[ihc-hide-content ihc_mb_type="show" ihc_mb_who="10,13,14,16,18,19" ihc_mb_template="1"] By Mark Rossano SUMMARY OPEC+ SUMMARYUS FRAC SPREAD UPDATECOVID IMPACTS RISING OPEC+ SUMMARY The OPEC+ meeting delivered a gift to the U.S. energy industry with the voluntary cut from Saudi Arabia (KSA) of 1M additional barrels. There was a disagreement over the February increase of 500k barrels with Russia and Kazakhstan supporting the rise while others wanted to keep levels constant from January. The compromise struck between Russia and Kazakhstan with the other countries resulted in an increase in production of 65k and 10k respectively in Feb and again in March. All of the other nations agreed to keep production flat through March, but Saudi Arabia offered up a voluntary cut of 1M barrels additional in both February and March. This was a surprise to the market that had a base case of the same targets in Feb vs Jan- instead they just got slashed by 925k barrels a day. The below chart shows what was agreed to without the voluntary cut from Saudi Arabia- you can see the small decline in cuts through March. The below highlights the key countries- especially KSA with their voluntary adjustment. Russia asked KSA not to make such a large cut because such a reduction will bring back non-OPEC production. The North Sea is already producing at a 3-year high with loading schedules showing 2.11M barrels a day in February, and now with Brent at $55 and WTI at $51 the U.S. will be able to hedge effectively and will be quick to bring back completion crews. The U.S. had about 26 crews pause work for the Holiday season, and with the current strip- we will see a quick recover back to about 160 completion spreads. The question becomes- why did Saudi Arabia carry out such a large cut given the perceived alth/recovery of the crude market. There are different ways to interpret the reasoning, which could easily be- KSA wants to see prices push higher in the near term to increase value or they see a weakening market that would require price cuts on cargoes in order to move product. Here is one side of the argument- Physical crude prices have fallen since the 2nd week of Dec, with slow sales across WAF and problem moving spot cargoes. Typically, the first week of the month sees an increase or stable pricing- but the 1st week of Jan has seen limited bids and price cuts out of Nigeria/Angola in order to move cargoes. “Sonangol cut its prices for three cargoes of Angolan crude, with offers cut for two of the consignments for the second time this week. Vietnam’s Binh Son Refining sought to buy sweet crude for March delivery including Nigerian grades. Prices cut by 30c/bbl for each of the three cargoes compared with offers on Jan. 4; Dalia and Girassol cargoes reduced in price for the second time this week. Chevron offered 1m bbl of Nigeria’s Pennington crude for Jan. 23-Feb. 2 delivery to Rotterdam or Augusta at Dated +$1.30/bbl: trader monitoring Platts window. Drops from +$1.85/bbl on Dec. 30.” The weak kick off to the year provided an incentive for KSA by assuming- I don’t want to get into a knife fight over cargoes- so we will let the market clear and the glut to lessen before we increase volume. We have highlighted how China typically sees purchases rise in Nov and early Dec as they prepare for Lunar New Year. This year is also unique with more Chinese refiners coming online and import quotas rising. With new facilities and higher quotas, there was a big push to purchase crude as we headed into the new year. What have we seen over the last few weeks: Physical price weakness in the marketAsia’s Lunar New Year coming up- Feb 12th (celebrations take place between Feb 11th-26th)An extension of lockdowns or renewed lockdowns in Europe/ North America/ Asia Rapid builds in refined products with more cargoes sloshing around The concerns over the market could have driven KSA action, but the large voluntary cut opens the door for others to pick up market share. Russia has been slow to sell Urals into the Chinese markets with limited demand in Europe as well. The reduction of KSA volumes could help move additional Russian volumes- “Chinese refiners skipped purchases of Urals crude again in December. Shipments from Europe might resume this month after Unipec bought the Russian grade in a tender. China last bought Urals for October loading, according to ship-tracking data and port-agent information compiled by Bloomberg.” By pulling crude off the market, other crude grades from Middle East nations and Russia will see support. The biggest buyers of oil remain refiners and with tight/negative margins and crack spreads- the rise in prices with slowing/sluggish demand will only make things harder. A demand trap is being created as we have feedstock prices rising and outpacing where global demand sits. We see the builds increasing in the US/ Europe/ Singapore while demand disappoints year over year. KSA isn’t helping their clients by cutting volumes AND increasing OSPs (official selling prices) as refiners struggle to clear the glut of refined products. The rising feedstock price (oil) will push prices at the pump higher, which is hard given the limited demand in the market already. Refinery margins have already been terrible, and with refined product storage either near or at seasonally adjusted highs- refiner utilization rates will stay depressed. The rise in oil prices- will ensure they remain well below seasonal norms. This would be a good thing if we saw refinery utilizations stay low AND big draws coming from storage, instead we have utilization at near record lows in the US/Europe/Korea as builds remain the norm. By cutting barrels and sending barrels higher, the US will find more opportunity to send crude into the global market. Saudi Arabia increased shipments into Asia in December, which was above y/y and close to the 2020 high in April- when the price war/OPEC disagreement showed up in the market. The following months showed a big reduction as OPEC+ reversed the increase in production and cut to OSPs. The additional shipments in Dec were delivered to Japan and China, but the continuation will be short lived with Japan experiencing a spike in cases and reducing total activity and China celebrating Lunar New Year- they took a chance to reduce total volumes China has just shut down a city of 11M people in Hebei in an effort to contain the biggest COVID flare-up in months. These type of scenarios will continue while the various vaccines work their way through the global population. Japan is talking about stopping international travel to kick off the year, and now China is experiencing a potential outbreak of COVID as floating storage and onshore storage remains at multi-year highs. It may be a strategic decision to let the market absorb the crude floating and provide support for prices as we gear up for summer driving season. Japanese Confirmed Cases and Deaths High-Frequency Data for Japan The increase in KSA OSPs is inline with historical averages with the price increases falling right around average spreads, and even with some of the cut in prices- those remain well above average. Even as production is reduced, KSA has the ability to maintain or at least support exports through their storage position around the world. Since this is a voluntary cut, it can also be reversed if they see a different outcome by selling additional volume from storage (maintaining exports) and replace it later with an increase in production. Regardless, this will hurt refiners further and cause bigger problems going forward as other regions take advantage of the reduction in supply. We are already seeing a rise in North Sea crude that is at a 3-year record of 2.11M barrels a day with “Seven cargoes of BFOET grades traded on the Platts window, the highest number in at least 12 years, according to Bloomberg calculations. Unipec bought four. Glencore and Vitol also purchased cargoes.” Norway is now approaching the highs from 2010- 1.757 with the current February schedule of 1.721M barrels a day. “Loadings of 13 main North Sea crude grades are scheduled to rise to 2.11m b/d in February, the highest in more than 3 years, thanks to record shipments from Norway’s Johan Sverdrup.” Middle East Super Light Crude Saudi to Asia OSP Spread vs Average Oman/Dubai FOB Middle East Arab Light Crude Saudi to Asia OSP Spread vs Average Oman/Dubai FOB Iraq and Russia remain the biggest cheaters in the OPEC+ deal, and while there have been pledges and commentary on making up cuts- it is unlikely they ever come to fruition. Iraq has kept up their export push with another 5% increase in Dec topping their target again. Nigeria has taken initiative to cut with Jan and Feb being below their allocated target of 1.516m barrels a day. They are also seeing less demand for their crude with discounts off of their OSPs increasing, so the cut is definitely timely. A big question will be how UAE reacts to the roll over because they have wanted to increase production, which also resulted in them producing well over their allotment at a point last year. They cut further the following month to make up for the breach in the agreed production amount, but the UAE was not happy about it and made sure to make that known in the Dec meeting. Now with KSA cutting flow- it could open an opportunity for the UAE and Kuwait to increase some exports and capture new market share. The ones to watch in Feb/Mar will be Russia, Iraq, and UAE to see what flows start doing given the pressure each country is under on a balance sheet side of the crude equation. If you don’t comply with the cuts, there has been nothing but “strong words” and “false promises” but no penalties for failing to comply. US FRAC SPREAD UPDATE The U.S. frac spread count fell 26 spreads from the peak on Dec 11th of 159 to close out the year at 133 across the lower 48. Our initial view was that it would take 4-6 weeks to see 26 spreads get reactivated as E&Ps were going to be a bit slower to bring activity back to the levels seen prior to the seasonal holiday slowdown. As WTI prices approach $52, the ability to hedge at north of $50 has increased through the first half of the year and by over $10 from 3 months ago based on the below curve. The price increase and potential to hedge will help support activity that was expected to be muted through Q1 and even Q2 as E&Ps took a “wait and see” approach to OPEC+ and COVID/ vaccine data. Now that Saudi has voluntary cut 1M barrels a day starting in Feb and we will only see a decreases of 925k barrels a day in Feb and 850k barrels a day in March, U.S. E&Ps will be quick to reactive spreads from the holiday slowdown. We expected to see the Permian and Eagle Ford quickly recover the 5 spreads reduced into year end, but it would take time to see the other 20 or so spreads get activated across other regions as some of the reductions normally persist through Q1. For example, the Bakken normally sees a holiday reduction, which typically persists until Feb/Mar when the weather starts to improve. Appalachia and Haynesville also see reductions that remain throughout the first two weeks of the year, but with LNG exports remaining robust there will be a pick-up in Haynesville activity. The increase in pricing will pull forward more activity throughout Texas. US FRAC SPREAD UPDATE The concerns around Biden and fracking are rising especially as it relates to drilling on federal land. We have started to see additional activation in the Delaware basin, especially on the side New Mexico, as concerns around federal land restrictions and new laws surrounding water rights. In some spots, new water sales will be restricted once the existing water rights expire causing prices to increase for fracking as water will need to be trucked to the site. The biggest pressure on a Biden administration isn’t so much a direct ban on fracking but making the process expensive or difficult to carry out. This will limit new activity and put pressure on the industry. This will pull more activity forward into Q1 as companies look to utilize the existing water rights and federal permits within New Mexico. The Midland recovered quickly off the lows, and the biggest growth spot for new spreads has been the Delaware which is unlikely to change in Q1. This will push Permian spreads well into the 80’s by month-end, and the Eagle Ford back above 20. Here is a breakdown of Federal Land in the US and basins: Appalachia will be able to hold about 12 spreads and will see about 1 or 2 spreads activate fairly quickly, but the bigger question marks will be the DJ basin and Bakken. With the new price deck, we expect to see the Bakken shake off some of their normal seasonal slowdown at add at least 2 spreads over the next 14 days. The DJ basin will see activity increase slightly, but it isn’t likely to see a big spike over the next 4 weeks as budgets are still tight and pivot to other areas. The Anadarko is likely to see at least 1 spread activate given the strength in the NGL and liquids market as demand and exports continue to outpace expectations. Over the next two weeks, we expect to see 10-15 Permian spreads, 5-7 Eagle Ford, 1-2 Bakken, as well as 1 Appalachia and Haynesville. The key metric to watch will be the amount of spreads located in the oil basins with the key number ranging between 130-140 in order to hold production at the current levels. The legislation in Colorado has now put the setback requirement on 2k feet, which shouldn’t impact too many locations. With fresh capital and limited viable DUCs in the region, many of the companies located in the region also have other basins- mainly the Permian attracting the lion share of capital. This will push DJ activity down and will likely be the only area to see a reduction in total spreads. The current dynamics in the market will keep U.S. crude exports at a fairly steady 2.6M- 2.8M barrels a day over the rest of Jan. U.S. crude has had a steady bid heading into Asia- especially Alaskan Northern Slope. With Brent trading at $54.36, U.S. crude grades can still make their way into the market but tanker rates are starting to rise which will carry some pressure on the spread between Brent- LSS and Brent- MEH. The Brent-LLS spread at $1.28 and Brent-MEH at $1.58 is starting to get a little tight, and will need to open up by another $.25 if we keep seeing tanker rates run higher. This is the initial range we have been talking about reaching when the LLS-Brent spread was sitting at about $.80. The whole front of the curve has shifted up that has pulled more crude out of storage given the backwardation. The brent time spread is back in backwardation by $.06 after the OPEC+ meeting occurred, but as physical prices slowed in Dec the spreads fell back below $0 and into contango. The demand situation remains an overarching problem with lockdowns extending and refiners maintaining reduced runs. The U.S. has seen an increase of exports into China- especially as new facilities come online and liquids demand grows throughout Asia. The below chart highlights why Russia was so concerned about cutting volume and providing a pricing incentive for US activity. The U.S. has seen a huge surge since fracking became a much bigger part of the energy mix. Shale has continued to expand from 2016, and we found the level where U.S. production saturated the market. The light/sweet market isn’t big enough to absorb 13M barrels of US crude, but at 9-10M there is a healthy market that will be worked out over the next 24 months. The below is a great breakdown of how the production growth has looked overlayed with OPEC+ and COVID actions. Brent Crude Prompt Time Spread WTI CRUDE CURVE US LOCAL SPOT CRUDE PRICES COVID IMPACTS RISING COVID in the U.S. is moving higher again following the holiday season and the rise in testing, which is driving new highs in daily cases- while the trend in hospitalizations moves in the wrong direction. The pressure on the economy is mounting as unemployment remains elevated just as hours worked are falling (new decline in payrolls for Dec- which will worsen again in Jan). As oil prices rise (driving up feedstock costs for refiners), prices for gasoline and diesel are also pushed up even though demand isn’t responding, and storage remains well above seasonal norms and near all time highs. Inflation is already increasing in key markets segments that will have impacts to consumer spending given the pressure on real wages and jobs. Gasoline prices (while still cheap) is climbing higher, and given prices reflect Brent (last incremental barrel) pressure remains to the upside. The move by KSA of voluntarily cutting 1M barrels a day of supply has pushed Brent back to about $55 even with demand remaining soft. Gasoline demand has slowed into the beginning of the Jan, and with new lockdowns in the UK and Japan, with extensions in Austria and Germany so far. The U.S. has maintained some form of restrictions that is being dictated by states, but the consumer has already adjusted following the holidays with the normal “lull” extending to the downside and taking longer to normalize back to the free holiday point. The Lunar New Year in Asia will cause demand to slow, but the case counts rising in Japan and South Korea is causing some sporadic lockdowns and restrictions that will slow demand as well. The below chart helps to show the run up of activity into the holidays for some and the steep drop off as economic activity slowed for the last 2 weeks of Dec. Some countries didn’t see the normal run up due to lockdowns and other restrictions, but the bigger focus is- How quickly can we return to the pre-holiday economic levels. January is usually a slow month as companies and workers all gear up for another year and budgets are double checked and starting to be deployed. The important piece of information to watch will be the slope of recovery as jobs slow across the board and prices (inflation) ramp up for things people purchase. So far- countries haven’t been able to get back to the pre-Holiday slowdown, but the real test will be where does Feb start off. Leading indicators are pointing to some strength in the economy, but the employment side of the equation remains lackluster, which remains the biggest concern. New orders and exports are in expansionary territory, which support further increases in industrial production- but it isn’t resulting in more employment. “The ISM services index followed its manufacturing peer in besting the consensus forecast, printing 57.2 versus a forecast of 54.5. Unlike the earlier survey, however, the reflationary messaging was not uniformly positive. New orders rose to 58.5 from 57.2, with export orders surging notably (57.3 from 50.4). But employment slid below 50 again (48.2 versus 51.5 in November) and the prices component, while remaining elevated, dipped slightly (64.8 versus 66.1).” The pricing component in both leading indicators are pointing to another move higher in inflation as we price increases are moving through the system. The bottlenecks in the system are also pushing the numbers higher as we see a wave of delays throughout the whole supply chain. The supplier deliveries (shipping delays) have helped drive the number higher to 60, but when we back that out- it is still positive- but closer to 55. The number points to a continue in industrial production/ manufacturing, but it hasn’t resulted in additional jobs given the data breakdown. “However, the survey also highlights how manufacturers are now not only facing weaker demand conditions due to the pandemic but are also seeing COVID-19 disrupt supply chains further, causing shipping delays. These delays are limiting production capabilities as well as driving producers’ input prices sharply higher, adding to the sector’s woes. “Firms nevertheless remain highly positive about the outlook for the year ahead, anticipating that vaccine roll-outs will help drive a further recovery in 2021, although some of November’s post-election exuberance has been tamed by the recent rise in virus case numbers, suggesting the near-term outlook will remain challenging.” Depending on the data set, we have employment sitting between 48-52, which is right where things are holding steady at very low rates. This is increasing total productivity per worker but keeping new hires flat, which we are seeing in the recent data from ADP and from Federal payroll data. We are also seeing participation rates down across the board as people “leave” the workforce without a means of getting a new job. People are also turning to pandemic unemployment insurance as their other options start to expire. The total people receiving some sort of benefit remains over 19M, and this is also coming with less states reporting due to the holiday season. We will see some bigger jumps in January as people who did not file show up for their benefits and states backfill missed reporting. The total participation rate remains well off normal levels even when we look back through previous recessions. There was also another wave of layoffs that took place in December, which will be followed up in Q1 based on the current high frequency data points. I can’t stress enough how important it is to look at the hours worked and the employees working across the US- especially as we see inflation data move higher. Real wage growth remains muted in comparison to price increases, and this was happening BEFORE COVID- so what is currently occurring is exasperating an already problematic situation. The state recovery tracker was trending lower as we headed into year-end. So far, the bounce from the holiday slump has been muted as companies have limited personnel and maximizing current employment levels. When COVID first started, we said that jobs were going to become more of a leading indicator because the pandemic was going to be the “excuse” companies were going to use to shrink the work force. It is difficult to let someone go… there are normally protocols. There needs to be a pattern of underperformance, a warning, a plan of correction with milestones, and if those are unattainable- the individual losses their job. When a company cuts a whole division or group, it has to create a financial reason where they are underperforming or missing targets or any other number of reasons. But in a pandemic, the excuse becomes much easier and limits the potential for lawsuits when you can just say… sorry- COVID. This has enabled many corporations an easy out to reduce total staff. We said that on any recovery- companies were going to be slow to hire back furloughed employees and for every 100 employees let go- we expected 30% to be hired back in 2020. If we keep seeing an expansion through Q1, there will be another 20% brought back but we are still well below the starting point of COVID. Outside of companies shrinking their employee base, we also have industries that have seen a wave of bankruptcies that will never open their doors again. This puts more people into the unemployment pool to compete for less jobs. The lack of employment opportunities will push people to get more competitive on salaries and accept reduced compensation. The reductions puts pressure on real wage growth, but as people are earning less- the market is seeing an increase in prices as inflation moves higher. Many commodities have all shifted higher as well as underlying costs rise, and many corporations pass through price increases. This is shifting inflation expectations higher, which we can see in both the US and Europe. The lack of jobs, pressure in real wages, and rising costs will limit the amount of discretionary capital consumers have in order to purchases goods. Our main concerns with global GDP growth remains with the consumer. A struggling consumer will also limit the amount of travel and consumption, which is why we see additional pressure on gasoline demand getting back to normal levels. There is a lot of hope placed on vaccine logistics and people getting back to normal once we reach the “herd immunity” levels. Many of the people who moved from urban to suburban settings also purchased cars to go with the new home. Even with these purchases, miles driven remains well below the 5 year average and other recessions. As we have the shift into a suburban setting, there remains a growing demand for a permanent shift in working from home. The pivot to home is happening in both the US and Europe based on the current data available, and each new release of information shows a growing demand for a blended schedule form both the employee and employer. A blended schedule will reduce the amount of people driving to work, because in the US, many people were already driving to work vs taking mass transit. The increase in WFH will reduce daily miles driven and offset the shift to the suburban setting. But many of these individuals/families moving into the suburbs are realizing they still have access to Amazon prime, door dash, uber eats, fresh direct, and other online services. This means their normal purchase patterns don’t have to change and help the delivery services optimize their routes. The UPS/ FedEx/ USPS truck is going to pass your house everyday- whether you ordered something or not. So the rise in online ordering, will just put more packages on the truck that is already driving by you, and this will increase trucking demand as their logistic system will be moving more packages- but it will reduce gasoline consumption and optimize routes. There are many layers to the population shift- especially as more people move out of high tax/ congested regions and into more open space. Gasoline consumption also increases when you are idling in stop and go traffic versus being in areas that have less congestion. There are many shifts and layers to the movements of refined product demands, and it will take time to really see the long-term shifts in consumption across diesel and gasoline. My view is that gasoline consumption normalizes at the low end of the 5-year average and diesel demand remains flat as we are currently seeing a massive utilization in trucking. The bigger issues that are underpinning the current problems in everyday society remains the lack of social mobility and inequality. This exists on both sides of the aisle and is pushing people to lash out in the worst way possible- violence, trashing national monuments, even (as of recently) storming capital hill. This has been created over the course of the last 20 years as we tried to stop the business cycle and supported firms/banks that were “too big to fail”. Now we are sitting with a record amount of zombie companies, record setting unemployment, and a global economy that is sputtering at best. I did a show on social mobility and inequality (came out today- 1/8). The underlying problem is the lack of mobility in the US and the growing inequality that is expanding as we hinder the natural progression and rebirth of the economy and social advancement. Without a natural rise and fall of failed industries/businesses- we are left with misplaced anger that lashes out, and in the extremes, becomes civil war/ revolution. The "natural" economic cycle limits bloodshed and allows for hard work and ingenuity to be rewarded. If a company fails- it can enter bankruptcy and if it is viable will be financed- if not- it is liquidated and enables for another (more efficient) business to replace it- rewarding those that practice SOUND BUSINESS PRACTICES and not criminality and corruption. By stopping the cycle- we inflate bubbles/ protect zombie corps/ suck the lifeblood of ingenuity that caps mobility and increases the spread of inequality. Monopolies are created and white-collar crime runs rampant as corrupt business practices are rewarded. The bubbles are being inflated and stimulus issues in order to cover up the growing cracks in society and the economy with liquidity. This is the narrative being created to hide the failed government/ fed/ banking businesses practices, and it will keep growing until China lashes out and we redivert our attentions to a common enemy that is "external" instead of "internal. Inequality/ social mobility thru history has been "corrected" by allowing the progression of the business cycle and when it is withheld under the guise of any "ism" war/ conflict ensues- internal or external is a matter of generational dynamics and geo-political underpinnings. When we look throughout history, revolutions/ civil wars erupted to adjust the inequality that expanded over time, but as economies became bigger and more advanced- we had natural adjustments in the business cycle. This provided opportunity without the need for blood shed as the natural cycle created opportunities and potential advancement. The problems on a global level are vast, but fixable- but withholding the business cycle and protecting corporations that squandered cash and leveraged balance sheets to carry out buybacks should be pushed into bankruptcy. The bond holders should have known the risks they were taking when they were purchasing paper that had no tangible asset behind it, and instead was going into a financial swap of stock for debt. The new issuance wasn’t going to a factory, assembly line, R&D to create innovation, but to purchase stock at insane valuations at or near all time highs. If we increase the hurdle rate and clean up balance sheets- we can start the long process of healing and adjusting the insane skew that has been created in society. [/ihc-hide-content]