Saudi Arabia recently cut their OSP’s or official selling price into key markets given the oversupply in their floating storage market. “Saudi Arabia lowered most oil prices for Asia, in a sign of the regional market weakening with the global economic slowdown. State-controlled Saudi Aramco cut its key Arab Light grade for December sales to Asia, its main market, by 40 cents to $5.45 a barrel above the regional benchmark. The move was in line with refiners and traders’ prediction of a 35-cent drop, according to a Bloomberg survey.” As we discussed, there was going to be a likely reduction in pricing in order to move the excess in floating storage back into the market.

This will prompt other countries in the region to follow suit- especially the UAE, Kuwait, and Iraq. Even with the recent cut in pricing, it’s important to recognize that this is still at a very elevated rate versus historics. In the short term, this will provide little comfort to refiners that are struggling to recover the distillate shortage that exists on a global level. Even as pricing was cut into Asia, pricing remained stable into the US and actually increased into both northwest Europe and the Mediterranean. Another important point, medium and heavy grades were reduced which should help refiners source crude to increase distillate/ diesel capacity. The Middle East is a is a key source for heavier barrels that are high in distillate cuts. By reducing the price of the heavier barrel, it will help margins to Asian refiners to attempt to fill the shortage in distillate storage. This is very important especially as we head into the winter months, we’ll see the a big increase in underlying diesel demand.

Physical crude prices have come under pressure once again especially in West Africa. it is likely caused by the increase in bread pricing as demand continues to diminish. Nigeria and Angola have struggled so far in the early start of November to sell additional cargoes for December loading. Given the overhang in the floating storage market as well as the Middle East floating storage market as seen below, we see physical price differentials getting weaker. this won’t be uniform as distillate heavy crudes still trade at a steep premium while lighter crudes will trade at a broader discount.

Mercuria offered to sell Forcados on the Platts window. Some November Nigerian barrels are still yet to find buyers, holding back the country’s December sales, according to traders. IOC issued a tender seeking West African crude for early January loading.

PLATTS: 

• Mercuria offered Nigeria’s Forcados on CFR Rotterdam basis for end-November delivery at Dated +$8/bbl: person monitoring window

SPOT MARKET:

• Up to ten cargoes of Nigerian crude for loading this month are yet to find buyers, traders said
  • Increased competition from Azeri and Libyan barrels into Europe, as well as expensive freight costs, are curbing Nigerian sales
• Some December Nigerian barrels are moving but trades so far are largely limited to tenders
  • NOTE: Pertamina purchased two Nigerian cargoes, and IOC bought 1m bbl of Nigerian supply in tenders earlier this week
• Angola’s sales have also had a quieter week, with the country still looking to sell about 15 out of 36 December cargoes 

Floating Storage in the Middle East

The chart above helps to highlight just how oversupplied the floating market is for the Middle Eastern countries. As we have been highlighting, this is a key driver on pricing metrics when looking at the OSP markets. Floating storage is at the highest level it’s been at for all of 2022, and KSA has taken steps to try to move these additional barrels into the market. We believe the adjustment will be muted because Asia has not been a big buyer of Middle Eastern crudes. India and China have already taken a large component of their needed oil from Russian exports and term contracts from the Middle East. The barrels that are left in storage will struggle to find a home given the pricing dynamics that were set up for both Europe and the US. Typically, on a seasonal basis, we see floating storage starts decline at this time and hit its lowest point by year end. This is typically driven based on the rising demand for heating oil and diesel in the winter months. By keeping prices elevated, we will see more crude get stuck in floating storage and struggle to find a home.China

Supertanker Crude Imports

Chinese imports have already reached the highs of 2022 and additional purchases are unlikely at these levels heading into year end. Storage within China remains at the highs as refinery throughput still remains depressed. When we look at Shandong refiners, you can see that they have already started to soften closer to our target of 67% utilization rates. The state owned refiners aren’t doing much better still staying below the government’s target of 85% utilization rates. The issue remains the oversupply of refined product within the country which should prompt additional export capacity heading into the new year.

Based on the pricing charts shown earlier, you can see that there will be no relief coming into the US and Europe. This will keep the Atlantic basin short and keep the region reliant on West African barrels to make up the distillate shortfall. When we look at the global diesel market, there remains a broad shortfall that is the most extreme on the East Coast of America. This is a big concern heading into the winter months where PADD 1A or New England consumes the most heating oil in America. The pricing structures have gotten so extreme it is now profitable to move diesel from Houston to New York Harbor on a Jones act vessel. The below chart looks at the diesel crack which you can see remains near the highest it’s ever been. There is a lot of staying power around a crack spread of about $70 heading into the winter months. It will be supported by record low storage and heating demands in the winter months. The issue remains sourcing the necessary distillate heavy barrels to maintain an elevated production level. With the lack of import capacity, it will be difficult to cover the shortfall driving up prices to all-time highs. The only thing that can save us will be Mother Nature providing a warm winter.

The range for the diesel crack spread should stay between 65 and 75 on the average going into year end. The biggest overhang will be the gasoline storage component. Right now, gasoline imports from Europe remain at the lows because of the elevated day rates driven by the flows of diesel from the US into the Atlantic basin. the high price of shipping has shut down the arbitrage for gasoline between Europe and the East Coast. This is creating a record oversupply of gasoline in Europe.

ARA Gasoline Storage

While we have a record amount of gasoline storage in Europe, we are very close to the 29-year average in the US mostly driven by the East Coast and the Midwest.

US GASOLINE STORAGE

The reason we talk so much about gasoline storage is because the gasoline side of the crack spread could become a very big overhang as we look at refinery activity heading into the winter months. Diesel will remain profitable but as the overhang of gasoline storage intensifies it could result in refinery economic run cuts. The value of the distillate crack is going to have to carry whatever pressure the gasoline crack puts on the total economic equation.

SINGAPORE DISTILLATE STORAGE

In short, the market is missing these distillate barrels that it has no way to remedy. We don’t have enough distillate heavy crude to feed into our refiners in order to close the gap. This will continue to support elevated prices for diesel that have pushed well above $2 against its gasoline counterpart. The below chart helps to show the difference between gasoline and diesel pricing in the US market. while gasoline still remains elevated versus historics diesel is pushing back to the highs averaging over $5.30. We believe there is more staying power in diesel prices at these levels especially heading into the winter months. Gasoline, we think has the ability to stay at these levels while having more fluctuation over the coming months. The biggest problem for diesel prices is the impact it has on the total supply chain helping to keep inflation at a very elevated level.

The market rally today on the back of news from China that the COVID zero policy was going to change. The problem with this view is it goes against the current mantra coming from the CCP especially the mouthpieces post the communist Congress. When we review what happened at the recent Congress there is a growing focus on control and less about growth. Last week we highlighted some of the key points that came out from Congress, and it’s centered around ways to push party agendas and less about economic expansion. When you consider how Xi has been able to win a third term, he is now going to look at ways to solidify his power and less about how to continue to push economic growth. While the market is hopeful on a reversal of the COVID policy, it isn’t supported based on the key people that we must watch for a change in the narrative.

The signal we’ve been waiting for the recent rumors that have roiled markets, claiming imminent relaxation of China’s zero-COVID policy, should be put to rest.

• On Wednesday, the zero-COVID signal we have all been waiting for since the conclusion of the 20th Party Congress finally came.

As we predicted, again, and again, and again (but we’re not bragging): China’s commitment to zero-COVID remains unchanged, even with the Party Congress done and dusted.

The signal came at a leadership meeting of the health ministry (NHC) to study the outcomes of the Party Congress.

• NHC chief Ma Xiaowei spoke at the meeting.

According to the meeting readout, NHC’s leadership called for (NHC):

• “Unswervingly adhering to…the ‘dynamic clearing’ overall policy”
• “Striving to control sudden outbreaks with the smallest scope, shortest time, and lowest cost”

Déjà vu? That’s the exact same language used to describe China’s COVID containment policy – word for word – from before the Party Congress.

What that means: China’s zero-COVID policy remains the same, in principle, scope, and intensity.

Get smart: In recent days, rumormongers took advantage of the complete silence from the central government on zero-COVID to orchestrate an artificial market pop.

Get smarter: They were largely successful because investors hate the zero-COVID policy so much that they’d believe in any half-baked rumors.

The bottom line: Buckle up and prepare for lockdowns, because zero-COVID isn’t going anywhere anytime soon.”

Based on the quotes above we are not seeing any shift in the way the CCP is viewing its current policy stance. We absolutely understand the excitement because it would mean a big reversal and a reopening that would be good for underlying crude demand as well as economic expansion. Unfortunately that isn’t how the Congress ended and what the important individuals that have either retained their power or have been moved into power are positioning themselves.

This is why when we look at expansion and underlying debt loads, we’re concerned about the future of the Chinese economy. We have been very clear about our views that the Chinese economy is still on the downward slide which was again supported from the data that was released this week. A key concern we have had over the last few months is the mounting debt that has come from the growing budget deficit at the federal government level. Chinese government has expanded their role of trying to backstop not only companies but now is looking to expand that further into the common buyer. As global growth slows, they will look to ways to drum up additional demand and the way they want to do that is by increasing local consumption. This is why we have focused so much on common prosperity and how that is going to be financed. Foreign companies are concerned about what that’s going to mean for their profitability and how they will have to pay into any additional taxes. When you look at the budget deficit you get an idea of how concerned you should be given the shortfalls that continue to persist throughout the Chinese economy. Based on the quotes below from Trivium, I think our views are well founded to see doubling down on a lot of his policies that have become the cornerstone of his views of communist growth.

“We’ve said this one before: The new lineup is stacked with Xi’s allies. 

• The big man has successfully kicked out current PBSC members who are widely regarded as his counterweights, such as Li Keqiang and Wang Yang. 
• Another more liberal voice, Hu Chunhua, who was once considered a potential Xi successor, and who many had picked to become the next premier, not only failed to make the PBSC – he dropped out of the Politburo, too.
• The new PBSC members – Li Qiang, Cai Qi, Li Xi, and Ding Xuexiang – are all Xi’s confidants who have worked alongside him for years or have enjoyed close connections to Xi’s family. 

The key takeaway: Xi is even more powerful than we expected.

• And he is now surrounded by supporters and yes-men.

The implication: More than ever before, Xi has an unobstructed path to determine China’s future.

The last year has shown us how firmly driven tech policy campaigns can cause unexpected problems:

• In July 2021, at the height of Xi’s tech crackdown, the so-called “Double Reduction” policy wiped out the value of China’s edtech industry overnight. 
• The year-long crackdown on China’s ride-hailing giant Didi raised more questions than answers. 

Our take: Xi will double down on his signature policies – and be in a position to pursue them with even greater vigor. This means:

• Xi’s Common Prosperity (CP) initiative will be accelerated.
• Zero-COVID will face less opposition within the Party and be rolled back only if and when Xi sees fit – meaning tech companies will continue to battle against supply chain disruption for the foreseeable future.
• Xi will go all out in pursuing the innovation drive so China can escape US attempts to constrain China’s tech sector.

The bottom line: Businesses and investors will face a more uncertain China environment in Xi’s third term.” The core issues he faces remain on the consumer front. Based on the charts below you can see just how much of a problem Xi faces when reviewing the service economy. Typically, a growing economy goes from farming to manufacturing to services, but the service sector of the Chinese economy has been failing. When you look at the employment side it has been well below growth and actually in contraction since the end of 2017. The Chinese consumer continues to struggle and is unlikely to go out and make large purchases especially as employment fears persist.

When we pivot to the manufacturing side, things don’t look any better and are still contracting as well. As you can see below, employment continues to be an overhang even in the manufacturing sector, which has been a huge driver of economic expansion. A key leading indicator “new orders” is also showing deceleration and the continued contraction of the underlying economy. In other words the Chinese economy is getting hit from all sides.

The biggest piece that I believe the market is missing is the issue across the employment spectrum. It is a problem that has persisted since at least 2018 and has only gotten worse over the last few years.

When we consider exports, every time exports have slowed from China they have turned around and invested in infrastructure. They have typically doubled down on their infrastructure investments which would show up in the credit impulses. Just by reviewing the below chart you can see that every time there was a drop in exports there was a big surge in credit impulse. But this time it’s different we are not seeing the same turn higher in credit impulses as demand for new leverage has diminished to nothing. To make matters worse the marginal propensity to spend indicator for households and non-financial companies has plummeted. This only exasperates the problem and is one of the core reasons why the common prosperity movement has taken hold because Xi believes that he can drum up this household spending. We don’t believe Xi has the ability to change the course of the consumer. Given the issues along employment and underlying spending it’s unlikely that we see the consumer change course anytime soon. There is also a cultural difference where many Asian nations normally have a higher propensity to save versus spend.

The Chinese situation and other emerging markets aren’t any better given the shift in the federal funds policy. The Fed just announced another rate increase of 75 basis points which now puts us heading straight for terminal value of over 5%.

We have highlighted over the last few quarters that the US terminal rate would sit between 5 percent and 5.25%. The market is starting to come around to our way of thinking and is pricing in US terminal rate of over 5%.

Even as the market starts to price in a rate above 5% there was still an expectation of a cut that would roll out in the third quarter of 2023. As we have highlighted in the past a failure of the Fed policy in the 1970s was to cut rates too soon. Powell has addressed those concerns and voiced them and has stated that they will not make the same mistake. We believe this means that once we get to about 5% or likely past 5% there will be a pause for over a year to ensure that the rate hikes have time to work their way through the economic backdrop.

This is where I think the market is getting it wrong and you’re seeing the hope of a power put or at least a reduction in the Fed funds rate faster. We believe that flies in the face of commentary and direction that has been given directly from Powell.

The Fed is facing a broad liquidity problem not because of macroeconomics but more because of the inner workings of the bond market. There are just too many sellers and not enough buyers as there remains a buyer. The volume of treasuries head has continued to go up while there is no longer a buyer of last resort. Our largest buyers over the last several decades have been Japan, China, and the Fed. We now face a market where the buyers are dwindling and the treasury is increasing the amount of volume coming to market. This changing dynamic is creating more pressure on the liquidity front of the treasury market. Unfortunately that dynamics aren’t going to improve because the Fed has been unable to shrink its balance sheet at the rate it requires.

QT has been slower than expected in part due to the collapse in MBS refinancing rates (the Fed’s MBS portfolio is taking much longer to reduce without direct sales). The fact that the Fed still remains behind their own target to shrink the balance sheet, jobs remaining elevated, and inflation re accelerating- we will continue to see rates moving higher over the next few meetings.

The Fed has a dual mandate of full employment and inflation. As we see the jobs market remaining stable and inflation accelerating it will keep The Fed driving rates higher. This will continue to happen even as the leading indicators and the regional fed data turned negative and show that there is more pain ahead not only for Q4 but also well into 2023. “Getting tougher to dismiss prospect of recession with LEI now falling by -1.4% year/year … not yet at average decline seen at start of prior recessions, but keep in mind there is wide variability around that average (+2.7% to -7.6%).”

As the US declines and is the largest consumer in the world, the fear of a global recession only intensifies. Leading indicators of new export orders have firmly rolled over with more pressure coming from the bigger nations such as Japan and China. Essentially this is all about weak global demand since it’s about export orders.

As the dollar remains strong, it is only putting more pressure on not only export orders but also manufacturing pmis. All of this continues to highlight the weakness that remains in the global market that is accelerating to the downside as we head into 2023.

As the charts below show no matter what metric you choose we continue to see economic contraction that is only picking up the pace into next year.

Every exporting nation has seen their new orders plummet into contraction and have guided to an even worse start to the fourth quarter and beyond. The below chart just summarizes the global manufacturing new orders contracting steeply into recessionary territory.

This shift has pushed global manufacturing PMI firmly into recessionary territory.

The recessionary pressures are only getting worse when you layer that over with global monetary policy. On a global level about 70% of central banks continue to increase rates. As inflation remains a growing problem, we don’t see a pivot on the monetary policy front.

The regional view as Federal Reserve data continues to support a growing slowdown with all metrics now in negative territory. Even as the economic growth dwindles, we are still seeing an increase in prices received and prices paid. Both of those metrics are rising albeit at a slower pace but still an expansion. Essentially, we have the definition of stagflation where you have economic activity dwindling and going into a recession while prices continue to press higher. The problem remains that all of the leading indicators of these regional data sets are showing an acceleration to the downside which points more towards a recession in either Q4 of 2022 or Q1 of 2023. The speed of that recession will be determined by when the consumer finally stops spending. Based on the below chart we believe that we are reaching that point.

Credit card rates have firmly moved up and we believe the rise in rates is going to diminish the amount people are able to spend. The above chart helps highlight how the savings rate is now at the lowest it’s been since the great financial recession as credit card loans move to new highs. Overall, global economic growth is going to continue to move negative and we are likely already in a recession but it won’t be registered on economic datasets until Q1 of next year.