Economy & Markets

Independence Days

Topics: A revised map of the United States; investing in equities before a recession; Russia’s natural gas squeeze on Europe leads to another rescue program for Italy; the high cost of pariah status for the oil refining industry

Independence Days. Europe’s energy crisis, China’s commodity trade war with Australia and other examples of resource nationalism (India and Indonesia restrictions on exports of wheat, sugar and palm oil) all reinforce the following: reliance on food and energy imports creates supply, price, currency stability and national security risks. In the US, food and energy imports as a percentage of consumption are the lowest out of all manufactured goods categories, resulting in a degree of food and energy independence uncommon to other countries. 

This prompted me to create a map of the United States in which each state is sized based on its production of food, energy and minerals. I used 2021 production values; had I used 2022 data, the results would be more amplified. The results: states in the Northeast, Southeast and Pacific Northwest shrink relative to mid-Western and mid-Atlantic states, and Texas. As the Biden administration evaluates options to reduce the highest US food and energy inflation in decades (overtures to Saudi Arabia and Venezuela for more oil; a ban on export of US refined products1; gas tax holiday; increase from 10% to 15% in summertime ethanol blends to boost gasoline supply but which has driven corn prices to all-time highs - see Appendix I and II), I think about this map a lot2.

  • Energy includes crude oil, natural gas and coal, plus electricity generated by nuclear, solar, wind, hydro, geo-thermal and biomass
  • Non-fuel mining includes metallic metals (cobalt, copper, iron ore, REE, nickel, platinum, palladium, zinc), construction aggregates (gravel, crushed stone, construction sand) and other industrial minerals (gypsum, lithium, peat, potash etc)
  • Food includes gross receipts of farms (meat, dairy, poultry, fruits, vegetables, food/feed crops)
The US is a “Republic” which ascribes electoral and legislative power to some states in this revised map that is in excess of their population shares. Their critical contributions to food and energy independence are often underappreciated by an increasingly urbanized society (see below on the energy disaster now facing Germany), so I generally believe that a Republic ends up in the “right” place. But I also know that it’s a difficult time to have that discussion. There are different kinds of independence; while US energy independence has finally been attained, other kinds of US independence are suddenly disappearing. They are outside the scope of this report; I will refer you instead to press articles on JP Morgan’s policies with respect to its employees and their reproductive rights and health3.
In any case, food and energy inflation and independence also bring to mind another chart below. The unwinding of the largest stimulus program in history has resulted in a repricing of “real world” vs “digital world” assets, with the former comprised of equities linked to the food, energy and mining products used to build the US state map. The repricing of “digital world” stocks has resulted in more reasonable growth stock valuations for the first time in a while, and is part of the “investing before a recession” topic we discuss next. 
Line chart shows the energy dependence and independence of Europe, China, US and Russia through comparing net imports of oil, natural gas and coal in million tonnes of oil equivalent. The chart shows that recently the US hasbecome energy independent, while China and Europe continue to be high importers of fossil fuels. Russia remains a net exporter
Line chart compares the performance of energy, food and mining companies to the performance of companies predominantly within the digital space since June 2019. The chart illustrates the outperformance of the energy, food and mining companies, or “real world” assets, over the last few months.

Lessons learned on energy independence: Germany

Germany, aiming for 100% renewable power by 2035, is now pushing the G7 to rescind a commitment to halt financing of overseas fossil fuel projects. Instead, Germany wants the G7 to “acknowledge that publicly supported investment in the gas sector is necessary as a temporary response to the current energy crisis”. Why? For the first time since the war began, Russia is cutting gas supplies to Europe via the Nord Stream pipeline (see supporting chart below), leaving Germany with only 10 weeks of supply. The risks: damage to Germany’s industrial furnaces requiring 75% gas inputs, gas rationing to homes and businesses, an exodus of manufacturing jobs and a steeper recession. One vital choke point: the world’s largest integrated chemical complex run by BASF which sits at the beginning of many industrial supply chains, including ammonia for fertilizer. BASF Chief Executive Martin Brudermüller: “There is no short term solution to replace natural gas from Russia”.

A postscript: Eastern Europe, long wary of relying on Russian gas and ridiculed as paranoid by Germany, is moving forward with plans to source nuclear technology from the US. These countries might have sourced it from Germany had the country not sold its nuclear technology assets to Russia’s Rosatom during the Merkel administration.

Sources: Bloomberg, Wall Street Journal, Foreign Policy Magazine, JPMAM.

Investing in equities before a recession

I don’t know if there will be a recession in the US, but chances are rising so let’s assume there will be. In the last Eye on the Market, we discussed how equity markets usually bottom before recessions and how equity markets were already rising by the time the recession was underway (see table below which summarizes the results). If that’s the case, investors need to be on the lookout for signals that are not as stale as employment and GDP. Historically, PMI surveys have been the best leading indicators. We expect these surveys to continue falling, but will be watching closely for turning points.

Another equity market signal: in past cycles, equity markets did not bottom until long term Treasury yields were declining, or at least until they stopped rising. The first chart below shows 10 year Treasury yields; the vertical bars represent equity market bottoms. In the last three cycles, bond yields started falling well before the equity bottom. From 1950 to 1982 when rates were rising on a secular basis, Treasury rates hit their peak right at the equity bottom. So, while I’m not a technician, a sign that the PMI index has bottomed out and that Treasury yields have peaked would be a good sign for investors, even as economic data are still deteriorating.

Line chart shows the 10 year Treasury yield and vertical bars representing S&P 500 Index bottoms since 1950. The chart illustrates that bond yields often peaked prior or right at equity market bottoms.
Line chart compares the Global Manufacturing PMI survey to the 10 year Treasury yield. The chart illustrates that manufacturing activity is declining while the 10 year Treasury yield has been increasing since late-2020.

Meanwhile, market signals on investor capitulation are mixed. As shown on the left, there has been a spike in the number of companies trading below the value of cash on their balance sheets. To be clear, companies that are destined for insolvency can trade below cash value for good reason (i.e., when the value of their non-cash assets are insufficient to repay liabilities). But as a measure of capitulation, this is a sign that investors have thrown in the towel on many of their ill-fated growth investments. In contrast, the chart on the right shows a survey of retail investor asset allocation preferences (which are still elevated) vs consumer sentiment (which has crashed). The growing gap between the two suggests that retail investors are still too optimistic. 

I put more stock in the first chart (i.e., more capitulation) when combined with (a) data we discussed last time on how the average stock in the Russell 1000 Growth Index, the NASDAQ and the Russell 2000 Small Cap Index is down 40%-50% from peak levels, and (b) a sharp decline in hedge fund and risk parity fund leverage4.

Line chart shows the percent of stocks trading below the value of cash and short term investments on their balance sheets since 1990. The chart illustrates that 12% of companies are trading below their cash, with many investors having transitioned away from various growth investments.
Line chart compares the Michigan Consumer Sentiment Index to AAII equity asset allocation since 1990. The chart illustrates that although consumer confidence has fallen to its lowest level (50.2) ever, many retail investors are optimistic and still prefer equities.
On a related note, I read an article in the Atlantic on the “end of the Millennial lifestyle subsidy”. The article notes that millennials have effectively been subsidized by overly optimistic investors and that this subsidy is now ending. Let’s assume that a prototypical millennial wakes up in a Casper bed, exercises on a Peloton, takes an Uber to their WeWork office, spends time on Snap while waiting for DoorDash to bring an Impossible Meat burger for lunch and takes Lyft home for a Blue Apron dinner. In aggregate, these companies were supported by equity investors despite having aggregate $6 to $10 billion in annual free cash flow deficits since 20185. Many of these companies will now have to be profitable to survive, which may involve higher prices to customers.
Bar chart shows the total annual free cash flow of various millennial companies from 2018 to 2021. The chart illustrates that since 2018, these companies have had roughly $6 to $10 billion in free cash flow deficits.
Line chart compares WeWork’s revenue, capital expenditures, cash from operations and free cash flow since 2019. The chart illustrates WeWork has improved their free cash flow deficit due to decreasing capital expenditures, rather than increasing revenue or cash flow from operations.

Russia’s natural gas squeeze on Europe indirectly leads to another rescue program for Italy

Inflation pressures are rising in Europe, in part since Russian supplies of natural gas to Europe are being cut again. For the first time since the war began, Russia cut gas flows to Europe through the Nord Stream pipeline: NS1 flows are down by 60% as Russia claims the need for turbine maintenance. Producer and consumer prices are rising in Germany at the fastest rate since 1980, and markets expect European headline inflation to hit 9% later this year which is ~2% higher than current ECB forecasts. As a reminder, natural gas shortages affect both energy and food prices since natural gas accounts for 70%-90% of nitrogenous fertilizer costs. As the ECB raises policy rates and credit spreads widen, this creates problems for one the world’s most indebted countries: Italy.

Area chart shows the amount of natural gas Russia exports to Europe via the Nord Stream 1, Ukraine, Yamal (Poland) and through LNG since January 2019. The chart shows exports have recently fallen significantly, primarily driven by Nord Stream 1 exports to Europe.
Line chart which shows both the German consumer price index and the producer price index since 1980. The chart illustrates that both series are rising at the fastest rate since 1980, the CPI is currently at about 8% and the PPI is approaching 35%.

I haven’t written about Italy for a while. Its default risk declined in 2012 when the ECB partially socialized Italy’s debt problem among other members of the Eurozone. Given Italy’s high sovereign debt, it needs low rates: as Gavekal Research has highlighted, every time Italy’s government bond yields drift above its economic growth rate (left chart), its debt ratio has gone up (right chart). Now yields are rising and growth is falling in Italy, threatening another surge in government debt. 

However, it looks like yet another ECB rescue program is on the way. We expect an announcement in July; the ECB organized an emergency meeting when Italian 10 year yields hit 4% (~2.5% over Germany), which appears to be some kind of tolerance threshold. We expect the ECB to “sterilize” its purchases of Italian debt by soaking up money supply via European bank deposits, similar to the Fed’s repo program. As usual, the ECB hopes that the threat of intervention will be enough to drive Italian yields down without actually having to buy them. It should be obvious at this point that Italy is a permanent financial ward of the Eurozone, and that German savers who pay for this have effectively lost their economic independence.

Line chart which shows Italy’s 10 year government bond yield and the rolling 7 year nominal GDP growth. The chart illustrates how yields are rising to around 4% while GDP growth is falling to around 1%. This relationship suggests Italy’s debt ratio will go up.
Line chart which plots Italy’s debt to GDP ratio since 1992. The chart shows that the ratio has increased from less than 100% to above 150%. We also highlight three periods of rapid debt growth: Euro accession phase monetary tightening, Eurozone balance of payment crisis and the COVID stimulus programs.

Appendix I: US refining capacity, gasoline prices and the high cost of pariah status

  • US refining capacity has been falling since COVID while US refined product consumption is back to pre-COVID levels
  • US gasoline refinery shutdowns have increased due to (a) high maintenance/repair costs, (b) declining institutional investor interest in oil & gas, (c) declining bank lending to oil & gas, (d) widespread opposition to refinery expansion and (e) conversion of refineries to biofuels instead [Marathon, Phillips 66 and HollyFrontier]. Refinery shutdowns are very costly and practically impossible to reverse
  • US refineries are operating at the upper end of historical capacity utilization
  • Russia is the 2nd largest refined products exporter after the US, so sanctions affect global prices for refined products
  • If US refining capacity continues to decline, options for eventually importing refined products are unfavorable
Line chart which plots US refining capacity and petroleum product consumption since 1985. The chart shows that while petroleum product consumption is back to pre-COVID levels, capacity has fallen from 19mm barrels per day to below 18mm barrels per day.
Bar chart which shows US refinery capacity shut down by year since 1990. The chart shows that there was a huge spike during COVID and approximately 1 million barrels per day of capacity was shut down between 2020 and 2021.
Line chart shows the utilization rate of US refineries since 1990. We include a dot for the latest utilization rate of 93.7% as of June 10, 2022. This represents the second highest utilization rate since the early 2000s.
Bar chart shows the top exporters of petroleum products in 2021. The US and Russia are the two largest exporters by a wide margin, exporting 140 million tonnes and 130 million tonnes respectively. The third largest exporter is Saudi Arabia with ~60 million tonnes and the rest of the top 10 export ~20 million tonnes each.
Line chart shows crude oil prices as refiner oil acquisition costs vs gasoline prices, which have both risen substantially in 2022
Line chart shows the US crack spread, which is the difference between refined oil product prices and refiner oil acquisition costs. Crack spreads have risen to all-time highs in 2022

Appendix II: energy/food independence and food price inflation

  • The US has finally reached independence in both food and energy. Europe is also a net food exporter, but is still a substantial energy importer
  • US farmers seeking to boost the food supply requested that the USDA relax rules related to the Conservation Reserve Program that pays them to keep land idle. So far, the USDA has only made minor adjustments, allowing farmers with CRP contracts expiring in 2022 to start planting now
  • US corn prices are rising due to (a) an increase in US ethanol blends over the 2022 summer driving season, (b) the impact of rising natural gas prices on nitrogenous fertilizer costs and (c) a 25% decline in Russian fertilizer exports (Russia usually accounts for 15%-20% of global fertilizer exports, see bar chart). US tariffs on imported fertilizer have not been reduced; instead the Administration announced a grant program designed to boost fertilizer production
Line chart shows US food and energy independence. The US has been a net exporter of food by a small amount, from 1975 to 2022. The US was a net importer of energy until 2020, when they achieved energy independence and became a net exported
Line chart shows European Union food and energy independence. The EU has been a net exporter of food from 1975 to 2022. The EU is a net importer of energy, and this has grown more drastic in 2022
Line chart shows the consumer price index for food in the US and the EU. Both series have spiked up in 2022 to levels not seen in several decades
Line chart shows US corn prices from 1992 to 2022. Corn prices are around $8 per bushel, which are the highest levels seen in the last decade
Line chart shows the North America fertilizer price index from 2002 to 2022. Levels have come down from all-time highs of almost 1,300, and are now around 800
Bar chart shows Russia and Ukraine’s share of global exports in 2021. Russia and Ukraine typically account for 15-20% of global fertilizer exports

1 Export bans on refined products could lead, counterintuitively, to higher gasoline prices. A refined products export ban could divert gasoline supplies to domestic markets rather than foreign ones. But given low diesel demand in the Northeast, refiners could also be stuck with excess diesel that they would have to store (i.e., an expense rather than revenues). If so, refiners might actually cut runs until overall refining profitability per barrel is restored. A temporary Jones Act suspension might be needed as well in order to avoid domestic shipping costs offsetting the benefits of increased gasoline supply. A better solution: an export ban on gasoline only, allowing diesel to still be exported. See JP Morgan Commodity Research, June 22, item #7.

2 In a future world of much greater renewable energy, US energy independence would decline: China is by far the largest producer of PV modules, wind turbines, lithium ion batteries, electric vehicle mineral processing and related cathode and anodes.

3 “JPMorgan tells employees the bank will pay for travel to states that allow abortion”, CNBC, June 24, 2022. Maybe one day the firm will allow me to write a piece on the history of the 14th amendment, substantive due process, the 70 years of Supreme Court cases which led to Roe and Casey in the first place and the economic consequences of repeal. Seismic shifts from the Supreme Court may not be over: watch for a ruling on “major questions” and nondelegation doctrines. The Court might end up curtailing the ability of the Executive Branch (EPA, OSHA, USDA, DOL, etc) to promulgate rules, requiring Congress to pass legislation instead.

4 JP Morgan Global Markets Strategy Flows & Liquidity Report, June 23, 2022, see exhibits 2 and 4

5 One reason for the recent improvement: WeWork lost less money by reining in its footprint rather than by growing revenue or growing cash flow from operations. I thought it was notable that according to Bloomberg, the only two firms with research analysts covering WeWork are Mizuho Securities and Piper Sandler.

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FEMALE VOICE:  This podcast has been prepared exclusively for institutional, wholesale professional clients and qualified investors only as defined by local laws and regulations.  Please read other important information, which can be found on the link at the end of the podcast episode.

 

MR. MICHAEL CEMBALEST:  Good afternoon, everybody.  This is the late June Eye on the Market podcast.  This podcast accompanies the piece that we sent out this week called Independence Days.  It covers a bunch of topics in here related to energy independence, what’s going on in Europe and Russia, and the broader topic of investing in equities before recession with some metrics on where we are in the cycle.

 

So first on this Independence Day question, there is a lot of resource nationalism going on in the world, and what does that refer to?  China is having a commodity trade war with Australia.  Countries like India and Indonesia are putting restrictions on exports of wheat, sugar, and palm oil.  And then of course there’s all of the issues going on in Russia and Ukraine with respect to Russian decisions to halt exports of certain commodities and sanctions on the purchase of Russian commodity exports by other countries.

 

All of this reinforces something that a lot of people, myself included, have known for a long time, which is that relying on food and energy imports is a risky thing.  It creates supply risks, price risks, currency stability risks, and national security risks.  United States happens to be more food and energy-independent than most countries.  Food and energy imports as a percentage of consumption are the lowest out of all the manufactured goods categories.  In other words, the U.S. relies on imports as a greater percentage of consumption for most other things that get consumed.

 

So I wanted to visualize this, and so I created a revised map of the United States, in which each state is sized based on its production of food, energy, and minerals.  And the results were familiar but still interesting to look at.  The states in the Northeast, the Southeast, and the Pacific Northwest shrink relative to Midwestern states, Mid-Atlantic states, and Texas.

 

And I was looking and thinking about this map a lot as the Biden administration struggles to figure out options to reduce the highest level of food and energy inflation in decades, including things like overtures to Saudi Arabia and Venezuela to pump more oil, a possible ban on the export of refined products, gas tax holiday, increasing summertime ethanol blends, which helps boost the gasoline supply, but drives corn prices to all-time highs, things like that.  And so you can see on the first page what this map looks like.  And it’s interesting to look at.  

 

Now the concept of independence is a broad one.  The U.S., and this is mentioned a lot in Congress, the U.S. is a republic, which means that it ascribes electoral and legislative power to some states in this map that is well in excess of their share of the country’s population.  And in many cases, their critical contributions to food and energy independence are often overlooked and underappreciated by an increasingly urbanized society.  Around 85% of the people in the United States live in large cities.  And because some of these food and energy contributions are so critical and difficult to replicate through imports, I’ve always generally believed that a republic, whether intentionally or not, ends up in the right kind of “fair place” with respect to these contributions and the relative legislative and electoral power.  But I also know it’s a difficult time to have that discussion.  

 

There’s different kinds of independence.  And while U.S. energy independence has finally been attained after 50 years of trying, other kinds of independence are suddenly disappearing.  They are outside the scope of what I can write about and should write about and I’m allowed to write about.  But I will refer you instead to some press articles in the piece on J.P. Morgan’s policies with respect to its employees and their reproductive rights and health.  And I will just say in my own personal view, I’m glad that the firm did what it did.  

 

Getting back to the issues of the day on energy independence, take a look at what’s happening in Germany.  Germany is a country aiming for 100% renewable power by 2035 and is pushing the G7 nations to rescind and walk back a commitment to halt the financing of fossil fuel projects.  Instead, Germany wants the G7 to, and this is the quote from Germany, acknowledge that publicly supported investment in the gas sector is necessary as a temporary response to the current energy crisis.

 

Why is Germany, the architect of one of the most ambitious renewable transitions in the world, saying this?  Well they are learning an energy independence lesson, and it’s a painful one.  For the first time since the war began, Russia is cutting gas supplies to Europe via the Nord Stream pipeline and they’re cutting them by a lot.  And this is leaving Germany with only ten weeks of supplies.  And the risks to Germany are pretty substantial if these reductions are permanent.  A lot of Germany’s industrial furnaces essentially require 75% gas inputs, without which they crack and break.  Germany is facing the prospects of gas rationing to homes and businesses, an exodus of some of its hard-fought and hard-won manufacturing jobs, and a steeper recession.

 

So this question of energy independence is a critical one as we start thinking about Independence Day and the steps that different countries will need to take to become energy independent.  And this is something I’ve written a lot this entire year and the last few years, which is making sure that policies to reduce the supply of fossil fuels are properly calibrated relative to policies that reduce the demand for fossil fuels so that one does not outstrip the other.

 

In any case, this food and energy independence issue brings to mind some of the other work that we did this week.  The unwinding of the massive stimulus program ended up causing a repricing of real world assets versus digital world assets, where real world assets started finally going up, and those are assets linked to food, energy, and mining.  And the digital world assets have dropped sharply and obviously those are all the things you’re familiar with, whether it’s ride-sharing, digital payments, cloud computing, Fintech, food delivery, wearable tech peer-to-peer video gaming, all that stuff.  And that repricing in the digital world is pretty advanced and has resulted in more reasonable growth stock valuations for the first time in a very long time and as part of the whole investing before a recession topic that we get into as well in this week’s piece.  

 

I don’t know if this is going to be a recession or not in the United States, but chances are rising, so let’s just assume there will be.  In the last Eye on the Market, we discussed how equity markets usually bottom before recessions and how equity markets are usually rising by the time the recession is really in full swing and starts to get better.  So if that’s the case, investors need to be on the lookout for certain signals that are not as stale as employment and GDP.  We discuss some of those leading indicators in this piece.  We’re closely watching the manufacturing PMI level of ten-year interest rates.  

 

We have a chart in here showing the prior six cycles and how bond yields started falling before equities hit bottom.  But there’s a table that shows that if you wait until the economy has bottomed out or improving before you start investing again, the opportunity cost is pretty substantial, anywhere from 20 to 40% in the equity market that tends to rally during that timeframe.  

 

And one of my favorite capitulation measures is this chart that we have in here that looks at the number of stocks that are trading underwater.  Now what does it mean for a stock to trade underwater?  It’s when the value of the company trades below the value of its cash and short-term investments on its balance sheet.  In other words, the cash on the balance sheet and short-term investments could be liquidated for more than the stock is trading at. 

 

Now companies can still trade like that for a good reason if the value of their non-cash assets are not enough to repay their liabilities.  But as a capitulation measure, it’s pretty good.  And as we show in the chart here, the underwater stocks are now a higher percentage of the market that either in 2002 or in 2009.  And so to me, we’re gathering up a growing list of capitulation measures that that suggests that sometime this summer, maybe one more leg down the market will be a very interesting time to start putting money back to work. 

 

We have an interesting section in here as well on the end of the millennial lifestyle subsidy and talks about how a bunch of millennial-oriented companies were essentially financed by the markets despite having 6, $8 billion annual free cash-flow deficits in aggregate, and how a lot of these companies will now have to be profitable to survive, which is going to end up with DoorDash, WeWork, Lyft, Blue Apron, Uber, Peloton, impossible, all these companies are going to be under a lot of pressure, which means both layoffs and higher prices to consumers.  

 

Let’s go back to energy for a second, because I want to talk about this rescue program for Italy.  So as I mentioned earlier, Russia has cut the Nord Stream pipeline flows to Europe by 60%, which is enormous.  Now Russia is claiming the need for turbine maintenance.  Most of the Europeans that are close to this don’t believe that.  Producer and consumer prices are rising in Germany now at the fastest rate since 1980, and headline inflation in Europe might hit 9% this year.  

 

So as the ECB raises policy rates and as credit spreads widen in Europe, that creates problems obviously for one of the world’s most indebted countries, which is Italy.  I haven’t written about Italy for a while.  It was in real trouble in 2012, and that’s when Mario Draghi, in charge of the ECB, basically socialized Italy’s default risk amongst other members of the Eurozone.  Given Italy’s very high level of debt, around 150% of GDP compared to roughly 100% in the United States, Italy needs very low rates.  And every time Italy’s bond yields drift above its growth rate, its debt ratio goes up a lot. 

 

But it looks like even though Draghi is not running the ECB anymore, his legacy remains.  The ECB looks like it’s planning yet another rescue program for Italy.  We expect an announcement sometime in July.  And as usual, the ECB is hoping that the threat of intervention will be enough to drive Italian yields back down without them actually having to buy a ton of them.  And it should be pretty obvious at this point that Italy is a permanent financial ward of the Eurozone, and the German savers who are paying for this have lost their economic independence.

 

The last topic I want to talk about today is this issue of gasoline prices, because the administration is really trying hard to figure out what to do about high gasoline prices.  And a lot of this has to do with the high cost we’re all paying of having made the refining industry into pariahs, effectively.  And I have some charts here.  I generally never write, talk about anything unless there’s some data that can help me and my team and all of you visualize what’s going on.  So please take a look here at page six in today’s piece, ‘cause it’s just mostly charts that will help you understand what’s going on.

 

So when COVID hit, there was a collapse in movement for all the obvious reasons.  And some of the refiners that were already struggling either shut their doors or converted to biofuels instead.  But now all of a sudden refined product consumption is back to pre-COVID levels in the United States, but refining capacity is not and has dropped by about a million barrels a day on a base of let’s say 19 million barrels a day.  So something like a 5 or 6% decline, it doesn’t sound like much.  But in a lot of industries, things happen on the margin.  And if you’ve got a 5 or 6 or 7% decline in refining capacity and an increase in demand for that capacity, you can get price spikes.  

 

So just, let’s review.  The U.S. gasoline refinery shutdowns have increased in recent years, very high maintenance and repair costs, declining institutional investor interest in oil and gas, you can’t open your eyes every morning without seeing and feeling and experiencing more ESG-related pressure for people to bail on the refining industry.  That’s also affecting the banks.  There’s been declining bank lending to oil and gas.  There’s broad community and political opposition to the refining industry.  And as I mentioned, some of the refineries have shifted to biofuels, or at least are trying to.  And once these refinery shutdowns take place, they’re extremely costly and almost impossible to reverse.

 

And so now where are we?  Well, the refineries are operating at around 95% of capacity, very difficult in any industrial process to go above those levels.  Russia is the second-largest exporter of refined product after the U.S.  So sanctions and disruptions related to the war in Ukraine is affecting the global supply of refined products.  And you put all these pieces together, and you get a pretty big spike in the crack spread, which basically refers to refined product prices, less the cost of the crude oil that’s used in the refining process to begin with. 

 

And I don’t think there’s a lot of easy answers here other than the demand destruction that takes place as prices go up.  In other words, there’s a gasoline price that that will result in its own demise, happened to 2008 and essentially becomes so expensive for people to drive or fly that they begin to curtail their activities.  

 

But all the stuff that’s being discussed, whether it’s releasing the strategic petroleum reserve, bans on refined product exports are not straightforward in terms of the impact they would have on gasoline prices.  And there’s an interesting little footnote we have in this week’s paper piece that describes why an export ban might not work if it’s a ban that’s applied to all refined products because of a surplus of diesel that the refiners would end up with that they might have nowhere to go with.

 

And then to conclude, we’ve got some charts in here on food price inflation.  And just to tie all the pieces together, fertilizer costs are affected by natural gas, particularly nitrogenous fertilizer costs.  So now we’re at all-time highs on corn prices because of this decision to increase the ethanol blends, higher natural gas prices, a 20% decline in Russian fertilizer exports, and things like that.

 

So it’s a really important time for us to understand and appreciate energy and food independence and to focus on the policies that could sustain that food and energy independence on a long-term basis rather than just a short-term basis.  And that’s going to require a much more careful and thoughtful analysis about how the whole renewable transition is managed and how it unfolds.  As for the other aspects of independence which are disappearing in the United States, I wish I could talk more about those, but I can’t.  So I will thank you all for listening, and I look forward to talking to you next time.  Have a great day, bye.

 

FEMALE VOICE:  Michael Cembalest’s Eye on the Market offers a unique perspective on the economy, current events, markets, and investment portfolios, and is a production of J.P. Morgan Asset and Wealth Management.  Michael Cembalest is the Chairman of Market and Investment Strategy for J.P. Morgan Asset Management and is one of our most renowned and provocative speakers.  For more information, please subscribe to the Eye on the Market by contacting your J.P. Morgan representative.  If you’d like to hear more, please explore episodes on iTunes or on our website.  

 

This podcast is intended for informational purposes only and is a communication on behalf of J.P. Morgan Institutional Investments Incorporated.  Views may not be suitable for all investors and are not intended as personal investment advice or a solicitation or recommendation.  Outlooks and past performance are never guarantees of future results.  This is not investment research.  Please other important information, which can be found at www.JPMorgan.com/disclaimer-EOTM

 

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This report uses rigorous security protocols for selected data sourced from Chase credit and debit card transactions to ensure all information is kept confidential and secure. All selected data is highly aggregated and all unique identifiable information, including names, account numbers, addresses, dates of birth, and Social Security Numbers, is removed from the data before the report’s author receives it. The data in this report is not representative of Chase’s overall credit and debit cardholder population.

The views, opinions and estimates expressed herein constitute Michael Cembalest’s judgment based on current market conditions and are subject to change without notice. Information herein may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such.

The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

Non-affiliated entities mentioned are for informational purposes only and should not be construed as an endorsement or sponsorship of J.P. Morgan Chase & Co. or its affiliates.

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This communication is issued by the following entities:

In the United States, by J.P. Morgan Investment Management Inc. or J.P. Morgan Alternative Asset Management, Inc., both regulated by the Securities and Exchange Commission; in Latin America, for intended recipients’ use only, by local J.P. Morgan entities, as the case may be.; in Canada, for institutional clients’ use only, by JPMorgan Asset Management (Canada) Inc., which is a registered Portfolio Manager and Exempt Market Dealer in all Canadian provinces and territories except the Yukon and is also registered as an Investment Fund Manager in British Columbia, Ontario, Quebec and Newfoundland and Labrador. In the United Kingdom, by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other European jurisdictions, by JPMorgan Asset Management (Europe) S.à r.l. In Asia Pacific (“APAC”), by the following issuing entities and in the respective jurisdictions in which they are primarily regulated: JPMorgan Asset Management (Asia Pacific) Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited, each of which is regulated by the Securities and Futures Commission of Hong Kong; JPMorgan Asset Management (Singapore) Limited (Co. Reg. No. 197601586K), which this advertisement or publication has not been reviewed by the Monetary Authority of Singapore; JPMorgan Asset Management (Taiwan) Limited; JPMorgan Asset Management (Japan) Limited, which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number “Kanto Local Finance Bureau (Financial Instruments Firm) No. 330”); in Australia, to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Commonwealth), by JPMorgan Asset Management (Australia) Limited (ABN 55143832080) (AFSL 376919). For all other markets in APAC, to intended recipients only.

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In the United States, bank deposit accounts and related services, such as checking, savings and bank lending, are offered by JPMorgan Chase Bank, N.A. Member FDIC.

JPMorgan Chase Bank, N.A. and its affiliates (collectively “JPMCB”) offer investment products, which may include bank-managed investment accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC (“JPMS”), a member of FINRA and SIPC. Annuities are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPM. Products not available in all states.

In Germany, this material is issued by J.P. Morgan SE, with its registered office at Taunustor 1 (TaunusTurm), 60310 Frankfurt am Main, Germany, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB). In Luxembourg, this material is issued by J.P. Morgan SE – Luxembourg Branch, with registered office at European Bank and Business Centre, 6 route de Treves, L-2633, Senningerberg, Luxembourg, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE – Luxembourg Branch is also supervised by the Commission de Surveillance du Secteur Financier (CSSF); registered under R.C.S Luxembourg B255938. In the United Kingdom, this material is issued by J.P. Morgan SE – London Branch, registered office at 25 Bank Street, Canary Wharf, London E14 5JP, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE – London Branch is also supervised by the Financial Conduct Authority and Prudential Regulation Authority. In Spain, this material is distributed by J.P. Morgan SE, Sucursal en España, with registered office at Paseo de la Castellana, 31, 28046 Madrid, Spain, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE, Sucursal en España is also supervised by the Spanish Securities Market Commission (CNMV); registered with Bank of Spain as a branch of J.P. Morgan SE under code 1567. In Italy, this material is distributed by J.P. Morgan SE – Milan Branch, with its registered office at Via Cordusio, n.3, Milan 20123, Italy, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE – Milan Branch is also supervised by Bank of Italy and the Commissione Nazionale per le Società e la Borsa (CONSOB); registered with Bank of Italy as a branch of J.P. Morgan SE under code 8076; Milan Chamber of Commerce Registered Number: REA MI 2536325. In the Netherlands, this material is distributed by J.P. Morgan SE – Amsterdam Branch, with registered office at World Trade Centre, Tower B, Strawinskylaan 1135, 1077 XX, Amsterdam, The Netherlands, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE – Amsterdam Branch is also supervised by De Nederlandsche Bank (DNB) and the Autoriteit Financiële Markten (AFM) in the Netherlands. Registered with the Kamer van Koophandel as a branch of J.P. Morgan SE under registration number 72610220. In Denmark, this material is distributed by J.P. Morgan SE – Copenhagen Branch, filial af J.P. Morgan SE, Tyskland, with registered office at Kalvebod Brygge 39-41, 1560 København V, Denmark, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE – Copenhagen Branch, filial af J.P. Morgan SE, Tyskland is also supervised by Finanstilsynet (Danish FSA) and is registered with Finanstilsynet as a branch of J.P. Morgan SE under code 29010. In Sweden, this material is distributed by J.P. Morgan SE – Stockholm Bankfilial, with registered office at Hamngatan 15, Stockholm, 11147, Sweden, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE – Stockholm Bankfilial is also supervised by Finansinspektionen (Swedish FSA); registered with Finansinspektionen as a branch of J.P. Morgan SEIn France, this material is distributed by JPMCB, Paris branch, which is regulated by the French banking authorities Autorité de Contrôle Prudentiel et de Résolution and Autorité des Marchés Financiers. In Switzerland, this material is distributed by J.P. Morgan (Suisse) SA, with registered address at rue de la Confédération, 8, 1211, Geneva, Switzerland, which is authorised and supervised by the Swiss Financial Market Supervisory Authority (FINMA), as a bank and a securities dealer in Switzerland. Please consult the following link to obtain information regarding J.P. Morgan’s EMEA data protection policy: https://www.jpmorgan.com/privacy.

In Hong Kong, this material is distributed by JPMCB, Hong Kong branch. JPMCB, Hong Kong branch is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission of Hong Kong. In Hong Kong, we will cease to use your personal data for our marketing purposes without charge if you so request. In Singapore, this material is distributed by JPMCB, Singapore branch. JPMCB, Singapore branch is regulated by the Monetary Authority of Singapore. Dealing and advisory services and discretionary investment management services are provided to you by JPMCB, Hong Kong/Singapore branch (as notified to you). Banking and custody services are provided to you by JPMCB Singapore Branch. The contents of this document have not been reviewed by any regulatory authority in Hong Kong, Singapore or any other jurisdictions. You are advised to exercise caution in relation to this document. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. For materials which constitute product advertisement under the Securities and Futures Act and the Financial Advisers Act, this advertisement has not been reviewed by the Monetary Authority of Singapore. JPMorgan Chase Bank, N.A. is a national banking association chartered under the laws of the United States, and as a body corporate, its shareholder’s liability is limited.

With respect to countries in Latin America, the distribution of this material may be restricted in certain jurisdictions. We may offer and/or sell to you securities or other financial instruments which may not be registered under, and are not the subject of a public offering under, the securities or other financial regulatory laws of your home country. Such securities or instruments are offered and/or sold to you on a private basis only. Any communication by us to you regarding such securities or instruments, including without limitation the delivery of a prospectus, term sheet or other offering document, is not intended by us as an offer to sell or a solicitation of an offer to buy any securities or instruments in any jurisdiction in which such an offer or a solicitation is unlawful. Furthermore, such securities or instruments may be subject to certain regulatory and/or contractual restrictions on subsequent transfer by you, and you are solely responsible for ascertaining and complying with such restrictions. To the extent this content makes reference to a fund, the Fund may not be publicly offered in any Latin American country, without previous registration of such fund’s securities in compliance with the laws of the corresponding jurisdiction. Public offering of any security, including the shares of the Fund, without previous registration at Brazilian Securities and Exchange Commission— CVM is completely prohibited. Some products or services contained in the materials might not be currently provided by the Brazilian and Mexican platforms.

JPMorgan Chase Bank, N.A. (JPMCBNA) (ABN 43 074 112 011/AFS Licence No: 238367) is regulated by the Australian Securities and Investment Commission and the Australian Prudential Regulation Authority. Material provided by JPMCBNA in Australia is to “wholesale clients” only. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Corporations Act 2001 (Cth). Please inform us if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

JPMS is a registered foreign company (overseas) (ARBN 109293610) incorporated in Delaware, U.S.A. Under Australian financial services licensing requirements, carrying on a financial services business in Australia requires a financial service provider, such as J.P. Morgan Securities LLC (JPMS), to hold an Australian Financial Services Licence (AFSL), unless an exemption applies. JPMS is exempt from the requirement to hold an AFSL under the Corporations Act 2001 (Cth) (Act) in respect of financial services it provides to you, and is regulated by the SEC, FINRA and CFTC under U.S. laws, which differ from Australian laws. Material provided by JPMS in Australia is to “wholesale clients” only. The information provided in this material is not intended to be, and must not be, distributed or passed on, directly or indirectly, to any other class of persons in Australia. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Act. Please inform us immediately if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

This material has not been prepared specifically for Australian investors. It:

  • May contain references to dollar amounts which are not Australian dollars;
  • May contain financial information which is not prepared in accordance with Australian law or practices;
  • May not address risks associated with investment in foreign currency denominated investments; and
  • Does not address Australian tax issues.

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JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") offer investment products, which may include bank-managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC ("JPMS"), a member of FINRA and SIPC. Annuities are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states. Please read the Legal Disclaimer in conjunction with these pages.

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

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