MARCH 10, 2023
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FFTT “Tree Rings”: The 10 Most Interesting Things
We’ve Read Recently
Here are this week’s “Tree Rings”. Have a great weekend! LG
1. Initial thoughts on the potential broader macro implications of the
SIVB (not rated) situation (Page 2)
2. “Fed Chair Jerome Powell says Fed is prepared to speed up
interest rate rises” (Page 4)
3. “Current deficit spending is supporting growth…interest expense
of 4%+ of GDP…the Fed is chasing its tail.” (Page 6)
4. “UST market instability concerns that went away last year are
returning.” (Page 7)
5. “Convexity Maven – The Chips are Down” (Page 10)
6. “Biden to urge 25% billionaire tax, higher income, capital gains for
rich” (Page 13)
7. “China’s Xi Jinping issued an unusually blunt rebuke of US policy
on Monday” (Page 15)
8. “War in Ukraine drives new surge of US oil exports to Europe”;
“The economics of the US natural gas market are going to be
influenced more and more by international markets.” (Page 19)
Luke Gromen, CFA
FFTT, LLC
Info@FFTT-LLC.com
www.FFTT-LLC.com
Follow us on Twitter:
@LukeGromen
9. “US shale companies’ biggest and best wells are producing less
oil” (Page 20)
10. “Russia’s revenue from oil and gas almost halved in February”
(Page 22)
Initial thoughts on the potential broader macro implications of the SIVB (not rated) situation
Tree Ring: We have been asked for our thoughts on the SIVB situation (not rated), and whether it could be systemic. The
short answer is in our view, yes. Here’s why: At its core, the issue appears to be that funding costs for some portions of
the banking system are now or will before too long be higher than the yield on a good chunk of the banking system’s
earning assets. That is as systemic as it gets in our view.
In plain English, (as we noted a few months ago), “Luke Gromen Bank” (me) currently has a 2.95% 30-year fixed rate
mortgage. We have also repeated for months (ad nauseum) that we are overweight cash and short-term USTs, the latter
of which we have been earning 4.5-4.75% on for the last two months.
While it is great for “Luke Gromen Bank” to be making a risk-free Net Interest Margin (NIM) of ~200 bps, it implies some
portion of the actual banking system (broadly defined) is de facto upside down on those earning assets, if not already,
than in the not-too-distant future.
This chart below that we showed multiple times in 2H22 and early 2023 is an oversimplified directional graphical
representation of what is happening:
The Fed’s funding costs (which have risen with Fed Funds rates) have risen significantly above the yield on the Fed’s
portfolio, driving significant Fed operating losses and declines in Fed remittances to the US Treasury. This chart above is
a macrocosm of the same dynamic starting to weigh on US banks.
Conceptually, US banks could either raise deposit rates to compete with USTs (but this would hurt bank NIM’s and
therefore earnings), or the banks could issue significant new low-cost capital (equity secondaries, etc.), but this would
dilute share counts. We are not the right person to talk in greater detail on the mechanics of this, nor which banks may or
may not have this issue, other than the very loose conceptual framework laid out above.
2 • FFTT TREE RINGS MARCH 10, 2023
Our interest in this development is from a macro and US deficit perspective. Critically, the dynamic described above is at
its core being driven by a combination of higher inflation and insufficient foreign demand for USTs at the significantly
negative real yields (given elevated inflation) needed to avoid the US fiscal crisis/US banking funding issue now unfolding.
In essence, US government deficits are (once again) crowding out the US banking system, as banking deposits leave
banks to earn the much higher 30-day UST yield.
We say, “once again crowding out the US banking system”, because what appears to be happening is a slightly different
version of the problem we wrote extensively about in 2019, when Fed QT and rising US deficits drove Fed Funds Rates
(FFR) > Interest on Excess Reserves (IOER), which at its core was merely a symptom that the US government’s deficits
and Fed QT were increasingly crowding out its own banking system.
Back then, the stresses shown by FFR > IOER rose until “something broke” – in that case, repo rates spiked in
September 2019, forcing the Fed to begin re-growing its balance sheet in “Not QE.” In our view, it is very possible that the
SIVB situation is “something breaking” again; if so, we believe the Fed response will once again be more liquidity.
This “more liquidity” could take a number of forms (bank regulatory forbearance like in March 2020 (SLR exemptions on
USTs)), or the Fed cutting IOER or pausing QT for a time, but in our view, it seems likely that the Fed is now on the clock
to provide more liquidity to avoid a much worse outcome, once again forced by US deficits that are crowding out the US
banking system.
Until the Fed responds, it is likely to be good for the USD and gold, but little else. Once the Fed responds, it will likely be
negative for the USD and positive for just about every other asset. The key question in our minds is “will markets begin to
front run the Fed’s move to loosen liquidity (by selling off the USD, and bidding up gold, risk assets, and other FX)?”
Let’s watch.
FFTT TREE RINGS MARCH 10, 2023 • 3
“Fed Chair Jerome Powell says Fed is prepared to speed up interest rate rises”
Jerome Powell says Fed is prepared to speed up interest rate rises – 3/7/23
Jerome Powell Says Fed Is Prepared to Speed Up Interest-Rate Rises - WSJ
Federal Reserve Chair Jerome Powell said strong and sustained economic activity to start this year could prompt
central bank officials to accelerate interest-rate increases and will likely lead them to lift rates more than they
expected to combat high inflation.
Mr. Powell’s comments, prepared for delivery during the first of two days of Capitol Hill hearings on Tuesday, offered
his first public acknowledgment that a pace of quarter-point interest-rate increases isn’t set in stone.
“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest
rates is likely to be higher than previously anticipated,” Mr. Powell said in the remarks prepared for delivery before the
Senate Banking Committee. “If the totality of the data were to indicate that faster tightening is warranted, we would be
prepared to increase the pace of rate hikes.”
Tree Ring: Powell’s comments during his Congressional testimony drove a sharp sell-off across markets and a rise in the
USD. Powell’s interaction with Sen. Cynthia Lummis below caught our attention in particular:
Sen. Lummis: Do you think about the cost of borrowing for the US itself?
Fed Chair Powell: No, we do not. And we’re not going to. That would be fiscal dominance. If we were constrained in our
monetary policy by the budgetary situation of the US, and we’re not, we’re clearly not, the path we’re on is unsustainable, but
the level of debt that we have is sustainable. So, we do not think about interest cost when we make monetary policy. We
think about maximum unemployment and price stability. (Source: C-SPAN, via CN)
Powell’s response caught our attention for two reasons:
1. Because the evidence that the Fed actually IS “constrained in their monetary policy by the budgetary situation of
the US” is not only substantial, but that evidence continues to build almost weekly (and again this week, as we will
show.)
2. The “price stability” of the UST market (or, more accurately, price instability of the UST market) is one of the key
tells that the Fed is already in a situation of fiscal dominance.
Note also how forcefully Powell asserted that the Fed is NOT in a position of fiscal dominance above (he said it twice) –
we think he did that because of the implications of fiscal dominance laid out below by the Minneapolis Fed in this 1981
white paper:
…suppose that the demand for government bonds implies an interest rate on bonds greater than the economy's rate of growth.
Then, if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or
inflation forever.
Some Unpleasant Monetarist Arithmetic: Federal Reserve Bank of Minneapolis – Fall 1981 (via MM)
Some Unpleasant Monetarist Arithmetic | Federal Reserve Bank of Minneapolis (minneapolisfed.org)
In our view, Powell forcefully repeated that the Fed is not currently in a situation of fiscal dominance because of the
implications above (“the monetary authority is unable to control either the growth rate of the monetary base or inflation
forever”). The problem is that a growing pile of evidence strongly suggests the Fed is already in a position of fiscal
dominance.
4 • FFTT TREE RINGS MARCH 10, 2023
i.e., if the Fed does NOT increase USD liquidity enough, “the interest rate on USTs will be greater than the economy’s
rate of growth, with the US government running large deficits.” If the Fed wants to avoid this happening, it will have to
increase USD liquidity enough (also ceding control of inflation to the fiscal authorities, via a different method.)
The end game this implies is great for gold, gold miners, energy and EV-related commodities, industrial equities, and
BTC, and negative for the USD…with the understanding that the rising UST market volatility that has resumed and will get
much worse if/as Powell attempts to avoid his date with destiny of being the next Arthur Burns (sustained inflation) by
attempting to be Benjamin Strong (overtightening the world into a global depression) means that it remains prudent to
maintain our continued large allocation to cash and short-term USTs.
Rising rates will likely drive nonlinearly rising US deficits, which will put further upward pressure on inflation and downward
pressure on the private sector global capacity and production assets needed to make and ship the goods needed to quell
that inflation.
Shrinking private sector capacity (needed to make stuff for the government) against rising US government deficits (money
creation) will likely drive further increases in inflation, followed by more UST market instability (volatility), which as the
base rate for all other assets, will likely drive rising volatility across G7 rates, FX, stocks, bonds, real estate, and
commodities (which will hurt US tax receipts worse, driving US deficits higher, wash/rinse/repeat.)
Let’s watch.
FFTT TREE RINGS MARCH 10, 2023 • 5
“Current deficit spending is supporting growth…interest expense of 4%+ of GDP…the Fed is chasing its tail.”
Tree Ring: MMT (and monetary policy)
expert Warren Mosler continues to
forcefully highlight that the Fed’s rate
hikes are paradoxically putting the Fed
into a situation of fiscal dominance by
growing deficits (right, below.)
If Powell wants to stop inflation, he must
be ready to stand aside and let the UST
market dysfunction, up to and including
failed UST auctions and/or even a US
government default on USTs.
Alternatively, if the US government
shrunk its two biggest expenditures by
the amount that US interest expense has
risen (or more), it would be
disinflationary.
The problem is that interest expense (plus
Fed payments on Excess Reserves and
Reverse Repo (RRP) balances) are up by
some $1 trillion, while Defense is roughly
$880 billion, and Entitlements are roughly
$3 trillion in 2023.
So, for the inflationary impact of Fed hikes
on US interest expense plus Excess
Reserves and RRP to be neutralized, the
US government would have to cut the
$3.88 trillion combined Entitlement and
Defense budgets by ~$1T, or 26%...
…in the middle of an inflation biting fixed
income pensioners and in the middle of a proxy war v. Russia and Great Power Competition with China. In our view, that
is highly unlikely to happen.
This is probably why gold has held up so well despite the fastest Fed rate hikes in 40 years, and real rates returning to
positive levels – positive real rates in the US will only accelerate the pace at which fiscal dominance is being forced on the
Fed (and the pace at which a big chunk of the US banking system’s funding costs are > its earning assets), which is
VERY bullish for gold, as well as gold miners, BTC, and commodities.
However, real rates turning to positive levels increasingly appears to be paradoxically good for inflation by increasing US
Federal deficits. This in turn should drive continued increases in UST market volatility and therefore overall market
volatility (global FX, global sovereign debt, stocks, bonds, real estate, commodities.) We continue holding our barbell
approach to both play for the accelerating end game (sustained high inflation and/or significantly negative real interest
rates) and the volatility likely to worsen until we get there.
Let’s watch.
6 • FFTT TREE RINGS MARCH 10, 2023
“UST market instability concerns that went away last year are returning.”
Tree Ring: Former NY Fed trader Joseph
Wang noted recently that the factors that
drove UST market instability last year are
returning (right):
US policymakers appear to be aware of the
issue as well:
Dallas Fed’s Logan says financial
system vulnerable to bond market
stress – 3/3/23
Fed's Logan says financial system
vulnerable to bond market stress | Reuters
Apropos of Wang’s and Logan’s comments above, the MOVE Index (a measure of UST market volatility) shows that UST
market volatility has increased markedly since late January, and is now on the threshold of levels that have driven severe
UST market volatility and severe global risk asset and FX volatility (a.k.a., USD up sharply, everything else down):
Via DC
FFTT TREE RINGS MARCH 10, 2023 • 7
What changed in late January? In a word, the DXY bottomed:
Source: Barcharts.com
Powell can have price stability (low volatility) in the UST market, or Powell can have price stability (low inflation) in the US
economy, but he cannot have both. If he wants to get inflation back down to 2%, he will have to be prepared to stand
aside and be the first Fed chair to oversee failed UST auctions, and if that persists, a US government default on USTs. In
our view, there is zero chance Powell will allow either of those to happen on his watch.
Critically, the USD bounce and the MOVE Index increase have already been manifesting in UST auction weakness in
recent weeks:
Ugly, tailing 7y UST auction prints at highest yield on record; was the 4 th tailing auction in last 5 – 2/23/23
Ugly, Tailing 7Y Auction Prints At Highest Yield On Record | ZeroHedge
8 • FFTT TREE RINGS MARCH 10, 2023
What is the release valve needed to reduce UST volatility? The USD, from both a tactical and structural perspective, as
Joseph Wang notes below:
IMO should the market become really instable it would be solved by short term intervention, and in the longer term, some form
of YCC (Yield Curve Control).
Our friend DC sent us the chart below recently, noting:
10yr Term Premium Spread, Bund less UST. The term premium is defined as the compensation that investors require for
bearing the risk that interest rates may change over the life of the bond. Since the term premium is not directly observable, it
must be estimated, most often from financial and macroeconomic variables. Treasury Term Premia - FEDERAL RESERVE
BANK of NEW YORK (newyorkfed.org)
US 10yr Treasury Term Premium WIDENING versus GER Bund = pink line descending. In other words, the ‘compensation
risk’ the market requires to own USTs is widening versus European equivalent sovereigns. This has a direct impact on the FX
market via capital flows.
~1month overshoot of DXY, similar to mid-OCT/NOV 2022…$USD on thin ice.
Via DC
Translation? Rising UST market volatility (with DXY at 105, not 115) means the Fed is already in fiscal dominance, and it
also means another key moment in markets that was last seen last October (when Yellen expressed concern about UST
market liquidity at the IMF October meeting) is almost upon us: Unless the Fed is prepared to allow severe UST market
distress (which will only be good for the USD, and maybe gold), the Fed and/or Treasury will need to weaken the USD
again, soon…into still-elevated inflation.
We continue to patiently hold our aforementioned barbell strategy; if UST market volatility rises further, expect more large
downside days in global equities and big upside days in the USD. Let’s watch.
FFTT TREE RINGS MARCH 10, 2023 • 9
“Convexity Maven – The Chips are Down”
Convexity Maven – The Chips are Down: 3/7/23
Convexity Maven - The Chips are Down
Tree Ring: Harley Bassman is a bond market veteran expert; he periodically puts out a free missive – all one needs to do
is sign up for it (email list signup is available at the bottom of the link above.) His most recent missive grabbed our
attention for a couple reasons. He noted that the US 2y/10y UST curve is now inverted by the most in at least 40 years:
Source: Harley Bassman
10 • FFTT TREE RINGS MARCH 10, 2023
He also noted that the rate cuts the
yield curve was projecting would be
taking place into still-elevated inflation:
Source: Harley Bassman
And then went on to note that the degree of inversion in the yield curve implies a massive 88bp decline in the 1y forward
2y UST rate by next March…
Source: Harley Bassman
FFTT TREE RINGS MARCH 10, 2023 • 11
Bassman went on to note that the
MOVE (UST Volatility) Index (that
he created) has bounced to nearproblematic levels…
Source: Harley Bassman
…before suggesting something that raised
our eyebrows (right):
Bassman’s conclusion to his brilliant piece
raised our eyebrows, because (at the risk of
putting words in his mouth), it shows the Fed
is already in the fiscal dominance position
that Powell seemed to so fear in his
interaction on Wednesday with Sen. Lummis!
Bassman writes below that the denouement
of US Entitlement/Debt issues might take a
decade (we would take the under, by a lot),
but for our purposes the key is this:
The MOVE Index hitting these levels means
the next stage of the rolling US fiscal crisis is
imminent.
Ultimately, this will likely be negative for the
USD and highly inflationary, but we do not
know how close the Fed will allow a UST
auction to get to failing, so we will continue to maintain our barbell position.
Source: Harley Bassman
Longer-dated USTs seem like lose/lose at this point, which is interesting because the 10y UST yield continues to be
priced as if this is not the case (either the Fed stops UST dysfunction with more inflation-driving liquidity, or the Fed does
not and UST market volatility rises further, sending UST yields up further.)
Bigger picture, what grabbed us about Bassman’s missive and in particular, the suggestion above, is that US fiscal
problems are beginning to be noticed to be dominating yield curves, the economy, and most importantly, the Fed, by one
of the most experienced and brilliant bond market commentators on Wall Street. In our view, this is important from a
timing perspective, because consensus will eventually catch up to where Bassman is today, likely sometime in the next
several months. Near term, what Bassman describes is great for USD, but little else (including long-dated USTs), but
ultimately bad for the USD and great for inflation, etc. The MOVE Index hitting levels this high suggests the time between
“near term” and “ultimately” is likely to be brief from here. Let’s watch.
12 • FFTT TREE RINGS MARCH 10, 2023
“Biden to urge 25% billionaire tax, higher income, capital gains for rich”
Biden to urge 25% billionaire tax, higher income, capital gains tax for rich – 3/9/23
Biden to Urge 25% Billionaire Tax, Higher Income, Capital Gains Taxes for Rich - Bloomberg
Biden unveils plan averting Medicare funding crisis, challenging GOP – 3/7/23
https://www.washingtonpost.com/us-policy/2023/03/07/biden-medicare-taxes-gop/
Biden budget would cut deficit by $3 trillion over decade with 25% minimum tax on richest Americans – 3/9/23
Biden budget would cut deficit by $3 trillion over decade with 25% minimum tax on richest Americans (cnbc.com)
Tree Ring: Right on cue, the Biden Administration appears to be
attempting to do something to reduce the Fed’s fiscal dominance
problem and help the Fed fight inflation by reducing deficits (over
time). In doing so, Biden is seemingly directionally following at least
one of Mosler’s recommendations to stop inflation (right):
We will evaluate the proposals above under the assumption they will
get passed (we are skeptical, but that would simply revert us back to
the worsening US fiscal dominance situation described earlier.)
If passed, perhaps Biden’s plan to reduce
deficits and therefore inflation could work,
but we are skeptical – here’s why:
Percent of Income & Taxes Paid By Income Level
Source: IRS, FFTT
120%
With the top 1% of taxpayers paying 39%
of individual income taxes and 5% paying
nearly 60% as of a couple years ago (19%
and 29% of overall income taxes
respectively), anything that hurts US asset
prices (like a tax hike on wealthy asset
holders) could paradoxically reduce US
individual income tax receipts, driving
deficits higher instead of lower.
100%
80%
60%
40%
20%
California is seeing this very dynamic as
we speak – falling asset prices (and
wealthy taxpayers leaving California,
something a tax hike could spur some US
billionaires to do as well) have driven
California into a sharp deficit.
0%
Top 1%
Top 5%
Top 10%
Percent of Income
Top 25%
Top 50%
Bottom 50%
Percent of Income Taxes Paid
We also saw this paradox happen on a slight lag in 2016 due to Obamacare – designed in part with a goal of reducing US
government healthcare deficits by pushing more of the cost of care onto taxpayers (per the WSJ in late 2014),
Obamacare (which was effectively a tax increase) contributed to weaker US consumer spending and a decline in US tax
receipts that drove the US deficit to resume rising as a % of GDP in 2016, instead of falling.
We are watching the Biden tax hikes with great interest, as they could be important for asset markets and the US fiscal
position, but our initial reaction (assuming they can get passed) is that they are too little, too late…at a time when “big
enough tax hikes” would likely drive a counterproductive asset market decline. High Federal debt and deficit levels may
not have mattered for a long time, but they always ultimately do matter. They appear to matter now. Let’s watch.
FFTT TREE RINGS MARCH 10, 2023 • 13
“China’s Xi Jinping issued an unusually blunt rebuke of US policy on Monday”
Tree Ring: Tensions in the US/China “Great Power Competition” heightened this week:
China’s Xi Jinping takes rare direct aim at US in speech –
3/6/23
China’s Xi Jinping Takes Rare Direct Aim at U.S. in Speech - WSJ
Chinese leader Xi Jinping issued an unusually blunt
rebuke of U.S. policy on Monday, blaming what he
termed a Washington-led campaign to suppress
China for recent challenges facing his country.
“Western countries—led by the U.S.—have
implemented all-round containment, encirclement and
suppression against us, bringing unprecedentedly
severe challenges to our country’s development,” Mr.
Xi was quoted by state media as saying on Monday.
Mr. Xi’s comments marked an unusual departure for a
leader who has generally refrained from directly
criticizing the U.S. in public remarks—even as his
decadelong leadership has demonstrated a
pessimistic view of the bilateral relationship.
The accusation of U.S. suppression of China’s
development over the past five years comes as Mr. Xi
faces charges from investors that China’s economy has been damaged by his policies, including the emphasis on
national security.
The comments were part of a speech to members of China’s top political advisory body during an annual legislative
session in Beijing, according to a Chinese-language readout published by the official Xinhua News Agency.
US, China plunge further into a spiral of hostilities – 3/7/23
https://www.wsj.com/articles/u-s-china-plunge-further-into-a-spiral-of-hostilities-b9e539c0
Dutch government responds to US China policy with plan to curb semiconductor exports – 3/8/23
https://www.reuters.com/technology/dutch-responds-us-china-policy-with-plan-curb-semiconductor-tech-exports-2023-03-08/
Dr. Mahathir bin Mohamad, the former Prime Minister of Malaysia (the country’s longest serving Prime Minister) posted
two eye-opening tweet threads in the last two weeks:
14 • FFTT TREE RINGS MARCH 10, 2023
FFTT TREE RINGS MARCH 10, 2023 • 15
16 • FFTT TREE RINGS MARCH 10, 2023
We are watching these developments with great interest and increasing trepidation. Our clearest takeaway is this: The
bond market is NOT predicting an escalation of tensions into a full-on war. How do we know this? This headline:
US 2- TO 10-YEAR CURVE INVERSION REACHES 1 PERCENTAGE POINT – BBG, 3/7/23
How can we infer this from that headline? Because in the last major global world war, the US deficit as a % of GDP rose
by 25% of GDP. If the bond market was assigning even the slightest odds of a hot war between the US and China (or the
US and Russia, for that matter), the long end of the UST curve would be spiking because deficits (and inflation) would
likely explode higher in any such war:
FFTT TREE RINGS MARCH 10, 2023 • 17
While it may come as a relief that the bond market is not forecasting open war between either the US and China and/or
Russia, the bad news is that the bond market also did not forecast the US’ entrance into World War 2; long-term US
government bond yields were on the generational lows when the Japanese bombed Pearl Harbor.
As we also showed last week, the chart below shows that when Japan bombed Pearl Harbor, officially bringing the US
into World War 2, long-term US Government bond yields spiked from 2% to 2.5% virtually overnight (a.k.a. the bond
market crashed), because as Zoltan Pozsar so succinctly put it last August, “War is Inflationary.”
This then forced the Fed to cap 10y UST yields at 2.5% from 1942-1951 via Yield Curve Control (YCC), with the release
valve being the Fed’s balance sheet, inflation, and consumer goods rationing:
Yield Curve Control in the US, 1942-51 – October 2021
Yield Curve Control In The United States, 1942 to 1951 - Federal Reserve Bank of Chicago (chicagofed.org)
Our view is that the more US tensions escalate with China and Russia, the more positive it is for gold, BTC, global
commodity markets, defense stocks, and industrial production-related stocks and the worse it is for global bond markets,
particularly long duration bonds, which in the case of outright war would become essentially un-ownable as supply chains
collapsed globally, spiking inflation (and in some cases, hyperinflation), likely once again forcing Central Bank YCC and
then broad global economic rationing of commodities to civilians.
To the extent we continue to see an escalation of tensions, it might make sense for more speculative accounts and bond
funds to hold small amounts of out of the money puts (insurance) on bonds – if tensions keep rising, it may only take one
geopolitical incident to crash the bond market. Let’s watch.
18 • FFTT TREE RINGS MARCH 10, 2023
“War in Ukraine drives new surge of US oil exports to Europe”; “The economics of the US natural gas market are
going to be influenced more and more by international markets.”
War in Ukraine drives new surge of US oil exports to Europe – 2/26/23
War in Ukraine Drives New Surge of U.S. Oil Exports to Europe - WSJ
Since February 2022, when Russia invaded Ukraine, average monthly seaborne cargoes to the continent jumped
38% compared with the previous 12-month period, according to ship-tracking firm Kpler. A fleet of skyscraper-size
tankers carried more crude to Germany, France and Italy—the European Union’s largest economies—as well as
Spain, which alone boosted purchases by about 88% over the period.
Gunvor chief says loss of Russian gas will cement US export role – 3/6/23 (Via MP)
Gunvor chief says loss of Russian gas will cement US export role | Financial Times (ft.com)
The collapse of Russian natural gas flows to Europe has given US fuel exports pivotal new importance in the global
economy, the head of one of the world’s largest commodities traders has said, signaling a permanent change in the
structure of global energy markets. Torbjörn Törnqvist, chief executive of Gunvor, spoke on Monday just over a year
after Russia’s full-scale invasion of Ukraine.
Russia has since cut gas exports to the EU by about 80 per cent. He said that Russia’s decline as a crucial supplier is
putting more onus on US liquefied natural gas exports to plug the gap. “The world will not be able to live without US
LNG. It’s the balancing factor.” Törnqvist and other senior executives spoke on the first day of the CERAWeek
conference in Houston, an annual energy industry gathering. Swiss-based Gunvor on Monday said it had struck a
preliminary deal with US gas producer Chesapeake Energy to buy 2mn tonnes of LNG annually for 15 years from
2027.
Trading houses earned bumper profits in LNG trading last year by buying low-priced US gas to sell in Europe, where
prices soared as high as $100 per million British thermal units. On Monday the US gas benchmark, known as Henry
Hub, was trading at $2.56 per mmbtu, also well beneath Asian LNG prices of about $14 per mmbtu.
Nick Dell’Osso, Chesapeake’s chief executive, said that the price gap would remain an advantage for US shale
producers and exporters, but also bring international pricing into the US market. “The economics of the US natural
gas market are going to be influenced more and more by international markets as more gas is delivered
internationally,” Dell’Osso told the Financial Times in Houston.
Tree Ring: Two key things grabbed us about these articles:
1. Note that the article says, “War drives surge of US oil and gas exports to the EU.” It does NOT say “War drives
surge of UST exports to EU.” This dovetails with several themes we have been touching on, including how the
US is de facto using energy exports (from the SPR and per above, shale production outright) to defend the UST
market – if Europe was not getting energy from the US, it would be selling USTs to get that energy.
2. The trade-off is that as more domestic US energy production is exported, it will (particularly in the case of gas),
drive domestic US prices higher over time, putting secular upward pressure on US inflation from energy costs:
On Monday the US gas benchmark, known as Henry Hub, was trading at $2.56 per mmbtu, also well beneath Asian
LNG prices of about $14 per mmbtu.
This dynamic is good news for US energy prices, energy producers, and for industrial companies selling into those
markets. Higher energy prices are also good for gold over time. Lasty, it is likely bad news for long term bonds over time.
Let’s watch.
FFTT TREE RINGS MARCH 10, 2023 • 19
“US shale companies’ biggest and best wells are producing less oil”
US shale boom shows signs of peaking as big oil wells disappear – 3/8/23
https://www.wsj.com/articles/u-s-shale-boom-shows-signs-of-peaking-as-big-oil-wells-disappear-2adef03f
The boom in oil production that over the last decade made the U.S. the world’s largest producer is waning,
suggesting the era of shale growth is nearing its peak.
Frackers are hitting fewer big gushers in the Permian Basin, America’s busiest oil patch, the latest sign they have
drained their catalog of good wells. Shale companies’ biggest and best wells are producing less oil, according to data
reviewed by The Wall Street Journal.
The Journal reported last year companies would exhaust their best U.S. inventory in a handful of years if they
resumed the breakneck drilling pace of prepandemic times. Now, recent results out of the Permian, spread across
West Texas and New Mexico, are mimicking the onset of a production plateau that has taken place at other, more
mature U.S. shale plays.
At a major industry conference here this week, executives cited the stagnation in shale, saying it signaled a return to
more dependence on foreign energy sources and more challenging times ahead for major U.S. companies, after
most of them posted record earnings last year.
“The world is going back to a world that we had in the ’70s and the ’80s,” said ConocoPhillips Chief Executive Ryan
Lance, during a panel at the conference called CERAWeek by S&P Global. He warned that OPEC would soon supply
more of the world’s oil.
Oil production from the best 10% of wells drilled in the Delaware portion of the Permian was 15% lower last year, on
average, than top 2017 wells, according to data from analytics firm FLOW Partners LLC. Meanwhile, the average well
put out 6% less oil than the prior year, according to an analysis of data from analytics firm Novi Labs.
Chevron, one of the largest landholders in the Permian, drilled some of the region’s most prolific wells in Culberson
County, Texas, but some of its newer wells there have seen productivity decline.
The wells Chevron brought online in Culberson County last year are ultimately expected to produce 42% less oil, on
average, than wells that began producing in 2018, according to FLOW’s estimates. The top 10% of wells Chevron
brought online across the Delaware last year were about 25% less productive on average than its wells the year
before, according to Novi Labs data.
Devon has drilled some of the most productive wells the Delaware had ever seen, in an area the company dubbed
Boundary Raider. In 2020, its average well pumped more than 342,000 barrels over a nine-month period, but the
following year, its average fell to more than 167,000 barrels, according to FLOW President Tom Loughrey.
Companies’ midlevel wells are still producing steadily, but gushers are harder to come by, Mr. Loughrey said.
“The big well is coming down hard right now,” he said.
Tree Ring: We know we harp on this trend a lot, but it is one of the most important trends in macro, particularly given the
prior two articles noting that US exports of oil and gas have accelerated meaningfully and are expected to continue to
increase. This suggests a combination of rising foreign demand for US oil and gas and declining supplies of US shale oil
and gas (barring a substantial rise in prices from here.)
This in turn suggests that barring an energy productivity miracle rolled out on a very short time horizon, energy inflation
will likely remain a major tailwind to overall US inflation rates. Paradoxically, to the extent the Fed hikes rates to fight
inflation, they will likely put downward pressure on US shale supplies as shale tends to be interest rate sensitive.
20 • FFTT TREE RINGS MARCH 10, 2023
One last observation regarding this comment from the article above:
“The world is going back to a world that we had in the ’70s and the ’80s,” said ConocoPhillips Chief Executive Ryan Lance,
during a panel at the conference called CERAWeek by S&P Global. He warned that OPEC would soon supply more of the
world’s oil.
If he is right (and we believe that he is), then this chart needs to be in every investor’s head as it relates to the USD:
US Oil Production in Shale Era (orange, LHS) v. Broad
USD index (blue, RHS)
Sources: US EIA, Fed, FFT
14,000
130
13,000
125
12,000
120
11,000
115
10,000
110
9,000
105
8,000
100
7,000
95
6,000
90
5,000
85
4,000
80
A decline in US shale production should all else equal put upward pressure on oil prices (and other commodities), upward
pressure on gold, and downward pressure on the USD (which is in turn good for global economic growth, asset prices,
EM’s, gold, and inflation.)
Let’s watch.
FFTT TREE RINGS MARCH 10, 2023 • 21
“Russia’s revenue from oil and gas almost halved in February”
Russia’s revenue from oil and gas almost halved in February – 3/3/23
https://www.bloomberg.com/news/articles/2023-03-03/russia-s-revenue-from-oil-and-gas-almost-halved-in-february
Russia’s oil and gas revenue almost halved in February after Western restrictions on crude and petroleum products
took effect and gas exports to Europe fell.
Tax revenue from oil and gas plunged 46% in February from a year ago to 521 billion rubles ($6.91 billion), the
Finance Ministry said on Friday. Proceeds from crude oil and petroleum products — which accounted for over two
thirds of energy tax revenue last month — fell by 48% to 361 billion rubles, according to Bloomberg calculations.
Tree Ring: It is an interesting contest of sorts – Russian oil revenues are shrinking with the EU energy caps; US shale
production is rolling over; the US and global bond markets are under increasing stress; the EU is short energy; China is
short energy...what will break first?
Well, first off, the Russian energy caps appear to
be resulting in China getting increasing amounts
of cheap Russian energy, which all else equal is
good for China (right).
Also all else equal, what Russia announced this
week will give the precarious standoff above a
shove in Russia’s favor, to the detriment of EU
energy markets and US bond markets (but helpful
to US energy markets):
RUSSIA PLANS TO CUT OIL EXPORTS AND
TRANSIT FROM WESTERN PORTS BY 10%
IN MAR/FEB--SOURCES, REUTERS
CALCULATIONS – 3/7/23, BBG
22 • FFTT TREE RINGS MARCH 10, 2023
This additional wrinkle hit this week as well…also bad news for Europe’s energy situation:
Kazakhstan struggles to find enough crude oil to pipe to Europe – 3/7/23
https://www.bloomberg.com/news/articles/2023-03-07/kazakhstan-struggles-to-find-enough-crude-oil-to-pipe-to-europe
Kazakhstan is struggling to find enough crude oil to meet requests from European countries for deliveries through
Russia’s Druzhba pipeline system that would allow them to reduce their dealings with Moscow.
Germany is supposed to take delivery of a total of 40,000 tons of piped Kazakh oil this quarter, according to
KazTransOil, the state oil pipeline operator. That’s down by almost 90% from what was originally planned.
Kazakhstan’s producers are struggling to find spare barrels that would help European firms to wean themselves off
Russian supply, people with knowledge of the matter said. On top of that, they are also wary of using the Druzhba
link because they can earn better returns by using other export routes from the landlocked central Asian nation, they
said.
To recap – Russian energy is flowing in large volumes toward China, possibly at a discount (helping China’s Balance of
Payments all else equal…which it may not be.) Russian revenues are falling significantly (bad for Russia), but Russia is
responding by curtailing shipments west which should raise Russian oil revenues from Asia and EU energy prices all else
equal.
At the same time, Kazakhstan seems to be having some difficulty hitting shipment targets to the EU, presumably leaving
more of the EU energy market to the US to supply (bad for EU, good for US energy prices and suppliers, bad for US and
EU inflation and bond markets.)
Let’s watch.
Thank you for reading this edition of Tree Rings. Have a great weekend! LG
FFTT TREE RINGS MARCH 10, 2023 • 23
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24 • FFTT TREE RINGS MARCH 10, 2023