Primary Vision Insights – August 31st, 2020

By Mark Rossano

SUMMARY

Hurricane Update U.S. Drilling Activity Update Asian Market Update India Crude Demand South Korea Update Quick Japan Update Petrochemical and Refining Expansions Update to China-US Trade Deal Update on U.S. Economy (we talk more about it in our YouTube Economy Videos- released every Thursday)

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Hurricane Update

The U.S. crude markets reacted to Hurricane Laura as production was shut-in and refiners/petchem facilities reduced or shut down in the face of Hurricane Laura. We keep getting adjustments and based on the current metrics- this will be the most shut-ins rolled out since Hurricane Katrina came through the gulf. “On Monday, the storm had shut 1.5 million barrels per day (bpd) of crude oil output, 84% of Gulf of Mexico’s offshore production, near the 90% outage that Katrina brought 15 years ago.” “Some of the largest U.S. refineries are winding down in advance of Laura, which could become a major hurricane before landfall, shutting in nearly 2.9 million barrels a day of capacity. That’s about 30% of the 9.3 million barrels a day of U.S. Gulf Coast refining capacity, according to Lipow Oil Associates.” The drop off is meaningful in the near term, but some of these shutdowns were already happening due to low demand. The shuttered oil capacity is still below Harvey so far as landfall of Hurricane Laura was further West vs Harvey. Hurricane Harvey was also slow moving and stalled over Texas causing not only massive flooding but a record storm surge. Preparations remain in order across Galveston and Harris Counties with some mandatory/ recommended (voluntary) evacuation orders that could spread as the storm approaches. The storm surge of Hurricane Laura that was expected never really materialized, so the damages at the coast were thankfully not as significant as feared. Refiners have already restarted facilities with about 1M to 1.5M coming back by the weekend. There were some facilities that experienced damage- such as Citigo, which will take the 414k barrel a day facility about 4-6 weeks to fix. There have been reports of some other facilities that were damaged, but so far-nothing to the level of Citgo.

Oil production disruption due to Tropical Storms Marco and Laura amounted to 1.523m b/d in Gulf of Mexico, BSEE says.

1,65 mmcf/d, or ~61%, of natural gas production shut-in 281 platforms evacuated out of 643 manned platforms in GoM 6 rigs evacuated Data is for reports submitted by 37 companies as of 11:30 am CT Monday

A key metric to watch is: “How many of the refiners or units/processes that come back following the storm passing?” Several of the facilities were in the process of shutting units prior to the hurricane, so while not all 2.9M or so barrels a day will stay down- there is a good chance 25%-30% will remain shut or at least at reduced rates. Labor Day (in this case Sept 7 th ) signifies the end to driving season as the school year begins and summer vacations end. The difference this year remains the COVID hangover as many schools are beginning the year with remote learning. This directly hinders the ability to get to the office in general and will result in more people leaving the workforce over the next several months. The below chart breaks down how many school districts will kick off the year, and I believe many that begin in-person will be forced into a remote setting within a month due to complexity of not only maintaining distance but also keeping kids in seats because of the need to test EVERY time they get sick.

As unemployment and furloughs remain elevated into the school year, the complexity of managing child care is already resulting in a parent temporarily leaving the workforce in order to take care of remote learning or because the pricing of daycare has risen past a manageable level for family finances. Many people will be struggling to care for their children that have to stay home with remote learning, so the employment situation will get worse as additional people leave the workforce. It will lead to reductions in household spending as well with the loss of a second income. These are some issues we will discuss further as we evaluate consumer spending and trends emerging in the market.

U.S. Drilling Activity Update

The hurricane should have limited impact on completion activity given the path and speed in which it passed through, with maybe a few one-off or short-term disruptions but nothing meaningful. The impact was at the coast where infrastructure, such as refiners, docks, pump systems, electricity and other vital systems will be taken down and require repairs. This will create temporary bottleneck at the coast as onshore production continues and offshore production shut-ins come back online as export/refining capacity is slowed. This will create some short term disconnects similar to what we saw during Hurricane Harvey. So far, the damage does not appear to be all that significant at the coast given the weaker vs expected storm surge. A this point, only a few facilities are reporting damages with many already in the process of restarting. Harvey delivered a big blow to Texas, and you can see the impacts were very short- so the limited coastal damage delivered by Laura will be along the same lines: below are examples how quick the bounce back was for the most part:

Distillate Exports 2020 vs 2017

Gasoline Exports 2020 vs 2017

The bigger impact will come from the refining sector as some of these facilities were shutting down before the storm. When we look back to 2017, we never got back to the pre-Harvey levels because the Hurricane struck at a similar time and refiners kept rates down as it led into shoulder season. We will see a similar backdrop after 2.9M barrels a day of throughput was taken down. This will result in a big drop but depending on damage- we will see about 2M come right back. The remaining 900k is a mixture of facilities that were already cutting runs or taking units offline or deciding to keep them down given the timing of the storm. Some facilities are already coming back now that Hurricane Laura has moved inland, and some of the severe storm surges didn’t materialize in some areas. This will directly impact gasoline prices as the storm was less severe, which will result in more product still moving into the PADD1. The opening of the arb from Europe into the East Coast will keep those barrels flowing and will start hitting our market by mid-Sept just as we are shifting firmly into shoulder season. We will go through shifting refined product flows, but the lack of storm surge saved large parts of the refinery complex from damage that could hinder operations for weeks.

Refinery Utilization Rates Between 2020 vs 2017

PADD 1 Total Gasoline Storage- Back to 5 Year Average

The growth drivers in completion activity remain the ones we have been highlighting Permian, Appalachia, Bakken, and Eagle Ford. The Permian and Eagle Ford will see the most growth over the next 4-5 weeks as activity ramps in the area with additional spreads being activated. We expect another 3-5 spreads to start operating in the Eagle Ford and another 5-7 in the Permian over the next 4 weeks. The Bakken will remain relatively stable with Appalachia attracting another 1-2 spreads over the same time frame. The rest of the basins will remain relatively stable at their 4 week rolling averages as commodity prices have stayed stable in each region.

On a national level, we will see activity hold between 77-85 over the next 2-3 weeks and steadily increase as we head deeper into Sept- getting closer to an average of 83-87. The rolling 4-week average will see a shift higher (currently at 74), as we maintain more activity throughout Texas Sept into Oct.

U.S. oil exports will remain steady at about 2.7-2.8M as China is said to purchase about 20M barrels across Aug and Sept. The move to purchase crude was done ahead of meetings with U.S.-China trade deal officials to discuss progress on closing the wide gap that remains in meeting the terms of the Jan 15 th phase 1 trade deal. “Chinese state-owned oil firms have tentatively booked tankers to carry at least 20 million barrels of U.S. crude for August and September, Reuters reports, citing unidentified U.S. traders, ship-brokers, and Chinese importers. The two Chinese companies each have booked five to six supertankers, that each can hold 2m barrels of oil, for August and September loadings. PetroChina plans to buy 3m tonnes (about 22m barrels), of U.S. crude by year-end, a person briefed on the matter told Reuters.” Between flows into Europe and Asia, the U.S. will be able to maintain stable exports over the coming few weeks- especially with limited structural damage caused by Hurricane Laura. Magellan was already bringing some of their key facilities back online.

Crude pricing along the coast started to recover- specifically LLS and Magellan East as we saw tightness come back into the market between Brent and LLS. This spread is a good benchmark for flows going from the GoM to Europe, and after widening out over the last several weeks it tightened to a $1 after remaining at about $1.50-$2. The arb has firmed to reflect a reduction in shipping rates, and given current flows we should see the spread stay around $1-$1.50 over the next few weeks. Europe is receiving some large shipments of distillate from Asia over the next few weeks, and crude remains well supplied in the area so new purchases will be relatively flat. The bigger issue for WTI Cushing and WTI Midland pricing will be the reduction of refinery throughout driven by Hurricane Laura damage and reductions in anticipation of shoulder season. The Citgo refiner announced it will be shut for 4-6 weeks due to damages, which has a throughput of 418k barrels a day. This will impact total crude demand in the region and push more oil into storage over the next few weeks.

Asian Market Update

The bigger overhang in the market remains Asia with the large amounts of crude not only sitting onshore but also offshore. At first, the rise in offshore storage was being driven by Chinese offshore storage as India and South Korea were in the process of normalizing. China went out and swept the market buying any spot cargo they could in April/ May. All of these purchases “slow steamed” their way over to the coast and have experienced crowded ports and limited onshore storage resulting in a coastal buildup. China has almost finished the next 70M barrel storage facility, which will help onshore some of the glut- but as China was amassing these levels- India faced a resurgence of COVID and rolling lockdowns forcing many refiners to roll back runs. South Korea and Japan have faced economic headwinds that has left more crude offshore with little in the way of local demand and a crowded export market. The drop in floating storage came when India started back up, but as they have rolled back activity- floating assets started to build again and remain near all time highs.

Asian Floating Storage

China has the largest glut by a wide margin along the coast as onshore storage remains at record highs with little in the way of an outlet further down the value chain. “Chinese port congestion continues to keep oil in floating storage at extremely high levels. Platts Analytics believes that idled crude cargoes in Chinese waters remain around 100 million barrels.” Shandong or Teapot refiners remain well supplied onshore with more ships sitting offshore waiting to unload. The area is currently operating very close to tank capacity, and as runs are being walked back- it will be difficult to see how they make a real dent in the storage levels. This also comes at a time that rates normally start to decline for shoulder season.

Shandong Independent Crude Storage

Crude Tankers Offshore China

Refiners are being forced to reduce runs as the glut has spread down the supply chain. China’s gasoline and diesel stockpiles rose to a record 59.7 million tons in July with a fill rate of 74.63%, according to industry consultant SCI99. Gasoline inventories increased 6.3% from the previous month to 26.55 million tons and diesel stockpiles expanded 9.8% to 33.16 million tons. The fill rate is nearing the 80% to 85% level that’s considered the maximum safe level.” China has been slow to give additional export waivers to refiners, but as the builds have risen- additional waivers are being issued, which is sending more diesel into the floating market. The level of exports is expected to be back to Mar/April levels in order to free up storage to keep the flow of crude moving. Most of this flow is going to be pushed outside of Asia given the ongoing glut in the region as demand wanes and storage capacity fills.

China Export Commodity Refined Petroleum Oil

Diesel exports -49% m/m to ~132k b/d, lowest since 2015

Gasoline exports +43% m/m to ~302k b/d, highest since April Diesel output +3.9% m/m to 15.1m tons, highest since May 2018 Gasoline production +10% m/m to ~11.8 tons, highest since Dec.

As all of these problems reverberate through the system, China is forced to slow crude purchases, which is showing up in the physical markets. We are seeing diffs compress again as China has backed away from the market. When we saw a big drop in spot pricing, hitting the low in the chart below on about April 20 th - that just so happens to be when China got very aggressive in buying cargoes- and proceeded to purchase crude straight through May. China was able to purchase spot cargoes at a steep discount, and were quick to take advantage of the oversupplied market. As the prices climbed, China started to slow total buying and now with new supply entering the market (roll back of OPEC+ cuts) and slowing demand- physical prices are already starting to show the pain. Many of the purchases have been by speculative buyers as many of the SOEs and Teapots have either reached import quotas or maxed out areas to store oil at a “somewhat” reasonable price. “Buyers of October cargoes were western trading houses and not the usual Chinese independent refiners, as limited margin recovery, approaching quota limits, and mostly port congestion in China have reduced ESPO buying appetite from baseload buyers in recent months.” [1]

https://www.spglobal.com/platts/en/market-insights/latest-news/oil/082520-spotlight-limited-buying-appetite-china-downtrend-espo-crude-differentials

The dynamics above have driven China to set some record numbers on total “apparent” oil demand. Given the cost of keeping oil offshore, we will keep seeing oil imported but without a rise in refined product exports it will be near impossible to keep operating at these levels. Diesel and Gasoline exports will be pushed into the market in greater capacity because of storage levels across the supply chain.

India Crude Demand

The issues are also mounting in India that is facing a rise in COVID cases, which is resulting in more lockdowns and reduced refined product demand. The rise in the lockdown index has caused a reduction in consumer spending and overall industrial activity. This has pushed more trucks to the sidelines with almost 50% of the fleet sitting idle. “India’s oil-product demand is set to slump to a five-year low this financial year, with a bleak outlook for diesel consumption as the nation’s truck operators idle vehicles and consider cutting the size of their fleets. About half of India’s fleet is currently idle: trucking group. India’s truckers are facing multiples headwinds that are crimping diesel consumption and overall oil demand. Localized lockdowns after a flare-up in infections is slowing economic activity, while tax hikes on the industrial fuel over the past few years have eroded the transport companies’ profits.” These reductions have pushed refiners to shift from 85.4% in June to 83.31% in July and now below 80% in August. The shift is being driven by some of the largest refiners that shifted lower: Reliance Industries, which operates the world’s biggest oil refining complex in Gujarat state, continued to operate at a lower rate for the fifth straight month in July

Its two refineries operated at an average capacity of 74.2% last month from 83% in June, 91.7% in May, 94.8% in April and 95.4% in March Its export-focused plant ran at 49.1% in July, while the other plant operated at 101%

Diesel accounts for about 40% of total oil consumption in India, so the fact it is down 23% from pre-COVID levels is more important vs the bounce in petrol (gasoline). Petrol demand is back closer to pre-COVID levels and only down about 9%- but that is also starting to reverse as the rise in cases as kept people indoors. VRL Logistics Ltd. won’t be purchasing new vehicles and may scrap about 700 of its fleet of 5,000 trucks to rein in costs, Chief Financial Officer Sunil Nalavadi said earlier this month. The nation’s biggest trucker is currently operating at about 75% capacity. More than a third of its customers are small- and medium-sized firms, which have been hit hardest by the economic slump.

“We expect that 2020 will be a lost year for earnings growth,” VRL Chairman Vijay Sankeshwar said in the company’s annual report.

The future for oil product demand is expected to be an overhang, and based on the stalled recovery we have seen reverberate through the rest of the global economy- it is unlikely to see a big shift which will result in additional refinery slowdowns. Some of the above high frequency data points have started a downward trend- which we have seen happen every time an outbreak occurs. This will keep total demand capped, and the rising competition in international markets will limit the ability for India to export spare cargoes. As we talked above, China will be increasing their exports of refined products (especially diesel) in order to free up storage space. The pressure in diesel will remain as industrial production stays at record lows. The problems will persist as August was a worse month vs June and July as the reopening not only slowed but reversed in areas as we have seen in truck movements and shipping capacity.

India Industrial Production YoY

This is all resulting in a total decline of total sales in the market:

“Sales of diesel, the most widely used petroleum product in India, fell 20% m/m and 23% y/y to ~1.78m tons over August 1-15Seasonal rains and rolling lockdowns in several provinces impacted consumption of the fuel, used mainly in transportation, farming and construction, the officials said, asking not to be identified as they’re not authorized to speak to media.” The pressure in the Indian economy is going to persist, and the issues will only grow with tensions rising against China. India and Vietnam have entered into some lose military and economic agreements, which will only strengthen over the fears in the South China Sea and overland. China has also been hardening positions along the Doklam plateau and Siddak by building anti-aircraft installations only 50km from the 2017 flash point.

South Korea Update

South Korea is experiencing their own additional spread of COVID with the rate of spread increasing resulting in some lockdowns.

Total activity has really been impacted- especially when it is measured against the mobility of other regions- SK is the dotted red line that has experienced a steep drop over the last month and is now recording the lowest Daily Activity vs other Developed Markets.

The jump in positivity rate is what really drove the adjustment- as you can see the mobility numbers are inversely correlated to the chart below. I expect this to come under control over the next several weeks, but these different flare ups highlight how difficult it will be to see activity really normalize back to pre-COVID levels on any consistent basis.

The declines were really driven the most by the below- creating a big drop in the consumer as retail and recreation movement have shifted to levels not seen since April. This all correlates directly to the consumption of oil/gasoline in the market.

The lack of consumption across Asia is leaving a significant amount of product in Singapore storage that will have to find its way into the market. It is starting to flow into Europe, but the demand remains fleeting in the region.

Total Singapore Refined Products

Quick Japan Update

Japan has been holding at a daily mobility level around 80 as the country has faced economic headwinds all throughout 2019 with the SK-Japan trade war. The economy has lagged for years, so COVID was just additional pain. Total inventories remain at highs even as refinery utilization rates remain at record lows, and are falling further with Japan’s ENEOS shutting 2 crude distillation units at the Negishi refinery and the sole CDU at Wakayama in September for regular maintenance, a spokesperson for the Japanese refiner said by phone. ENEOS will shut No. 1 CDU at Negishi refinery from late-Sept. to early-Nov. and No. 4 CDU from early-Sept. to late-Oct. It plans to shut CDU at Wakayama refinery from late-Sept. to early Dec.”

Petrochemical and Refining Expansions

In short- there remain limited bright spots in Asia as economic headwinds persist across the complex. Next week- I will go into more depth around China and the issues they continue to have trying to stimulate the market. For now, I will talk through some great data assembled by BNEF that looks at new refining and petchem facilities that will be coming online over the next several years. The below kicks off by looking at refining.

Most of the new capacity is being built in China/ Middle East/ Asia in general with a smaller amount coming in Africa. Many of the African projects are already facing delays and will struggle to stay on track as the economy/financing means in some of the regions have declined significantly. For example, Nigeria’s new facility has been delayed by several quarters already, and the growing disruptions will only increase on a political and economic level. Another example is Saudi Aramco cutting their financing of a joint project in China following large outflows in foreign reserves and a growing budget deficit. On a local level, the Middle East should see the most likely “on-time” capacity additions through 2021 with many of the projects in 2022/2023 being delayed as some of the construction are either upgrades or additions to existing facilities. 2021 is supposed to see a big additional in capacity, and the problem remains total utilization rates. The global refining complex has struggled to break 80% due to COVID and a growing overcapacity in the market.

The rise of new refining capacity is also happening outside the U.S. and is meant to take advantage of the export/international markets. This will push more product back onto the U.S. shores as competition increases into both Europe and Latin America. The headwinds brought on by COVID will remain an overhang well into 2021 limiting total demand. Many of these projects are being financed by National Oil Companies and are subsidized by the nation in an attempt to capture a higher value product as well as provide sustainable jobs for the local populace. The oversupplied nature of the market will limit margin and inherent value derived from the facility over the coming years. This may seem like a natural “boost” to oil demand, but it will result in a reduction in utilization rates or other facilities being mothballed in the coming years. The other problem is- many of the facilities were built with coking capacity and require a heavier slate of crude. As the market gets “shorter” heavy sours and long light sweet- there will be a shift in the premiums in the market. It will also help the realized prices of offshore exploration and incentivize an increase in more offshore production.

The next stop is the growth coming in the petrochemical market:

A large part of the expansion is within China- as more refining facilities are being built to be directly connected to petchem as well. The goal is to optimize output across the hydrocarbon chain. The oversupply of chemicals in the market should slow down some of the construction, but because it is also linked to a refiner- some of them will be completed and keep margins under pressure for a longer duration. The complexes being built in the U.S. are still mostly ethane crackers, which will keep an oversupply of ethylene in the market for the next several years. The economic slowdown has only exacerbated the underlying problem, and the shift in octane needs has helped support facilities throughout Asia that typically crack Naphtha. The addition of petchems will be a tailwind for NGL and condensate demand, but we are also facing a similar issue in the petchem side as in refining. Utilization rates have struggled as the market was already overbuilt prior to 2020 and the COVID hangover just made the problem that much worse. Margins have been under pressure since 2018- and have only gone in one direction over the last 18 months. It will be difficult for the world to absorb this level of new capacity under the current economic constraints, but many of the facilities will come online regardless through 2021. Some of the planned capacity in 2021 will be delayed as many of them are additions to pre-existing structures and will either be scrapped or postponed. Over the next 10 years though, I do agree with OPEC/IEA in that plastic demand will continue to grow and be a driver over the coming decade. Many “green” products require many forms of plastics- so the demand will grow over the longer time frames.

Update to China-US Trade Deal

The trade deal has taken center stage again as China has come to the U.S. market for oil and agriculture purchases. The below data helps to highlight how far away China is to reaching the targets set out in the Jan 15 th agreement. Soybeans, Corn, and Oil will see a step up through Sept as China has come into the grains market in order to close a rising food shortfall at home. The country has come under scrutiny (again) for their fishing practices- this time in the Galapagos islands. The purchases, while large, still won’t be enough to close the total gap- given the wide gap. China is facing mounting food inflation at home with the most recent floods impacting huge swaths of farm and livestock land in the Yangtze Economic Regions. Armyworms have also worked their way north in the country and appearing for the first time in the northern corn belt. China is also facing drought conditions, which is also impacting net yields and driving the price of corn to 5-year highs.

The data above doesn’t yet reflect the purchases as they were done in August with some of the deliveries taking place throughout Sept. With only 4 months to go- it will be impossible to close the net gap. Soybean purchases so far in 2020:

Below is another way to look at the total flow of products based on China imports vs U.S. exports. The charts show where we need to be by Dec 31st in order to meet the agreement. These shortfalls are also happening at the same time as rising military tension between both nations play out in the South China Sea. The increased political and military issues will make it impossible or “politically unfavorable” of reaching the set upon goals. As we head into an election year, we expect the rhetoric to get tougher as we have seen new sanctions placed on Chinese citizens with President Trump talking more restrictions on Chinese apps operating in the U.S. China recently launched several missiles dubbed “Aircraft-Carrier Killer” as a warning to the U.S. passing through the region. “One of the missiles, a DF-26B, was launched from the northwestern province of Qinghai, while the other, a DF-21D, lifted off from Zhejiang province in the east. Both were fired into an area between Hainan province and the Paracel Islands, the source said.” [2] This comes as the U.S. has increased military activity across the air and sea in terms of freedom of navigation and reconnaissance. The tensions between India and China will remain but based on current activities any new aggressive maneuvers will wait for the Spring thaw. China has refused to withdraw from several key forward positions, and are hardening positions with additional infrastructure and equipment moving into the region. As mentioned earlier- China is hardening assets where the 2017 clash took place between China/India along the Siddak and Bhutan border (Doklam Plateau) with more roads and anti-aircraft installations on 50km from the flash point.

But back to the trade war: The charts just show what the target is and where we currently sit as of July- so as we go through Sept some of the gaps will close.

The U.S. will see additional increases in grain prices following a storm that ripped through large parts of the Mid-west destroying crops and grain silos. There has also been an increase in drought conditions resulting in a degradation of crop conditions-specifically for corn and beans. “While experts were still assessing damage from the wind storm that flattened corn fields in central and east-central Iowa, arid weather was taking a toll elsewhere. That could mean American farmers won’t harvest the record-large corn crop USDA predicted on Aug. 12.

“Drought conditions continue to expand across the region as widespread rains have not yet materialized,” Justin Glisan, Iowa state climatologist, said in a report. The outlook for production in Europe has also worsened following dry spells in key growers from France to Ukraine. In Europe, “it was the perfect vacation weather for sitting on the balcony, but not perfect for crops,” Rabobank International strategist Stefan Vogel said by phone. Prices also gained after data showed China’s corn imports climbed to a three-year high in July as the nation sought more supplies to plug a widening shortage and cool surging prices.”

U.S. agriculture exports to China up 11%, pork up 31% to a record, poultry up 7% “We are making some progress, real significant progress on the meat side of the equation” Soybeans are lagging, but that’s changing after exports to China falling 95.8% in July while China increased imports of Brazilian beans

Overall, drought conditions ranging from moderate to severe (D1-D4) rose to 39% vs 37%

Update on U.S. Economy (we talk more about it in our youtube Economy Videos- released every Thursday)

The U.S. economy remains in a steady state here with competing economic data points providing a mixed outlook. The biggest overhang is the lack of jobs in the market with unemployment elevated with another 1M added and continuing claims sitting at 14.5M.

The lack of job prospects is also putting more pressure on consumer outlooks, which will directly lead to a reduction in spending. Stimulus for both consumers and corporations have run their course, and now with the next round of fiscal stimulus hung up in congress another round of layoffs is set to kick off in Sept. The other problem remains school and childcare needs as 48% of schools will begin the year with remote learning. This will cause some individuals to drop out of the workforce because the cost of childcare has risen to a point that doesn’t make sense if a parent is furloughed or reduced to part-time. Due to smaller class sizes, the additional costs such as PPE/cleaning costs can’t be spread across more children pushing costs even higher. The problem is many of the job losses are structural and not cyclical, which will lead to a prolonged downturn in hiring. The overcapacity in the market and inefficiencies created through financial manipulation and other corporate practices have resulted in mass layoffs. All of this results in consumer confidence falling and resulting in reduced spending.

The limited availability of jobs is something we have highlighted through Indeed and the below chart. It is difficult to see how many of these jobs turn back around given the slowdowns we have seen across key economic/ manufacturing indicators.

The spending charts below help highlight how people are spending because as the extended unemployment benefits run out- there is a precipitous drop lower. This will only accelerate as benefits run out and families remain concerned about job prospects.

The level of unemployment and WFH activities is also resulting in a large drop off in total driving as highlighted by lending tree. This is something I have discussed CONSTANTLY so I will avoid beating this to death (Again) but people aren’t driving. Less driving is also putting more money into people’s pockets, but is hurting total tax revenue for federal and state governments that are facing deficits across the board.

There are more jobs that can permanently shift to WFH across key urban areas:

Many of these changes will become permanent over time with more corporations shifting away from the normal office lifestyle especially as people move not just into the suburbs but more rural locations. The shift in movements will be interesting to see how it impacts miles driven over the longer term. The chart below is from a KPMG report that believes their will be a permanent reduction in total consumption. The reduction will be driven by more people working from home and consuming more products through e-commerce and reducing total trips to stores. I am still not 100% it will result in a total reduction of miles, but I think the shifts lower will be enough to offset what “should be” an increase in miles driven as more people leave urban settings. I believe that if people have access to a car- they will be tempted to drive more often to stores, and while ecommerce works for some- in more rural settings the reliability of online shopping can be difficult. This could improve as the rural/suburban setting gets more crowded, but that will take time to develop. I still believe that net miles driven and total gasoline consumption will be depressed well into 2021- because of the shifts I have highlighted many times over the last several months- WFH/ consumer spending drops/ unemployment/ changing consumer behaviors (more online).

We have started to see some recovery in shipping levels over the last month- especially out of the west coast ports. California saw inbound containers rise as imports have increased with supply chains getting rejuvenated after running thin since Feb/Mar. This has been good for trucking, but rail has lagged just given the level of restocking remains more spot and smaller vs the requirement of large freight trains. Exports have also started to pick up as the dollar weakened making goods a bit cheaper for some countries (but not many as the USD weakened so did 96 currencies against it).

Rail freight volumes have come off the lows but remain down about 16% y/y, which is still a depressed number as 2019 was below 2018 (but those were harder comps). We will remain down about 15%-17% for 2020 vs 2019.

Total shipment volumes remain well off 2019, and are more inline with 2009 levels- which will struggle to improve further in August as consumer spending slowed. This will accelerate into Sept as households see additional impacts from the expiration of additional unemployment benefits. Cheap diesel is still helping to keep rates low even as we see utilization rates and total trucking demand increase. The total price index shifted higher in Aug with Truckstops Market Demand Index hitting a new 5 year high and taking out the 2018 highs.

Even though the Fed remains in a HIGHLY dovish stance, lending standards are rising around the world-specifically in the US and EU. Bad debt expenses are rising as corporations are sitting on a mountain of debt and face revenue declines. This makes new loans harder to obtain and require more proof/collateral against potential lending. It is also being driven by the rise in bankruptcies as banks have to preserve balance sheets as we set corporate bankruptcy records.

The issues we are facing in the U.S. are not unique and are happening on a global level. We believe that the GDP estimates remain too high- especially in some emerging markets: India/China. The market thinks there will be a swift recovery in Q3/Q4, but major headwinds remain to seeing activity normalize across many parts of local economies. We went through many of these headwinds on our Economy show, and will cover it further in our update on the US Dollar.

[1] https://www.spglobal.com/platts/en/market-insights/latest-news/oil/082520-spotlight-limited-buying-appetite-china-downtrend-espo-crude-differentials