Mar 13, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • The Ethiopian Airlines CEO said the pilot of the crashed Boeing 737 MAX 8 jet reported he was having flight-control problems and wanted to return to the airport. (WSJ)
  • Spotify filed a complaint against Apple with the European Commission. CEO Daniel Ek said the App Store purposely limits choice and stifles innovation "at the expense of the user experience." (Axios)
  • Rite Aid will part ways with its CEO, COO and CFO and cut about 400 jobs, along with $55 million in costs, as part of a turnaround strategy. (Bloomberg)
  • Volkswagen announced it will terminate 7,000 workers while also raising productivity in an effort to save 5.9 billion euros. (Reuters)
1 big thing: The age of American oil

Illustration: Rebecca Zisser/Axios

The U.S. has taken the global oil market by storm — becoming the world's largest oil producer in 2018 and on track to surpass Russia and perhaps even Saudi Arabia to become the world's top exporter by 2024.

  • The International Energy Agency (IEA) expects the U.S. to account for 70% of the increase in global production capacity in the next 5 years.

Why it matters: Thanks to the end of a 40-year-old crude oil export ban signed by President Obama, a shale boom and a host of geopolitical sea changes, the U.S. is poised to reshape the global oil market over the next 10 years and beyond.

  • "Inevitably, the status quo will change," Neil Atkinson, oil markets division head at IEA, tells Axios.
  • "The U.S. is becoming a big player in global oil markets, and it will become a net exporter of oil on average for 2021 for the first time in 75 years. This is a good thing for markets as it adds to consumer choice and flexibility and helps to improve global oil security."

What's happening: The U.S. is exploiting its natural advantages. The type of oil found in the U.S. is lighter and sweeter (contains less sulfur) than oil from other major producers like Canada, Venezuela and Iran. U.S. shale also allows eager investors to get oil fields online quickly rather than taking multiple years to develop.

That's leading investors to push more money towards shale projects, Michael Tran, managing director of global energy strategy at RBC Capital Markets, tells Axios.

  • "As a result what we believe you're on track for is a timeframe where the barrels that are coming to market are becoming lighter and sweeter and ... heavy, sour barrels are becoming increasingly constrained."

Global dynamics also are strongly in the U.S.'s favor.

First, U.S.-led sanctions on Venezuela combined with its state-oil company's slow collapse will see the country with the world's largest oil reserves reduce its already marginalized capacity by almost half over the next year.

  • Iran's production capacity is expected to fall by 1.2 million barrels per day and Nigeria is facing homegrown oil market woes.

Second, the UN's International Maritime Organization next year will bar ships from carrying fuel that contains sulfur content higher than 0.5% and cap their sulfur emissions, benefiting light, sweet crude.

  • Maritime shipping accounts for about 4%–5% of the oil market's 100-million-barrel-per-day total.

Third, developing countries like China, which are driving new demand for crude exports, also are likely to move more toward light, sweet crude as their populations rely less on generators and heating oil, and as construction spending slows down, reducing the need for asphalt — all of which rely on heavy crude oil.

The bottom line: Both market forces and international regulations are pushing global demand towards exactly what the U.S. is selling. Given the booming supply of U.S. oil, that likely means a cap on prices.

Bonus: Why the U.S. is still not energy independent
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Data: U.S. Energy Information Administration; Chart: Axios Visuals

"The U.S. is going to be by far the largest source of new supply for the market and that is going to be very light oil, so ... a lot of the oil we see coming to the market in the next decade is going to be lighter oil," Jason Bordoff, a professor at Columbia University and a former senior director on the National Security Council and special assistant to President Obama, tells Axios.

  • But that doesn't mean the U.S. will be able to satisfy all of its own oil needs.

What they're saying: Bordoff, Tran and Atkinson point out that as U.S. exports have grown so has U.S. oil demand, a result of big investments in petrochemicals projects and heavy crude refineries.

While the U.S. may become a net oil exporter, it won't be energy independent, at least in the foreseeable future. That's because the U.S. doesn't produce heavy crude and much of its oil refining infrastructure is built for it.

Robert Rapier explains in a 2017 article for Forbes:

  • "U.S. refiners spent billions of dollars installing fluid catalytic crackers (FCCs), cokers, and hydrotreaters that are needed to process heavy sour crudes."
  • "Heavy oil refiners would rather simply continue to import oil more suited to their needs, while the light, sweet crudes coming out of the U.S. shale plays are often a better fit for certain foreign refineries."
  • "Or, logistically it may simply be easier for Canada, for instance, to import U.S. crude for their East Coast refineries, while they export their heavy oil from Alberta to U.S. refineries that are equipped to process it."
2. Explaining the biggest jump in recession risk in 30 years

Economic models show the "largest one-month jump in recession risk in 30 years" for the U.S., and a 73% probability of a contraction in 2019, economists at UBS say. That's based on recent data, most notably the U.S. fourth quarter GDP report.

What it means: The U.S. economy is very likely headed for a contraction, the economists say, but that does not necessarily mean a recession.

  • "The most important part of consumer spending weakened sharply over the last few months," the economists said in a note to clients. That is, "consumption of durable goods, spending on household items and spending on recreational items."
  • "These categories carry a particularly large weight in the model due to their historical predictive properties."

So what's the difference between a contraction and a recession?

UBS economist Pierre Lafourcade tells Axios that what their model predicts is a "turning point in the cycle." Sometimes those become recessions, as in 2007, and other times policy reacts quickly enough to avert an economic slowdown strong enough to be a recession, like in 2015.

Still, the contractions cause strong market reactions and are reliably negative enough for the economy that they are worth highlighting on their own, Lafourcade says.

  • "We interpret them as aborted recessions, or soft landings, because they capture  periods where data was certainly softening."

Softening buys of durable goods — things like furniture, jewelry, sports equipment and appliances — were most worrisome.

  • "Essentially discretionary spending that gets cut when households start doubting their future income," Lafourcade says.

The bottom line: UBS analysts expect U.S. first quarter GDP will read a disappointing but not recessionary 0.4%, and will rebound to 2.5% in the second quarter.

3. Boeing is separating the S&P from the Dow
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Data: FactSet Chart: Axios Visuals

Boeing was once again the Dow's biggest loser, falling 6% on Tuesday. Thanks to that drag, the Dow finished the day 96 points lower, Axios' Courtenay Brown writes.

  • Meantime, Boeing was the S&P 500's second worst performing stock, but the index still closed higher.

Why it matters: The S&P and the Dow have diverged like this — meaning one index finishing higher, while the other closes lower — just five other days this year, per FactSet.

  • Boeing is the most influential stock in the Dow, which gives the heaviest weighting to the company with the highest share price.

Between the lines: Pressure is building on Boeing after the second deadly crash involving its 737 MAX 8 jet in the last 6 months.

  • Before the crash, Boeing accounted for about 25% of the Dow's rebound this year but continued losses, as 36 countries and more than 30 airlines have grounded its 737 MAX series.

Go deeper: U.S., Canada remain key holdouts in suspending Boeing 737 MAX jet

4. What the bond market is telling us
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Data: Investing.com; Chart: Axios Visuals

U.S. Treasury yields fell to their lowest level in about 10 weeks on Tuesday, as investors continue to buy safe-haven government debt even as the U.S. stock market rises.

Why it matters: While the S&P 500 has risen more than 11% so far this year, benchmark 10-year Treasury yields are back near their lowest levels of 2019. Despite those low yields, a Treasury auction of 10-year notes Tuesday saw especially strong demand.

  • Treasury yields had started to pick up after the delayed Q4 GDP report suggested prices could be picking up, but bond investors have lost faith and Tuesday's weak core CPI data (1.5% year-over-year and the first month-over-month reading below 0.2% in 6 months) closed the coffin on any further upward momentum.

The big picture: As we wrote last month, the bond market is showing that traders have no faith in long-term U.S. growth or inflation. Stocks are rallying based on expectations that the Fed will not raise interest rates, a theme that has been re-enforced by worsening global growth data.

  • John Herrmann, rates strategist at MUFG Securities Americas, tells Reuters that his bank's models suggested the Fed will hold rates through this summer and then shift to an easing monetary policy stance at its September meeting.
5. The weak coffee market
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Note: Chart shows continuous price of NYMEX coffee futures; Data: FactSet; Chart: Axios Visuals

Oversupply, the weaker Brazilian real, and trade jitters pushed futures prices for arabica coffee beans below $1 per pound — the lowest in more than a decade, Courtenay writes.

What's happening: Brazil is the top producer and exporter of arabica coffee beans. The country harvested a record amount of coffee beans last year and coffee inventories around the world hit a 4-and-half year high. Demand can't keep up.

  • "The slumping real has meant years of high local prices, which allowed Brazilian farmers to invest more, leading to better yields," Bloomberg reports.

Be smart: The entire agricultural sector is depressed and overall sentiment is low, largely due to U.S.-China trade tensions, Mike Seery, who runs commodity consulting firm Seery Advisors, tells Axios.

  • "Coffee just doesn't have anything going for it at this point."

Yes, but: Don't expect cheaper prices for your cup of coffee. "When prices move to the upside it affects the consumer, but when it's to the downside it doesn't affect the consumer very much," Seery said.

Dion Rabouin