude flows and WAF crude yields a high distillate cut. The reason why a “high distillate cut” is so important right now is due to the broad shortfalls in the middle distillate market. Diesel and other middle distillates are in a tight market as the light distillate/gasoline market has more than enough current capacity. This should have increased the flow of WAF and LatAm crudes, but things have remained fairly sluggish. “Sonangol has reduced its offer for its last April cargo of Plutonio. For Sonangol to still have cargoes at this time of the trading cycle indicates demand at current offer levels is just not there. China still offering 3 cargoes with no interest.” The lack of interest and remaining April cargoes has pushed Angola to keep their export quantities limited in May. It will be important to see how refiners react as they come out of the shoulder season (Spring maintenance), and if we see more active purchases in the market.

WEST AFRICA FLOATING STORAGE

It is important to consider the benchmark rates as WAF trades against Dated Brent while the Middle East trades against Oman/Dubai. The spread still remains at $9.65 but is well off the highs of over $20s, but even at $9 you can see just how elevated Dated Brent is vs Oman/Dubai. This will keep refiners focused on pulling down Middle East cargoes vs others in the market.

The shift in spreads is why the Middle East floating storage becomes so important. We should see this market remain fairly tight, but floating storage has been building over the last week. This could very well be a timing delay- so it will be important to look at how quickly the Middle East is clearing as they add more cargoes in March and April.

Total floating storage still remains at record levels driven by supply chain issues disrupting port activity, and broad availability of cargoes at this point in time. The excess capacity could be drawn down quickly at the end of maintenance season depending on demand, but so far the price of gasoline/diesel has started to create demand destruction. It has been slow so far, but it is accelerating especially at the Emerging Market level. Some countries have started to raise prices while others are waiting till April to adjust petrol prices hoping for the best. For example, “Thailand’s government can freeze local diesel prices at least until mid-April as it considers other measures should oil prices remain high. The state oil fund has 40 billion baht ($1.2 billion) to subsidize prices. Vietnam raises RON-95 gasoline price by 2,990 dong per liter to maximum of 29,824 dong per liter, effective 3pm local time, according to statement on the trade ministry’s website.”

GLOBAL CRUDE OIL FLOATING STORAGE

European floating storage will remain low as cargoes are pulled straight into the market, which will also support U.S. exports at about 3M barrels a day. Europe will need to replace ural cargoes and the easiest way is a blend of Libya, U.S., and West Africa. So far, we have seen a broad cut in exports from Russia along the lines of coal with crude and LNG slower to react to the import bans. Coal is also a bit more seasonal as we come out of winter, and we get a slowdown in underlying demand. The LNG and crude front will find a home based on shifts in trading protocols and India/China looking for discounted cargoes.

It will be important to see how ESPO and Sokol cargoes react because so far there has also been a shift in how trading is done. “Russian oil producer Surgutneftegas PJSC is offering buyers some financing flexibility on cargoes of ESPO crude as more and more companies shun the nation’s supplies following its war in Ukraine. Buyers that have already agreed to purchase ESPO that will be shipped this month won’t need a typical line of credit from a bank, according to traders involved in those transactions. Those taking the cargoes, which were mostly executed in January prior to the war, can instead use open credit that allows the customer to buy goods on a deferred payment basis, they said.” The shift in not needing LOCs will alleviate some near-term disruptions and keep flows moving in the near term.

This has also helped support some near-term flows as you can see below more cargoes are targeting India and China. These additional flows will also leave more WAF and Middle East cargoes in the market.

Russia is focused on maintaining some semblance of normal flows because they have limited storage capacity. They need to make sure they can keep product moving because they only have 8 days of storage. This can fill up very quickly, but China spare capacity to keep taking down “well priced” cargoes, and I believe they will remain a key buyer for Russia.

China has seen their trade with Russia grow over the last few years driven by oil and natural gas. China is now almost 35% of Russian energy exports. This is an important point as Russia is providing a significant amount of energy to keep the Chinese economy rolling along, BUT, China still relies significantly on U.S. and her allies for exports. Trade with Russia is about $100B while trade with the US is close to $600B, EU $500B, and Australia/ Japan/ South Korea/ Singapore $425B. This equates to about $1.525T that China would have to address if China got more involved in the Russian-Ukraine war.

The below chart just puts the sheer magnitude in perspective.

China would need to replace a huge amount of trade, and since exports and FDI (Foreign Direct investment) has been the only source of GDP growth- it won’t be something that Xi risks in the near term. Russia is still providing a pivotal asset to China- so they still need both parties making keeping them neutral in the process.

China has been working with Russia for years to diversify away from the US dollar, but instead they have been using more Euro- so still very much attached to SWIFT and U.S. banks. Dollar receipts accounted for 97% of Russia’s total exports to China in 2014 but fell to 37% as of 3Q2021; for euro, share rose from 1% to 48% during same period. China and India have offered to trade with Russia with Yuan-Ruble and Rupee- Ruble, but they have to be at fixed rates.

There was also talk about Saudi Arabia trading crude with China not using USD, but it is important to consider several things in that backdrop.

1. KSA was going to price crude in dollars but accept the equivalent in Yuan. So essentially the price would be in USD, but they would accept the set exchange rate in the equivalent Yuan.
2. KSA has their currency pegged to the dollar and the PBoC sets the exchange rate to USD each night. So essentially- they are still ultimately pegged to the dollar.

A large part of this is purely for show and more a warning to Biden/US as negotiations continue with Iran. The Iranian deal has been talked about constantly but following the ballistic missile launch and push back from the GCC and Israel it remains unlikely. As the 1st nuclear deal approached (95% completed under Bush) the GCC launched the price war on Iran to “discount” all of their crude in storage and take a huge chunk out of their profits. The ability for them to create the same impact given today’s geopolitical cluster fck and “Distracted” spy network- Israel and the GCC would launch an aggressive attack against Iranian soft assets to ensure the Houthis/Hezbollah don’t get a MASSIVE windfall again like they did after the 1st nuclear deal. The fact that the Houthis (Iran) were able to get kinetic assets into UAE to cause damage surprised the GCC and they know that if Iran gets a massive windfall- the attacks from Yemen are going to ramp up considerably. Biden should just choose the lesser of 2 evils and embrace the GCC because they have been investing on building up production over the last 4 years. It would be more likely to get a Venezuela deal vs an Iran deal at this point in time.

There also remains a ton of questions around demand destruction and at what point does it become more prevalent. We have already started to see it in Europe, but demand destruction in the U.S. will come in the form of a slow seasonal bounce. We haven’t seen a normal increase in driving activity along year/year comparisons, and we are seeing more consumers doing less to avoid spending money. The white line represents 2022, and we haven’t had a big shift higher even as distillate demand remains elevated due to the broad logistical/supply chain nightmare keeping trucks active.

The below chart purely looks at the seasonal gasoline demand surge that normal hits this time of year as we have spring breaks and more active. Instead- we are seeing activity remain fairly fixed/flat as driving doesn’t increase along seasonal norms. In the U.S., we don’t expect to see a huge drop in demand, but rather less seasonal movements. Many people are looking at the cost of travel/ hotels/ food and rethinking their vacations and pivoting more to a staycation backdrop. Work from home is also becoming more prevalent (again) in the U.S. and Europe as gasoline prices remain at elevated levels.

The underlying problem this time around is the broad stroke of prices around the world. Diesel prices are over $1 higher vs 2010/2011 levels and after 13+ years of global easy monetary policy- inflation is hitting all areas of the economy. This is much closer to the 70’s vs inflation rates we have seen over the last few decades. The global supply chain has yet to recover from COVID19, and now we have renewed lockdowns in China and a Russia-Ukraine war that is worsening an already terrible food shortage. The most basic goods are exploding in price as input/output and factory gate prices surge to record levels or levels not seen since the 70’s- early 80’s. The problem is- we are hitting these levels with Fed Fund rates at .5% following the recent increase of a quarter point. The below reverse repo purchases that are going into the Fed- today at $1.715T remains near a record amount- so we have factory gate/input prices surging with a record amount of liquidity in the market AND real wages failing to keep pace. This is a recipe for disaster.

Another key piece that makes the food situation worse is the growing shortfall of fertilizer as well as the rising price of the fertz. Russia and Belarus account for a huge percent of the world’s available fertilizers, and they won’t be exporting anything in the near future. So not only are we short food in the world- but we also don’t have the fertilizer available to try to increase yield. But- we are also facing a mother nature that is not cooperating with broad droughts and floods also cutting this years yield that is already short and building on weak harvests since the end of ’19.

China has been active because Russia-Ukraine account for a large amount of their grains. We already discussed the amount of corn, but here is just some other measures of different crops.

It is unlikely the U.S. and other areas will be able to make up for the losses, given the droughts in LatAm and cost of input costs- fertilizers/ seed/ diesel among other things. This will keep crop prices elevated especially as China absorbs more cargoes and other countries are left scrambling.

Emerging markets have already seen a bigger food price surge vs what they experienced during the Arab Spring or the Peasant Uprising. This will put more pressure on governments to try to maintain some semblance of normalcy through subsidies.

When we break this down into “real terms” when evaluating food prices- we are right back to levels not seen since 1974.

As these pressures keep rising- we are finally getting a market that is recognizing the rise in inflation which is becoming less and less “transitory.”

Supply chains remain severely constrained driving up prices further, which will keep prices elevated no matter what is attempted. All the Fed can do is try to maintain rates and keep a wage spiral from actually occurring (still a low level risk- but one that is still a possibility).

Wages have already been falling behind.

Real personal incomes on a 6-month annualized basis have been contracting for 5 straight months and are rolling over again.

The cost of good keeps surging with little in the way of slowing.

Which is why inflation is now the number one fear among small businesses.

As We have the savings rate falling further to 6.4% and is currently at the lowest rate since 2013.

To round out today’s insights here are some pressure points when we look at Europe and U.S. data sets… Europe never really recovered from COVID and now we have the U.S. rolling over again. Private consumption (especially real private consumption) is heading lower and we hit markets hard.

China did have a nice bounce in some of their data driven by the Olympics and Lunar New Year, but they now contend with a spreading outbreak that will hit consumption hard.

We also had the PBoC not cutting rates that the market expected, which is right in line with our views. For our devoted readers, you know that we don’t believe the PBoC will be aggressive in their easing stance- which has so far been the correct view.

But the move the Chinese press was anticipating – an interest rate cut – failed to materialize.

• The PBoC kept the interest rate it charges on one-year MLF funds unchanged at 2.85%.

Some context: If Beijing wants lending rates for households and companies to fall, the MLF rate has to drop first. That’s because the benchmark loan prime rate is anchored to the MLF. What we think: It wasn’t unreasonable to expect a rate cut.

• This was the first opportunity to cut rates since the Government Work Report explicitly called for lower interest rates last week.
• Supply chain pressure from resurgent COVID cases and the uncertainty brought about by Russia’s invasion of Ukraine are making regulators jittery.
• China’s stock markets have dropped sharply this week, with the Shanghai Composite Index falling almost 5% on Tuesday alone (Caixin 2).

So why no cut?

• It could be because economic data published this week was far better than anticipated.
• Or it could be because the Fed is expected to raise rates this week.

Get smart: That last reason is unlikely – the PBoC has been pretty vocal that it’s confident it can handle US monetary tightening.

Our take: We’re not sure why the PBoC didn’t cut the rate this time, but a cut soon is likely.

We also had Liu coming out and trying to support the market causing a huge bear market bounce in the country. The problem is nothing changed- just strong comments around the support of the government, but they are already stuck with a huge debt load that has only grown.

Liu sought to reassure investors with promises to:

• Support all companies wanting to get listed overseas
• Formulate a detailed plan with US regulators to resolve issues around US audit requirements for US-listed Chinese firms
• Implement “standardized, transparent, and predictable” regulation for platform companies
• Complete the rectification (i.e., crackdown) of major internet platform companies posthaste

Get smart: The FSDC is doing what it can to stop the bleeding. But there are still plenty of downside risk for Chinese stocks. Two reasons to go full bull:

• Possible secondary sanctions on China for its alleged support of Russia’s invasion of Ukraine
• The worsening domestic COVID outbreak

What to watch: If the FSDC can put coherent policies for internet companies in place, that could do a lot to clarify the outlook for China’s tech stocks

The below chart helps to put in perspective the local governments not only facing a rising interest rate but also the need to roll AND issue new bonds. The leverage issues in China are persistent, and only getting worse especially as debt costs rise.

China has talked about increasing their public spending, but it will be difficult given the debt load and the amount of fiscal easing that remains in the system.