[ihc-hide-content ihc_mb_type="show" ihc_mb_who="10,13,14,16,18,19" ihc_mb_template="1"] By Mark Rossano We don’t have much to report on when it comes to U.S. activity. Completion activity will remain on a steady growth rate on track to hit 235 spreads over the next 2-3 weeks as we have some more activity coming in Texas and additional crews picking up in the Williston. The U.S. is still well below historical levels across basins outside of the Permian and TX-LA-SALT, which remains elevated with more activity forthcoming. The gas basins don’t need the same level of activity to maintain growth, while the Bakken will need a pick-up to stem decline curves. There will be another pick-up in activity come Q3 as the majors and large independents bring back drilling and completion programs. A large portion (almost 78%) of activity has been driven by private companies. July will begin some larger programs that will bring more rigs and completion crews back to the market. The physical market remains disconnected from the paper markets as Asia imports remain well below normal and product exports accelerate from the region. There have been additional builds in both crude and products across the system, which has resulted in more deferrals in Nigeria, Congo, and Angola. Russia has seen a pick-up of sales into both China and the U.S’s PADD 5, which has helped tighten pricing from the April lows. “Asia’s crude imports in May were provisionally assessed by Refinitiv Oil Research at just 23.07 million barrels per day (bpd), down from 24.54 million bpd in April, 24.79 million bpd in March and February’s 25.2 million bpd. China is estimated to have imported 10.03 million bpd in May, up slightly from the official customs outcome of 9.86 million bpd in April, but below March’s 11.69 million bpd. India’s imports were estimated by Refinitiv at 3.90 million bpd in May, down from 4.46 million bpd in April. Gasoline sales plunged by 19% in May from April, while diesel consumption dropped by 19.9%, according to data compiled by state refiners.” The shift in Asian consumption is resulting in pressure on differentials in the market as countries struggle to clear loading programs. Observed flows of North Sea crude grades to Asian customers fell to a seven-month low in May, according to port agent reports and ship tracking data compiled by Bloomberg. A combined 12.6m bbl, or 406k b/d, of North Sea crude was shipped to Asia last monthThe daily volume was the lowest since October; it compared with 467k b/d in April and an average of 645k b/d for the first quarterChina will receive 2.6m bbl, the lowest since August; South Korea and India 2m bbl each; the remaining 6m bbl will go to unconfirmed Asian destinationsMay flows to Asia include 12m bbl of Johan Sverdrup, 600k bbl of FortiesSales of Republic of the Congo’s Djeno crude are slower than normal, with no trades yet of any July-loading cargoes. Nigeria plans to defer three cargoes of Brass crude from June into July.All six cargoes of Djeno crude planned for July are unsoldNOTE: A month ago, three out of seven cargoes for June loading were soldOne June shipment also unsoldAbout 14 cargoes of July-loading Angolan crude are left to sell out of 32 shipments planned. That’s a relatively steady pace of sales for a typical monthTwo to three cargoes of Angolan crude for June-loading are still seeking buyers out of 37 shipments scheduled Drops from 5-6 on May 21Sonangol reduced offer price for a third spot cargo, of Dalia crudeThe 950k-bbl shipment for July 17-18 loading now offered at 35c/bbl more than Dated BrentDrops from +50c/bbl on May 20Nigeria plans to ship 81k b/d of Brass crude in July compared with a revised tally of 44k b/d for JuneJuly’s plan includes three cargoes, all of which are deferred from JuneNOTE: Cargo sizes vary from 610k-950k bblReason for delay not known; some shipments from several other Nigerian grades also delayed from June to July Glencore offered Brent for June 20-22 at Dated -60c/bbl, FOB: trader monitoring Platts window Compared with -45c for its previous offer on Tuesday Glencore sold Brent to BP for June 20-22 loading at Dated -50c, FOB: trader monitoring Platts window Increased buying from China and India helped to push observed Urals flows to Asia to a one-year high in May. Shipments from Russia’s Pacific ports to the U.S. rose in May to the highest level since at least January 2019The U.S. was the second-biggest destination for Russian Pacific crude last month, overtaking Japan and South KoreaUrals strengthened in late May after trading in April at the lowestin about a yearThe grade traded on Platts at $1.65/bbl below Dated on May 28It had traded at a discount of $2.80/bbl in late AprilObserved flows of Russian Urals crude to Asia rose to a one-year high in May as China and India increased purchasesMercuria bid 100k tons of Urals for June 25-29 delivery at Dated -$1.35/bbl: trader monitoring Platts windowPrice is the highest since Feb. 9, compared with -$1.65 for previous trade on May 28 Demand from China’s teapot refineries for June-loading Suezmax cargoes seems lukewarm as most of them are looking for cargoes for August-September delivery now: traders It normally takes 5-6 weeks for Suezmaxes to reach China from the Black Sea Flows from WAF have been hindered with discounts still not enough to move cargoes. There has been a shift now in crude quality demanded with some of the Russian cargoes finding more favor vs the WAF/LatAm grade. This is pulling up urals while leaving other grades at steeper discounts to find a buyer. We are reaching a point as we reach Urals at $1.50 below dated brent that WAF cargoes will move in great quantities. The U.S. has seen spreads tighten with LLS vs Brent tightening to $.22, which keep flows heading into Europe. Instead- this will pull more Middle East, Libya, and Russian cargoes into the mix. MEH vs Brent is at $1.66 both of which are the tightest we have seen in over a year. This will limit total flows of U.S. crudes into the market, as we are seeing imports increase into the U.S. The U.S. has maxed out the light end of feedstock, and in order to increase runs in PADD 3- the runs will have to get heavier. This will result in more imports heading into our markets, so now we will have a steady rise of refined product and crude imports into the country. Oil imports will rise into PADD 3 and 5 (with PADD 2 remaining elevated from Canada) as refined product imports maintain elevated imports into PADDs 1 and 3. We have already seen a steady flow of product, which is increasing as product shifts end points from Europe and into the U.S. markets. “U.S. imports of gasoline from Europe rose to their highest in three weeks for the seven days ending May 27, according to bills of lading and ship-tracking data compiled by Bloomberg. Gasoline imports increased to 460.8k b/d, the highest since the period ending May 6Transatlantic refined fuel flows from Europe, mostly gasoline and blending components, climbed to 3.51m tons in May Compares with 3.49m tons that sailed aboard 91 tankers in April, according to fixture reports and tanker tracking data compiled by Bloomberg. For June, 10 tankers have sailed so far with 363k tons, plus an additional 19 tankers have been provisionally booked to load 749k tons in the coming days. More cargoes likely to emerge for this month. Distillate Imports Gasoline Imports All of them are trending higher as storage levels and product in transit shifts higher. Asia and the Middle East have been pushing more product into the market, which is showing up in storage and flows into the Atlantic Basin and Pacific. The shift in China policy (in the near term) will result in more fuel oil being exported and a drop in some gasoline/diesel exports. This will result in additional run cuts out of Teapots to make way for some increase in runs for state-owned enterprises. The shift is being done to make way for SOEs and forcing the smaller independents to cut utilization rates. It will also shift oil flows as China will require less crude (cut runs) and push more light-cycle and bitumen into other regions. Asian flows are going to see some sizeable shifts across India, Singapore, Malaysia, China, and South Korea (and smaller level in Japan) as product and crude flows shift. It will shift crude flows with some increases into Chinese SOEs and less into teapots as more product that normally flowed from Southeast Asian nations into China heading into other markets or just cutting total runs. The U.S. is also struggling over a narrative problem with the constant view that pent up demand is going to surge into the market. The below chart shows the “Google Searches” for re-opening activities as they peaked April 25th. The activity has cooled off as we have seen a steady rise in prices across the board, but some of the data has been skewed by the Colonial outage and normal seasonal bumps. We still have several states recording over 10% gasoline stations with outages, which has kept the implied demand numbers elevated- though they have started to normalize. There remains a significant amount of speculation in commodities that have been baking in a big inflation surge while bonds have been dismissive of the pressures. I think both asset classes are wrong and it falls somewhere in the middle- bonds have priced in too little as commodities have priced in too much. We are seeing the slowdown in Asia, which typically leads the U.S. on activity parameters. What we continuously monitor is U.S. activity vs historic norms factoring in seasonality. As the chart shows above, we normally see an increase in activity, but as Colonial flows normalize further- gasoline demand will show something closer to 8.9-9M barrels a day of demand. The below charts help to show how we are coming to a peak in speculation and pricing. We have shown in previous reports how credit impulses have already fallen hard, and China has focused on trying to reign in prices as well as liquidity (more on that later). The U.S pricing pressures didn’t stop this past month and are heading higher again on the back of rent/mortgage costs as prices continue to pass through to the consumer. Input prices have flat lined and should remain flat over the near term as other pressures roll through such as delivery delays and freight costs. Another big factor that is coming back into the mix is wage costs, which had a big step up over the last few weeks. The rise will be muted as we have now seen some shifts in employment and underlying production as the delivery delays force temporary manufacturing pauses and furloughs. Here are some charts that reflect the recent shift lower in not only production but also in employment. They are both in expansionary territory, but employment has fallen very close to the 50 level which just means it is more just treading water vs actually expanding. ISM respondent: “The continued global supply chain tightness and raw material shortages from the Gulf make it less likely that any business can recover this year. Demand is strong, but what good is that if you cannot get the materials needed to produce your finished goods?” The biggest drivers of the beat remain supplier delivery times that isn’t a positive contribution to the underlying market. The increase in ISM new orders, just below 17-year high & longest delivery times since 1974, indicate manufacturers continue to struggle w/supply shortages, shipping delays & difficulty finding skilled labor. ISM May prices paid eased from highest level since mid-2008. We have now seen a record in delivery time delays: As for future production, the highest reading on record for order backlogs (70.6 vs. 68.2 prior) and lowest for customer inventories (28.0 vs. 28.4 prior) point to factories playing catch-up for an extended period, a positive for momentum in the coming months and quarters. Though significant inventory build is unlikely over the short term as demand soaks up supplies, the transition from stock depletion to accumulation will, over time, add to GDP. Past cycles, and the current extreme for customer inventories, is shown in the chart below. The increase in inventory will happen over time as companies and customers see “some” recovery in inventory allowing them to be a bit more price sensitive. Right now- everyone is a price taker because we have a record shortfall in inventories- especially when compared to underlying sales to inventory ratios. It is resulting in a big drop in inventories but also a big rise in the backlog of orders as companies don’t have the capacity to fill orders. The backlog, inventory shortfalls, and price taker setup is resulting in output prices pressing right back to the all-time high levels. In the next section, I go through India/China just showing how this is all going to remain in the system given we are still at the early stages of it moving throughout the system. This is existing in deliveries across raw materials, semi-finished, and finished goods. Based on the underlying issues, we will see the problems persist over the next few quarters: As the “final numbers” for U.S. inflation pinned to the highs and well above the Fed target rate, the next wave will be in the housing/ rent increases as labor costs are just starting to emerge as another pressure point. We haven’t seen much in terms of wage pressure, but the latest jobs data saw a big spike in total costs which will get passed through the system. This will also provide underlying support for inflation in consumer prices as house inflation moves higher as well. “Although employment remained well short of normal, numerous other signs were more characteristic of a very tight labor market. Job openings are at record levels and in March the quits rate was at a historic high. There were 1.0 job seekers for every vacancy, still somewhat less tight than the pre-pandemic labor market. In addition, wages for production and nonsupervisory workers rose 0.5 percent in May, an increase that likely understated the true increase in wages because of the addition of lower-wage workers in sectors like leisure and hospitality. Holding the industry composition constant, wages grew by 0.6 percent, or 7.2 percent at an annual rate, making composition-adjusted wage growth in April and May faster than in any pre-pandemic two-month period since the early 1980s.” These are typical pass through items, but the rise in furloughed employees as manufacturing will be a headwind as the service sector drivers higher. On the other side, house inflation is up and out: Home prices +13.2% y/y in March according to S&P CoreLogic Case-Shiller National Home Price Index10-City Composite +12.8% y/y (+1.1ppt)20-City Composite +13.3% y/y (+1.3pt)10th month of accelerating home pricesHighest since Dec 2005 There has been a steady rise in rents across all major metros: As all of this is priced into the system: U.S. risk of stagflation. Core PCE prices increased by 0.7% in April with annual core PCE inflation rate up to 3.1%, a multi-decade high. Real consumption fell by 0.1% in April. We are watching prices go higher as “real consumption” falls as stimulus dries up and we see some normalizing of savings- especially in the lower quartiles. The inflation story is about to heat up again with another round of price increases on a global level. It is important to look across the supply chain and how other growth markets will be impacted by the rising inflation. When we consider political and social stability, the food and agriculture is very important because there are few things people will go to war over and food is one of them. With shortages persisting throughout the world driven by droughts, shipping, and rising demand- the price of grains has a lot of support throughout this planting cycle. The lack of rainfall reduces underlying yield by starving the crop of water, but it also reduces river levels hindering the movement of barges and ships that have to be ladened with less product to match the falling water line. Yield is under pressure after a late frost as well that hindered early crops and resulting in potential shortages. The delays at ports and limitations on available ships is also hindering the flow across the ocean. This is resulting in additional rot and grains lost at port or in transit. All the while demand is going higher after a very weak 2020 that saw crops destroyed by locusts, army worms, droughts, floods, storms, and shifts in meat production. Various outbreaks of swine and bird flu resulted in total losses taking food off the market. There is a counter point saying that it resulted in less feed, but that is something that only lasts for so long as people are priced out of the available meat and move down the food chain. It typically moves like this: Beef, pork, chicken, soybeans, corn, wheat, and lastly rice. The flow of most expensive to cheapest and as groups of people are priced out of one area they move down the chain. The rebuild of pork and chicken is fairly quick, but the impacts to people’s spending have been exacerbated by price increases and wage compression. The meat production costs have risen with feed costs so even as volume returns to the market- the costs haven’t come down to the same degree. This is resulting in more inflation and general price increases across the system. The last time we had a spike in pricing in 2010-2011 kicked off the Arab Spring. As people can’t afford food and governments are forced to cut subsidies protests and uprisings accelerate. The pricing pressure is going to mount as countries have maxed out fiscal and monetary policy in order to stimulate economies following COVID19. This will put more pressure on the underlying consumer and create more strife and frustration. It will take time for this to build up as we saw anger build throughout 2010 culminating in 2011 uprisings. Instead, we have already seen protests and grain silos being raided due to broad shortages in the market. Instead of easing in this cycle, we are coming to a point that Emerging Markets and even some Developed markets will start tightening (at least) monetary policy to avoid a runaway inflation backdrop. Emerging markets are running hot and well above the range laid out by the local central banks. The tightening cycle will start to accelerate as central banks look to bring some of the excess liquidity back under control. This has played out in China with additional cuts in underlying liquidity that we will talk about more in a few paragraphs. It is not very likely that we see ANY type of ECB changes as Europe comes out of the last lockdown as the central bank looks to provide excess support on the reopening. The PEPP purchases have also accelerated allowing member nations to borrow more and provide additional fiscal stimulus. This has played out the most within Italy as Germany faces an election in 2021, and France has seen a bit of a slowdown across key metrics and what is shaping up to be a pivotal 2022 election. The ECB has increased their PEPP purchases with the elevated level likely to remain in the system over the next few months at least. India is facing a rise in prices across their whole system that will keep flowing down the supply chain impacting the recovery on the other side of the recent COVID19 spike. Rising prices exist throughout their whole supply chain with a large portion of it still sitting at the upstream and midstream/processing side of the cycle. These costs will be passed down the supply chain through rising prices to the local and international consumer. The consumer good is still fairly cheap vs where costs sit because many of these rises were delayed due to COVID and local economic pressure, but as the economy starts to reopen- there will be an acceleration in rising prices. We have already seen that in gasoline and diesel prices that were just shifted higher again setting a new record. “Transportation fuel prices in India continued with their upward streak, with state run oil marketing companies (OMCs) raising petrol and diesel prices in the backdrop of a rally in global crude oil prices. With state run OMCs raising petrol and diesel prices by 26 paise per litre and 23 paise per litre respectively in Delhi on Tuesday, petrol and diesel was selling at record highs of ₹94.49 per litre and ₹85.38 per litre respectively in the national capital at Indian Oil Corporation Ltd's outlets. India is particularly vulnerable as any increase in global prices can affect its import bill, stoke inflation and widen trade deficit. India spent $101.4 billion on crude oil imports in 2019-20 and $111.9 billion in 2018-19. It is a key refining hub in Asia, with an installed capacity of over 249.36 million tonnes per annum (mtpa) through 23 refineries. Indian Oil Corporation recently said its capacity utilization, which had reached 100% in last November, has come down to 84%, as states across the country have imposed lockdowns. Energy consumption, especially electricity and refinery products, is usually linked to overall demand in the economy.” This is just one key input across the vast system as India consumes a significant amount of diesel across its industrial complex from powering facilities to moving products around the country. The rise in the country will keep pressure on the local and foreign consumer. The consumer food inflation level will begin to see upward pressure as companies look to recover the underlying cost increase: If we look further back up the supply chain again, at the manufacturing input cost vs finish good inflation- these highlights what will slowly be passed on to the underlying consumer. The raw materials, labor, shipping, and ancillary costs are all higher with more pressure behind it that will send prices up further. Freight rates are also staying elevated due to the global shortages keep pressure on the underlying shipping market. The moving averages help to highlight just how strong recent increases have been in pricing vs just looking at the year over year. The goal is to minimize base effect and look at the underlying trend that is showing a strong price response that has yet to be fully implemented down the supply chain. “The three-month moving average of manufacturing input inflation (month-on-month SAAR) surged to 28.1% in April 2021 from 5% in February 2020. In contrast, year-on-year inflation stood at 17.4%. Since August 2020, retailers seem to have absorbed the rising inflation in finished goods rather than passing them on to consumers. The three month moving average of consumer goods inflation (month-on-month SAAR) eased to 4.6% in April 2021, from 7.7% in August 2020. Over the same period, the three-month moving average of finished goods wholesale inflation (month-on-month SAAR) rose to 9.3% from 2.4%.” The pressure on pricing is also coming at a time of slowing PMIs (Purchasing Manager Index) across Asia. In the U.S. and Europe, we have seen rises across the PMI levels but a large part of that has been driven by pressure in pricing and underlying shortfalls on delivery times. I will expand on that in a moment. PMIs have been slowing month/month as countries face rising COVID19 cases that have hindered local movements as well as pressure on underlying contributors. Costs continue to rise as employment declines and supply delivery delays rise resulting in a slow down at the manufacturing level. Many companies are running short on the inventory side resulting in prolonged delays and temporary shuttering of production lines. Trade is also starting to slow down a bit while still remaining elevated, but more along the lines of just coming off the highs we have seen the last few months. Supply chains have moved additional pieces of the supply chain out of China, but the adjustments take time providing some tailwinds to Vietnam, Malaysia, South Korea, Japan, and India while China faces a decline- making the local consumption shift all the more important. China has been open the longest out of any country and is still facing problems internally across consumption. President Xi and the CCP has been targeting internal consumption drivers under the Dual Circulation Strategy but have failed to see any meaningful recovery of local spending across all income levels. Pressure has been mounting since the 2019 surge, which was driven by tax incentives and other forms of mitigating against trade war fall out. As we progressed through 2019, things began to normalize and fell through the “normal” running rate. This was only made worse by COVID19 that has yet to see any meaningful recovery and is still running well below pre-COVID levels. Retail sales are trading below the pandemic levels even though we should have seen an “increase” following aggressive marketing and sales that occurred throughout April and May. The miss so far makes things all the worse given the fact that corporations and the government have been aggressively trying to shift the tide. Instead, the local consumer still remains cautious as inflation also hits their wallets and underlying problems throughout the country are pulled to the surface. The consumption patterns have hit all aspects of life with limited desire to spend remaining across the Urban and rural setting. The lack of spending, slow business growth, and tax cuts carried forward are limiting tax receipts as more tax revenue is being used to support previous borrowings. The pressure is mounting as the government tries to limit new issues to help reign in the debt levels and stabilize liquidity. By doing so, the PBoC needs to keep key avenues for cash injections that circumvent pre-COVID channels to limit red tape and speed distribution. “Chinese local government financing vehicles sold the least amount of domestic bonds last month since 2017, as new stock-exchange approval rules tightened deal activity. May’s 88.9 billion yuan ($13.8 billion) of issuance, just one third of year-earlier levels, followed a record 2 trillion yuan of sales during the first four months of 2021 as companies acted to meet a wall of maturities, according to data compiled by Bloomberg. Investor appetite remains weak due to record bond defaults in China, meaning last month’s sluggishness may continue, said Vivian Li, head of fixed income at HSBC Jintrust Fund Management Co.” Bond default fears remain elevated as the country faces more bonds coming due and needing to be refinanced. Local and provincial governments are facing cash shortfalls that are being supplied by the PBoC cash injections but it really isn’t sustainable as the amount of debt keeps mounting. Local government financing vehicles have been pulled back under control, but only with spare cash flowing down through the “temporary COVID cash pipelines” that have been left open. The concern has grown over the last few months as the Huarong debacle remains a huge overhang on the debt markets. Bond prices have come under pressure as rates are pushed higher across private and state-owned enterprises resulting in higher interest rates and underlying expenses. The government is focused on trying to reign in inflation fears and bond rates by providing underlying support. Chinese regulators are putting ever more pressure on property developers to constrain the debt needed to fund their activity. As the article points out, "real estate contributes to about 29% of China’s economic output if its wider influences are factored in, according to a joint research by Harvard University and Tsinghua University". And Beijing is right: the fact that the debt associated with this kind of investment has been rising so much faster than its GDP contribution over the past 10-15 years is prima facie evidence of malinvestment. The amount of bad investment in Chinese infrastructure and property easily overwhelms the amount of investment that can be productively absorbed by the high tech sector or other parts of the economy, even if we assume that there are no frictional costs (above all politcal costs) to engineering such a shift. But if over a 10-15 year period the debt is associated with a sharp rise in the country's debt-to-GDP, as has certainly been the case with China, then the debt funding these investment projects must be rising faster than the associated increase in debt-servicing capacity. The off-balance sheet debt that has been climbing over the years has been a key target for the PBoC to pull excess capacity out of the market. The pressure is all coming as PMIs slow or at least pare back from recent spikes as the underlying data continues too worse. A recent surge in prices for raw materials such as iron ore, crude oil and coal sent the subindex for input prices to 72.8 in May, the highest level since November 2010, while output prices notched up a record-high reading of 60.6, according to Monday’s PMI data. But not everyone gains from the higher input costs. Total new orders retreated to the lowest level in a year as fewer bookings from overseas markets pushed new export orders into contraction territory, the statistics bureau said. Chinese exporters were also under pressure from the yuan’s rally, which makes Chinese goods more than expensive in the global markets. Financial regulators said in a meeting last week that the yuan won’t be used as a tool to support exports via depreciation or contain imported inflation via appreciation. Monday’s data showed larger manufacturers performing better while a subindex tracking small enterprises fell into contraction, below the 50 mark. Another big underlying problem for employment and underlying consumption is the struggle for small and medium sized corporations that are seeing outsized pressure vs state owned and large enterprises. The unbalance economic backdrop is a key reason the CCP is trying to support or at least provide tax and other benefits to smaller entities. [/ihc-hide-content]