Month: March 2022

By Michael Every of Rabobank

More swings in geopolitics, more Fed histrionics, and more market hysterics: yet for equities, any time is ‘Peace in our time’ time: there is no reality-denying, can-kicking delusion they cannot embrace, imbibe, snort, or main-line. Allow me to soberly unpack another volatile day, and the *very* volatile days to come.

Yesterday started with the new ‘normal’: bond yields higher, even if 2.50% in US 10s was a line in the sand, and curves flattening; commodities bid; and stocks saying in times of high inflation and war, they provide a safe haven. Then wild claims started flying around: “Russia to wind down operations around Kyiv!”; “Mutual trust!”; “Ukraine can join the EU!”; “Zelenskiy and Putin to meet!” Suddenly, Neville Chamberlains on trading floors everywhere were waving pieces of paper.

The most immediate impact was in oil and the commodity complex, which was hammered. That saw bond yields reverse their earlier spike. Equities then decided that as well as being a safe haven against inflation and war, they would thrive with less inflation and peace. Then oil prices went back up again on a US inventory draw-down. But it didn’t matter: US 10s closed 12bp lower from their intra-day peak at 2.40%, while 2s only dipped 11bp and, briefly, the 2s-10s curve inverted. We had already seen other parts of the curve invert, but 2s-10s is a key recession indicator: with the kind of inflation and supply-chain backdrop we have, more so. Yet that didn’t bother stocks.

US consumer confidence showed expectations falling to 76.6, lower than during Covid, with lower earners the most despondent. That didn’t bother stocks. Poor people don’t spend money, right?

A Bloomberg article by former New York Fed President Dudley said: “The Fed Has Made a U.S. Recession Inevitable: Jerome Powell is far too optimistic about the chances of a soft landing.” That didn’t bother stocks. What does a former Fed president know?

Current St. Louis Fed President Bullard said he favored a Fed Funds rate of over 3% by the end of this year. That didn’t bother stocks. Who is Bullard anyway?

Philadelphia Fed President Harker stated inflation was at unacceptable levels and he wants to see a series of “deliberate, methodical” rate hikes, with 50bp steps not off the table. That didn’t bother stocks either. Apparently it doesn’t matter that we are only one 25bp hike into an aggressive hiking cycle and the curve is *already* inverted: Fed, shmed – we have peace in our time!

On that peace, look up the Russian military doctrine of ‘maskirovka’ (deception). Yes, it’s as old as the hills and not exclusively Russian, but not all armies embrace it as openly as Russia’s does, even if they sometimes do a rubbish job of it: recall the 150,000 troops now swarming over Ukraine were supposed to just be on a “training exercise?” Stocks don’t.

We do see a fighting pullback of over-stretched Russian forces from Kyiv, which from day one they never had the manpower to take if they faced serious urban resistance, which they do despite the US trying to airlift President Zelenskiy out at the start of the war. However, those Russian forces are pulling back to the eastern front to try to encircle 80-100,000 Ukrainian troops holding the line there. They are not going home to buy stocks, even if the Moscow stock exchange is open again.

Imagine what the suddenly pragmatic and all about “mutual trust” Russian negotiating position will be if that encirclement succeeds: and how bloody the fighting is about to get in Ukraine’s agricultural and industrial heartland as they try. Stocks can’t.

A ceasefire has still not been achieved, and neither the US nor the UK are taking Russia seriously yet. Former Russian foreign minister Kozyrev says: “This could easily be a manoeuvre to buy Russia time to regroup and then hit has hard as they can.” Former Finnish president Hendrik tweets: “Analysts say it’s little more than a tactic for regrouping. Why would you take seriously *anything* Russians say?” Ukrainian intelligence alleges Russia is concealing a mass mobilization of combat reserves and conscription of Chechen convicts to replenish its fighting forces. President Zelenskiy says: “Ukrainians are not naïve…Of course, we see all the risks. Of course, we don’t have a reason to trust the words of representatives of a country that wages war against us.” Stocks do though.

Yes, we have a potential peace positive in the status of Crimea reportedly being kicked into the long grass for 15 years. Ukraine can remain neutral, outside NATO. It might even be allowed to join the EU. But it insists on inviolable security guarantees from the UK, Turkey, the US, France, and Germany that will force them to defend it – a de facto NATO Article 5. It wants this passed into legislation so there can be no repeat of the 1994 Budapest agreement that was supposed to protect it in exchange for relinquishing its nuclear arsenal. Moreover, Ukraine won’t accept territorial losses in Donbas. Why should it surrender access to the Sea of Azov or the Black Sea, or its industrial and agricultural base: to placate Moscow, or stocks? Kyiv also insists on a referendum to cement any deal‘s legitimacy: how does one hold one during a war with millions of refugees; and how would the fired-up population vote?    

However, there is no Damascene conversion underway in Russia. Its Duma just proposed a bill that would only give ethnic groups the right to obtain citizenship if they speak Russian, and envisions adding the definition of “state-forming people” for ethnic Russians and “representatives of Belarusian and Ukrainian peoples that are related to the state-forming people.”

Yet President Biden’s huge gaffe in talking about regime change, walk back, and walk back of the walk-back, disquieted parts of the Western alliance: as such, it would suit Russia to try to look like the more reasonable party again. Indeed, one can see how Russia could now try to split the West again. France and Germany may welcome any opportunity to deescalate: President Macron doesn’t seem to be able to go more than 48 hours without calling the Kremlin. Stocks will love it.

By contrast, Poland, the Baltics, the UK and US will want to keep up the pressure on Russia. The Atlantic’s ‘Don’t Let Up Now’ perhaps reflects D.C. thinking:

“Nothing in Russia’s pronouncements or behaviour suggests that the long-term goal of the Putin regime has shifted from the desire to subjugate Ukraine, replacing President Volodymyr Zelenskiy and his subordinates with a quisling government and eliminating the country’s independence in all but name. Indeed, the apocalyptic rhetoric of Russian news commentators and senior civilian leaders suggests that the war’s aim has not changed. The giddy aspirations of February 24, though, have encountered the realities of the battlefield. Delusions are often modified by the sight of hundreds of burning vehicles…

Thus, the West should support Ukraine by extending only limited promises of sanctions relief to Russia, and it most definitely should not reward Moscow by lifting them entirely should Russia accept a status quo ante cease-fire. And even when official sanctions are lifted, it makes sense to discourage Western companies from doing business there by every means possible.

This sounds harsh, and it is. But there is another Clausewitzian truth to be faced here, that war is a contest not just of armies but of societal wills, and the West must aim to break Russia’s societal will through the grinding up of its army and the devastation of its economy.”

Indeed, if sanctions on Russia are removed with no concrete security guarantees in place for Ukraine, what stops this happening again with better logistics from the Russian side? Stocks won’t like that thought: but luckily they seem to believe everything Putin says – and nothing the Fed does.

Meanwhile, look at the biggest picture to really see ‘Peace in our time’ dynamics. The White House’s proposed defence budget sees a headline increase of around 5% in nominal terms, but real terms decrease. At a time when supply-chains are the front line in the New Cold War and maritime power is vital –which the stand-off in the Black Sea and Sea of Azov underlines, as does the potential threat to Taiwan– the US Navy is being downsized. The budget proposes decommissioning 24 ships, 11 of which are less than a decade old, together while adding just 9. The outlook, according to some analysts, is that the 298-strong Navy is heading for around 280 by 2027, and perhaps 240 in out years. Up to 10,000 sailors may also lose their jobs. By contrast, China is building ships at a frenetic pace.

Wasn’t weakness projected by the West a contributing factor to this war in Ukraine? If so, what signal does a fading US Navy project in a fragmenting world? And as another military analyst pointed out years ago out, if the US gets dragged into a war on the relative scale Ukraine is facing, it would also find its stock of military assets would be rapidly depleted – it has no spare capacity to ramp-up production to replace them at the rate they would be lost. In short, the US would have only a narrow fighting window before, like Russia, it would have to rethink its tactics, strategy, and perhaps even willingness to escalate.

How many allies will the US need to bring on board to compensate for its relative loss of power? We see AUKUS – but defence spending in Australia and the UK isn’t high enough either. We see The Quad – where Japan and India are spending more, but India is not a given in the US camp given its relations with Russia. We see Europe realising it must rearm – but with the risk of political or bureaucratic delays. Worse, given how long it takes to build military power, which regions will the US have to retreat from to focus their attention where they see it matters most? Look at the Sunni Arab-Israeli military alliance emerging precisely because of that shift – even as Middle Eastern energy begins to matter even more to many. This all matters for markets, which rest on politics, which rest on power, which ultimately rests on the military.

If the US wanted to spend more on the Navy, how could it afford it? Grow faster? How, without structural reforms that are anathema to Wall Street? Make money from its maritime military control? Monetizing in an inflationary environment where the US no longer controls supply chains? If anyone can do military MMT, the US can… until it can’t because the rest of the world walks away – which, circularly, revolves around US military power! Look at what is happening to JPY as the BOJ carries out Yield Curve Control. Or, inversely, by trying to slow down China’s rate of growth, so it can’t afford to build so many ships? Anathema to Wall Street again: but capital outflows from China have accelerated since the Ukraine war started.

For now, the US, and the Eurodollar, are hegemons – as underlined yesterday. Russia is weaker, not stronger, after attacking Ukraine (even if a wartime, largely untradable RUB even more jerry-rigged than CNY is almost back to its pre-war level against USD). Many say China has also been warned off any moves on Taiwan. Yet if you want to look further ahead, look at the US military budget and its capacity to sustainably project military power against an economic peer, not a militia or weaker emerging market. But then again, why worry about any war when anytime is ‘Peace in our time’ time for markets?

Oil prices are higher again this morning as optimism about Russia-Ukraine talks fade fast (and API reported significant inventory draws across the board last night).

“Markets remain skeptical of an immediate cease-fire,” said Keshav Lohiya, founder of consultant Oilytics.

Russian production outages “will quickly snowball if the current situation continues.”

The war is already taking its toll on Russian production, which fell below 11 million barrels a day in the second half of March, while deliveries to refineries slid about 11%. Supply is starting to show a “significant decline relative to the beginning of the month,” consultant OilX said in a note.

API

• Crude -3.00mm (-1.588mm exp)

• Cushing -1.061mm

• Gasoline -1.357mm

• Distillates -215k

DOE

• Crude -3.449mm (-1.588mm exp)

• Cushing -1.009mm

• Gasoline +785k

• Distillates +1.395mm

The official DOE data confirmed a sizable crude invenbtory draw last week and Cushing stocks also fell. However, the product side saw inventories build, perhaps suggesting demand fears are warranted…

Source: Bloomberg

Cushing stocks failed to maintain their very recent rebuiild and remain near operational lows…

Source: Bloomberg

US Crude production picked up modestly last week…

Source: Bloomberg

WTI was hovering just above $108 ahead of the official data and slipped lower after the data

Finally, we note that retail; gas prices in the US (on average) are very slightly lower over the last week…

Source: Bloomberg

Sadly for Biden’s approval rating (and drivers across the country), the recent resurgence in crude prices suggest pump prices will soon be on the rise again.

Bloomberg Intelligence Senior Oil & Gas Analyst Fernando Valle notes that “short-term balancing for the crude-oil market may remain elusive as inventories continue to drain in the West and stay well below 10-year averages for refined products and crude. This may be compounded by attacks against Saudi Arabia’s oil infrastructure, while issues with equipment and service bottlenecks in North America will limit growth, and crude inventories may continue to drop. Consumer subsidies may limit demand destruction, with California, France, Brazil and Mexico being the latest to enact policies to cut prices at the pump.”

And don’t expect any help from OPEC+, which meets on Thursday to discuss its supply policy for May, with the group expected to stick with its strategy of modest output boosts even as the war in Ukraine disrupts flows. Major importers are urging OPEC+ nations with spare production capacity to open the taps faster, but the group’s key members have so far remained unmoved.

Authored by Jason Ditz via AntiWar.com, 

Addressing the Iran nuclear deal, EU Foreign Policy Chief Josep Borrell noted “sometimes they think they’re almost there. And other days not.” That seems to be a succinct summary of what is happening with the Vienna talks.

Borrell came in trying to facilitate the tail end of negotiations, but is now suggesting that Iran is the hold-up, and that the status of the Revolutionary Guard (IRGC) being removed from a terror blacklist is clearly part of what’s slowing this down.

That’s a surprise, as previous reports were that the IRGC de-listing deal was separate from the Vienna deal. Iran, moreover, had issued statements suggesting the two didn’t need to be resolved at once. Here’s what Borrell said: 

“The JCPOA, it’s not getting to an end,” Borrell told the European Parliament after returning from a trip to the Gulf, referring to the accord formally known as the Joint Comprehensive Plan of Action.

“It would be a shame not to reach some sort of an agreement when we’re so near to reaching one. But I cannot guarantee that we will reach an agreement,” he said.

Borrell offered some other details on what’s been happening in recent weeks, including that one of Russia’s concerns was that the sanctions relief would put Iran’s oil back on the market, lowering prices and potentially costing Russian oil major revenues.

Days ago, Borrell blasted Russia at the Doha Forum:

“It seems that two weeks ago, we almost had it. Then Russia came, Russia was obstructing,” by withholding approval of what seemed a done deal because Moscow was looking for leverage over the West in its war in Ukraine, Borrell told MEPs in Brussels.

Specifically, he said, Russia wanted to prevent sanctions on Iranian oil being lifted “because if Iran started producing oil there will be more supply in the markets, and that’s not in the interest of Russia.”

That too is interesting, as the price of oil was seen as a big reason for the Iran deal right now. Borrell said it was resolved with a confidential assurance to Russia on overall trade, which is interesting because the US is very much resisting any deals with Russia recently.

Borrell indicated that his team is making the rounds between Tehran, Vienna, and DC trying to work something out. Long story short, however, it seems that the deal could either happen really soon, or continue to get dragged on with minor delays.

Millennials (born between 1981 to 1996) have spent much of their lives living in an economic utopia where goods are cheap and plentiful. Unlike the generations before, these youngsters have yet to experience rapid inflation and shortages until now. 

On Tuesday, BlackRock Inc. President Rob Kapito told an audience in Austin, Texas, hosted by the Texas Independent Producers and Royalty Owners Association, that an entire younger generation is quickly finding out what it means to suffer from shortages, according to Bloomberg. 

“For the first time, this generation is going to go into a store and not be able to get what they want,” Kapito said. “And we have a very entitled generation that has never had to sacrifice.”

He said the economy suffers from “scarcity inflation” due to the fallout of labor shortages, lack of agricultural supplies and affordable housing, and high energy prices. 

Perhaps the latest data from the Conference Board’s Consumer Confidence captures the mood of millennials, which by the way, is not great at the moment. Their confidence in future economic expectations is slumping.

Inflation at a four-decade high is hampering households’ ability to spend. Their real wage gains are negative when factoring in inflation, and their inflation expectations in March soared to a record high. Inflation fears aren’t going away. 

Weakening sentiment and worrisome inflation are because not everyone can easily navigate today’s economic turmoil. Younger generations tend to be renters, own nothing, and have limited savings as they spend well beyond their limits. 

Kapito warned: “I would put on your seat belts because this is something that we haven’t seen.” 

Some folks are not entirely enthused by Kapito’s comments… 

The president of BlackRock calls Americans who don’t want to pay $10 a gallon for gas or not be able to feed their families “entitled”

I support eating the rich during these difficult times pic.twitter.com/qxgB9hrjlF

— Pedro L. Gonzalez (@emeriticus) March 30, 2022

By Irina Slav of Oilprice.com

Private equity investment in oil and gas has been on the wane in the past few years amid the drive toward more ESG-oriented investments and pressure on the industry from the federal government, which has prioritized a shift to renewable energy.

This is changing, however.

With oil prices lingering in the three-digit territory and the U.S. and other large consumer countries scrambling for more oil and gas, the industry once again looks attractive.

The Wall Street Journal reported this week that oil and gas investment funds in the United States are seeing renewed interest from investors in the industry. One of these, Post Oil Energy Capital, told the WSJ’s Luis Garcia that “We see investors more interested in investing in our new funds going forward than we’ve seen in the last 18 to 24 months.”

The firm also said it had plans to set up a new investment fund to take advantage of newly opened investment opportunities in the oil and gas space. A sector player named Lime Rock Management, for its part, told the WSJ’s Garcia that it had recently raised more than $500 million to spend on oil and gas fields.

It appears that, unlike the persistent constraints in the industry itself, which are preventing U.S. producers from boosting output as quickly as many would like them to, energy investors cannot resist prices of above $100. And these are likely to remain there for a while yet.

“EIU expects oil prices to remain elevated above US$115/barrel for most of the year. The risk of further spikes in prices has increased as well,” said the chief economist of the Economist Intelligence Unit, Matt Sherwood, this week.

Sherwood cited falling Russian oil production because of the sanctions and the fact that spare production capacity among OPEC+ members was concentrated in Saudi Arabia and the UAE, and it was only about 3 million bpd, besides the apparent unwillingness of the two countries to deploy it.

What this price outlook means for the industry is continued investor interest, it seems. The longer prices remain elevated, the longer investor appetite will last, and this is very welcome news for independent drillers.

These have been hailed as the big winners of the latest price rally as they were not subject to shareholder pressure with regard to capital discipline. Yet, as one CEO of an energy independent told Oilprice, the small drillers’ club is not trouble-free.

Banks and private equity firms have been shunning oil and gas investments, Margaret P. Graham said last week, following the agenda of the federal government for a shift to renewables.

The independents are seen as a big driver of any U.S. production increase this year and next—and this increase is expected to be substantial, according to the Energy Information Administration. Renewed interest in oil and gas investment, therefore, is even better news for future U.S. oil and gas production trends.

It will, however, take time. Last year, the WSJ’s Garcia reported, private equity funds raised $2.48 billion across seven oil and gas funds. This compared with $15.66 billion raised across 21 funds in 2020. Yet, with prices set to remain high, fund managers appear to be cautiously optimistic.

“We are still not seeing a lot of that activity with endowments and foundations that made it a policy not to invest in fossil fuels anymore,” Jeff Eaton, managing director of fund placement gent Eaton Partners, told the WSJ. “We’re seeing it from some of the groups that either don’t have those policies in place or are willing to look past them a little bit because they’re starting to see a potentially attractive investment opportunity.”

It appears that the tables are turning as the world’s energy demand grows while supply stagnates, offering new opportunities to energy investors and new sources of much-needed funding for energy companies.