Primary Vision Insights – June 30th, 2021

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By Mark Rossano

SUMMARY

U.S. Completions NGL Update U.S. Job Market Deep-Dive

U.S. Completions

U.S. completion activity continues to move along the lines we have laid out with last week coming in at 235 active spreads. There will be another increase this week as activity picks up in some of the other basins (non-Permian). We expect to see another pick-up in the Williston, Western Gulf, and some of the fringe basins. Anadarko will also attract activity as the NGL basket pricing, exports, and storage supports additional activity in the region. The pace of rigs will accelerate in July (already started) as DUCs are replenished or at least held constant after working through inventory over the last year or so. The Permian will see some additional activity over the next 4-6 weeks, but we are getting close to full utilization in the region and to bring back other spreads will require a higher price and time to repair/replace equipment and hire new labor. The trend of additions will be higher, but the pace of additions will be slower- especially when compared to rigs.

Spreads in the U.S. for crude have tightened to the point that it makes sense to pull crude from the coast and push it into Cushing. We have seen spreads flip to almost $.25 from MEH into Cushing with some others promoting storage vs exports. The flows of imports have increased, and we see that accelerating as we progress into July. Refiners (especially PADD3) need a heavier slate of crude that U.S. shale can’t cover, and as they push to 92%-94% utilization rate imports of heavier crude will have to increase to meet the demand. There has already been a steady flow from Russia, ME, and increasing from WAF. Refiner crack spreads have turned firmly negative in Asia and Europe, which will keep their operations muted and leave cargoes in the water. Angola still hasn’t sold out July, which will be one of the first times in a long time (I believe the last time was ’08) where Angola kicked off the loading month with cargoes still to sell.

According to Kayrros, Chinese oil inventory sits at 974.2M barrels, which is the same level it was at in June 2020. In Jan of 2020, China was sitting on 860M barrels- so we are still not seeing a meaningful draw down from China’s storage. China kicked off the year with 1.017B barrels in storage so it has worked through 43M barrels over 5 months to get back to the “worst” part of the Chinese lockdown. Now we have the OPEC+ deal unwinding, a cut to China teapot quotas by 35%, and new levies on light-cycle oil. We are going to see crude and semi-refined product displaced into other markets as Teapots cut runs and leave excess product in the market. Refiners in Singapore/ South Korea/ Japan will have to decide if there is a different market for the product or cut runs to account for the reduction in underlying demand.

U.S. refiners have increased purchases of ESPO and Sokol crudes with more coming from the ME and a steady rise of WAF (mostly Nigeria). Refiner crack spreads are worsening (again) in Europe- especially the Med- leaving an overhang in the market with available cargoes. There is already an influx of Naphtha pushing into Europe that will limit some imports of crude (especially light-sweet) that is being displaced from Asia/ Latin America. The underlying physical market remains backwards with Dubai getting cheaper vs WTI/ Brent/ WAF as new barrels come to market from the ME. The shift in spreads will limit U.S. exports and bring in more imports based on price as well as refinery operations.

NGL Update

The NGL basket is being supported by steady exports, slow builds, and reduced production. We have been and remain bullish on underlying pricing as the international market demand for NGLs stays robust. We have to be cognizant of the replacement factors though as the market is now long naphtha with more coming to the market. Production remains slow, which is keeping storage at 2017/2018 levels all the while exports remain well over the 5-year average and on track to set a new yearly record. Demand in Asia remains robust, but the shift in naphtha builds and flows is going to keep pricing capped and start putting some downward pressure. Petrochemical facilities (especially in Europe and Asia) have optionality with the type of feedstock they can run ranging across the NGL and condensate barrels. As pricing has increased across NGLs, we will start to see naphtha runs accelerate as storage and available capacity becomes available. The “length” of naphtha in the market is being driven by refiners increasing operations, which is causing storage levels to rise around the world. Latin America typically relies on U.S. naptha flows as a blending stock for gasoline, and with COVID restrictions and cases limiting total activity- the U.S. is trying to export more into Europe and flows into Asia all but stop. There is also growing naphtha exports from Asian markets with South Korea increasing flows to 2.72M barrels or a 45% rise in May. LPG on the other hand- have seen a steady decline in exports while rising demand keeps flows steady across the residential and commercial backdrop. The residential flows will remain fairly even while we expect to see pressure across the industrial players as feedstock adjustments increase. India/ China imports have held up well (and even grown) during various lockdowns and impacts to underlying demand. Even if demand dipped, it quickly bounced back as residential consumption becomes a bigger part of the mix and seasonally supportive of steady imports.

DOE Total US Propane/Propylene Exports

Propane and Propylene Storage Levels

The storage levels will remain depressed against the 5-year average in the U.S. as exports hold strong and local demand remains steady. Crop drying will be the next increase in potential flow, but that will be dictated based on yield and precipitation at time of harvest. Drying crops is always necessary, but the length of drying is dictated by those two key factors. The underlying NGL basket remains elevated moving back to the 2021 highs as ethane exports always remain elevated- pushing prices higher across the board. Crude and natural gas prices rallying provide an underlying tailwind, but the growth of demand for the liquid’s basket will provide support even as crude/natural gas prices level off. The growth of petrochemical demand in the ME and Asia, which is absorbing local liquids production and pulling more from other locations. The U.S. has also increased their exporting capabilities with new facilities that came online over the last two years helping to “debottleneck” the coast. China has also brought on more ethylene capacity, and an ethane cracker doesn’t have the same flexibility as other assets. An ethane cracker needs to be at least 87% ethane (for the most part) in order to work effectively. The increase in exports will also help keep ethane prices well positioned even as ethane recovery accelerates to cover the rising demand.

US Total Ethane Exports

North American Spot LPG Propane Price/Mont Belvieu LST

North American Spot LPG Iso-Butane Price/Mont Belvieu Texas LST

North American Spot LPG Natural Gasoline Price/Mont Belvieu non-LST

North American Spot Purity Ethane Price/Mont Belvieu non-LST

Naphtha flows have accelerated into Europe as our product struggles to flow into Asia and Latin America. “U.S. oil refineries are increasingly sending surplus naphtha to Europe as traditional buyers in Latin America dry up and Asian buyers find supplies more locally. Europe’s imports from the U.S. are poised to be the highest this month since at least the beginning of 2016, according to oil analytics firm Vortexa Ltd. Arrivals are expected to soar to 363,000 tons, a jump of 46% from May. The petroleum product can be blended to make gasoline, or in plastic production. The variety going to Europe is thought to be for making fuel.” As U.S. refiners have ramped up, it has thrown off more condensate, but due to the level of gasoline and blending stock storage- we are looking to increase total exports. This helps to manage underlying storage, but the market is coming under pressure on the naphtha front. As prices fall- petrochemical facilities will start to play the arb and move into naphtha away from NGLs. “At the same time, demand for the so-called blend-stock from Latin America, which accounts for about 50% of all naphtha exports from the Gulf Coast, has been poor due to weak gasoline consumption amid ongoing mobility restrictions, he said. Similarly, buyers in Asia have been unable to take all of the barrels offered by the U.S., as lengthening supplies in locations such as India, the Middle East and the Mediterranean are more competitive due to their shorter voyage time and relatively cheaper freight, Tyler said.”

“About 411,890 tons of naphtha from U.S. are headed for Asia in June so far, according to Vortexa. That’s down from 415,000 tons shipped in the previous month. Asian naphtha buyers are expected to draw about 1.24 million tons of the feedstock from Europe and Russia, according to Vortexa’s provisional June data. The naphtha being sent from U.S. to Europe is mostly the surplus blending stock, which is mixed with gasoline, according to traders. There is not enough demand for such naphtha in Asia, where crackers mostly import light-virgin and heavy full range grades for producing petrochemicals, they said.”

Storage levels have been increasing across Asia and Europe across the light distillate space, which will help pull more product into the petchem mix. The refining complex remains oversupplied resulting in more closures around the world, and in China the limitation on Teapots helps make more room for SOE (state owned refiners) to ramp up.

As some refiners shutter other mega facilities come online, the new assets are going to be importing additional feedstock. The mega facilities will be able to capitalize on shared flows, but others will require imports to bridge the gap for what is missing. The NGL inputs will continue to expand across China and the Middle East as they rely more on NGLs and other liquids sourcing. Petrochemical demand will remain robust over the next decade, and be supportive of additional flows keeping prices elevated around the world. North America is also bringing capacity on, which will increase local demand as well as the export market.

Any Iranian deal will bring a flood of condensate to the market quickly, but it would be a one-time surge as the flows normalize after the initial bump. Prices would increase once sanctions were officially lifted, and Iran wouldn’t be selling product at steep discounts. It would increase the available volumes for U.S. trade partners, such as India and South Korea, but the overall pie of demand is getting bigger allowing for more product to enter the market. The shuttering of refiners and increase in petrochemical throughput provides support for U.S. exports and long-term pricing.

We expect to see prices hold steady at these levels after seeing a strong increase in prices over the next few weeks.

U.S. Job Market Deep-Dive

The U.S. jobs market is throwing off some contradicting data points as “available” jobs keep increasing while unemployment/ jobs data remains disappointing. It is not a one size fits all solution for the jobs conundrum, but a multitude of factors that are impacting hiring and potential employees searching.

Employers are looking for very specific skillsets and because of the size of applicant pools are unwilling to train someone. They would prefer to wait for the “perfect” fit. Companies are facing an increase in costs and are unwilling to increase salaries/benefits to attract talent. Businesses would rather leverage current employees and increase their hours vs hiring a new individual. Potential employees don’t see an incentive to take a job given the current unemployment benefits. Job seekers are unwilling to take a job because so many are posted they would rather find the “perfect” job. New technology investments have replaced some job positions, or additional technology has reduced the responsibilities of an old position resulting in lower pay. The underlying data is skewed given the ease in which a company can post on job boards, and the amount of people looking for a job is much lower.

Factories are having a tough time matching with workers and underlying hiring because of the shortfall in skills and wages. There is currently less than 30% of hiring in the manufacturing space as companies wait for the right skills or are relying more on current employees. Depending on the Fed district, we have seen some softness in hours worked as assembly lines are forced to cut utilization rates due to inventory shortages. This has slowed down the need for hiring as some facilities furlough current employees again waiting for the supply chains to normalize. Inventories are now at historic lows with sales to inventory rations moving to extremes and only get worse. This is hindering some of the hiring as job postings still remain active.

I can speak from person experience that on several occasions (about 8) I was in the last round of interviews when the following happened:

The position was terminated. A hiring freeze was rolled out. Company hired internally.

How many of these job postings are just to test the waters and to get a gauge of current salaries? How many of them are to meet current employment regulations, but the job is technically already filled either internally or with a pre-chosen candidate? The ease of posting on sites such as LinkedIn, Indeed, Job Seeker (pick your site) can help flood the market. When we review the Beveridge Curve, job postings NEVER fell to the normal levels seen during economic slowdowns. Instead, job opening rates just flatlined, while the unemployment rate exploded higher. Now, we have a surge (record) of job openings even though the unemployment rate remains elevated.

The new claims have started to increase again as some of these furloughs are rolled out and some states see an increase due to delays. We are now below 15M total individuals getting unemployment, but still at near historic levels (trough of 2008).

The hope has been that as the emergency unemployment benefits expire and some states reinstitute the need for proof of job searching to receive benefits. So far, we have seen some individuals at the low income level going back to work, but at the high/middle income levels there hasn’t been the same type of impact. We are still at the early point of data sets given the first tranche of expiring benefits happened June 12 th - we will have some more clarity in the July data release.

The average hourly earnings had a bounce, which was pulled lower with more lower income individuals picking up hours. So far- the data remains stagnate on hourly wages, which is also a driver for a the slow down in hiring. Can the company pass on the additional labor costs? Will the potential employee accept the lower or reduced wage? Back in 2020, we highlighted that the jobs market would see a big bounce off the bottom but stagnate once we reached 50% of capacity hired back. Our view was that many companies already had “too many” employees vs what they required and that inflation trends were going to be persistent limiting the ability to pass on labor costs. We broke it down as the following: If a company furloughed 100 people- within 6-9 months 50 of those people would be hired back. Over the next 6 months, another 25 of those people would be brought back in some sort of capacity, but that would be it. This leaves 25 people that were initially furloughed left to find a new job either within the industry or try to switch into a new one.

Throughout the downturn, companies also invested in technology to increase efficiency and connectivity, which is now a growing goal across the next two years. The goal is to increase investment in workflow automation across all facets of the business- as broken out in the second chart. The initial shift has been in businesses resilience and ease of generating business ideas. Many of these shifts will replace the need for some employees or reduce the responsibility of new employees. With reduced responsibility or cash generating (P/L Responsibility) comes with lower pay and underlying benefits.

We can see that playing out in the below industry sectors where vacancies remain persistent (we showed the manufacturing industry earlier). The issues remain pervasive across many industries and verticals as technology adoption reduces the need for the number of employees.

There has also been a big increase in people who are retiring. The start of the pandemic saw the numbers jump by over 2%, but as these jobs are replaced by (likely) younger and less experienced individuals- it typically comes with a pay cut. How many of these jobs were also deemed “Too expensive” or “repetitive” after the individual retired? Companies will do a lot of things to try to limit cost, and by trying to reduce the salaries/benefits for some of these jobs would be top of the list. It is unlikely some of these individuals will return to the workforce in a meaningful way, which will shrink the available worker pool. So is participation rate higher vs expectations?

Participation rate remains well off the normal pace as people either struggle with childcare, have a severance package, or one family member cares for the children. The pace has been stagnating for some time with only recently some positive movements in individuals searching for jobs.

Wages have failed to keep pace with inflation and general share of GDP over the last 40 or so years. “Wages & benefits averaged 72% of nat’l income from ‘70-‘95, then steadily declined to 65% by ‘14; increasing share of pie went to business owners & white-collar workers, as tech adoption picked up & union membership declined.” The adjustments have been widespread as we exported inflation and outsourced large parts of our supply chain. Now we are faced with a rising cost of living and a wage backdrop that has failed to keep pace with the broad increases. The U.S. is now importing more inflation with more behind it, and in order to pay the “cost of living” adjustments is becoming harder at the previous employment levels. Companies will focus on getting more work out of the current employees instead of trying to hire new ones, especially with some broad uncertainties with supply chains.

We can also look at it a little differently through the medium wealth category because debt levels have only grown for the same age group over the last several decades. Some of the more bullish commentary highlights the improving balance sheet of the homeowner/consumer, but to what point- because the level of debt has almost doubled while wages stay stagnate. As pressures remain in supply chains, it is unlikely we see companies moving quickly to hire.

Inflationary pressure remains across many (if not all) industries limiting the ability to incur new costs. Another interesting impact- how many people will not be a W2 employee but instead a 1099? It reduces the underlying cost to the company from a tax and benefits perspective, and it allows for some short-term work in more of a consulting backdrop. It also costs companies money and productivity to train new employees, which is becoming a growing hurdle. This is another underlying cost that is recouped by paying less salary upfront, but with the limitation of bonuses/raises becoming more prevalent- employees have been unwilling to accept these reduced terms.

These leads to another key fact

Employers see a massive pool of unemployed- so wait for the best candidate. Employees see all these job openings- so wait for the best job.

All of these issues will rectify over time, but the view that we get a big snap back was always wrong and still remains highly unlikely. It will be a prolonged shift higher, and the longer people stay unemployed it is unlikely they will get the same salary they left. Would a company rather higher someone unemployed for 4 weeks or 56? It is the same as someone being warm stacked vs cold stacked- so the person sitting on the sidelines for so long will accept a reduced salary. There is also a sense of panic the longer someone sits on the sidelines, and they will be more willing to take a lower wage or be “underemployed”. The thinking is- “I will take this job now to get benefits and income, while I look for something else more suitable.” Now- those that are currently unemployed- are competing with people working but looking. This is driving the increase in “quit” ratios, which is more indicative of a tight job market. The high-end earners are seeing the most pressure so far throughout 2021 with more pressure coming across “white collar” jobs. Companies are looking to shave cost and that is coming in the way of less middle and upper management. We also described individuals retiring, and if someone was making $300k after being with the company for 20 years- will you start their replacement at the same level? Probably not. Our base case from last year was the pressure would mount on employment, but it would also be disproportionately weighted to the high- and middle-income brackets. Wage compression at the top level will have a bigger impact on consumer spending given their level of discretionary cash. We expect to see some stability in the bottom quartile, but do to the increase in wages at this level- much less hiring to offset the increases. We break down some of these headwinds with bottom quartile wages and total employment in a few paragraphs.

The answers won’t come quickly, and the issues will be prolonged and vary based on income levels. The below breakdowns highlight the nominal pressure on wages as well as the problem broken down by income levels. The data at the bottom is from March, and we have seen since a rise in the low wage portion with the high/medium wage coming under pressure. This is also important when considering discretionary cash and consumer spending because those at the top are typically the biggest drivers in consumption. As we see more pressure at the top, we will see some of the U.S. spending slow down or at least shift from “goods” (durable goods) to more services. We are already seeing an underlying shift in consumption patterns.

Some of the weekly earnings have recovered, but based on the below breakdown- it is still well off of a normal base (pre-COVID) and makes up typically lower paying jobs. These are the underlying increases I talked about above- wages at the low end have risen but still well off normal and flat lining.

The shift from goods to services will keep accelerating as individuals choose… as prices keep rising we will see the pace of spending also cool.

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Primary Vision Insights – June 30th, 2021

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