Primary Vision Insights – July 21th, 2021

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By Mark Rossano

SUMMARY

US Completion Activity Crude Demand Update China Data Update

I wasn’t able to fit the geopolitics into this report, so it will be in the next with some of the inner workings of EM markets and pressure on crude demand from that perspective. I will also provide a broader outlook on NGLs.

US Completion Activity

U.S. completion activity started off the first full week of July with a steady increase of 4 spreads. We expect to see a steady rise of spreads hitting about 254 as we head into the middle of August. The pace of additions will be gradual with on average about 2-4 added each week. The pricing metrics remain supportive within the U.S. across crude, natural gas, and liquids. There has already been an acceleration of spuds this month with some new names joining the list. Rig additions will outpace frac spreads as completion activity remains steady with most additions centered around the Williston and Texas. The Permian will get closer to 130 spreads over the next few weeks with the Williston reaching 20 within the same time. Natural gas activity will start to pick-up as well given how the curve is shaping up, and demand for LNG remains robust around the world.

Spread additions will remain gradual without a big “surprise” number as E&Ps/OFS are dealing with labor shortfalls and repairing equipment. This is slowing down the activations and by being more measured in their approach helps protect some pricing and cost increases. We are well on our way to hit our target number of about 270-275 active spreads, but the first test will be 250- because in order to get the additional 20-30 spreads into the market we will need to see pricing improve and bigger repairs on cold stacked equipment. None of that is impossible and so far supplier order books are suggesting some of this horsepower is slated to return to market.

Refinery utilization remains at 29-year averages in the U.S.- or about 93%- which will keep a steady flow of imports heading into the U.S. The spread between WTI/Brent; WTI/Dubai; WTI/WAF is going to keep our exports muted over the coming few weeks. WAF spreads have already softened attracting more European and U.S. buyers. West Africa and the North Sea saw additional deferrals due to continued headwinds in physical demand. Several OPEC+ nations have struggled to sell crude in June, and the problems have carried over into July/Aug. We already have some grades getting hit with deferrals into August.

Urals and CPC traded at almost 2 year lows to see some bounce in pricing (still well below normal), but it has started to fade as competition mounts between WAF/ Russia/ Libya on clearing barrels.

North Sea Troll crude loadings for August are revised down to 8 cargoes from 10 after all the cargoes were deferred by 2-16 days, according to revised loading program seen by Bloomberg.

August loadings now stand at 4.8m bbl or 155k b/d Combined loadings of BFOET grades are also revised down to 755k b/d from 794k b/d previously Two cargoes of Troll, originally planned for end-August, will be deferred to early September

Sellers of Nigerian crude have started to offer their cargoes at lower premiums in response to slower sales so far this month, according to tradersQua Iboe offered at 80c-$1.25/bbl more than Dated Brent for August loading; Bonga at $1.30/bbl.

There are 10 Angolan. Arbors left and new programmes expected end of this week or early next

Sales of West African crude accelerated in the past week as lower offer prices encouraged more cargoes to flow West of Suez, according to traders involved in the market.

Fewer than 30 cargoes of Nigerian crude for August-loading are still seeking buyers, or almost 60% of about 50 shipments planned Drops from 70% on July 7 Many of the past week’s sales for Nigerian crude have gone to West of Suez buyers including Europe, U.S.: traders NOTE: Sellers reduced offer prices this week in response to slower sales earlier in the month Ten cargoes of August-loading Angolan crude are yet to find buyers, or about 26% of the 38 cargoes scheduled Drops from more than half unsold as of July 7 2-3 cargoes of Republic of Congo’s Djeno for August, a popular grade among Chinese buyers, are yet to find buyers out of seven planned Gunvor sold Urals to Total for Aug. 3-7 delivery at Dated -$2.45/bbl: trader monitoring Platts window Urals last traded at -$3.65 and -$3.45 on July 7 for 2H July delivery Total bought another cargo from Gunvor for July 24-28 at -$3.10 Total bought a third cargo from Glencore for July 26-30 at -$2.90 Litasco sold a cargo to Shell for July 26-30 at -$3.15 Vitol offers to sell 550k bbl of Nigeria’s Egina crude on CFR Augusta basis for August 1-15 arrival at $2.75/bbl more than Dated Brent; vessel Lipari: person monitoring trading window Drops from $2.90/bbl on July 13 Glencore offered to sell 950k bbl of Cabinda crude on CFR Rotterdam/Augusta basis for August 6-15 arrival at 75c/bbl more than Dated Brent; vessel Stena Supreme NOTE: Glencore bought a cargo of Cabinda for July 19-20 loading from Sonangol via spot offer last month

We are still waiting for clarity from OPEC+ following the impasse between UAE and KSA. Now Iraq has requested that their baseline be adjusted. We still hold to our previous report as what will happen over the coming few weeks with the OPEC+ deal. Our belief that the next decade will see “oil” demand driven by liquids/NGLs continues to play out.

Pricing remains robust reaching new 2021 highs.

We have seen some of these increases in the past, but with additional capacity for exports- it is likely we see them remain “sticky” and less of a flash in the pan. Chemicals/ plastic demand only continues to grow and our ability to play a bigger role in the international market will keep prices elevated.

Crude Demand Update

Crude demand has seen a seasonal rally as we now shift into peak summer driving and travel season. Our call back in March was that we would see a shift higher in demand along seasonal norms but fall short of “normal” as we progress through peak demand. So far, this call has been spot on and probably a little too elevated when we factor in demand loss out of Asia driven by the spread of COVID19. The bigger question now: will demand catch up to 2019 throughout the rest of the summer or will we have to wait for something closer to the fall to see more normalizing demand. The easiest one (in my opinion) is the adjustments in jet fuel demand as we look at TSA passenger throughout and departures. I am not sure if anyone has flown recently, but it has moved from one circle of hell into another. Delays/ cancelations/ understaffed are all a common thread and based on commentary- they don’t plan on normalizing departures or hiring back too quickly. Airlines are looking to fill planes and maximize capacity vs bringing back another departure. This will keep airline tickets elevated and while passenger volume has risen- it is more important to look at underlying departures to track underlying jet fuel demand. The lack of business and international travel will be problematic over the longer term. We have seen some business travel return, but it has decreased in frequency and total distance driving more of a structural shift. For example, sales and consulting roles that required 4 days a week/ 3 weeks a month of travel have seen an adjustment to 4 days a week/ 1 week a month and the remainder done through zoom or other forms of video communication. These are the type of shifts that will remain while we will see international travel come back to some degree as borders are reopen. As COVID19 variants cause case spikes, the normalizing of borders keeps getting delayed capping some of the bigger demand drivers of distance. Another key aspect will be underlying cost as airline tickets get more expensive: less flights + higher wages + more expensive jet fuel = ticket prices going higher. Airlines want some structural adjustments to maximize capacity, but it also drives up prices that limit who can fly. I am not saying deals still aren’t available, but they are becoming less frequent- which is pushing people to travel within driving distances. Wages (especially at the higher end) have failed to keep pace with inflation, and now with airline tickets going up- it will become harder to fly with a family. When looking at TSA throughput, our view was that we would see passengers rise along seasonal lines, but cap the run up to be about 500k-750k below normal. When you look at the chart below, you can see that we have seen a steady rise (along seasonal lines) and have paused the run up- sending us sideways. We believe this persists through the remainder of peak vacation time, and we see passengers decline along seasonal lines again as the summer comes to an end. The lack of TSA movements is attributed to less business and international travel, but also less people that either “feel uncomfortable” or just can’t afford the cost of flights. We will eventually get back to some sense of “normalcy” but there will be some underlying changes in how airlines operate and how consumers use flights.

Shifting to global departures- the chart is a bit skewed because the starting point is Dec 2019 and doesn’t show summer of 2019, but I will walk through it because it is a great visual. North America has seen a steady rise along seasonal norm, which is also happening in Europe and “Rest of World.” But even with some of the seasonal increases, many areas are well off of easier comps given timing. We have also seen a pause in departures when we look abroad into Asia Pacific and the rest of the world. COVID19 cases rising have caused a shift lower in total movements due to government lockdowns, but also the consumer changing their inherent travel/spending patterns to limit exposures. The slow roll out of vaccinations has kept many countries cautious as case counts rise. The vaccine has been shown to limit the impacts of the disease even if contracted, but the key metric to watch going forward is- hospitalizations and deaths. Cases lead to hospitalizations on a 2-week lag and death by 4-6 weeks. So far- the recent variants have been proven to be more contagious but aren’t resulting in the same stress on infrastructure. Not to say we aren’t seeing an increase in hospital utilization, but it is “less severe” when considering ICU and length of stay.

The spread is still keeping people on the sidelines, and we are already seeing future scheduled departures falling. They are declining for 2 reasons- less global demand and seasonal adjustments. “Globally, the passenger flight schedule for the 11 weeks ahead declined by around 1.8% since last week. APAC cut more than other regions yet again: 2.2% lower than this time last week across the next four weeks as the region falls behind in the battle against Covid.” The 11 week look forward takes us into Sept when we normally see flights decline, but they are falling from a much lower base. All of this points to depressed jet fuel demand throughout the rest of the year (at least). In the U.S., the slow down in departures and cap on TSA passengers will keep demand levels moving sideways. We are expecting to sit between 1.3-1.5M barrels a day of demand until we get into sept- where 2016-2019 show a seasonal decline in demand. This will shift the weekly demand lower and closer to 1.2-1.3M barrels a day. We expect to see seasonal adjustments just at a step down from “normal.”

Gasoline demand is the one where we see the most confusion or at least people grabbing on to one data point vs looking across the complex/ supply chain. The gasoline supply chain has been under stress with shortages of truck drivers to get product from the racks (blending facilities) to the gas stations. This has resulted in some sporadic outages but creating lumpy movements in storage and EIA Supplied data. The data was already lumpy week over week, but the new wrinkles are creating even more noise that we try to sift through by analyzing multiple data sets and projecting forward. Our view has been that we would maintain a fairly stable base of 9.2-9.3M barrels a day with some seasonal spikes higher, but for the most part average closer to that spread. We utilize data sets across GasBuddy, TomTom, cell phone data, Google/Apple mobility, Department of Transportation, and toll information to try to assemble a complete picture. We also factor in “Blending Stocks”, which are typically a good indicator of actual demand- especially in the summer that requires a higher cut of octane components due to government restrictions. Summer grade vs winter grade is dictated by Reid Vapor Pressures so that it can pass through the atmosphere more easily with a limit on the benzene used in the summer months. The composition of summer grade is inherently more expensive to make vs winter, which also drives higher prices in the summer months and not just demand. As we approached Memorial Day, our view was that we were going to see a “new high” watermark set that would see other weeks move up or down by about 1% from that level. Based on the data we were reviewing, July 4 th was going to set the new peak, but fall back within 1% of the previous 4-week average. We expected a nice spike as people were using July 4 th as a means of seeing people after a long hiatus caused by the pandemic. We don’t think July 4 th levels will be reached again until we get to Labor Day, but depending on the spread of the Delta variant- the holiday could reach the same levels but unlikely to surprise to the upside. As we progress through this week, the data continues to decline vs last week but still remains within 1% of the 4-week average with some downward pressure remaining given the TomTom and Descartes data.

When we zoom out a bit and look at the broader global mobility market, there is more softness in Asia and Europe with the rise of cases. We have harped on the fact that even without a meaningful government response- consumers will naturally adjust some of their habits to avoid unnecessary spending. Peak congestion has been shifting lower in many regions- especially Europe and the Americas (North America is misleading as it factors in all of the Americas.) There was a big China data drop, but we will go through those numbers in a bit. China has been hovering between 90%-95% as pressure remains on the consumer side, but the biggest shifts remain in Americas and Europe. The rest of Asia has already been struggling with COVID cases rising, so there has been limited change from the current levels. I think it is important to look at the historics though- where were we in 2020 (especially China which has clearly weakened since 2020 and Rest of Asia before cases hit recent records. Even when cases are lower, we just aren’t seeing the underlying activity do to concerns, but more importantly a stress on consumer balance sheets. Inflation and job insecurity is a much bigger problem that is keeping spending and general activity muted on a global level.

Shifting further into the demand profile using other tracking methods- Descartes Labs puts current gasoline demand at about 9.3-9.4M barrels a day (9.362M b/d- this past week), and they have typically been about 200k-500k above EIA data- but much closer to 200k above on average. So this puts our typical gasoline demand at the 9.1M-9.2M barrels a day category. The Department of Transportation also has us about 1.2% below 2019 currently, and when I look at the most recent “official” month this is the breakdown- about 4% below normal as dictated in 2019. Typically, the official numbers are slightly below the estimated, but it would make sense to see a bit more activity in the summer months where many can be outside and feel more “comfortable” interacting.

May 2018- 269.1B miles May 2019- 270.5B miles May 2021- 259.7B miles

The next question is- what happens when we get to fall? Schools will be reopening, and most companies are targeting a return to the offices either full time or at least flex schedule. Our view into the summer was that the weekend activity would outperform by 5%-10% but the weekdays would underperform by about 25% when looking at mobility. So far this has been fairly accurate with the underperformance during the week closer to 15%-20% and the weekend outperformance about 5%-7%. This still leaves us short driving activity, which is driven by multiple factors including gasoline prices, flex schedules, work from home, and other impediments to daily activity. We expect some of the underperformance to abate in the fall with a bit more of a “normal” activity regime, but less activity to occur on the weekends. There will still be the structural changes driven by more work from home and flex schedules keeping the activity below 2019 but running close.

The problem will be on the jobs front that remains well off pace, which we have highlighted closely a few weeks ago. The pressure on employment isn’t adjusting soon as companies are preparing to do more with less employees. This helps to reduce some of their underlying costs and protect margins that are getting squeezed by the supply chain. This will keep some of the activity coming back to normal even as some people return to the office. But as people received their vaccines, we saw an increase in mass transit activity vs the previous year. This is more a comfort level on vaccines and helps avoid some of the underlying congestion. So far- we are very consistent vs last summer but the next big test will be residential vs workplace as we move into Sept/Oct. The pace of vaccinations has already slowed considerably as some people refuse to get it outright or others are still nervous about receiving their shot. This will also keep people hesitant moving back into an office environment or at least on a permanent basis.

Many employees have also stated they are either more or equally productive at home vs the office. Every person is different, but based on all the data sets I have seen- it is pretty consistent that 70%-75% of Americans believe they are either more or the equally as productive. The below chart puts it closer to 83%, which is why I think the “flex schedule” finds more adoption over the coming few years.

Price remains a major factor and given the stress on individual balance sheets- gasoline demand is much less inelastic as some investors believe. In the past, $3.50 was the point at which people adjusted their activity, but as prices for everything have risen- it reduces the underlying pain point for gasoline. It is much closer to $3.10-$3.15 that consumers look to adjust some of their consumption. Don’t get me wrong- you aren’t going to be able to NOT buy gasoline- but is there a way to fill up once a month instead of twice? Or every other week instead of every week? These small shifts add up- especially as more people feel the underlying pinch across all consumer products and services. We are coming into the point of pause when you look at prices getting closer to the top end of the range.

The reason for it is the spread of inflation across all aspects of life- not just the car or coach being purchased. But everyday items that add up over time with wages failing to keep pace. Wages have seen some rise at the lowest level, but when we look at high/middle incomes we have seen much less appreciation, and it looks even worse when leveled against inflation. Plus the headlines love to bring up savings and wealth- but it is MASSIVELY skewed to the top 10%. U.S. households added $13.5T in wealth last year- largest in 3 decades- but over 70% went to the top 20% of income earners and 1/3 to the top 1%.

When we look at the data differently, the wealth has been concentrated even further at the top of the stack. The top 10% of the US controls 88.7% of the wealth broken down by equities and mutual funds while just total net worth the 1% controls 32.1%.

So when I hear about “pent up demand” and all of these other narratives- it is important to break down the skew of where the wealth and savings reside. Did these wealthy individuals not travel during COVID? Were they first to get back to normal in Mar/April? My comments were that in Mar-May we saw the “great reopening” and it was underwhelming. Now we are at a current normal pace to remain off the 2019 pace, which to be fair was even weak compared to other years.

One of the bright spots we have seen is across the diesel and general distillate space. Diesel demand has been robust driven by trucking, rail, and shipping industry. The shortfalls in the broad logistics space have driven companies to rely on “any means necessary” to get products through their supply chain. This as increase the use of trucking and rail with little fluctuations over the near term expected. The supply chain bottlenecks will last throughout 2021 and based on our industry contacts- well into 2022. The issues are pervasive and hitting at all levels keeping prices elevated and, in some parts, still rising higher. The trucking demand has leveled off but still remains at records based on several different data sets below.

On the expenditure and rates side- even though total cargoes have stabilized- pricing is still moving up as diesel prices hit fresh highs. This is increasing the use of rail capacity as companies try to leverage the volumes that can be moved on rail versus other means of transportation. Some of the rail data was skewed last week as wildfires impacted movements in the Pacific Northwest and Canada. In general, rail intermodal will stay at mid to high double digit figures- which is also supported based on the constant surge of port activity.

Truck miles remain above pre-pandemic levels, and it is unlikely to shift lower over the next 12 months given just how short companies are with inventories and demand for “home delivery” stays elevated. More consumers are going back to stores, but many of them are still relying on online shopping and delivery services, which will also be supportive of diesel consumption.

The boats keep showing up bringing more product from abroad as we have spent the last 40 years exporting inflation and manufacturing. This has left us vulnerable to international pricing and supply disruptions. The Los Angeles port expects to handle 10.5M TEUs of cargo this year, which is a monster number and would be record setting. Based on the weekly data we look at- it is very likely to be achieved and keep the demand healthy for trucking and rail.

The demand will also keep diesel prices strong and increase the underlying cost that gets passed all the way down to the consumer or end-user. These pressures will keep inflation metrics strong across the board.

We take all this information and look at underlying demand as an aggregate. Demand is moving higher but at a very measured pace and remains off pace when compared to ’17-’19. The demand dilemma is compounded when we look abroad and see the slowdowns in Asia that have sent more refined product into the U.S., Latin America, and Europe. The U.S. is one of the most vaccinated countries in the world with 48% fully vaccinated, but yet we are still not back to “normal” levels. A country that is the largest economy, biggest consumer, and pumped $15T into the economy- yet here we are. Now when we look out at countries with less vaccinations and bigger impacts ranging from inflation to COVID- it is difficult to see us closing the gap in crude demand this year that the market is expecting. Global markets issued stimulus with the belief that it would generate growth and offset some of the inflationary pressures. Instead, we are seeing the start of a rate hike cycle abroad in an attempt to counter the inflationary pressures, which are now being imported at rising quantities into the U.S.

China Data Update

China just released a slew of new economic data points that conflict within themselves, but also goes against recent actions and on the ground data aggregation. For anyone following China, I am sure that statement doesn’t surprise you- but trying to understand what is actually happening is important given the implications on global trade and growth. Retail sales beat a lowered number with broad metrics showing issues kept arising on a month over month basis. GDP grew by 1.3% quarter on quarter, much higher than the 0.4% q-o-q growth in the first quarter, but still below the 1.6% average Q2 growth rate for the previous 5 years (excluding 2020). The 2-year average growth rate for retail sales in the first half of 2021 is way below the equivalent for industrial production (4.4% versus 7.0%), the good news is that in May and June retail sales growth outpaced industrial production (0.70% versus 0.56% in June and 0.81% versus 0.53% in May), although year to date (because of a terrible January) industrial production still grew marginally faster than retail sales. May was also “retail month” and many companies offered broad discounts and sales. The GDP expectations in the market remain at 8.5% or higher where it is likely to be much closer to 6%-7%- especially when we factor in the broad slowdowns on the ground. While I can highlight what the underlying data says- it is important to recognize that for now GDP growth in China is still mainly a political decision and has little to do with a real underlying economy that can only deliver sustainable growth rates of roughly half the GDP targets. The government is also reducing their expectations of retail activity with a new reduction: “On Thursday, the Ministry of Commerce (MofCom) published the 14th Five-Year Plan (FYP) for Commerce Development.”

Making headlines:

The plan projects that retail sales – a proxy for domestic consumption – will grow at 5% annually for the next five years. That’s a sharp drop from the 10% annual growth targeted in the last FYP.

It is also important to look at official government releases, shipping (exports/imports), and what is happening in the PBoC/ debt markets. These each tell a bigger story in terms of where are their slowdowns that concern them and how are they going to address it. We have been highlighting that the local consumer has been weak for years, and in order to address it President Xi launched the “Dual Circulation Strategy.” This was used to promote local consumption because it wasn’t naturally occurring to the level that the CCP needs given the growing rift with the international community- especially their biggest customer: The US. This also force them to deploy more support into the market as retail sales and the underlying consumer struggles. Jobs have bee cut and employment slowed- especially in rural regions- another push that has been driven by the CCP… support rural investment and communities. “A spate of defaults by state-owned firms since late last year pushed investment into LGFVs from lower-risk regions in the first half of 2021, said Wu Qiong, executive director at BOC International Holdings. “With the fresh lending curbs, we expect additional pressure on weaker LGFVs in fiscally weaker provinces.”

We have been discussing the risk of LGFVs (Local Government Financing Vehicles) as several regions are under considerable stress and require either new cash injections or large rolls. The PBoC cut the RRR (Reserve Requirement Rate) from 12.5% to 12%, but they did it across all banks and not just targeted and the smaller assets.

The cut was more for iquidity purposes at the bank level due to the amount of bad debt sitting on their balance sheets. The PBoC is going to adjust liquidity by cutting the RRR while letting some MLF (Medium Term Lending Facility) funds expire. There is about 1.1T remimbi slated to expire over the next 2-3 months with 400B RMB maturing yesterday- no word yet on how much was allowed to expire. The RRR releases about 1T yuan- and with the expiring MLF there are ways to manage liquidity and replace borrowing bases. In effect, the PBoC is replacing a relatively high-cost source of bank funding (i.e. MLF) with a low-cost, long-term source of funding.

If Beijing's motive for cutting the RRR was limited to helping small firms only, the cut would have applied to only small banks. So far, the regulators have dealt with distressed debt caused by the pandemic by encouraging banks to exercise forbearance. For banks, that means they don't have to recognize bad loans, so they don't need to hold additional capital against the loans. But regardless of whether a delinquent loan is recognized, it's a drain on liquidity. That’s because the bank still needs to pay interest on wholesale funds and deposits – even as a large number of loans fail to generate interest payments to the bank.

These measures won’t be about pumping up credit growth overall – nor will they offer significant support to the broader economy. It is all about managing liquidity and bad debt at the bank level, but doesn’t address the broader problem that the CCP/ PBoC have been harping on: Supporting micro and SMID businesses. An example, “premier Li Keqiang: To support micro, small and medium-sized enterprises, we should combat monopoly and unfair competition and should make the recent measures of RRR cut more structural to help enterprises and labor-intensive industries to ease financing difficulties.”

The next RRR cut will be a bit more targeted and not across all banks- instead targeted at small banks so they can compete more against large banks on lending. Typically, smaller banks lend to the targeted companies Li is referring too, and it will provide some cash inflow- but even with these adjustments- companies are still reducing their borrowing. Just because you make it available- doesn’t mean a company will take advantage- especially if they are unsure if they can pay it back. Many provinces have issued debt to these companies as well through SPBs (Special Purpose Bonds) and LGFVs, which has exacerbated an already treacherous debt situation. This will keep the PBoC more targeted in injecting cash as they push more in at the bank level but remove liquidity at other points. The goal is to keep the credit impulses from falling further but also from rising too high.

The CBIRC has sent “Document 15” to banks and insurers with this directive:

The document ordered financial institutions not to help local governments hide or increase hidden debt by lending to local government financial vehicles (LGFV) illegally.

LGFVs are used by local governments largely to fund infrastructure. They are the biggest source of off-balance-sheet government debt risk in China Banks and insurers must not provide liquidity financing to LGFVs that hold implicit government debt. The central government has been zeroing in on the off-balance-sheet debt of local governments this year. According to some official calculations, about a quarter of provinces will use more than half of their fiscal revenue between now and 2025 to repay capital with interest. That will make it very difficult for local governments to provide fiscal support to their economies. [1]

This is why China will manage financing: “Monthly aggregate social financing surged to 3.67 trillion yuan, up from May’s 1.92 trillion yuan and beating the consensus forecast of 2.89 trillion yuan.”

Even with the rise in some of the financing- we had some fall off at the M1 level: “China M1 money supply (usually a leading indicator) rose 5.5% YoY in June (lowest since Apr. 2020; v +6.1% YoY prior) *Real M1 (adjusted for CPI) rose 4.4% YoY in June (lowest since July 2020; v +4.8% YoY prior).”

The PPI in China took a pause after rising in a straight line since the end of 2020. We have been calling for a “pause” in price increases and more of a sideways move as elevated prices are supported but customers adjust buying. We have seen consumers start balking at price increases and given the backlogs in the system- there has been a bit of a pause in buying. The PBoC is also releasing some volume of commodities from strategic reserves to help offset some of the price increases.

The fall in the headline index was mainly due to a weaker base effect. Prices are still increasing on a m/m basis, albeit at a slower rate – 0.3% m/m in June versus 1.6% in May.

Exports rose this past month along the lines of our expectations after imports rose last month and some of the shipping issues resulted in a surge of activity. Exports were also supported by “dollar value” vs “tonnage” as the value of what was exported rose even though tonnage slipped.

The stronger-than-expected increase in exports may reflect the fact that Chinese companies are passing through higher costs to overseas customers.

This means that the value of exports rose even if the number of products sold did not grow by as much.

Higher commodity prices – rather than strong domestic consumption – likely also explains the continued strength in imports.

For example, the value of iron ore imports increased 83% y/y by value last month. But by tonnage, shipments were down 12% y/y.

Exports continued to provide support to the Chinese economy last month – but the headwinds are stacking up:

Chinese exporters need to raise prices not just to cover higher input costs but also to offset renminbi appreciation – this risks making Chinese goods less price competitive. As economies in the West lift COVID-19 restrictions, overseas household spending should shift from goods manufactured in China to domestic services.

The bottom line: China's economy won’t be able to ride the wave of strong overseas demand much longer. We expect to see exports weaken over the coming months as demand weakens abroad. The pressure on the Chinese economy will increase throughout the remainder of Q3.

[1] https://mailchi.mp/341a4c063853/new-guardrails-for-the-social-credit-system?e=21cdcdff2c

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Primary Vision Insights – July 21th, 2021

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