Primary Vision Insights – September 28th, 2020

By Mark Rossano

Summary

Frac Spread Update and Projection Update on Refined Product Storage and Demand Oil Storage Rising Globally Libya Coming Back Online OPEC+ Non-Compliance Rising Crude Oil Storage and OECD Gains Mounting Pressure on Refiners as New Capacity Comes Online Economic Backdrop Worsens Globally Lack of Fiscal Stimulus Hurts Spending Global Debt Levels Impede Economic Growth and Investment Global Trade Starting to Pick-up but a Long Way to Go India/ China/ Taiwan Updates

We also have videos covering some of these topics at a higher level here: https://www.youtube.com/c/PrimaryVisionNetwork/videos

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Frac Spread Update and Projection

Frac spread activity has found some steady momentum back to 89 on more spreads in the Bakken, Western Gulf, and TX-LA-SALT. These areas will see relatively stable activity at these levels through the rest of the year with new activity being generated by the Permian. The Permian has been relatively flat, but will start to pick-up as we get into Oct. Over the next 4 weeks, we expect to get back above 40 active spreads in the Permian and shift closer to 43 as work continues in preparation for year end and 2021 planning. Appalachia and other natural gas regions will remain stable as the natural gas curve is fairly supportive even as the front month has been pushed lower. The curve doesn’t support movement much above current activity, and we look towards Texas to be a driver over the next few weeks. The activity we expected in the Eagle Ford has now materialized, with a 1 or 2 spreads to pop up, but the next increase in activity will be Permian driven. The other fringe basins will be held relatively constant over the next several weeks as competition for CAPEX increases into year end.

As pressure across U.S. crude pricing increase, E&Ps are going to home in on premium acreage to drill DUCs and provide completion activity with the best returns. The front month has come under pressure helping to incentivize storage, but the overall curve remains depressed vs Aug which will impact the speed of activity over the next several months. It will be hard to see a serious increase in completions given the pricing backdrop over the next few months. The question becomes: “Do I drill some of my best assets or leave it in the ground to maximize returns?” As balance sheet stress intensifies and companies look to bridge the gap, we will see more completions of quality assets even at the depressed pricing in order to generate enough cash flow to reach the other side of the downturn. Based on the below backdrop, E&Ps can deploy some hedges centered around puts because many would want to avoid locking in the upside but would be willing to protect from further downside. So far 2021 hedges remain light while we have seen an increase in activity protecting the remainder of 2020 to provide some support to keep activity going into year end.

U.S. pricing has remained range bound with pressure rising to the downside as global production drifts higher through Nov and demand headwinds persist. Nigeria, Norway, Iraq, Libya, OPEC+ in general are taking Oct/Nov exports and flow higher. Libya is expected to come back online (feels like it is a monthly joke now), which I will go through in a bit more detail later. This will increase pressure in a tough European market and keep U.S. flow struggling in the market. So far, U.S. exports has been supported by Asian (specifically China) demand, but if things slow into Asia spreads will start to widen quickly. Louisiana Light Sweet (LLS) and Magellan East Houston (MEH) remain the key grades into the global market, and it is best to look at those vs Brent (trading at $41.64). The spread should be between $1-$1.50, but it has so far maintained something closer to $.80 as shipping rates have come down. As we see an increase in crude movements, prices should drift higher putting us back above a $1 but not by much given the current market conditions.

Update on Refined Product Storage and Demand

Our confidence on the rise in activity in Texas (specifically the Permian) comes from the opportunity to either sell to local refiners, storage, or directly into the export market. The optionality can help protect realized prices to a certain extent, but the global market is getting crowded as we have increased competition from OPEC+ nations, North Sea, and Latin America. The mounting pressure from new supply is happening at a time where demand is shifting lower not only due to COVID but also shoulder season. Refinery utilization rates around the world are heading to record lows this offseason, which will put more crude in storage ahead of the winter rise in demand. The concern I have going forward is the level of diesel sitting in storage ahead of when we should be seeing a rise in demand. Jet fuel is already pricing at levels that incentivize it being blended back into the distillate cut, which will just push the storage levels to new highs as even offshore disty levels shift higher. There just isn’t enough demand to absorb the current level of diesel/ distillate sitting in global storage, which will keep refinery runs depressed well into the winter season. The below chart drives home the current backdrop of pricing across the refined product space. Shippers have already accelerated the blending of kerosene, and at these levels it will accelerate- especially given the drop in inherent jet fuel demand.

Jet Fuel Implied Demand

The lack of travel is going to be a global issue that will keep storage levels elevated across the distillate complex. Flight departures and general airplane activity has declined precipitously versus expectations and will remain depressed across the globe.

“Passenger flights scheduled to depart in October from the 133 airports tracked by BloombergNEF have been reduced by more than 25% since August 23. The cuts are due to weak demand as virus outbreaks continue to plague the aviation industry.”

The pressure in air travel will remain a problem as companies and consumers alike look to cut costs and reduce total spending. We have been consistent in our view that TSA throughput will stay at between 550k-750k a day through the remainder of the year. Europe flights are being reduced as COVID cases increase in France, Spain, UK, and Italy (to a smaller degree) and consumers shift accordingly. The below TSA chart drives home just how much pressure will remain in the jet fuel market. This will keep jet-kerosene flowing into other parts of the refined product chain.

The problems in the refining complex are a global issue as many areas struggle under very low or negative margins. The product to focus on as we head into the shoulder season and coming winter months will be the distillate market. The diesel/ disty market has been an overhang, but started to draw down a bit in the U.S. last week. The draw had a lot od support from the drop in refiners across PADD 3 and PADD 2 driven by Hurricanes in the GoM and the disruption at BP Whiting in PADD 2. The overarching problem will be the amount of refined product demand in the U.S. As refinery utilization rates remain at around 75% over the next 2 weeks and trend closer to 68%-71% through Oct, there will start to be some draws from products as refiners try to “right-size” storage. KSA and other OPEC+ nations are trying to manage the oil builds by adjusting the optics with lower builds in not only the U.S. but other OECD nations. This is leading to a bigger problem as Iraq-Basrah spot crude cargoes are just sitting in the market without a home and KSA has 78m in crude stockpiles- highest level since April according to Kpler. Below are some charts showing the glut in the distillate market that remains problematic:

DOE Distillate Storage Levels

International Enterprise Singapore Oil Products Singapore Stock Data

International Enterprise Singapore Middle Distillate Singapore Stock Data

PJK International ARA Gasoil Inventory

Driving on a global level also remains below pre-COVID levels with more WFH being pushed into the mix of the future. Commute times have been shifting higher over the last 30 years, and now with the advent of proven technology- we will start to see some blended schedules.

Why it matters: Commuting was costing American workers an increasing amount of time, money and life satisfaction. After a glimpse of life without the daily slog, workers may not want to go back to normal, which could have major effects on cities around the country.

By the numbers: In a survey released Thursday, the freelancing platform Upwork found that those who were working remotely because of COVID-19 were saving an average 49.6 minutes a day because they were no longer commuting.

For the majority who commuted by car, staying off the roads has saved $758 million a day in time, fuel and health costs, which adds up to more than $90 billion since mid-March. [1]

While more people are moving out of Urban centers, these are individuals that have relied on shipping services more than most. So we will see some increase in miles driven as we get past COVID, but the surge will be limited because WFH will become a more permanent fixture on a blended schedule (2 days in office 3 home or vice versa). Many FedEx and UPS trucks pass your house each day- regardless if they stop- so we should see more logistics and supply chains maximized with a move into the suburbs. The growth in MPG efficiency will also help some of these efficiencies and offset some of the expected “surge” in gasoline. We remain more measured on our view of miles driven because so far we have been spot on with miles driven and total gasoline demand. Gasoline demand has plateaued and will now shift lower over the next few weeks inline with seasonal norms, but the headwinds will persist well into 2021 as the consumer struggles and job growth stagnates.

The below data points are a bit more bullish on the Middle East and Asian front, but India/China remain the overarching problem. Fujairah has seen an increase in demand, which has pulled more product out of storage and is a positive data point for shipping as well. The shipping sector has started to pick up as exports have increased from key hubs- such as Germany, China, and South Korea. While it is still down on the year, we have seen an increase across the complex- more on that later.

Japanese data may look a bit better, but the refining complex and general activity is far below normal as oil throughput is at record lows. The inherent declines in refinery activity and still low imports of refined products (specifically diesel) helps to drive home how the 3 rd largest economy in the world is experiencing an extended slow down. “Japanese oil refiners went on a buying spree last week -- aiding spot prices of some Middle Eastern crude grades -- but some traders are skeptical the pace of purchases will be sustained. Japanese processors including Fuji Oil and ENEOS Holdings bought at least 9 million barrels of oil from Abu Dhabi and Qatar on the spot market for November loading, according to five local traders who buy and sell those grades. The purchases were unusually large and came after muted buying over the past couple of months, they said, asking not to be named as they’re not authorized to speak to media.” Japan has a lot of capacity right now to take in crude, and they are taking advantage of discounted spot cargoes sitting in the market. I don’t see Japan ramping their volume, but instead picking up well priced spot cargoes.

Oil Storage Rising Globally

Japan has been experiencing a large slow down across exports/imports and just general activity (as reflected by PMIs and GDP), but we will go through that in our trade section. The bigger issue now is the India and China overhang as product exports increase while oil in floating and onshore storage remains near or above record levels. Even as some of the shipments into China slip, they remain above seasonal norms:

The number of VLCCs and ULCCs signaling China in the next 3 months fell to 91

Compares with 93 in the previous week, which was the highest since the week ended Aug. 7 Seasonal average at about 86

Each refiner has import quotas and the independent or “Teapots” that reside in Shandong have reached about 88% of allotment but are normally at 65%-66% by this time of year. Unless they get a new quota, it is unlikely we will see an increase in Teapot purchases and refinery utilization rates will start to come down faster. Gasoline and Diesel exports will continue to rise through Sept and will follow through in Oct as local demand remains slow and refinery utilization elevated. We are starting to see refinery utilization rates drop lower across state owned enterprises (SOEs) and Independent Refiners. China crude stockpiles are now approaching record capacity as they continue to creep higher: “Chinese crude inventories, including strategic petroleum reserves and commercial stockpiles, rose to near record capacity in the week ended Sept. 24, according to data from Ursa Space Systems.

Inventories climbed to 72.7% of total capacity, just short of the record 73% set in the week ended Aug. 27 Stockpiles have increased 15 of 19 weeks from May 21 through Sept. 24”

China Shandong Crude Stock Storage

The local consumer remains underwater as consumer spending and imports struggle internally. Pressure remains as retail sales, imports, and just general consumer activity disappoints:

The activity at the refiners and slow local demand is pushing more product into the export market. The shift in products is not unique to China or Singapore (as we showed above, but all of Asia is experiencing a bigger glut that is sending new supply into Europe. Trade flow of products has shifted significantly over time, and will only continue to change as new refining capacity comes online in Asia and the Middle East and puts pressure on older Asian refiners (Japan) and European facilities. China has built integrated capacity on “mega” facilities linking chems and refining to optimize output. We discussed new build out last week and will cover closures lower.

China Diesel Exports

China Gasoline Exports

The next backdrop is the loss of demand in India, which has seen a big shift in flows that either end up in storage or get pushed into the market:

India Imports and Exports of Refined Products

The above backdrop helps provide color to the commentary the previous few weeks how trucking demand is down over 50%. We have diesel imports down 93% while exports are up 36% overall- these headwinds will persist through the end of the year as industrial production struggles within India. The pressure has already shown up in Indian refining with additional cuts to throughput. “Indian refineries utilized 76.10% of crude throughput capacity last month, a fall from 83.31% in July, according to oil ministry data.” The nation’s refineries processed 16.15m tons of crude during August, a fall of 8.7% from July and a decline of 26% from a year ago,

Several plants operated at lower capacities due to lower product demand and planned shutdowns : ministry Reliance Industries, which operates the world’s biggest oil refining complex in Gujarat state, continued to operate at a lower rate for the sixth straight month in August Its two refineries operated at an average capacity of 75.8% last month down from 74.2% in July, 83% in June, 91.7% in May, 94.8% in April and 95.4% in March Its export-focused plant ran at 45.8% in August, while the other plant operated at 107% State-run Indian Oil, the nation’s biggest refiner, operated its nine refineries at an average rate of 66.7% in August falling 90.6% in July and 97% in June

The trend continued in Sept as COVID cases climbed to new highs and remain elevated across the country. The below trend remains negative through Sept, but is starting to adjust as we head into October with new active cases declining. It will take time to get the market to adjust, and with new cases rising with their trade partners- it will be difficult to see a big economic recovery in a short period of time. This will keep a lid on industrial production, and weigh on total activity. Driving already started to return to some semblance of normalcy, but the trucking/industrial side will face headwinds as we progress through the end of the year. This will weigh on GDP expectations, which we will discuss later on a global level.

These overhangs in key areas has kept floating storage elevated throughout Asia. The amount of oil in transit has fallen, but will start to recover as Libya and Nigeria start to increase their total flow. Other OPEC+ nations have also adjusted some of their exports/production numbers higher with many inline with expectations. Iraq is an interesting case where we still have spot Basrah cargoes floating in the market. The fact these still remain in the market is concerning for several reasons:

These should have already been sold due to the grade of Basrah It means that Iraq has (again) failed to meet it’s OPEC+ target.

“Saudi Arabia and Iraq both exported crude at a higher daily rate in the first half of September than they did during the previous full month, tanker-tracking data compiled by Bloomberg show.” “Exports rose to 3.26m b/d during the first 15 days of September, an increase of 247k b/d from the daily average in all of August, when the country exported a revised 3.01m b/d, according to tanker-tracking and port-agent data compiled by Bloomberg.” Oil traders are reporting a sharp increase in Iraqi export cargoes for next month, as they look for clues to the country’s ability to meet its OPEC quota. A larger-than-normal number of Iraqi crude cargoes is being sold in the spot market for October loading, according to five people involved in the market in Europe and Asia. The additional shipments are available on what’s called a destination-free basis, meaning they can be purchased and shipped anywhere. The extra cargoes probably indicate higher overall output and exports, according to several traders, and would add oil to a market that’s already experiencing a glut.”

Libya Coming Back Online

Libya is the dark horse in a race to bring new capacity to market. As we discuss in this write-up, the GCC-specifically Saudi Arabia and UAE- have been struggling with widening government deficits. This limited the amount of money they could keep using to support General Haftar and the LNA. I have always said it was a matter of time before the money ran out, and Russia is in no position to use capital (outside of men and equipment) to backstop the loss of oil revenue. Libya expects to be at about 260k barrels a day by the end of the week, and we believe they can achieve 350k barrels a day relatively quickly. The ability is driven by the amount of crude currently in storage, and the relatively intact equipment. We think 750k barrels is possible within the next 6 months, but getting back to 1.1-1.2M barrels will be difficult without investment to repair damages.

The initial flow will come from 3 key terminals – Hariga (which has already seen its first ship), Zueitina and Brega. In order for the NOC to give the green light on safety, all mercenary/ military personnel have to not be in or near the facility. The key will be getting several fields operational before we can see Libya producing 760k barrels a day.

The current ports also have the most available oil in storage to support near term flow:

Libya has been an “unknown” for almost a year now as we have had cease-fires and agreements that have fallen apart several times to this point. The difference now- the LNA and GNA have stopped finding international money to fund their ambitions. This will push both sides to export oil and figure out ways to share the oil revenue through the NOC.

OPEC + Non-Compliance Rising

We have highlighted in other write-ups and on our YouTube channel how much Iraq remains in non-compliance. The below chart was discussed when OPEC+ met last week to go through current compliance and walk through the market outlook. Iraq promised to be “super serious” this time to walk this back, but instead we see more cargoes coming out for October with current spot STILL NOT SOLD. The market remains saturated with crude as we see in terms of total floating storage with a large part of it sitting in highly opaque markets in order to give an appearance of a falling market. The EIA and OECD numbers are closely watched, but it becomes harder to track crude in some of these areas we have been highlighting. The bigger issue for Iraq and Nigeria remain the health of their economies, which have struggled with low oil prices and trying to stimulate growth. “Like many other OPEC+ members, Iraq’s economy has been battered by the plunge in oil prices. The Iraqi budget deficit will hit 22% of gross domestic product this year, higher than anywhere else in the Middle East and North Africa, according to the International Monetary Fund.” Iraq is sitting with a widening budget gap, which prompted OPEC+ to agree to allow Nigeria/Iraq and other cheaters more time to make up for over producing. Based on current oil flows, many of the cheaters are still miles away from even pretending to get close to those figures- which will keep floating storage elevated and Asia at near record highs.

Saudi Arabia and other GCC nations were the only reason the OPEC+ deal even remotely worked in terms of reducing flow. Iraq and Nigeria were the worst offenders (with Iraq still the worst), as Saudi took the brunt of the cuts in order to adjust the market. This includes the voluntary cuts they also agreed too, which is why it is so steep in relation to other markets. UAE was also one of the countries that agreed to the extra cuts, but based on the current data- they not only started to cheat, but also saw a big spike in exports putting them into the “Cheating” category. Many countries are facing rising economic weakness and government shortfalls driven by limited crude pricing and stimulus within each country.

The below chart helps to show the shift in flow from the UAE as production increased, but exports really outpaced as local demand diminished and they looked to clear some of the glut in storage. The exports will remain elevated even as the UAE cuts back in production in order to fall in line with the OPEC targets. The above chart helps to show by how much the UAE broke compliance because they were initially part of the GCC nations that offered up voluntary cuts. The struggling budget deficits will keep driving governments to find ways to close the gap- extra crude into the market is just an easy one.

Saudi Arabia, which is perceived as one of the strongest countries in OPEC, is seeing their budget deficit worsening based on the IMF data below. KSA has already adjusted their spending across conflicts in Yemen, local subsidies, investments in China (refining and petchem), and other areas in order to preserve foreign reserves and stem the bleed. Based on the chart below, we can see the pain has been real for years now and is catching up to many of the countries- especially KSA. This is why it will be hard to get the cheaters to stop as they are trying anything to keep dollars flowing into the market.

Russia has also slashed their refining capacity, and we are seeing more flow coming to market: “Urals exports from three main western ports will rise to 4.94 million tons, or 1.17 million barrels a day in October, according to loading programs seen by Bloomberg. That compares with 1.11 million barrels a day in September, but well below the 2.09 million seen a year earlier.” Russia is starting to experience more competition from Iraq with additional Basrah volume in the market and North Sea grades rising by about 300k barrels a day to 1.89M. Libya will also bring another 260k barrels online quickly, which will start to erode the Urals premium- so watch how Russia responds- additional flows are likely.

Nigeria has already announced an increase for Oct with Nov already posting ANOTHER increase. The total amount for Oct is supposed to be 1.635M vs Sept of 1.517. Nov takes it up by almost 200k barrels to 1.816M barrels a day. These increases are a far cry from the cuts that have been discussed to bring them back in line for cheating.

Floating storage has gone sideways over the last few weeks as we did get a short term dip (a month) of reductions from Nigeria while Angola reduced some Nov volume to about 1.183M barrels a day which is back to the recent lows.

West African Floating Crude Storage

The next logical question: “Why would Angola cut while Nigeria pushes increases?” A large part of Angolan crude settles in the Chinese Crude Futures, and with an oversupplied Chinese market- onshore and offshore- storage space is getting tight. This is limiting the delivery capacity especially with cuts in runs at SOEs and Independents approaching their import quotas.

Angola and Nigeria Loading

Crude Oil Storage and OECD Gains

Crude supple remains well over the 5-year average just as we have new capacity coming to market, which will keep commercial stocks elevated. The problem is the optics that OPEC is hoping for by drawing down OECD because it is much easier to track vs other regions. The idea is to pull supply away from the areas as refiners go into turn around season with conservative expectations putting throughout at about 75% utilization rates. This will cause refined products to draw and limit the builds, and hopefully allow for some draws to resume or at least limited builds in commercial stocks. While builds remain “contained”, the hope would be that winter kicks off early and heating oil/diesel demand picks up helping refiners to increase rates. We track all markets and while KSA and other GCC have a notion to limit OECD flows- Nigeria/ Iraq/ UAE appear to have a different agenda. The U.S. has also purchased several KSA cargoes- so at some point based on the Saudi budget shortfall- they will increase exports to take back market share. It is too early to attempt this kind of move given the glut in the market, but if the cheating persists- KSA will have no choice but to get more aggressive to take market share.

Even with reduced flow to OECD nations, it will be difficult to see the glut clear effectively with refiners experiencing such distress. Refiners have been struggling under the weight of stock builds driven by weak demand. The below is a quick snap shot of implied demand in the U.S., and we can see that even before we reached “peak” COVID- demand was trending below the last few years. We have said countless times how we began to get bearish crude demand driven by the fall in global distillate demand. When we look at industrial production, PMI, exports-imports, and other economic indicators headwinds will persist for an extended period of time. The glut in refined products has pushed crack spreads and refinery margins to record lows.

The below is just one example of the pressure in prices that started to decline in 2019 and only accelerated down as COVID spanned the globe.

When we turn to the U.S. WTI 321 Crack spread we can see the peak, and how things really turned lower and remain under pressure. It is important to realize how weak spreads remain and are drifting towards the COVID lows. The pressure is mounting across the globe with crack spreads heading.

The pressure in crack spreads is leading to outages across the global complex- including India, Russia, U.S., China, and Europe. I believe we will see additional surprises to the upside on shut-downs and reduced throughput as pressure mounts on crack spreads. “Russian refiners had 1.22 million barrels a day of processing capacity offline as of Wednesday, according to an emailed report. That’s the highest since May, and is higher than the same week a year ago.” This is a big increase and will put more crude on the water for export.

The below chart puts into context just how steep the drop-in run rates are in comparison to historics. Only in 2008 and 2005 did we have rates lower vs right now both with severe hurricanes. Even at such depressed levels, we aren’t able to get total product storage down- we have made some headwinds in gasoline but distillate remains at record highs.

U.S. Refinery Utilization Rate

Mounting Pressure on Refiners as New Capacity Comes Online

Refiners are also facing a rise in closures due to weak demand that has been permeating the market for over a year now and with new capacity coming online it will become harder to compete. “Global refining capacity closings announced this year have risen above 1 million barrels a day (b/d). Over 650,000 b/d of closures have been confirmed, with 350,000 b/d looking at closing or conversion.” Some will say “COVID” but the issues have been rising over the last several quarters, and now with new capacity coming online and weak demand persisting due to the soft macro backdrop firms are making the decision to roll back activity.

“Capacity additions will far exceed oil product demand growth globally. We expect the cumulative surplus of refining capacity to reach 5.2 million barrels per day (m b/d) by 2025, assuming all planned projects reach commissioning. Overcapacity will put increasing pressure on refining margins. Simple refineries will be hit hardest, as they will be less able to shift their crude intake and product output to maximize margins. Weak margins will push high-cost refineries out of the market. Plants with higher operating costs and lower levels of flexibility, especially those in Europe, are most at risk of closure.”

The below charts give a breakdown of the growth I have been discussing for years now- China has modeled its refinery backdrop inline with the U.S. by importing cheap feedstock and exporting higher value products. This has been a big driver behind the Made in China 2025, which dictated building out massive complex industrial facilities and BRI- Belt and Road Initiative- secure cheap feedstock. The backdrop has created an oversupply of refining/chemical capacity- but the mega facilities have the ability to undercut competition- especially in Europe. The Middle East also took a page out of the U.S. book and instead of exporting cheap feedstock- decided to export the finished products which yield a higher margin. The shift has been in the works since 2014 and will persist over the next few years as facilities finally come online. This is why we have been talking about the change in trade routes with China no long being a key import target for refined products, but rather an area with the growing capacity to export.

European refiners are the weakest link in the global refining chain with Japan not far behind. The backdrop means we can expect to see new closures over the next 12 months or additional conversions into bio-fuel/renewable fuel production.

The below backdrop provides significant opportunities over the coming years with more optionality to hit different types of high value chemicals.

Economic Backdrop Worsens Globally

As we have discussed in our Econ videos, pressure remains across the macro-economic backdrop that will be a headwind on demand on the other side of COVID. The below final GDP figures and estimates tell a big story: 1) The trend was down from 2018 into 2020 and 2) the expected recovery is much higher vs what the actual data is showing. When we consider how GDP is calculated GDP= C (consumer) + G (government) + I (investment) + (X-Y) or Exports – Imports. By looking around the world, we saw a marked slow down in company investments, exports dropping, and a consumer that was weakening. The government strength has persisted as countries utilized various forms of monetary and fiscal policy in an attempt to drum up some growth.

The below chart helps is just one example of the steep fiscal deficit countries are facing in order to stimulate their economies. This exercise is being carried out across the globe, but the depth of the recession still remains deep because unemployment will stay a huge overhang. Many of the jobs that were lost were given the excuse of “COVID” because it provided an easy excuse or company out to slash whole departments. It is usually very difficult to terminate a position because you have to build a case/ track record of reasons supporting the layoff. COVID was the clean-cut excuse used to slash departments. The fact remains that many of these individuals will struggle to find new employment because of the limitation on new opportunities.

Here are just some examples on reduced employment factors:

The effects will be even greater on inherent spending because the “wealthier” quartile is the one that has been impacted this time around. The higher wage earner has a high level of discretionary income, but many of the layoffs have also impacted middle and upper management positions. Now- these individuals/ families have more savings and ability to protect some spending on core goods, but the ability to splurge on big vacations, purchases, or extravagant events will be severely limited. The limitations is driven by the lack of job opportunities/postings for the top-third of the wage earners.

Lack of Fiscal Stimulus Hurts Spending

Another key issue is the lack of new fiscal stimulus in the market as the $600 left the market and now the additional $300 is set to expire. This is taking personal income down to pre-recession levels if we don’t have any fiscal stimulus. The surge in personal income was also driven by $1,200 in direct checks + $600 and $300 in unemployment support. As these all dwindle, we are seeing spending drop off, and it all started to accelerate when the $600 first expired.

The below provides a great backdrop of how spending has changed without the additional support from the government. This is playing out in other areas of the world as well- especially Asia and Europe.

ShopperTrak Foot Traffic

The global hours being worked has fallen around the world- peaking down about -18%, but as COVID cases grow around the world. Job losses have increased everywhere for different reasons:

A drop in exports limiting the need for manufacturing The Service sector (as reflected in service PMI data) has contracted Weak consumer reducing local spending Job security/ job losses becoming a problem pushing people to save Companies conserving capital so cutting back on CAPEX Childcare issues limiting the amount of hours a family member can work Corporations cutting back on everyone’s hours

These are just some reasons that we can see more pressure on working hours around the world. Based on our research, we are seeing something that will fall between the baseline and pessimistic projection. The limitations are real, and given the massive size of debt sitting on global balance sheets at the corporate, government, and personal level will be an overhang for several years. Lending standards are tightening for all entities, which is limiting the flow of money through the system. We have covered it in detail across the U.S. and Europe.

Global Debt Levels Impede Economic Growth and Investment

The growth of debt to GDP will weigh on the recovery in spending as many areas of the economy (if not all) are completely saturated. The overhang is real and is appearing in investments, lending, and consumer spending just to name a few. It is also a net negative when you consider the movement of money through the system- the velocity of money has been the inverse of this chart (calculated as V= (PQ)/M which is just Price * Quantity of goods and services produced divided by the money supply. As the money supply has increased exponentially (the denominator getting bigger) while prices have increased the real economic output has fallen. This has led to a decline in the net velocity of money as prices have anticipated the increase in money supply and front run the rise offsetting the additional purchases. We have also had a significant amount of capital go to shore up balance sheets leveraged to the gills with debt- and paying down debt or putting cash cushions behind debt is a net negative movement.

Banks are now sitting on a growing cash hoard to offset the rising bad debt expense, which we can see below with money supply growing (entry point is the banks) and reducing the growing of Commercial and Industrial loans. The lack of movement through the system (velocity of money) can also be seen directly here with the banks sitting on a growing cash hoard The problem is- the cash can’t move because it is strengthening a weak balance sheet and leverage that grew to exponential proportions (again), which came to light in March. Many banks through their Prime Brokers and lending activities became insolvent in March, which pushed the Fed to get very active in the market to push cash to shore up balance sheets- which has become known as “The Powell Put”.

These are just some examples of the issues that permeate the system on a global level. The PMI data points have been mixed with some of the European Manufacturing data coming in above 50 and showing some expansion. The growth on the manufacturing side has been more than offset in some cases from the drop in the service sector. This is putting net negative pressure on the local economies, and with growing COVID cases across parts of Europe- I expect revisions lower over the next month. The new COVID cases will be a headwind on total economic activity as consumers adjust spending patterns accordingly to avoid exposures. Japan on the other hand (the 3 rd largest economy in the world) has been sputtering for several quarters now, and will continue to be a problem as PMIs across all sections single contraction. Export/Import remain a problem, and is indicative of a bigger problem through at least Q4.

Japanese PMI Data

Japan Import/Export

Germany Data Manufacturing PMI

Global Trade Starting to Pick-up But a Long Way to Go

There have been some increases in U.S. trading with imports rising into the West Coast- mostly coming from China. The below helps to show that we are now back to the “pre-COVID” drop, but you can see the trend has been negative since the 2018 peaks. The flow of goods has now caught up with demand as supply chains and have slowed down throughout the U.S while Imports remain elevated on the west coast.

The below chart shows the increase in imports, but exports have leveled off and started to head lower.

The flow of goods on an intermodal level has increased with supply chains getting rejuvenated and flow of trucking staying at all time highs. The oversupply of trucks in 2019 led to bankruptcies, but also left a significant amount of capacity available for 2020, which is now being picked up. Rates have risen due to rising demand because diesel prices remain depressed.

U.S. imports on the aggregate remain well off pace even as we are getting a big pick-up in grains over the last 2-3 months. The grain exports will remain a big bright spot, but imports will continue to languish as the local consumer struggles overall and the supply chains backfill.

U.S. Imports- By HS2 Commodity Name

India/China/Taiwan Updates

Before we dive in- we should mention the interaction between North Korea and South Korea- “South Korea's Defense Ministry confirmed that North Korea shot and killed a SK official who was drifting at sea. His body was set on fire not long after. - President Moon condemned the killing and demanded an apology.” So far- this looks like a one off event with little follow through- but something to watch for a possible escalation.

Iran and the U.S. are in the news again with a potential to have some sort of meeting/ prisoner swap. This also comes at a time when: “Islamic Revolutionary Guard (IRGC) announces "martyrdom" of Gen. Hamid Khodadi, deputy chief of its security. The general was the right-hand man of Gen. Qassem Soieimani who was killed in a US operation in Iraq. Not clear how, where & when the IRGC commander met his death.” We keep seeing things within Iran deteriorate further with another death, rising explosions/espionage, and economic stress. Iran continues to lose ground with Proxies in the region and is weakening further on many fronts. I continue to hold to the belief we could see a big shift in regime over the next 6 months… stay tuned.

India and China remain a key focus for us, but we have had “high level” meetings take place between both parties where they agreed to not send NEW reinforcements and stop current troop movements. This is all for show because as you have the Himalaya winter coming on fast- you will naturally be restricted in movements. The below gives some backdrops to the additions that have been made since the Doklam Plateau incident in 2017. China continues to test the waters and boundaries of its adversaries- especially Taiwan and India. China has tested the limits of Ladakh and Sikkim in order to address India’s preparedness.

“The Chinese Communists further escalated the tensions with Taiwan on Sunday, by sending a mass of 43 warplanes across the Taiwan Strait, crossing the historic "median line" or "middle line" separating China from Taiwan, and entering Taiwan’s air defense identification zone (ADIZ).

The incursions came from multiple directions and involved a combination of sophisticated fighter jets and heavy bombers, without modern precedent, marking a significant escalation in cross-strait tensions. Taiwan responded by scrambling its own warplanes, which intercepted the Chinese warplanes and escorted them back in the direction of China.

The Chinese Communists went even further when Foreign Ministry Spokesperson Wang Wenbin claimed in a statement that "Taiwan is an inalienable part of Chinese territory; there is no so-called median line of the strait." The "median line" was established in 1954 to establish rules to prevent Taiwan-China conflicts.” [2] Taiwan remains a key factor of testing with China running recon missions to identify, which direction Taiwan scrambles jets/ what type of jets/ speed in response… all key things to address a possible invasion. While China tests Taiwan, they also tested and underestimated India’s setup in the LAC and Bhutan/Sikkim. China has now become more strategic by building new facilities and support assets in order to strengthen positions. We have seen air defense, anti-aircraft, airbases become a big focus over the last 2 years- even before the Ladakh incident. This is important because you can see that China was ANTICIPATING something as they increased the buildouts throughout 2019. It only accelerated in 2020 BEFORE the actual incident. This is a key factor when we are trying to determine Chinese intentions.

The below puts these new assets along the border so it is easier to see just how far reaching the asset construction has been since the Doklam crisis.

There is also updates to pre-existing infrastructure to “harden” positions.

China has also opened more “training centers” and “work camps” for Tibetan rural laborers. “Beijing has set quotas for the mass transfer of rural laborers within Tibet and to other parts of China, according to over a hundred state media reports, policy documents from government bureaus in Tibet and procurement requests released between 2016-2020 and reviewed by Reuters. The quota effort marks a rapid expansion of an initiative designed to provide loyal workers for Chinese industry.” So we have China increasing the use of forced labor in Tibet at the same time we see steel production increasing in the area. “Beijing has set quotas for the mass transfer of rural laborers within Tibet and to other parts of China, according to over a hundred state media reports, policy documents from government bureaus in Tibet and procurement requests released between 2016-2020 and reviewed by Reuters. The quota effort marks a rapid expansion of an initiative designed to provide loyal workers for Chinese industry.” [3] The issues are growing with more workers from Xinjiang and Tibet being moved into force labor camps… just a hint- NAZI Germany did something VERY similar.

This is also happening at the same time steel production is at an all time high in that region… just as new hardened infrastructure is being built across the LAC (Ladakh), Sikkim, and Bhutan. The issues will persist and this is a place to watch for escalation over the next 12 months with both sides facing: 1) slowing GDP 2) food shortages 3) local pressure. The issues are real, and the backdrop of China looks a lot like Germany and Japan circa 1930’s.

IISI Crude Steel Production Data/China

India has not been sitting idly by and has moved in-kind to Chinese aggression in order to maintain primary site lines and match aggression in key areas. The below is a great backdrop of the new positions India took to make sure they maintained the high ground and ability to keep tabs on Chinese military movements. India has also been testing new missiles, drones, and other military assets in the Bay of Bengal as a means of “warning” and saber rattling with China. The testing has increased in frequency and intensity, while targeting assets that replicate Chinese naval and general military equipment. So far- India has responded in kind with new construction of hardened assets, but India already had the most infrastructure and all-weather roads/bridges in the Ladakh area- so they don’t need to match building in the same way. The shifts by India have been more to meet Chinese aggression while taking high ground to protect current infrastructure. Russia was quick to come to the aid and support of India by speeding up the delivery of equipment to India… India and Russia have a very long and healthy alliance.

[1] https://www.axios.com/commute-remote-work-benefits-fe55566b-af80-4a2f-95ce-2140ca6b358c.html [2] http://generationaldynamics.com/pg/xct.gd.e200923.htm [3] https://www.reuters.com/article/us-china-rights-tibet-exclusive/exclusive-china-sharply-expands-mass-labor-program-in-tibet-idUSKCN26D0GT