Energy: Oil and Gas
Energy is the cornerstone of the global supply chain.
Whether or not we admit it is a vastly different story.
Natural gas prices have moved to a record during the “Shale Revolution,” just now taking out the 2007 highs.
It’s important to remember that we were NOT producing 100 billion cubic feet a day when we hit those figures.
Natural gas is a key component of everything: electricity generation, heating homes, and
powering facilities.
It’s also a key input to everything from petrochemical creation to refining, fertilizers… the list goes on.
The price of energy has risen across all key variables driven by under-investment, political turmoil, and geopolitical shifts.
As supply remains constrained, the only way we can get a meaningful adjustment is through demand reductions.
Factory gate prices keep moving higher, which will put more pressure on consumer spending.
Another huge factor is diesel prices, which have been relentlessly rising.
Diesel prices have just hit a new record (I feel like I say that every day) driven by global shortfalls that are unlikely to fall back to normal in the near to intermediate-term.
There is no quick solution to creating more diesel without a sharp drop in demand.
The last time we saw this kind of move was in 2008, and it only started to move lower after demand fell off a cliff.
Diesel prices hit every part of the supply chain and given the current storage levels globally, we are in a tough spot to see this drop off without some extensive pain.
I’m sure you have seen those “diesel surge charges” included in your delivery breakdowns, and it has added more to the underlying cost of many items.
Typically, fuel and labor are straight pass-throughs to the end-user, which can accumulate from the raw material to the finished product.
When a refiner creates 1 barrel of diesel it also creates about 2 barrels of gasoline, and it’s hard to adjust that ratio.
But a key issue is the type of crude available because there are a wide variety of crude grades.
Europe and the U.S. have stopped importing Iranian barrels and are shunning Urals (Russian crude) which is adding to the shortage of distillate.
These barrels typically yield a higher cut of distillate during the cracking process to create different refined products like gasoline, diesel, kerosene, and propane.
The distillate is the liquid product condensed from vapor during the distillation process.
There are many different types of crude oil in the market typically measured by: sweet/sour (how much sulfur is in it), heavy vs light (the API gravity or viscosity of it), and TAN (acid).
Refiners will typically blend these different cargoes together and adjust the cracker accordingly to run the varying qualities.
By removing Venezuela, Iran, and Russia from the mix we are missing heavy barrels in the market.
This has driven up the price of replacement barrels.
So from the refiners’ perspective, they are seeing all of their key input costs going up: natural gas, crude oil, and labor.
Refiners also have to deal with the storage of products, and gasoline/light distillate is a growing problem in Europe that is sitting on a seasonal record.
In 2008, we had a surge in crude pricing mixed with peak demand that culminated in the Great Financial Crisis.
This time around, we have crude prices below 2008 peaks but many supply chain bottlenecks, including the Ukraine-Russian war.
Russia is not only a big crude exporter but also exports a significant amount of diesel into the market.
Russia can’t risk shutting in facilities, so they will keep dumping into the market at any clearing price.
We have seen differentials go as wide as $37 below dated Brent in order to keep things fluid.
China being in a lockdown has reduced its buying needs, which has left more Russian and West African crude in the markets.
But, Russian crude can’t flow into Europe and the U.S. because of sanctions (at least not at pre-Ukraine levels), while West Africa is good but limited in the amount of diesel it produces.
Are Workers That Expensive?
Labor and fuel are typically a straight pass-through, which is only moving higher across the board.
We had employment costs move back to new highs as March-June normally sees a big hiring boost.
Given the tightness in the labor market, companies are paying up to bring on new employees.
Inflation, but not Wage Inflation
Prices at the consumer level are already hitting hard: “Real disposable income is now slowing considerably. Disposable income rose 0.5% in nominal terms but fell 0.4% adjusted for inflation in March. While real disposable income remains 1.6% above its pre-Covid level, it’s now 3.7% below its pre-Covid trend.”
Wages have failed to keep pace as we have been discussing, which will keep the pressure on retail sales
GDP Breakdown
Since the consumer makes up over 70% of GDP, as the U.S. consumer goes, so does U.S. growth.
The slowdown is causing a big step up in inventories, which is resulting in a slowdown in new orders.
But inventories are moving higher throughout the supply chain, which will make the hit even worse.
Retail inventories climbed 2% in March, up from 1.4% est. and 1.5% in the prior month (revised up from 1.1%); in level terms, inventories are firmly above the pre-pandemic peak.
We now have a consumer facing a mountain of price increases, wages that have risen but not enough, and elevated inventories.
This is a recipe for… “I am going to skip the store this week or I am not going to buy that (insert item) right now.”
I think the below chart speaks volumes where the savings rate has taken a nose-dive while inflation rates push to a multi-decade record.
The problem remains a fickle consumer, but the shifts are very apparent: US consumers are still spending but they’re doing so with more discretion: cutting back on goods & indulging in services.
Nominal outlays are up 1.1%, but mostly reflecting a 0.9% rise in prices as real spending is only +0.2%.
Price Paid and Prices Received for services are at a record level.
So as people shift their spending, it will be more into services and less into goods.
Many people have already purchased items with government transfers, which is why a “fiscal” drag” is a real thing.
In the U.S., a typical American receives a check for $2k and will spend $5k.
This money went directly to a TV, couch, appliance, or some other item… but how many of those will you purchase?
So not only were the needs met, plus those prices have gone up by over 30% with more pressure coming.
The spending on services should be a growth spot in Q2.
But as prices keep rising, we expect a big drop off into the end of May/June.
As rates rise, it will put more pressure on available credit as financial conditions only get tighter in the next few months.
The fiscal response (government) has already been tapped out.
With over 50% of our budget sourced from treasury bills, the cost of borrowing is going to rise.
Rising rates are also going to hit emerging markets even harder as global manufacturing output has already moved into contraction.
As global real wages continue to fall, so will economic growth.
Until tomorrow,
Freedom Financial News
