By Mark Rossano

The U.S. completions market remains stable with a small reduction this past week as assets moved to a new location and some smaller basins reduced seasonal activity. We will see a fairly steady grind higher over the next 3 weeks as companies try to make a final push ahead of the seasonal down time of Thanksgiving to Christmas.

The futures market had a small pullback on the front month, while the rest of the curve remains supported well through 2024. Our concerns remain at the front end of the curve with a lot of expectations of a cold winter and additional fuel oil demand being prices firmly into the market. The physical market has shown some price rebounds after a program cleared Urals at about $1.50 less dated Brent and Asia purchased SOMO (Iraq crude) for $.15 above dated Brent. This is below the high of $.30 but above the one before that was $.60 below. Urals have softened a bit since the program, but still remains at about $2 less dated brent.

As I closed this document to send over, a headline came across showing a big cut in Sonangol sales from West Africa for Dec loading.
Sonangol sold a cargo of Gimboa crude for December loading to a spot buyer in China, said traders familiar with the matter.

• The 600k-bbl shipment for Dec. 27-28 loading was last offered at $2.10/bbl less than Dated Brent on Oct. 27
o Price was cut from -$1/bbl on Oct. 26 and -50c/bbl on Oct. 22
• Sonangol also reduced its offer price for a cargo of Girassol crude, price list seen by Bloomberg shows
• A 1m bbl cargo of Girassol crude for Dec. 2-3 loading offered at $1.80/bbl more than Dated Brent
o Drops from +$2 on Oct. 27; previously offered at +$2.15/bbl on Oct. 22

There is definitely a “quality” and “location” backdrop in the market with ESPO trading at steep premiums while other grades have to slash pricing to attract buyers. Typically- these grades are absorbed into the Asian markets, but China (specifically) has been slow to take down additional cargoes and some cargoes have been sold into the Atlantic Basin. WAF and the ME continue to tell a diverging story vs what the crude curve indicates- especially for Dec ’21 vs Dec ’22. I still believe that is a good spread to play- short Dec ’21 and long Dec ’22.

We had some increases in middle and heavy distillates around the world as coal stockpiles were said to increase in China. Teapots have cut exports significantly, and China has been rationing diesel and gasoline while they evaluate underlying storage. We expect to see an increase of imports over the coming weeks coming from WAF into Asia, which will be supported as Brent/WTI price themselves out of the market. At the current spread of WTI vs Dubai staying at over $4, it is hard to rationalize the cost of shipment to bring those cargoes from the US into Asia.

There have been comments back and forth in Europe about how much natural gas Putin/Gazprom will send into western storage. So far- the comments have been that Austria and German storage will start getting filled Nov 8th and Russia will help provide some additional flow to keep prices elevated but off highs. It is still unclear if there will be strings attached to it connected to Nordstream 2, but I am sure we will learn more as we approach Nov 8th. In the meantime, Europe has increased their imports of middle distillate from the Middle East as more cargoes are delivered from the UAE and KSA (way more from UAE) as they look to increase gasoil storage. European refiners have been importing gasoil while exporting fuel oil as the arb from the Atlantic basin into Asia remains wide open. The ability to sell the heavier products will also allow refiners to ramp up activity a bit to target the middle and lighter part of the stack and export the heavier product into Asia.

The other key issue in the market remains the divergence between Cushing/ PADD2 and PADD 3. Cushing is draining (again) this week and we should see another 1M+ draw putting us closer to the low from 2014.

This is all happening while PADD 3 rapidly fills and sits at the second highest (seasonally adjusted) with only 2020 a higher point in time. PADD3 will remain elevated as refiners keep utilization rates depressed and exports stay limited. We will also see a pick-up in imports that will help keep us elevated heading into Nov.

This is all happening as the world remains well situated for crude when you factor in floating and onshore storage when compared to historics. We are still well below 2020 levels but right in the “normal” seasonal range when comparing 2017-2019. This is why the biggest overhang remains demand as supply should be fairly stable with OPEC+ bringing another 400k barrels back online when they meet Nov 4^th. We don’t see any surprises from the meeting coming up, but a steady increase in production over the next month. This is why we still hold to the fact that Middle East and WAF floating storage is an important indicator of how quickly the additional barrels are clearing into the market. The biggest overhand will be demand and economic growth, which we go into detail on next.

The recent GDP number was really a mixed bag with some strength and other points of slowing as inflation accelerates to kick off Q4. There remains a tailwind of inventory rebuilds and broader CAPEX that will be deployed as fixed assets reach a breaking point. We should see a fairly strong Oct, but the big “tell” for how Q4 unfolds will be Nov. My view is we see a big pull forward of spending and activity as Nov/Dec sees a bigger drop off as inflation exhausts budgets on a corporate and consumer level. We see rising risk on the underlying consumer, which continues to play out in the underlying data as income falls and inflationary pressures push higher. Saving rates have dropped as near term cash loans have accelerated, which points to growing pressure. I will go through the below data throughout the next section:

The next big travel even will be Thanksgiving, and so far, travel expectations have been reduced as people look to save some money and do more day trips There has been a reduction of shorter 2-3 and 4-6 days, which will help local areas but limit the size of consumption we are used too.

The cuts are so far fairly broad, but the biggest reduction is happening at the highest earner level. Consumer confidence has been waning- especially on the future (next 6 months) causing a bit more caution on spending. We expect to see spending pulled forward to Oct as more payday loans and cash advances were used to increase holiday spending.

Consumers are very much aware of the global supply chain issues and have been changed spending patterns to make sure they get presents before the holidays. We are already seeing spending numbers hit new records as recent price surges haven’t stopped the consumer (yet). The below chart helps to highlight what kind of borrowing has been pulled forward to cover the rise in costs for gifts.

The rising cost of goods is a key reason holiday sales have surged so far based on early forecasts (value vs volume). The consumer is currently willing to not only by the same amount of goods but also tolerates a higher price, but that appears to only be the case for the Holidays. There is growing evidence that the ability or willingness of the consumer at this price is starting to wane, and we expect that to become more apparent as we head into Nov/Dec. The pressure is growing on the consumer as government transfers dwindle and savings are pulled back out to cover the rise in underlying living costs.

This underlying shift in wages vs inflation vs spending is causing many people to take their GDP growth estimates for 2022 down while shifting their inflation forecasts higher. We saw inflationary pressures slow in Sept, but reaccelerate in Oct and continue into Nov.

The concerns around inflation are causing a broader shift in Central Bank policy globally as banks look to adjust stimulus and rates. The Fed is no different and will likely start the tapering process in Nov starting with a reduction in MBS (Mortgage-Backed Securities). With their help, we have seen home prices reach a new all-time record of $404,700 with more pressure to the upside.

As prices drive higher- the disconnect grows between wages and housing and based on today’s data dump- it isn’t getting any better. Real estate pricing has gone vertical while hourly earnings have risen- it pales in comparison to the actual run up.

The increase in wages is also happening at the lowest two quartiles- both of which are not in the market to buy homes, which has only worsened on the recent run up. The amount of people leaving their apartments to buy homes has plunged as prices have increased and inventory of even somewhat affordable housing has disappeared.

These issues are only being exasperated as income dropped further in Q3 with spending remaining stable. A bigger issue is the cost to employers has increased by 1.3%, but it hasn’t flowed down to personal income to the same level due to the rise in prices and the drop in government transfers. Income to the employee (consumer) has weakened, which comes full circle to why we are seeing more “cash advances” and “payday loans.” Savings have been dwindling (especially for 80% of Americans), which supports our view that a lot of spending will happen in Oct with a sharper drop off in Nov/Dec- kicking off 2022 in a weaker footing. The levels of the Core PCE Deflator is going to keep driving higher as food and housing prices shift higher over the next several months. The pace of inflation slowed a bit in Sept but has since accelerated (again) in Oct and will continue to be a driving force well into 2022.

The shift in income and spending will put additional pressure on economic growth, but we do expect to see some strength derived from inventory rebuild and CAPEX spending to replenish aging fixed assets. There is a huge problem in this country as assets age, which will require a big cycle of spending to repair and replace these assets. A large part of recent corporate investment has been focused on equipment and IPP, which is important for how business is being transacted now and, in the future, – but it has also left behind fixed assets. In the next wave of investment, it will be driven by fixed assets that will help counter a slowing consumer and elevated trade deficit in the GDP calculation.

There has been a global push since ’08 to localize some manufacturing after a push since the ‘70s to send everything abroad. Supply-chain crisis fueling desire to retreat from globalization, just as GFC did … share of world trade accounted for by global value chains (where product crossed at least 2 borders) rose from 37% in 1970 to 52% in 2008, when it then plateaued.

US GDP missed estimates and will face headwinds as exports slow/imports rise, PCE durables decline, gov’t transfers slow, but the inventory build, PCE service increase, and investment will help soften the blow. The question will be how long does the consumer stick around? The third-quarter GDP report showed an expected slowdown, with supply-chain bottlenecks crimping consumer spending, investment, and trade flows. However, a strong gain in services spending hints at greater-than-anticipated momentum for inflation-adjusted services at quarter-end, with positive implications for the fourth quarter. The rotation away from goods and toward services spending is evident in the chart below. Digging deeper, services spending provided a bigger contribution to the 3Q gain than inventories, a driver featured prominently in the BEA’s release.

The price of inventory shifted higher again, which will keep companies and consumers cautious on how much they want to stock up at elevated prices. Depending on the product, they may have limited choice on purchasing just to maintain normal operations, but they will just try to bridge the gap while waiting for some prices to normalize. Some reprieve from inventories, which added 2.1% to GDP growth after subtracting in prior two quarters. This will be lumpy at best, but will be a positive contribution over the next several quarters, but as you can see from the bar chart above- it will vary as to what it does for GDP growth.

Consumption remains the biggest driver of the U.S. economy, which is why it is important to look at how spending has shifted. We still believe that the consumer will increase service spending as goods consumption slows closing the gap further. The path of movements remained consistent vs our expectations and will continue to tighten over the next few quarters. The dollar value of goods vs services will bring down total spending- but it won’t be a collapse just a repositioning of dollar movements.

The biggest issue remains the disconnect between wages and spending as well as what that will mean for corporate profits as labor expense rips higher.

Companies expect wages to keep moving higher, which was proven out (again) in Q3 and will be a driver of cost increases in Q4. The issue companies face is the ability to pass on further cost increases as the supply chain is already sending prices to record levels. At some point, the consumer will be unable to keep up with price increases and result in a much broader slowdown.

Real final sales are starting to contract as the GDP Price Index shoots above estimates to 5.7% & will accelerate further in Q4 (just wait for people to get their heating bills!) Consumers are getting more concerned about the future also pulling forward spending.

An indicator exhibiting late-cycle behavior is the spread between Conference board’s calculation of Consumer Expectations and Present Situation Indexes … simply, spread shows consumers are comfortable now but their outlooks have soured considerably. This reverts back to what we are seeing as a broader spread between the richest and poorest quartiles and how they will react to rising prices.

Per latest Conference Board data, spread between high- and low-income individuals’ confidence still low relative to history and pre-pandemic territory, but hasn’t revisited its pandemic low and is broadly recovering.

Underlying prices continue to driver higher, which is impacting the low-income individual to a much greater degree vs high income eroding confidence and points to a broader slowdown in consumption. These price increases are happening across the country in all facets of products and services.

These pressure points have so far not curbed broader trends on travel, but it will be important to see how these trends play out over the next month. The below travel backdrop could very well be just seasonally normal searches for the upcoming holiday season. In 2020, we had a decline in activity, but in a “normal” year we typically have an increase in activity as people plan for Thanksgiving and Christmas. Thanksgiving being one of (if not the largest) travel holiday of the year.

On the economic backdrop, banks are sitting on a plethora of cash, and even by increasing debt issuance to a record level of $314B- they are still flush with cash. The loan to deposit ratio is still at record lows as banks struggle to find places to invest the capital. U.S. banks are overrun with cash and they’re loading up on debt; 6 largest U.S. lenders have issued about $314 billion of bonds so far this year, already most for any year since 2008, according to deal logic and the WSJ.

This comes back to the law of diminishing returns biting hard as every new incremental dollar adds little to no value and eventually carries a negative impact. As we have record home prices- why is the Fed still buying MBS? They keep buying TSY to fund the insane deficit to maintain “affordable” interest expense, but as the inflationary pressures mount so will the need to taper and naturally drive-up rates. This creates a broad risk as the Fed owns nearly 30% of the fixed income market. We have already seen the failures of the liquidity trap in Japan, and we are heading down the same path with all of this money sloshing around with no way to get it to the corporation or consumer. But, if it did get that far down the chain- what would happen to underlying inflation? Instead of being at 5%+ would we be at over 10%?

The U.S. keeps issuing new spending initiatives that is driving the deficit higher, and will need to be financed more and more with debt. Our current budget is supported with 53% borrowings, and while that isn’t a huge issue right now with rates so low- what happens when we have to roll this debt at higher rates?

The budget gap is expanding but so far interest payments have remained fairly stable- but only as long as when we roll this paper the rates remain low. As the Fed is forced to taper, the open market will be required to take down more and more bonds/t-bills resulting in a higher interest rate. This will drive up interest expense over the coming years and act as a very large headwind to growth.

The issues in the market aren’t going away and inflation has been pulled front and center (again) as corporations and consumers see the squeeze accelerating as the mismatch remains on wages.

The drive-in wages, food, and housing/rent will keep these numbers heading higher.

All the while short term growth will be supported, but when we look further out over time- there is a steep drop off in activity.

This is why inflation remains the biggest tail risk and rising as China worsens and global growth comes under pressure. We still remain concerned on underlying market positioning as the amount of exuberance remains in the market as more landmines are thrown down weekly.

As more people are viewing this to be less and less transitory:

While positioning remains mostly bullish: