[ihc-hide-content ihc_mb_type="show" ihc_mb_who="10,13,14,16,18,19" ihc_mb_template="1"] By Mark Rossano SUMMARY US Activity UpdateNGL Pricing, Storage, and FlowsPhysical Crude Markets & Crude Demand Implications with Rising COVID CasesOnshore & Offshore Shifts in Crude StorageChina Data Weakness & What Their Debt Loads Mean for GrowthInflation Off to the Races: Emerging Market Issues to Persist (Especially as Rates Move Higher)What to Expect at the Upcoming OPEC+ MeetingWe Provide a Geopolitical Update Here- More to Come in the Next Report: https://www.youtube.com/watch?v=y_wpmeAAngo US Activity Update The national frac spread count jumped to 220 last week after several smaller basins saw a jump in activity. We expected to see additions start in Cherokee, Fort Worth, San Joaquin, as well as the other regions, but all the activity came at once with many of them opting to start 2 spreads. There is normally a seasonal bump that kicks off in April/May, but with commodity prices remaining strong- there was a pull forward of more activity. Many of these regions normally see 2 spreads active, so the current 220 should be the near term high in completion activity. We will see 1 of the spreads drop off in some of the basins while some of the other region Ardmore, Arkoma, Green River, and San Juan pick up 1 or 2 spreads as activity fluctuates back and forth. Based on the timing of the additions, we could see another 5 spreads added to the national number- but it will be difficult to maintain that level of activity over the near term. We will absolutely see more activity around the country, but the recent trend will shift to see more rigs activated with spreads holding steady over the next few weeks. In 2017, the national spread count had a 4-week rolling average of 288 on the National level, but the key difference is in the underlying basins. We have already exceeded the numbers in the Permian with current activity sitting at 115. The natural gas basins won’t see the same level of activity as in previous cycles given associated gas levels, but also general efficiencies that have been achieved. What we will need is additional rigs to replenish some of the reduced DUC inventory- especially in the Bakken and Eagle Ford. We will see completion crew additions in the Bakken, but the rig additions should outpace in order to build out running room. At the current pace, the Williston will keep seeing declines unless we see some additional capacity starting up in the area. We should see DAPL stay in operation through the new environmental review, so that will alleviate some near-term pressure and bring back spreads closer to seasonal norms. The Permian (Texas in general) will remain the biggest driver of activity, but the strength in the liquids market will keep spreads busy in more liquid’s rich areas as well. We are going to see the Permian remain robust, but the pace of additions will slow in order to let the market digest the current run rates. The bigger shift now over the next few weeks will be a steady rise in the rig count, while frac spread count additions slow. We normally see a fairly steady increase in activity into the summer months, but the speed of additions will dissipate, and smaller basin work will fluctuate. This will keep the national number around 220 and pull the 4-week rolling average much closer to 220. As we get into May, we will start to see some additional work commence in the Permian & Bakken, which will keep driving us closer to 250 spreads on the national level. As we head into May/June, pricing pressure will start to come back into the market as firms rush to hire and purchase spare parts to get equipment ready for field work. We are on track to have 250-275 spreads operational in the U.S., which will push us to oil production levels of about 11.5-11.7M barrels a day. We are so far tracking closely with the 2017 pace (rate of change), and based on underlying pricing- we will see steady additions just at a lower rate. The trend is clearly up, and I expect to us match pace with 2017. Primary Vision National Frac Spread Count Seasonally adjusted We are currently seeing a big spike in crude focused spreads as E&Ps look to capitalize on pricing, while also addressing the lack of activity last year and arrest decline curves. U.S. production has fallen from the high achieved in Nov 2019 of 13.1M barrels a day (or EIA official 12.86m) to about 11.1M barrels a day. We won’t be pushing back to the highs, but the below spread splits and above completion activity will be enough to not only stabilize production but also start adding production. US spreads have done little to incentivize more flows into the international markets as Europe and Asia demand remains under pressure. Flows of refined products have started to move from the Middle East into Europe, but the movement of US products will stay relatively weak over the near term. Brent vs LLS has moved into a wider spread to $2.36- which should be enough to open up more flows, but anytime we see a movement in US prices the Urals bucket prices at a steeper discount. The Brent vs MEH spread is now at $3.75 as the adjustments in the physical market remain fluid. India was expected to issue another tender for June-July loadings in WAF (mostly Nigeria), but with COVID ravaging their country- there still hasn’t been a third tender. At this point, India purchased about 13M barrels for June-July to be preemptive, but now with the issues in their country- some of these cargoes are being considered for resale or deferral. The market to watch will be WAF because cargoes in the region keep building up, which is also pushing more cargoes into the Middle East. The shifts in the market are real with cost inflation all over the supply chain, which is being complicated by some countries experiencing a rise in COVID19 cases and others in the early stages of reopening. There is a significant amount of liquidity sloshing around the system that cost inflation is still in the process of going from the company to the consumer. European imports of oil products from the Middle East, mostly middle distillates, are set to jump to a six-month high in April with a sharp pick-up in flows to the U.K., France and Italy. 29 tankers hauling 2m tons of Middle East refined fuels are due to arrive in Europe this month, the most since October, according to ship-tracking and fixture data compiled by BloombergThat includes 19 ships that have arrived so far with 1.3m tons, plus another 10 tankers that are en route with 694k tonsCompares with 884k tons that arrived in March aboard 14 tankers, the lowest monthly total in a year NGL Pricing, Storage, and Flows The liquids market remains supportive with the arbs opening up to Asia with demand being strong across the petrochemical, industrial, and local consumer. Arab gulf prices still remain at seasonally adjusted highs, which is keeping U.S. exports in solid demand. Some prices have come down off the highs, but we still remain at the strongest position since 2018. The uplift from the NGL and condensate bucket will provide a boost to well head economics, which will persist throughout 2021. The lack of refinery utilization rates is limiting feedstock for petchem facilities, which is keeping them active in the market. “Steam cracker operators at petrochemical plants in Europe and Asia are facing a dilemma over which feedstocks to use, according to Energy Aspects Ltd. Propane is now much cheaper than naphtha in the spot market, and in the front month. Warmer weather in the Northern Hemisphere and Saudi Aramco’s “healthy May loading schedule for LPG cargoes” are among factors that pushed down propane prices relative to naphtha.” The shift in economics will keep a strong bid for propane, but naphtha demand still remains strong even as some facilities have opted to switch some parts of the slate. Mont Belvieu Frac Spread (NGLs Pricing Basket) BFV/EU Propane CIF NWE Cargo vs Naphtha CIF NWE Cargo Spread M1 North American Spot LPG Propane Price/Mont Belvieu LST North American Spot LPG Normal Butane Price/Mont Belvieu LST North American Spot Purity Ethane Price/Mont Belvieu non-LST The recent data out of the EIA from both storage and exports remains supportive of LPG flows into the international market as well as local pricing within the U.S. Storage is running above 2017, but we believe the pace of builds will be close to 2017 levels. Frac spread counts have started to increase in liquid heavy regions, but we are still well off normal levels as exports remain supportive of keeping storage seasonally adjusted low. The arb into Asia remains supportive- especially with Arab pricing at current levels. As India and Japan face renewed lockdowns, it is actually supportive of LPG because more people will be home and consuming LPG for cooking and general residential usage. LPG was the first to recover and never saw the same degradation in demand like gasoline, diesel, or jet fuel. DOE Propane & Propylene Storage in the US The flows into Asia may see some slowdowns, but the general trend will remain robust and keep flows either above seasonally adjusted highs or at least near highs. As we pivot into summer demand, we should see builds remain below the 5-year average as exports and local demand remain well above average keeping pricing elevated. The plastic market will remain strong with housing and industrial usages staying robust, which will be supportive of ethane pricing over the rest of the year (at least). This will keep ethane rejection relatively low, as companies look to recover more for the petchem side. We have always gotten a very strong ethane supply response when demand rallies, but the demand will stay elevated throughout 2021 (and likely beyond) that will keep prices supportive of recovery. We don’t see a big spike in ethane prices, but the supply/demand backdrop will keep margins fairly healthy in this region. DOE Propane & Propylene Exports from the US Physical Crude Markets & Crude Demand Implications with Rising COVID Cases The physical market has seen some price appreciation over the last few days after Libya announced a force majeure out of the eastern part of the country. Hariga has announced FM, which is impacting about 200k barrels a day of exports. “Agoco operates the larger 200,000 b/d Sarir and Mesla fields, along with the smaller Hamada, Nafoora, al-Bayda and Majid — for a total production of around 280,000 b/d, according to NOC and Libyan sources.” The risk continued to widen as another 100k barrels came under fire after: “Sirte Oil, which can produce around 100,000 b/d, said it was unable to fulfil obligations to its contractors, and had accumulated financial debt and a shortage of spare parts.”[1] The new O&G minister agreed to pay about $232.5M to the NOC in order to settle the funding dispute and reopen some of the ports. It is unclear so far if the money will be enough to placate the subsidiaries and smaller companies to keep crude flowing to the coast. Prior to the issues over payments, Libya was producing about 1.28M barrels a day and exporting around 1.15-1.2M barrels a day. There will be enough production and crude in storage to maintain the current level of 836k, and we should see the country reach about 1M in May- but if we see prolonged cuts to production exports will remain close to 800k barrels. So far, this appears to be more of a tactic to secure additional capital during the budget negotiations happening in the newly elected government. The new government will need money generated from crude exports to help finance the rebuilding process after 10+ years of civil war. A big part of that will be investments into oil assets that have been ignored for an extended period of time. The goal was set to reach about 1.8M barrels by the end of the year, which won’t be achieved without investment across the whole supply chain of Libya’s assets. The next incremental level of production is possible with limited investment, but in order to achieve their goals of 2.5M barrels a day it will take significant investment and time. The cut in Libya flow sent some underlying physical prices higher in Europe with Urals seeing a bit of a rally. Prices are still firmly negative, and still within the ranges we have been highlighting over the last several months: Chevron offers to sell 1m bbl of Nigeria’s Pennington crude on DES Rotterdam/Augusta basis for June 7-13 delivery at $1.13/bbl more than Dated Brent; performing vessel Almi Explorer: person monitoring window. Dips from $1.28/bbl on Wednesday Total bought 100k tons of Urals for May 4-8 delivery from Vitol at $2.70/bbl less than Dated Brent, CIF Rotterdam: trader monitoring Platts window Compares with -$2.30 for previous deal on April 21Total has bought eight cargoes of Urals so far this month on Platts window Sonangol offered 950k bbl of Gimboa crude for June 29-30 loading at parity to Dated Brent, according to a price list seen by Bloomberg Sonangol allocated seven term cargoes to Sinochem, and three to Unipec, said traders with knowledge of matterSonangol owns 15 crude cargoes for June loading; it’s unclear whether remaining 4 cargoes are term or spot cargoesGunvor offered 100k tons of Urals for May 2-6 delivery at Dated -$2.35/bbl: trader monitoring Platts windowVitol offered 100k tons of Urals for May 4-8 delivery at Dated -$2.30/bblGrade last traded at discounts of $2.30, $2.40 on MondayVitol offered 100k tons of Urals for May 4-8 delivery at $2.25/bbl less than Dated Brent, CIF Rotterdam: trader monitoring Platts windowGrade last traded at discounts of $2.50, $2.55 on April 16Litasco sold 85k tons of CPC Blend to BP for May 5-9 delivery at - $3.25/bblTraded price of CPC was the lowest since April 30, 2020Chevron sold same amount of CPC to Petraco for same dates at -$3.20/bbl Russia will export a total of 15, 100k-ton cargoes of Urals crude from two Baltic ports from May 1-10, according to a partial loading program seen by Bloomberg. The volume is higher than 12 cargoes a month earlierLoadings from Primorsk will be seven cargoes May 1-10, unchanged from a month earlierLoadings from Ust-Luga at eight cargoes, vs five for the first 10 days of April Surgut sold 4 cargoes of Russian ESPO crude for June loading at a premium of about $2.10-$2.40/bbl to the Dubai benchmark price, according to traders who asked not to be identified. Surgut sold three June-loading cargoes at $2.30-$2.40/bbl premium in last reported transaction of the same gradeSpot differentials of Russian ESPO climb $1/bbl vs last dealRongsheng Petrochemical Co. came to the market early this month to snap upabout 7 million barrels of Middle Eastern varieties for June-July delivery. That’s up from 5 million barrels bought in March, and puts it on course for the biggest monthly purchase since October, according to data compiled by Bloomberg. Sales of CPC Blend have picked up recently since the grade plunged to one-year low of $3.25 discount last week: traders involved in the market Spot price discount has narrowed to about $2.60/bblAsian refiners have bought about 7 Suezmax cargoes of CPC Blend for May loading so far We have seen some appreciation in pricing for Urals, but still well below normal with ESPO starting to see some additional interest as Chinese refiners prepare to come back from a deep turn around season. The remaining turn arounds are expected to end by mid-May so they will be purchasing now for cargoes to be loaded at the end of May. This has brought some activity back into the market, but weakness has crept into some other Middle Eastern grades on top of West African cargoes still very slow to clear. India has recently been a big buyer of cargoes from West Africa, but the massive spike in COVID19 cases and lockdowns have hindered refinery run rates. India’s Mangalore Refinery and Petrochemicals Ltd. has cut oil processing rates and will likely have to make an unplanned shutdown at one of its crude units as a deadly second Covid-19 wave pummels fuel demand.The company reduced its refining capacity by 15% to 1.1 million tons in April and could trim rates even further next month, according to a person familiar with the matter, asking not to be identified as the information isn’t public. The rapidly spreading virus has already had an impact on demand, with fuel sales from the largest retailers sliding during the first half of this month.India’s healthcare system is buckling under the strain of the virus resurgence, which has led to renewed restrictions in some areas. Refiners were forced to slash crude processing last year after the first wave led to a national lockdown and plummeting fuel consumption, filling storage tanks. MRPL may be forced to cut rates to 900,000 tons in May, down from the typical average of 1.3 million tons, the person said. We expect to see another 200k barrels to be cut in the very near term with more downside expected across the complex. All forms of refined product demand have gotten hit hard with more downside expected in the gasoline complex. Diesel never recovered back to normal consumption, so the drop won’t be as aggressive in that area. Gasoline will see the largest set back, and given the rapid spread of COVID and limited vaccine availability- we are still expecting exponential growth of the spread that will hinder driving and consumer behavior further. The activity across India, South Korea, and Japan have come under pressure with lockdowns expanding in India and Japan. So far, there hasn’t been any official South Korean lockdown proposed, but the consumer is adjusting behaviors with reductions across all forms of activity. Japan will extended the state of Emergency with India also seeing a 7 day lockdown in Maharashtra with more expected over the coming days. “Consultant expects more Indian states will implement partial or even full lockdowns as Covid-19 cases rise, according to report. The 10 states facing the highest risk account for 66% of Indian gasoline and 62% of gasoil demand Gasoline demand may be hit by 100k b/d in April and 170k b/d in MayGasoil demand may be reduced by 220k b/d this month and 400k b/d in the next” The net impact is expected to be about 550k barrels a day in May, according to consulting group FGE. CHANGE IN NEW COVID CASES The renewed lockdowns have pushed India to pull back on their crude purchases as well as extended deferrals and re-offers. West Africa was already struggling to clear cargoes across Nigeria, Angola, and Congo. Nigeria was a big seller into India, while Angola sold some spot cargoes into the market as well. China coming back a bit will help pull some Angolan/Congo cargoes into the market, but they still remain slow so the build up of unsold cargoes will create a spike in floating storage in the region. “The price of crude grades that typically yield more fuels such as diesel are starting to weaken in Asia ahead of an increase in OPEC+ supply and amid faltering Indian demand due to a deadly coronavirus wave. Iraq’s Basrah Heavy crude for May loading was recently sold at a discount to its official selling price for the first time since early 2018, according to data compiled by Bloomberg. That compares with a premium of more than $1 a barrel just two months ago.” State oil marketer sold 1m bbls of Basrah Medium crude for May 29-31 loading at about a 30c/bbl premium to the grade’s OSP, said traders who asked not to be identified. Last month, SOMO sold an April-loading cargo of the grade at a premium of 60c-70c/bbl in a tender Iraq has been looking to increase flows, which has pushed some prices down in the region as Murban block trades are increasing out of the UAE. China saw some increases in run rates as state owned refiners have ramped up, but the government is cracking down on Independent refiners (Teapots) for running at elevated rates. This is a tactic that China has used in the past when demand is weakening, and they want to cut run-rates to protect margins at state-owned facilities. We are already seeing state-owned assets ramping following turnarounds, but China needs to make room for the assets and will force teapots to cut runs further. Onshore & Offshore Shifts in Crude Storage Onshore and offshore storage remains elevated across the system with more ships inbound, and more cargoes heading into the Chinese markets. Exports of refined products remained elevated throughout March, and we had some curbs at the beginning of April that have now accelerated to close out the month. As refining assets ramp back up in China, we will see a big increase in exports across the Asian complex- especially with Japanese assets still down due to an earthquake and fire shuttering some units. Japan made a decision in the early 2010’s not to invest in upgrading refining assets to meet the new Café Standards because they believed there would be enough product in the floating market at reasonable prices. Japan also decided that some refining capacity was important for national security, so utilization rates will remain low but some facilities will stay operational for the foreseeable future. It was a similar breakdown in Australia after one of three remaining facilities decided to close. The damage to Japanese assets will limit their crude imports, which will be made up for by additional cargoes going into the Chinese markets. Japan will turn around and take down some of the exported products from China over the next few weeks. China Crude Oil Imports China Diesel Exports China Gasoline Exports China Shandong Crude Stocks China Shandong Fuel Oil Stocks Asian Floating Storage China Supertanker Crude Imports Activity remains a headwind across Asia on the refined product consumption front, but exports-imports will stay strong- especially outside of Chinese markets (more on that later). General mobility is starting to roll back over in the rest of Asia, while Europe sees some recovery in the region. Europe toll road miles have started to dip again, which will cap some of the upside in the near term. The bigger issue will be the slowdowns in the rest of Asia that will limit total demand and expansion of crude demand. India will limit new crude purchases that will leave cargoes in the market and keep pressure on physical crude pricing. Chinese data dumps point to some slowdowns that will limit near term economic expansion. China Data Weakness & What Their Debt Loads Mean for Growth China data remains skewed by year over year comps that provide a solid base effect, which is also starting to drive many data sets to extremes. It is important to look at month/month (to address trend) as well as normalize against 2019 figures to gauge total economic movements. Chinese GDP slowed Q/Q to .6%, which is moving growth in the wrong direction. “Normal” growth from Q4 into Q1 is typically around 1.55%- so not only are we way off base, but the pressure is mounting in key facets of the economy. China Q1 GDP on a Seasonal Chart We can also break it down across 2020/2021 levels to “normalize” the data and compare it to 20129. The first quarter of 2021 was 10.3% higher vs the 1st Q of 2019 for an average growth rate of 5% over the last 2 years. The GDP growth for 2019 was 6%, so that means we are currently running about 1% below the targeted rate from 2019. The bigger issues are the composition of growth that has perpetually been financed with significant debt expansion. China has been trying to drive local investment and consumption, which was NOT the “high-quality” growth that drove this number- it shrank in this period. The limitation on targeted growth meant that almost 200% of last year’s GDP was represented by things that the PBoC and CCP are trying to limit- such as property lending. China added new debt equal to more than 33% of GDP in order to achieve nominal growth of 3% last year. Put a different way: last year was terrible for debt and non-productive investment, but it was the only way to generate some form of GDP growth. China Economic Data China Retail sales The above data points provide a breakdown of recent economic points of interest out of China, but they also are skewed by the easy comps of 2020. Retail sales for Q1 were up an annualized 4.2% from the first Q of 2019, which is showing a slow down in retail sales by lagging GDP by 2% points. This is confirmed by the Q1 residential income data, which grew by an annualized 4.6% vs the 1st Q of 2019- which also lagged GDP by over 1%. The Chinese economy has been moving in the wrong direction, and with the PBoC and CCP looking to limit the expansion of debt- we will see headwinds to underlying growth. Beijing will look to take advantage of directed consumption (Dual Circulation Strategy), exports and business investment (tied to consumption and exports) to force a sharp cut in growth in investment in infrastructure and property so that they can achieve GDP growth this year of 6%. The goal is to achieve this expansion while keeping the debt-to-GDP ratio steady (which still requires adding new debt equal to roughly 20 percentage points of GDP). China is off to a weak start in trying to curb loans: New bank loans in China rose more expected in March from the previous month due to strong corporate and household demand, as the central bank walks a tightrope between supporting the rapidly recovering economy and containing debt risks. Chinese banks extended 2.73 trillion yuan ($416.62 billion)in new yuan loans in March, up from 1.36 trillion yuan in February and exceeding analyst expectations of 2.45 trillion yuan, according to data released by the People’s Bank of China (PBOC) on Monday.That pushed bank lending in the first quarter to a record high of 7.67 trillion yuan, according to Reuters’ calculations based on central bank data. It beat the previous peak of 7.1 trillion yuan in the first quarter of 2020, when policymakers began rolling out unprecedented measures to deal with the shock from the coronavirus crisis.The surge in loans has led to worries among authorities, with financial regulators telling banks to trim their loan books this year to guard against risks emerging from bubbles in domestic financial markets, sources told Reuters last month.Despite the March surge, growth in outstanding yuan loans eased to 12.6% from a year earlier compared with 12.9% in February. Analysts had expected 12.6% growth.“I personally believe social financing is a more important gauge... its growth rate is at a relatively low level (for March). If it continues to slide, the contraction in credit looks pretty evident,” said Hao Zhou, senior economist at Commerzbank.Growth of outstanding total social financing (TSF), a broad measure of credit and liquidity in the economy, slowed to 12.3% in March from a year earlier and from 13.3% in February. The spread between SOEs and private firms interest rates continue to move higher: EM Inv Grade OAS/Duration vs. Rating The issue is being exacerbated by local governments struggling throughout large parts of China (especially rural regions- hence the importance of rural reform). It is important to point out that China will make policy pushes mandatory months if not a year earlier before they will admit to an underlying problem. Any China watcher has known of the growing issues in the rural communities, which has been blown open by the COVID19 pandemic. Part of the COVID19 relief efforts allowed the central government a mechanism to transfer fiscal funds directly to local governments and bypass provincial authorities. The central government has decided to make it permanent – and make it larger. Even as China records “growth”, many local governments are under fiscal stress and the government is looking at long term solutions- IE Rural programs. The central government has budgeted RMB 2.8 trillion for direct transfers this year, up 65% from last year’s RMB 1.7 trillion. At Wednesday’s meeting, Premier Li Keqiang reminded his colleagues what the money's for: Offsetting the impact of the removal of some 2020 support policiesSupporting employment and local businessesFunding basic services like healthcare and educationPaying salaries for local government officials While money is being pushed down the system, the tax shortfalls will remain in the system requiring China to borrow more from the global market. This is why the issues at Huarong are such a big issue- because the confidence in their bonds have been hit hard. Four banks were created during the Asian Crisis to handle bad debt at banks by consolidating the assets and finding ways to either restructure, securitize, or sell-off in order to clean up balance sheets. The CEO Lai Xiaomin was executed for his roll in leveraging the company up- especially in the offshore bond market by over $20B, which doesn’t include the onshore leverage. These 4 companies received preferential treatment internally with the best rates/ projects because they are mostly owned by the Ministry of Finance (the largest being Huarong). The PBoC has so far agreed to assume $15B worth of assets in order to clean up the balance sheet. This would alleviate some underlying pressure, but there still remains some extensive issues with the underlying debt that still remains in the market. The bank (like many in the country) also has perpetual bonds that are owned by other banks that also have the same fixed income assets circulating. This is just a glimpse of the contagion that is in the system, and points to the bigger issue of connections in the whole system. The current events in China have widened spreads in the market and leaves firms with less room to maneuver, and with the authorities dialing back credit growth- it will be difficult to grow. The refinancing rations fell to 112% in 2020 (lowest since 2018) and has remained below 120%. It has gotten harder to roll over debt, and now the debt being rolled is at a higher rate vs previous. “A default at a central state-owned company like Huarong is unprecedented,” said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group. Should one occur, he said, it would mark “a watershed moment” for Chinese and Asian credit markets. Along with three other bad banks, Huarong swapped delinquent debts for stakes in hundreds of big SOEs and, in the process, helped turn around chronic money-losers like the giant China Petroleum & Chemical Corp. Will the Chinese government stand behind $23.2 billion that Lai borrowed on overseas markets -- or will international bond investors have to swallow losses? Are key state-owned enterprises like Huarong still too big to fail, as global finance has long assumed – or will these companies be allowed to stumble, just like anyone else? The PBoC can’t let any of these companies fail because the borrowing at all government levels (central/ provincial/ local) are going to be held constant year over year as they attempt to pull more liquidity out of the market. This is being achieved by reducing available Remimbi through the short-term window and by adjusting the peg. There is still more work to do as the CNY still remains massively overvalued in the market, but the PBoC is trying to make adjustments slowly to not spark more inflation fears. PPI is rising around the world, and China is no exception so the devalue of the currency is trying to be done on a very controlled basis. The below chart shows the roll over of M3- but the pace of adjustments has slowed as the PBoC contends with the rising rates in the region. Even as the M3 adjustments ease, the pace of commodity purchases will pare back and some pricing will start to adjust a bit. The adjustments in the Chinese debt market have also shifted credit impulses that will be a headwind for commodity prices over the next few quarters. China has financed their expansion with easy credit that was used for projects that failed to not only provide a rate of return but didn’t even cover the initial investment. Provinces and local governments have been forced to use tax revenue to cover the shortfalls in the infrastructure/industrial projects that were mandated over the last decade. The Special Purpose Bonds (SPBs) were used to keep the merry go round going, but over the last 5 or so years- the project options have degraded and left many governments holding the bag. The slow down in credit will directly slow some of the rise in raw materials that we have seen over the last few months. The below also shows the slow down in foreign holdings of Chinese government bonds- it is still strong but the new money flows have slowed. The pressure on spreads will keep new fund flows capped, and put additional pressure on Chinese bonds. China has also increased their purchase of treasuries by a small amount, but as they contend with controlling inflation expectations and trying to devalue their currency slowly- the additional collateral helps in the process. This is also important as the fear of bond defaults remain elevated with more expected to come throughout Q2. Inflation Off to the Races: Emerging Market Issues to Persist (Especially as Rates Move Higher) India has also been looking to find ways to counter inflation as data from the country shows how it is pushing to the upper band set out by the RBI. The range has been set at 2%-6% and it came in at 5.52%. The rise of COVID19 in India will be a problem for monetary and fiscal policy as GDP comes under pressure and the ratios of debt-to-GDP worsen due to the level of spread and infection. It is unlikely we get another national lockdown, but we will see rolling city/states going through 7-day periods of restrictions. It is likely they could be extended as India continues to set records on new infections, which are only the ones that were tested for vs what is probably actually happening per day. I am not surprised to see this level of gold buying as India will continue to experience inflation pressure. The growth of non-performing loans is another key problem that India is grappling with among other Emerging Market countries. Russia has opened up their Sovereign Wealth Fund and raised rates to help counter some pressure, but India is trying to maintain dovish monetary policy and fiscal stimulus. The problem remains inflation, rising non-performing loans, and spreading COVID19. A key topic we have been addressing over is the rising inflation pressure throughout the supply chain. PPI (Producer Price Index) has pushed higher around the world, which will lead to higher prices as more companies look to recover their rise in prices. Raw material prices are up across the board as are shipping costs with delivery delays throughout the system. The problem we face today in the US- we have been exporting inflation for decades now as we pushed our manufacturing to the lowest bidder. The last decade was a push to become “asset light” and “at-time-deliveries.” This reduced overhead and total costs at the corporate level enabling them to reduce inventories throughout the system. Now we are paying the price from a stressed supply chain that is seeing shortfalls from labor to underlying supply. COVID19 has created a problem across mines, ports, ships, and factories with limited labor available to carry out the necessary job to move products through the system. The stretched labor force is also starting to crack demanding higher wages and better conditions for the work they are carrying out. This has led to residual shortfalls as strikes shut down mines/ports or create worker led slowdowns. Input price across the board have been a huge problem, and with import/export prices pushing higher- the pressure will remain across the system for at least the rest of 2021. Just as an example, US march import prices rose 6.9% (highest since Jan 2012) as export prices rose 9.1% (highest since Sept 2011) on a year over year level. If we adjust it and look at the trend month over month, the pain also continued with import prices up 1.2% and exports up 2.1% as the trend higher remains consistent. Around the world- we have seen PPI beat estimates around the world and reflect the rising raw material, shipping, and delivery costs. The problem now is the rising unfilled orders and inventory issues that are spreading throughout the system. The semiconductor shortfalls are a constant in the system being caused by shortages of materials, water, and heightened demand. The supply side remains a constant issue- especially in products that were once “deflationary” such as technology and hardware. The PMI data for the U.S. came in red hot surging to various records across key pieces of the internal metrics: U.S. IHS MARKIT APRIL FLASH MANUFACTURING PMI AT 60.6 (VS 59.1 IN MARCH) U.S. IHS MARKIT APRIL FLASH SERVICES PMI AT 63.1 (VS 60.4 IN MARCH) U.S. IHS MARKIT APRIL FLASH COMPOSITE PMI AT 62.2 (VS 59.7 IN MARCH) "Average cost burdens continued to rise in April, as higher fuel, wage, shipping and PPE costs drove inflation. The rate of increase softened slightly, but was still one of the fastest on record. The rate of charge inflation quickened, however, as stronger client demand allowed firms to pass on a greater proportion of hikes in input prices to clients." "The IHS Markit’s composite gauge of prices received rose to a record in March. Supplier delivery times at manufacturers were the longest on record.” The problem is the supply chain isn’t going to fix itself any time soon, and now the prices are being passed on to the consumer at an accelerating base. So the question turns to the consumer: When do they reject higher prices? At what point do we see the consumer throttle back spending because prices have gotten to a point that requires an adjustment to spending. The problems are hitting many aspects of life from the essentials (food) to used cars and everything in between. The market is sitting at an uncomfortable position with prices still heading higher based on the international data point while stimulus keeps pouring into the U.S. and global markets. We are coming to a point of “pause” in the rally of some of these data points- but while they will stop going up- we don’t expect a pull back in price. This will keep inflation moving through the system as prices are passed on further to the consumer- or a transfer from prices paid into prices received. Bloomberg Grains Subindex What to Expect at the Upcoming OPEC+ Meeting The OPEC+ meeting should be a “non-event” with the current rise in production is held steady for another month. I don’t think they will adjust anything in the near term due to COVID19 spreading in Asia and remaining sticky in parts of Europe. Saudi Arabia needs to get their crude back into the market after making the voluntary 1M barrels a day production cut. They have been selling more out of storage in order to balance out flows against the drop in production. OPEC+ will officially hold a full ministerial meeting in addition to the monitoring committee- they were initially talking about “downgrading” the meeting to just the monitoring group. May production shouldn’t be adjusted, but there could be some caution talked through on June-July increases depending on how long COVID19 risks remain in Asia. I don’t think any of the expected ramps will be adjusted at this point. It is also important to point out that Saudi Aramco is exploring a potential sale of upstream assets. So far, it has been limited to “fringe” regions and not the core production regions, but KSA needs new money in order to invest in expanding production in the region. It could also be a valuation game to see if the stock is trading at a discount in the market. “Crown Prince Mohammed bin Salman, the kingdom’s de facto leader, told business executives last month that Aramco and the energy ministry are working on an “ambitious program in upstream and downstream” that’s bigger than previously-announced plans. The push could involve additional spending of 500 billion riyals to 1 trillion riyals ($133 billion to $266 billion) over the next ten years, he said.” Exxon is currently looking to sell a stake in Iraq’s West Qurna-1 oil field, and KSA may want to get in on the discussion to get a sense of valuation. An important factor when looking at global crude demand and supply is the spare capacity sitting at OPEC. The last time we entered a “super cycle” was in 2009 when OPEC spare capacity averaged about 1.7M barrels a day. Instead- we currently sit at about 8M before we even consider what is sitting behind the gates in Iran. A valid counterpoint to the current spare capacity is the view that at the end of OPEC raising production levels- there will be much less capacity sitting behind an artificial wall. The levels below still ignore Iran & Libya, but they have been exempt from the deal at the outset- so this is just looking at a more normalized view of capacity. We remain cautious on the demand side as we attempt to cover weekly in our EIA show to demonstrate a stalling of recovery that is reverberating throughout the world. India has now posted its second consecutive day of 300k+ new COVID cases, and it is unlikely we will see an adjustment in the near term as vaccine roll outs struggle to accelerate in Asia, Europe, and the Emerging Markets. India is a vital piece of the pharmaceutical supply chain as creator/ assembler of many drugs the world consumes daily. India was a key piece of the puzzle to get vaccines to Emerging Markets and Europe, and with the rise in cases- will they start to limit exports? Will they have to curb manufacturing to manage their own lockdowns? Global supply chains already remain stressed to a breaking point, and the rise of COVID in a key place will reverberate through the system. India was supposed to see an acceleration of exports over the next few months, but we have already seen expectations cut and more to come. This will keep COVID19 around longer vs what the market expects. [1] https://www.argusmedia.com/en/news/2207879-libyas-oil-ministry-authorises-noc-funds-in-budget-row?backToResults=true [/ihc-hide-content]