By Mark Rossano

• Food and Geopolitics
• Inflation Update in the U.S. and China

There isn’t much to update on the frac spread side as we remain close to our target of about 275 active spreads. The Permian spreads we discussed last week showed up in the data and will remain around 140 into the seasonal slowdown as some spreads are picked up in the smaller basins as well as the Haynesville and Eagle Ford. The smaller basins will get one more push before things calm down for the holiday season, while the rest of the basins maintain elevated activity. We are starting at a much lower level versus previous years so the drop from Thanksgiving to Christmas won’t be as big as years with normal activity. Rig additions will continue throughout the rest of the year and well into 2022 as DUCs are replaced for drilling programs.

Inflationary pressures remain across the OFS space as labor, raw materials, and other input costs keep prices fluid and rising. Spot contracts have seen an uptick, but in order to attract work, some OFS deals have been signed with 2–3-year terms. Term contracts are fine as long as there are some mechanisms within them to pass on cost shifts and try to protect margin as prices will maintain their upward momentum. We are also seeing more adoption of duel stim or simul-frac (depending on what you call it) outside of just the Permian. Many of these conversations are still very early stages, but the process is starting to expand given its success in the Permian.

We don’t expect to see any reduction in activity, and we are in place to hit about 11.65M barrels a day exit rate. Our high-end target from March 2021 was 11.7M barrels a day- so the market is right inline with our estimates. Our early estimates for next year put us at an exit rate of about 12.3M barrels a day in 2022 given the level of activity and current price regime. There are some issues at the Panama Canal with LPG cargoes, which is pushing Asia (India and China) to rely a bit more on the Middle East. The canal authority is prioritizing container ships and LNG vessels, which will continue through Q1’22 based on early indications. This is creating bottlenecks at the canal that won’t be alleviated any time soon, which will be an overhang on LPG exports. Exports will still stay strong, but this will be an overhang that we will be tracking more winter demand pulls more cargoes into the canal. More to come next week!

• Food and Geopolitics

The food situation continues to worsen as prices rallied again following the WASDE report that was either inline with expectations are slightly below estimates. The bullish backdrop remains on pace with more demand and exports occurring as many tenders were re-issued or have increased into year-end. Russia put in place a trigger for exports based on internal/external prices in order to cap local pricing and ensure enough food for their citizens. The yield in Russia has been an unknown as they have been reducing underlying yields. “Russia could change the formula it uses to calculate grain-export taxes if there is a major surge in global prices, Agriculture Minister Dmitry Patrushev said at a government meeting.

If there is a significant increase in global prices, “let’s say up to $400 per ton or more, the formula for calculating the floating export duty will be revised upward,” Patrushev said.

NOTE: FOB wheat export prices in Russia are currently at about $330.50/ton and French prices are at $336/ton, UkrAgroConsult data show.

Russia also plans to set a grain export quota for January-June of next year”

The concern is around the explosive move higher in food prices that have triggered concerns around the world. Each of those spikes have resulted in riots, protests, and regime changes, which is why many Middle Eastern nations are still buying even at these elevated prices. The high reach in ’10-’11 was the impetus for the Arab Spring, and those nations have maintained purchases even through this rising price cycle. They are also much lower on reserves given the weak yields over the last 2 years that pulled down state spare capacity, so there is also much less slack in the system vs previous years.

“Even as wheat prices soar, some of the world’s top buyers are piling in. Global trade of the staple grain will leap to a record this season, buoyed by an import frenzy in the Middle East, the United Nations said on Thursday. Iraq, Iran, Turkey and Afghanistan are all loading up after drought hit their harvests earlier this year, draining local supplies. Egypt is also replenishing stockpiles, the agency said. The gains highlight how the region is paying up to ensure food security, even as wheat prices soar to multiyear highs. That will put additional pressure on those economies, although rising oil revenues could cushion the blow for some nations.”

The USDA has their own estimates on where we will see global wheat trade play out over the next few months. Global wheat exports will reach an all-time high as Russia, the European Union, India and Ukraine are all shipping out more than expected. That’s according to the U.S. Department of Agriculture’s monthly crop report out Tuesday, which showed that exports will reach 203.2 million metric tons. The battle for what country holds the wheat-export crown remains a close race: The USDA upped its estimate for Russia by 1 million tons due to a bigger harvest, but the EU is still poised to take the lead for now. The U.S. is falling in the wheat export ranks, though: It’s sales will be surpassed not only by the EU and Russia, but also Ukraine and Australia. That’s largely due to high domestic prices for varieties like spring wheat, the USDA says. U.S. yield has come under pressure with estimates consistently getting revised lower as weather impacts the total output levels.

The recent data from the USDA still has things tight going into next year and will support elevated prices as exports remain robust into key demand areas- especially China.

U.S. exports into China have slowed over the last few months but were strong enough through the last few months that we are still on pace for a record number of exports.

China also saw a spike in their own inflation (more on that later), but a big driver of it was food-especially vegetables. We are seeing the pressure spread from grains and hit hard across meat as well. Consumers are “trading down” on quality as people try to maintain consumption but are sacrificing for cuts of meat as well as type.

Before Covid, meat processors struggled to meet their labor needs, which increased the hiring of immigrant workers mostly from Mexico. More than a third of the workforce was foreign born, according to a 2020 report by the Economic Policy Institute. That hurt the industry when the Trump administration curtailed immigration.

For America’s meateaters, this is a problem. Some cuts have soared 25% over the past year, while others are fetching near record prices, making meat one of the biggest contributors to pandemic inflation. And industry experts expect meat to keep gaining through the holidays and beyond. “The sticker shock is what we all need to be prepared for,” said Bindiya Vakil, chief executive officer of supply-chain consultant Resilinc. “This is here to stay, at least through the summer of 2022.” The below looks at it a little different across the different types of meat, and as steak/beef keeps moving up- the transition to chicken and pork will keep moving higher. The substitutions will keep pulling the lost valued product higher as consumers transition into different types of products.

But as you can see from the chart above, beef products have been trending higher for the last 10 years, and it is unlikely that stops anytime soon. We will see some prices level off, but it will be stuck at these elevated levels- especially when we factor in fertilizer prices and so far, future pricing. Milk has also seen a steady rise, but just like everything else in grains- it began well before COVID. The COVID situation made things worse, but the price of grains were already starting to move higher as yields were weakening in ’19 and the beginning of 2020 saw a big disruption in yields driven by broad floods, droughts, pests, and other livestock illnesses. The problems were only compounded by COVID, and now with energy (NG) prices spiking- the cost of making fertilizers is pulling the future price of crops even higher.

The below shift helps to show how food/grain prices really started to shift higher before fertilizers really started to go parabolic. As yields struggle, farmers will use more fertilizers and chemicals to boost production and try to maximize whatever remaining yield they can. Grain movements start to shift higher, which started to pull the fertilizer price up. But as we come into 2021- the massive shift in natural gas has pushed prices further as facilities are forced to shut down due to input costs. This has created fear of shortages in 2022, so farmers have gone out ahead of schedule to lock up volumes for next year. This also leads to higher prices for crops next year as farmers try to regain the input costs they need for planting.

European fertilizer producers have cut ammonia output by a quarter amid concerns that natural gas prices will remain high until mid-2022, CRU Group’s Head of Fertilizer Chris Lawson said in an interview.

• Plants that have remained operational despite higher production costs have curbed output by 7.2m tons, further tightening the region’s supply of nitrogen fertilizer
o This is in addition to ~3.2m tons of output lost after some plants shut down amid soaring energy costs
• NOTE: European gas and power prices surged to record-highs in recent weeks amid a supply crunch and uncertainty over Russian flows to the region
• Fertilizer producers are holding back from ramping up production due to fluctuating gas prices
o NOTE: European gas prices rose Thursday after Belarus President Alexander Lukashenko said he might consider shutting down a key pipeline linking Russia to Europe
• Some farmers in Europe may miss out on supplies for use in spring 2022, Lawson says
• Curbs on fertilizer exports from China and Russia, combined with a potentially colder-than-usual winter, will likely exacerbate the crisis
o Lawson sees prices remaining elevated for the next 6 months
• A significant drop in fertilizer prices, similar to in 2008, is highly unlikely as demand for the crop nutrient is expected to remain high amid tight supply and low inventories

The price spike is happening around the world and is not just tied to Europe, but they are the ones with the highest input costs forcing them to be the first to shut down. There are broader issues in fertilizer costs around the world with the North America still the lowest cost even as prices roof back to the highs. This will keep prices elevated across grains, which bleeds down into the livestock side of the equation as well. Food prices will remain sticky for an extended period of time, and normally results in a much broader global conflict.

China course grain imports for 20/21 have doubled from the previous record. “Imports of corn and barley each reached new highs, while sorghum reached the second-largest volume on record. Major suppliers for corn were the United States (69 percent) and Ukraine (29 percent); for sorghum, the United States (77 percent) and Argentina (14 percent); for barley, Canada (29 percent), France (26 percent), and Ukraine (26 percent).”

The FAS report also pointed out that, “Imports of non-grain feed ingredients (NGFI) also grew from the prior year. Strong cassava imports can be attributed to high domestic corn prices as feed mills and fuel ethanol plants may have turned to a cheaper alternative to domestic corn. Imports of distillers’ dried grain (DDGS) improved from a year ago but were small as the antidumping and countervailing duties on U.S. DDGS remain in place.

China’s imports have surged following a huge drop in last year’s yield that has been weakening since 2018. The Yangtze River Basin flooding in 2020 destroyed huge swathes of farmland and livestock that came at the same time armyworm and locust outbreaks hit total yields. China was also still recovering from outbreaks of bird and swine flu- so they have spent the last year trying to refill storage while trying to limit inflationary pressures. Inflation is starting to rise as companies have struggled to pass on costs into the international market and factory costs keep rising. Inflationary pressures are going to continue to grow within China damaging the consumer even more.

All of these industrial initiatives and drive to build out a bigger system sounds fine, but it is coming at a rising cost to the rest of the world. China has approximately 21% of the world’s population, but only about 6% of the world’s arable land, which also happens to be where most of their populace lives. The lack of rainfall in 60% of the country limits the amount of food they can produce for themselves, pushing China to purchase more from other nations and increase fishing activity.

The richness of the South China Sea makes the 9-Dash Line EEZ grab all the more logical for a growing populace. There is only so much fertilizer, seed traits, and soil management that can be done to optimize yield. But overfishing can create the same long-term damages and ecological effects, which is a big problem. Their aggressive fishing tactics have recently led to a handful of Vietnamese fishing vessels being sunk, and several African nations revoking their fishing licenses.

This picture highlights many of the incidents that have happened with several more taking place since 2019. The color-coded chart shows where many of these fishing vessels overlap and how more incidents are bound to happen.

The massive rise in Chinese purchases of food has come on the back of extreme droughts, flooding, locusts, army worm outbreaks, swine flu, and avian flu (just to name a few) tightening the food supply and driving nationalistic behavior in other countries to protect local citizens. Thailand and Russia have enacted restrictions on exported food to ensure sufficient local supply. Global extreme weather events have also slowed the harvest and planting of core crop lands (most recently, in Brazil), which is keeping the current supply chain extremely tight. Food security is a rising theme for many nations, and there is a lot of farmland just south of China in Indian territory.

The topography of Asia creates many weather restrictions, with the Himalayan mountains limiting moisture movements farther inland. It has created flat lands, rivers, and soil perfect for growing crops—but the Himalayas also creates a natural barrier for moving heavy equipment (especially military equipment) through the mountain range. Lately, China and India have come to blows in several key areas: Sikkim, Doklam Plateau (in Bhutan), and the biggest in Ladakh where soldiers were killed on both sides. Bhutan requested India’s assistance to stop the movement of Chinese soldiers crossing into their borders. While the conflict ended without incident, both sides have been building additional military resources and moving equipment into the region. Farther to the West in Ladakh, soldiers were killed on both sides after China ambushed an Indian patrol, sparking a heated exchange. China and India have claimed pivotal territory high ground and have strengthened nearby assets to support forward positions. Even as both sides agree to pull back forward positions in an attempt to de-escalate, India still has a number of restrictions on Chinese goods, including a ban on over 50 Chinese apps. The problem is: they are big trade partners and can’t risk a near-term escalation. It doesn’t mean one can’t happen, but each side continues to test the military waters to understand positions. The Ladakh region is a key area for the Indus Water Treaty (the water in the region serves large parts of India and Pakistan), as well as an intricate part of the PAK-China Economic Corridor.

China has already created close relationships with Bangladesh and Myanmar (supporting the coup; there are many logistical and commodity reasons they want control) that open up their flows to the Bay of Bengal. If China were to push South through the Sikkim, it would cut off India at the choke point—delivering farmland to Chinese control and opening up the Bay of Bengal to China. A huge portion of the world’s population lives along this China-India border and need the food and water it provides.

Flash droughts in China are making it more important to find ways to diversify their food supply, as we can see below in the 2019 picture. The population density in the region and slowing global economy create a powder keg waiting to ignite. Wars typically aren’t fought during periods of strong economic growth, but rather during hard times where one country wants (needs) someone else’s resources.

Africa is another place that has seen a big shift in weather patterns that have impacted underlying yields in key growing regions. The continent has faced shifts in crops due to political pressures and misuse of farmland that has damaged total output. But, the weather patterns have created broad droughts that have limited total output, and it is impacting more people now than ever before. Africa is a big flashpoint going forward as economic conditions worsen in the region and food shortages/costs stress an already tenuous eopolitical backdrop.

Pressure is mounting in some key areas over the last few months with Belarus and Poland seeing a rise in tensions over the last month. The problems escalated when Belarus forced a Ryannair flight to land and arrested Raman Pratasevich and his girlfriend Sofia Sapega. Raman has been an outspoken critic of the recent Belarus election and Alexander Lukashenko. In June, the EU, US, and UK imposed sanctions on Belarus, which have seen an escalation over the last month. Russia has been flying bombers in Belarus airspace as a show of force/ support while Belarus attempts to push thousands of migrants into Poland.

“Hundreds of migrants from the Middle East, Africa and Asia are trapped in Belarus on the border with Poland, with thousands more migrants on the way to the border. Poland has installed a barbed-wire border fence to prevent the migrants from crossing, but the migrants are using wire cutters and shovels, supplied by the Belarus military, to cut the wire or dig up the fence.

The Belarus military is standing behind the migrants, shooting their guns into the air, threatening any migrants who attempt to turn back from the border. Poland’s military is standing on the other side of the barbed-wire fence, blocking any attempts by the migrants to cut the barbed wire and cross into Poland.

Poland has deployed more than 12,000 soldiers to the border and a volunteer Territorial Defense force was put on alert, according to Poland’s defense ministry.

The European Union is describing the Belarus policy as “weaponizing migrants.” Belarus has extended this policy from Poland to Lithuania and Latvia.” [1]

Russia has been moved assets around Russia and increasing forces near the Ukrainian border. “Russia says military deployments on its territory are an internal matter and it denies any aggressive intentions, while accusing the U.S. of provocation by sailing warships in the Black Sea close to its territory this week… With the West preparing fresh sanctions against Belarus over what it sees as a manufactured migration crisis, President Alexander Lukashenko threatened Thursday to shut down a key pipeline carrying Russian gas to the EU if Poland closes their border. “I would recommend the leadership of Poland, Lithuanians and other empty-headed people to think before speaking,” he said.”[2]

This is all happening at a very tense time as Gazprom storage still remains well below normal storage levels and Russia is putting pressure on Germany to push through Northstream 2. It is unlikely this materializes into much given the current weather and difficulty in moving heavy machinery in the cold, muddy conditions. It doesn’t mean it can’t be done- just that saber rattling is more likely given as Belarus heats up and Russia looks to gain more leverage over Europe (especially on the natural gas side).
As we have discussed in previous reports, as the military presence grows so does the chance of a “mishap” or an event that spirals. Poland has moved troops to the border to keep the migrants on the Belarus side of the fence, while the Belarus soldiers provide bolt cutters and shovels to get through the fence. The Belarus soldiers are also firing over their heads to keep them from trying to turn back. So the migrants are the ones that are stuck in this mess and just pawns of a much bigger game being played.

There was an attack on the Iraq prime minister Mustafa al-Kadhimi when 3 explosive drones attacked his residence with 2 of them being destroyed but one of them reaching its target. The drone attack follows widespread riots and protests on Friday, where Iran-backed militias were protesting the results of the October 10 parliamentary elections. The Iran-backed Fatah Alliance won only 17 seats, down from 48 seats in the previous parliament. Iran has been losing influence in the region, which was confirmed again with the sweeping defeat in parliament. Muqtada al-Sadr picked up a significant amount of support and initially wanted to expel the U.S., Iran, and Turkey. But the rhetoric of kicking the U.S. out has really slowed down, and now the attack against the PM has put a pause on it all together. On the other side, there is another push to expel Iranian assets from Iraq and purge a lot of the Iranian militia that still exists within the country.

Muqtada al-Sadr and the Sadrists

The biggest winner in last month’s parliamentary elections appears to be the Sadrists, the political party of Muqtada al-Sadr, who got 73 seats. Those with a long memory will recall that al-Sadr is a highly respected Shia cleric who opposed American intervention in Iraq during the 2000s. Today he strongly opposes all foreign intervention, including intervention by the US, Iran and Turkey.

With or without the drone attack, there’s a feeling that Friday’s violent protests represent a turning point in Iraq. According to one analyst, Muqtada al-Sadr had been using the time since the October 10 election to negotiate with other political groups in order to form a governing coalition, and Friday’s violent protests have forced those negotiations to end.

There is a growing conflict between the Sunnis and the Sadrists on one side, and the pro-Iranian Fatah alliance on the other side. In the meantime, the Iranians are attempting to pressure the Iraqi government to demand with the withdrawal of American forces, just as the Americans had to withdraw from Afghanistan. This conflict will continue during the next few months, but it seems unlikely that America will be forced to withdraw from Iraq, as long as the Americans are seen as a countervailing force to Iran, especially in view of the disastrous results of the American withdrawal from Afghanistan.

There have been a lot of articles going around China: “The Chinese military is using mock-ups of a U.S. aircraft carrier at a weapons-testing range in a remote western desert, new satellite imagery shows, indicating the People’s Liberation Army is focused on neutralizing a key tool of U.S. power. Satellite images depict targets in the shape of a carrier and two Arleigh Burke-class guided missile destroyers at a testing facility in the Ruoqiang area of Xinjiang’s Taklamakan desert, the news website of the U.S. Naval Institute reported. Both types of vessels are deployed by the U.S. Seventh Fleet, which patrols the Western Pacific including the waters around Taiwan.” As this story broke, 16 warplanes of China’s PLA entered Taiwan’s air space again. I don’t think it surprises anyone that China has a replica of the assets they could potentially be fighting in the South China Sea. It is the little talked about article showing the build out of Chinese Nuclear Silos in key strike zones.

Russia is just as scared of China as the U.S. is when it comes to their nuclear arsenal and hypersonic missiles. The location of the newest silo construction is a strong strike point to Russia as well as hitting all major cities in the U.S. Our ability to hit those silos are doable, but hard because they would need to fly deep into Chinese territory in order to be effective.

As this has come to light, the U.S. has had to increase their estimates of the amount of nuclear missiles that China has and the underlying capacity. If we think back to the cold war, the goal was to always have “one more” than your enemy. The objective was to overwhelm the defenses because if you launch 500, but the enemy can only take down 450- that means the strike was a “success.” The idea was the “Tripod” to ensure essentially- “mutual destruction” as a way to deter against any launch to begin with. So while Russia plays the game of running military drills with China and being friendly, there are a lot of issues just beneath the surface. China and Russia have been enemies for the last several thousand years and little has changed on that front. China claims a large piece of Eastern Russia as their own under the same doctrine used to support the nine-dash line. Russia ran a war game on the North and Eastern part of the country and invited the Chinese military to come watch as it included all three branches of the military and 10’s of thousands of troops. Just think- which is the only country that can actually invade this part of Russia? It was a show of force and essentially a demonstration of what would happen if China got any ideas of enforcing their claim. Russia is also (and has been) very close allies with India, and Russia was the FIRST country to support India after the Ladakh incident. Russia also accelerated the delivery of equipment and weapons systems to India with many Indian personnel currently in Russia being trained on how to work the equipment. Geopolitics is always very complex with many twists and turns, but Putin is working off the view of keep your friends close but your enemies closer.

• Inflation Update in the U.S. and China

The inflation story is heating up again with an acceleration in October, which is what we were calling for based on the leading indicators. Inflation still remains hot, but the pace of increase will slow again in Nov based on some of the underlying data. Container and shipping rates have slowed a bit, which will help slow the rate of change. But the inflation cat is out of the bag, and now that it is roaming free- it will be very hard to capture. All metrics of inflation are over 2% (the Fed target) and all being pulled higher as the increase in prices is broad based and not just tied to supply chains and “reopening” activity.

The supply chain still remains an underlying problem keeping inflationary pressures across the board, but the issues are expanding and broad based as wages accelerate and pick up the torch from the shipping arena. This isn’t to say shipping issue are behind us, but it is to say that some of the biggest cost surges are behind us. The port delays still remain pervasive on both sides of the ocean between the U.S. and Asia- so the time to ship and sitting at port will be a cost overhang well into 2022.

The presence of the supply constraints that will easily remain into the 2H’22 will keep inflation sticky at the high end of the range- while rents and wages drive the broad base expansion in pricing and underlying CPI.

Real wages have continued to weaken as inflation has increased and salary increases haven’t been able to keep pace. This means that companies will be pushed to increase wage rates as labor shortages persist and living expenses keep rising.

As real wages come under pressure and fears around financial situations grow, it is no surprise to see a big drop in consumer sentiment. We are now LOWER than the beginning of COVID and at levels not seen since 2011! The U.S. market is sitting here with inflation rising and real wages falling which is NOT a receipt for growth. The pressure on the consumer is mounting as companies try to pass through more cost increases and keeping inflation plastered to the highs.

As we have been saying, the pull of inflation is dragging what is deemed as “sticky” to new highs and it is just starting to move with little in the way to stop its move higher.

The spread between CPI and PPI remains vast as everything from logistics to raw materials to labor keep pushing up.

We are rapidly approaching a point where the consumer will reject price increases as the ability to trade “down” is exhausted as we discussed in the food segment above. The pressure on the consumer is peaking as savings have been exhausted and people are turning back to debt.

We have already discussed how people are relying more on payday loans and cash advances, and here is more data supporting the use of credit to purchase holiday goods.

The surveys are getting worse as people expect their financial situation to worsen over the coming six months, which will result in people doing less. Consumers will look to conserve cash as savings have been drained, government transfers slow, and prices keep shifting higher.

Productivity has also fallen per hour, which is keeping the slack in the market elevated: Productivity in 3Q21 was very weak (-5% annualized rate, orange), bringing 4-quarter moving average (blue) into negative territory for first time since 2016 (now lowest since 2011)

Small business optimism is going lower just as quickly as consumer sentiment: Oct NFIB.

Small Business Optimism fell to 98.2 vs. 99.5 est & 99.1 in Sept; no change in % of employers anticipating job creation; 31% see increased capex & 53% anticipate higher selling prices … net expecting better economy fell to -37% (orange), worst since Nov 2012.

“Shockingly” the fear is around inflation and rising wages. The rise in CAPEX and compensation will be passed through to the consumer resulting in- you guessed it- higher prices. This is an endless cycle of prices getting pushed through until the consumer cuts back more aggressively and additional costs can’t get moved through the system.

The above data is playing out globally and not just being reflected in the U.S.

China is another place where prices have started to rise on the consumer as companies struggle to pass more cost off on the export market.

China’s General Administration of Customs released trade data for October on Sunday.

The headlines (SCMP):

• Exports rose 27.1% y/y in dollar terms in October, down from 28.1% y/y growth in September.
• Imports increased by 20.6% y/y last month, up from 17.6% y/y growth in September.
• The trade surplus was USD 84.5 billion in October, compared with a surplus of USD 66.8 billion in September.
• Stop us if you’ve heard this one before: Exports came in above expectations once again.
• The consensus forecast was that exports would increase 22.8% y/y.

A quick refresher: The argument that Chinese exports would fall was rooted in the idea that as COVID-19 restrictions are lifted, overseas households’ spending habits would shift from consumer goods back to service sector activity.

• High case rates, however, mean that consumers are still nervy about leisure activities.
• Surplus savings are still being funneled into goods’ binges.
• While overseas demand is still booming, the import data painted a less positive picture of domestic consumption.
• Import growth came in below expectations of 26.6% y/y.
• Imports were boosted by purchases of fuel to plug China’s energy shortages:
• Coal imports nearly doubled last month.
• Imports of commodities used in construction painted a more worrying picture of domestic economic activity:
• Iron ore imports fell 14% y/y by volume in October.
• Get smart: With real estate spluttering, and a new wave of COVID-19 cases threatening an already weak consumer sector, the economy is becoming increasingly reliant on exports.

The slowdown in imports is a bigger concern and what we have been pointing to regarding the health of internal demand and growth of exports. Imports are indicating what is to come and the pressure buildup as all facets of the Chinese economy struggles. Exports are the only thing helping the Chinese economy right now and with all costs roofing- the government is running out of options to keep prices capped and have allowed some price increases to be passed on to the consumer. We expect to see more internal price increases over the next few weeks as China tries to protect their export market.

All the while- the government faces fiscal drag and the PBoC still unable (or unwilling) to increase the credit impulses by capping liquidity in the market.

But all prices are roofing with a lot of room to pass some of this off to the local consumer.

While the real estate situation degrades further, it has bigger implications for all sides of the economy including commodities and consumer spending.

Onshore debt is just now starting to show cracks as the CCP has started to increase the rhetoric around special purpose bonds and local government financial vehicles. We will need to watch lending in SPBs and LGFVs to see how much of this is being pumped into the infrastructure system. Right now- local gov’ts and provinces are choking on previous investments as tax revenue is going to pay interest + principal. Many areas are struggling w/ low tax rev. At the heart of the bond market rout is concern that developers may have far more debt than disclosed on their balance sheets. That’s after some companies struggled to pay public and hidden debt despite appearing to have sufficient capital. Making matters worse is developers’ inability to roll over maturing debt due to surging borrowing costs that effectively shut them out of the dollar bond market. China’s 10 largest developers by sales owe a combined $1.65 trillion in liabilities. The stakes are high. Chinese banks had more than 51.4 trillion yuan ($8 trillion) of outstanding loans to the real estate sector as of September, an increase of 7.6% from a year earlier. The exposure was more than any other industry and accounted for about 27% of the nation’s total lending, according to official data. About 41% of China’s banking system assets were either directly or indirectly associated with the property sector at the end of last year.

As real estate developers have struggled for financing, they have turned to WMPs (Wealth Management Products) again that INCRAESE the exposure of the local consumer to the housing market. These are the type of instruments that wiped out holders in Evergrande, which is expanding into other developers. China had a total of 27.95T yuan (USD$4.3T) of outstanding WMPs end Sept, up 9.3% YoY… In Q3, China saw 9.88M new WMP investors, w/11,700 new WMPs issued, raising 31.9T yuan.“ The exposure to consumers is growing in the wrong direction and is only making the underlying problem much worse.

These are China’s two biggest property developers: Country Garden & Vanke’s dollar bonds are starting to fall, which changes the stakes for authorities, investors and even the strongest developers as contagion spreads.

Evergrande escaped default on Wed after paying the $150M in bond coupons at the end of the Grace Period. There will be more events as companies reduce their holdings in Evergrande and its subsidiaries, which is also playing out in the largest developers within China. Here is a list of events to watch for Evergrande going forward: