Economic Activity Hits A Decade-Low

Friday, March 27, 2020

1. Economic activity plunges to decade-low

- The U.S. economy contracted at the fastest rate in March since the depths of the financial meltdown a decade ago.

- IHS Markit’s purchasing managers index saw manufacturing activity drop to a reading of 47.6, while the services index plunged to 39.1. Anything below 50 is a signal of contraction. The composite of those two fell to 40.5 in March, down from 49.6 in February.

- In the eurozone, the comparable index fell to 31.4 in March from 51.6 in February.

- “We are confident that the speed of the collapse now is faster than after the crash of September 2008, at which point the economy had already been in recession for a year; this is an overnight stop,” Ian Shepherdson, chief economist at Pantheon Macroeconomics said in a note to clients. “We expect a further decline in April, which ought then to be the floor, or close to it.”

2. Oil majors begin cutting

- Much of the financial stress in the U.S. shale sector has been concentrated in small and medium-sized drillers. But even the oil majors are drilling unprofitable wells with oil in the $20s.

- This week, they began to reverse course, after ramping up drilling in the Permian over the last few years. Chevron (NYSE: CVX) announced that it would cut its spending by $4 billion, and spending in the Permian by half.

- ExxonMobil (NYSE: XOM) has a dividend yield at about 10 percent. It saw its credit rating downgraded last week by S&P. It has taken on debt for years to cover its dividend.

- “Exxon now yields more purely on its dividend [than Chevron], but that indicates higher stress,” Liam Denning wrote in Bloomberg Opinion.

3. Steep Brent contango

- The futures curve for oil benchmarks has collapsed at the front end, a reflection of a massive state of oversupply, at least in the short run.

- The substantial contango – when near-term prices trade at a discount – incentivizes storage for sale at a later date. But analysts warn that storage will rapidly fill up this year.

- “If the forward curve is viewed as an indication of market expectations, the market is expecting the situation to improve considerably as the year progresses: while the May contract for Brent is currently trading at around $27, the price of a shipment in December has already reached $38 per barrel,” Commerzbank said in a note.

- “It is questionable whether demand will improve to such an extent during the course of the year, however,” the bank added.

4. Oil demand could collapse by 20 mb/d

- As more regions and countries go into some version of a lockdown, oil demand is collapsing.

- Demand forecasts from a long list of investment banks continue to be revised down, with the latest round seeing demand falling by 15 to 20 mb/d in the second quarter.

- Goldman Sachs, for instance, is forecasting a drop in demand by as much as 18.7 mb/d in April, with a full-year forecast of a decline of 4.25 mb/d for 2020.

- “A demand shock of this magnitude will overwhelm any supply response including any potential core-OPEC output freeze or cut,” Goldman Sachs warned.

- The bank says that refined product storage will fill up, which will then lead to a fill up in crude storage, precipitating a collapse in prices below $20 per barrel.

5. Job losses set to surge

- More than a million jobs in the oilfield service industry could be lost this year because of the global pandemic and the OPEC price war, according to Rystad Energy. Shale services will suffer the most job losses.

- There are more than 5 million people around the world employed in the oilfield services sector, and the industry could lose 21 percent of them this year.

- “Low oil prices are likely to persist in 2021 and could lead to further workforce reductions. But as we move into the second half of 2021, with better market fundamentals and a fading Covid-19, recruitment is likely to pick up in the shale sector and from 2022 will also kick-off in the offshore sector,” says Audun Martinsen, Rystad Energy’s Head of Oilfield Service Research.

- Shale services could see a 32 percent decline in the workforce, while offshore could lose 19 percent, for example.

6. Spike in volatility

- The global recession could be at least as bad as in 2009, according to Barclays. The bank says growth could contract by 0.3 percent in 2020, a bit worse than the 0.1 percent contraction in 2009.

- But these figures rest on a quick restart to the global economy following a several-month slowdown. “We expect a healthy recovery during Q3 and Q4 - insufficient to prevent a contraction of the global economy for 2020 as a whole, but laying the foundations for 2021 to start with robust momentum,” Barclays said. The bank admitted that there is downside risk if lockdowns persist, or if the pandemic resurfaces in the fall for a second round.

- This crisis did not have a financial origin, such as excessive debt, but there is also a risk of broader financial contagion. “An astonishing scramble for cash and stomach-churning volatility has led to a breakdown in market functioning,” Barclays noted.

- The $2 trillion U.S. stimulus, along with coordinated monetary and fiscal bazookas from around the world, have been well received by financial markets.

- BlackRock’s Rick Rieder says bond market volatility may have peaked.

7. Palladium prices rebound

- Palladium – the best performing commodity in 2019 – recently saw prices fall in half, but staged a bit of a rebound over the past week.

- Palladium and platinum are used in emissions control technologies in the automotive industry, so the pandemic and the collapse of auto sales has hit hard.

- But supply disruptions have halted the slide in prices. “This is because South Africa plans to impose a lockdown for the next three weeks in an attempt to fight the coronavirus outbreak,” Commerzbank wrote in a note. “This will also affect platinum mines, which are responsible for more than 70% of global platinum mining production and just shy of 40% of the global palladium mining supply.”

- The outage, over the course of three weeks, would impact 250,000 ounces of platinum and 150,000 ounces of palladium.

- “This will hardly offset the shortfall in demand brought about by coronavirus, however. Based on a conservative estimate of one month of lost demand from the automotive industry, this would result in an 800,000 ounce demand shortfall for palladium,” Commerzbank concluded.