Bi-Weekly Geopolitical Report – Reflections on the New Cold War (August 21, 2023)

Posted on August 21, 2023August 21, 2023 by Amanda Ahne

Bill O’Grady | PDF

Note: Due to the Labor Day holiday in two weeks, the next edition of this report will be published on September 18.

Our geopolitical research over the past 15 years has had a consistent theme—that U.S. hegemony is under strain. Essentially, costs of America’s hegemonic role have become unbearable for the domestic economy and society. As America’s hegemonic position comes under pressure, we think a new Cold War is emerging.

In this report, we will examine the key features of American hegemony and how those features were closely tied to the Cold War. From there, we examine the shock of the end of the Cold War and how various aspects of American policy and global economics changed as a result. As always, we close with market ramifications.

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Weekly Energy Update (August 17, 2023)

Posted on August 17, 2023August 16, 2023 by Amanda Ahne

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF

Oil prices did break out of the trading range but were unable to maintain the uptrend. We suspect the recent pullback is corrective in nature and not the start of a major selloff.

(Source: Barchart.com)

Commercial crude oil inventories fell 6.0 mb, much lower than the 2.3 mb build forecast. The SPR rose 0.6 mb which puts the net build at 5.4 mb.

In the details, U.S. crude oil production rose 0.1 mbpd to 12.7 mbpd. Reported production has been rising, but there are also reports arguing that further increases may be difficult. Exports rose 2.2 mbpd, while imports rose 0.5 mbpd. Refining activity rose 0.9% to 94.7% of capacity, the highest level since early June.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories. The last decline is consistent with seasonal patterns. Inventories remain a bit below their seasonal average.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $66.20. Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in late 1985. Using total stocks since 2015, fair value is $93.89.

Market News:

The threat of a strike by Australian LNG workers led to a massive jump in European natural gas prices. Prices had been weak because European inventory levels were seen as elevated. The rise shows how vulnerable Europe remains due to the loss of Russian supplies.
- Drought is threatening water levels in the Panama Canal. If they become severe enough, it may affect global LNG flows.
The IEA notes that, despite efforts to transform the energy sector, oil demand is hitting new records. The energy transition has dampened investment in oil and gas, and therefore, if demand continues to rise, oil prices will likely rise as well.
A couple of weeks ago, we noted that temperatures were likely being affected by the sunspot cycle and El Niño. We can now add volcanic activity to the list. Volcanic eruptions tend to spew particulates into the atmosphere, which reflect sunlight back to space and cool the planet. We are currently seeing a large eruption in Sicily.
- However, not all eruptions have the same result. A deep water eruption in Tonga may have had the opposite effect.
- A new heatwave is hitting the Pacific Northwest.

Geopolitical News:

There are further indications that the Kingdom of Saudi Arabia (KSA) and Israel are planning to normalize relations. Washington has been taking an active role in encouraging this development. It’s not a done deal yet, but there is evidence of progress. Making a deal would help build an anti-Iran alliance.
- The KSA appointed a non-residential ambassador to the “state of Palestine.” Since no state actually exists, this action is more for show, but it may give the KSA a vehicle to criticize Israel’s policies against the Palestinians.
The U.S. and Iran appear to be close to a prisoner deal that will free five Americans currently detained in Iran. In exchange, Washington will unfreeze $6.0 billion of Iranian assets. The Biden administration continues in its quest to resurrect the JCPOA; we continue to doubt this will ever occur. However, there is more to the deal than is being discussed in the press—Peter Zeihan has his take here. There is still a good chance this deal will fall through as there is strong opposition on both sides.
- We note the U.S. has asked Iran to stop selling drones to Russia.
- While these indirect talks continue, naval tensions in the Persian Gulf remain
The war in Ukraine has disrupted global supply chains. As part of this situation, we note that oil majors have suffered large losses by exiting Russia.
- Despite the war, the West remains dependent on Russian nuclear fuel.
- Sanctions generally leak. One way that Russia and India have avoided sanctions was to price Russian oil sales under the price cap but inflate shipping costs. A recent report suggests this workaround may have added a billion dollars to Russian oil revenues.
- Despite Russia’s aggressive actions to avoid sanctions, the RUB has been rapidly depreciating. The currency weakness does suggest problems in the Russian economy. To defend the currency, the Russian central bank lifted its policy rate 350 bps. The currency crisis has been raised to the presidential level.
- The war in Ukraine has severely damaged demand for industrial gases in Europe. Weak economic growth and fears of higher prices have depressed industrial activity.
President Xi encouraged party members to work on ensuring energy security. We have noted that China has been engaging in an “all of the above” energy strategy, looking to expand coal, nuclear, hydro, oil, and natural gas resources. As with nearly everything in China, Xi framed the energy situation in terms of national security.
Iraq’s oil exports to the U.S. have recently surged.

Alternative Energy/Policy News:

In the extraction process, it is not unusual for byproducts to be produced. When mining for copper, nickel or silver is also often extracted. When drilling for oil, natural gas is often found as well. Lithium is often a byproduct of oil and gas drilling, and with lithium prices rising and demand strong, oil companies are starting to try to capture lithium in the drilling process. Where does the lithium come from? When drilling for oil or gas, a normal byproduct is salt water mixed with oil, and this brine contains lithium.
There are two competing technologies for lithium-ion batteries. One uses lithium, nickel, manganese, and cobalt, and another uses lithium, iron, and phosphate. This article is a primer on the two different types.
- S. metals demand is being boosted by the Inflation Reduction Act. Research suggests that demand for these metals likely exceeds production capacity.
- As the energy transition continues, Africa’s mineral wealth is attracting the attention of both the U.S.-led and China-led blocs.
In the U.S., EV sales remain healthy, but there is growing dissatisfaction with the charging infrastructure. Without resolution, this could stall sales.
Although Mongolia is landlocked, as we noted in a recent report, it has been trying to foster an independent foreign policy away from Russia and China. The U.S. is supporting Mongolian exports of rare earths. It will be interesting to see if China begins to interfere with the trade.
In Brazil, BYD (BYDDY, $66.43) is taking control of a large Ford (F, $12.30) auto factory, providing further evidence that China’s EV industry is making global inroads.
Last week, we noted that China was using pumped storage for energy production. Beijing has announced a new pumped storage project in the Gobi Desert.
The buildout of electricity transmission lines is a key element in expanding renewable energy. Often, such projects pit environmentalists against one another.
Supermajor oil companies are becoming interested in direct air capture, which would pull carbon out of the atmosphere directly.
A Montana judge ruled that the state’s approval of fossil fuel projects was unconstitutional because environmental factors were not taken into account. Although the news is getting lots of attention, the ruling was rather narrow and may not set a precedent.
There is an underlying tension between rapidly building out the alternative energy industry and encouraging unionization. The UAW is pressing for union membership, whereas firms are hoping to avoid organized labor.
- Much of the investment in alternatives is being done in “red” states.

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Asset Allocation Bi-Weekly – Where’s the Recession? Examining Employment (August 14, 2023)

Posted on August 14, 2023August 11, 2023 by Amanda Ahne

by the Asset Allocation Committee | PDF

In August of last year, our yield-curve indicator signaled an inversion, which implies that a recession is set to occur within 16 months, on average. And so, we are still within range of a recession occurring by year’s end. However, the economic data continues to show improvement, raising hopes that the economy will avoid a full downturn. In our May 22 report, we noted that new home sales were doing quite well, mostly because existing home sale listings were unusually low. Essentially, the fact that most homeowners have a mortgage rate well below the current market is dampening home sales. This improvement in housing has lowered the odds of recession.

In this report, we will discuss another aspect of why the recession has been avoided thus far—the labor markets continue to remain tight. In Walter Scheidel’s book, The Great Leveler,[1] he postulated that inequality rises over time and that there are only four consistent factors that cause inequality to retreat: mass industrial war, revolution, the breakdown of civil society, and pandemic. Scheidel noted that after the Black Death, the loss of workers due to the plague led to a dramatic decline in workers, causing wages to rise. Fortunately, the COVID-19 pandemic was not nearly as lethal as the Black Death, but it did have an impact on older workers’ participation in the labor force.

The chart on the left shows the over-55 labor force, while the chart on the right shows employment for the same cohort. We have regressed a time trend through both series starting in 2000. Note the onset of the pandemic led to a notable drop in both the labor force and employment for this age bracket. How important is this development? If the pre-pandemic trends had remained in place, the current unemployment rate would be 4.9% instead of 3.6%.

Using our Fed indicator, which subtracts CPI from the unemployment rate, if we use the pre-pandemic trends for employment in the labor force, then the indicator would be reading -1.94 instead of the current -0.63. This reading would be consistent with at least steady policy and would likely be signaling the need to ease policy.

Overall, this study suggests that the labor market is tight because of older workers exiting due to the pandemic, an unusual circumstance. Since the lethality of COVID-19 increased with age, it made sense that older workers left the workforce. There has been speculation that they will eventually return, and they have, according to the data, but not to the pre-pandemic trend levels. This analysis doesn’t mean the labor markets are not tight, but the tightness is partially due to the circumstances surrounding the pandemic. Labor market tightness has tended to support wage growth which, in turn, has supported economic growth. Although we still expect a recession in the coming months, there is a clear case that the lack of existing home supply and the exodus of older workers have reduced the economy’s sensitivity to rate hikes. If inflation continues to decline (as we expect), then there is a chance that the U.S. can avoid a formal downturn.

[1] Scheidel, Walter. (2017). The Great Leveler: Violence and the History of Inequality from the Stone Age to the 21^st Century. Princeton, NJ: Princeton University Press..

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Weekly Energy Update (August 10, 2023)

Posted on August 10, 2023August 9, 2023 by Amanda Ahne

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF

Oil prices are challenging the upper end of the trading range but so far have failed to breakout above that level.

(Source: Barchart.com)

Commercial crude oil inventories rose 6.8 mb, well above the 3.0 mb build forecast. The SPR rose 1.0 mb.

In the details, U.S. crude oil production jumped 0.4 mbpd to 12.6 mbpd. The adjustment factor, which is a plug number to make the supply balance sheet “balance,” has been high in recent weeks. We suspect the DOE had been undercounting barrels and thus has adjusted production higher. Exports dropped 2.9 mbpd, while imports were unchanged. Refining activity rose 1.1% to 93.8% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories. Last week’s rise partly offset the large draw from the previous week. However, inventories remain a bit below their seasonal average.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $64.21. Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in late 1985. Using total stocks since 2015, fair value is $93.30.

Market News:

Increasingly, the Kingdom of Saudi Arabia’s (KSA) oil production policy is deviating from the rest of the cartel. As we noted last week, the Saudis extended their unilateral production cut of 1.0 mbpd. Although the policy has successfully lifted oil prices, in the past, such unilateral policy has led to falling market share. It’s not clear if the Saudis believe other sources of oil would not cause a similar result, or if the goal of lifting revenue is trumping other goals.
The U.S. oil industry is scrambling to attract engineering talent. High wages for engineers and concern about climate issues among younger workers may constrain future oil production.
The DOE has issued its short-term energy outlook; the government is expecting modestly higher prices next year for crude oil and natural gas.
Former VP Pence has unveiled his proposed energy policy. The goal is to make the U.S. the world’s largest energy producer by 2040.

Geopolitical News:

Last week, Ukrainian drones attacked a Russian oil tanker for the first time. Although it doesn’t appear that any oil flows were affected, if this tactic escalates, it could further constrain global oil supplies. This action is a clear broadening of the war.
Iran’s continued harassment of Persian Gulf shipping is leading the U.S. to explore the idea of placing armed American troops on commercial ships. Iran is putting missiles and drones on its vessels to threaten regional shipping.
In the wake of recent hajib protests in Iran, the government is creating a fourth intelligence agency, mostly to respond to domestic unrest.
In the broad spectrum of human relationships, power is an important element. In international relationships, it may be the most important factor. As we have noted in recent reports, the KSA and China have been taking numerous steps to improve relations. Part of this process has involved technological and scientific exchanges. Research from Carnegie suggests the KSA may be shaping these exchanges to its advantage; in other words, the exchange may be more beneficial to Riyadh than to Beijing.
- The mirror image of trade flows is payment flows. To make payment flows effective, both parties need financial products where excess flows can be invested. We note that China and the KSA are in talks to have ETFs cross listed, which could create reserve assets in the currencies of both nations.
- The KSA is indicating that it intends to expand investment into China.
Russia is starting to sell oil to China via the Arctic Ocean.
Azerbaijan and Iraqi Kurdistan are working to improve relations. This decision is raising concerns in Iran, Iraq, and Turkey. For Iran and Iraq, an independent Kurdistan is a potential threat. Although Turkey usually tries to quell Kurdish nationalism, it is friendly with Azerbaijan and would therefore likely want to peel Iraqi Kurdistan away from Iraq.
- We note that the central Iraqi government and Iraqi Kurdistan have agreed to draft a new oil law. Essentially, Baghdad is trying to solidify its control of the Kurdistan region.

Alternative Energy/Policy News:

Fusion power is back in the headlines. One of the keys to the scientific method is repeatability. If an experimental outcome isn’t repeatable, it probably isn’t real. U.S. government scientists are claiming they have achieved a net gain in a fusion reaction for the second time. Although we doubt fusion will be commercially feasible for decades, we do note that researchers are starting on the process.
China continues to make inroads into global auto markets. In July, the bestselling EV in Sweden was a Chinese nameplate.
- The Inflation Reduction Act created incentives to build EVs and key components in the U.S. One way this was structured was to deny consumers the tax credit if the car or batteries came from outside the U.S. or from nations without a free trade agreement with the U.S. Such restrictions create incentives for evasion. China is apparently investing heavily in South Korea’s EV battery industry, likely to create an avenue to gain access to the U.S. auto market. South Korea has a free trade agreement with the U.S.
- Chery Automotive, a Chinese SOE and the country’s ninth largest automaker, is teaming up with Huawei (002502, CNY, 2.38) to provide the operating system for some of its vehicles. The U.S. considers Huawei to be a potential conduit of information to the Chinese government, so it will be worth watching to see how Washington responds to nations importing these cars.
- A price war for EVs in China has emerged, meaning it’s cheaper to purchase electric than gasoline vehicles.
- As we have noted before, Western policymakers need to balance the goal of reducing carbon emissions with the foreign policy goal of isolating China. As this report points out, it’s a difficult tradeoff.
It’s likely that the early adoption phase of EVs is coming to a close. If so, it means new buyers will be more discriminating in terms of price and when making comparisons to gasoline cars. That may mean that adoption will slow, and hybrids might become more prominent.
New technology could spur expanded use of geothermal power by expanding the use of horizontal drilling to create more “hot spots” to generate power.
As we have documented on numerous occasions, the move away from fossil fuels will entail a wholesale shift into metals. Copper, lithium, nickel, cobalt, and other metals will be needed for many of the alternatives, from windmills to solar panels to EVs. As we have also noted, China dominates many of these metals, both in their mining and processing. The West is trying to source these key inputs from areas free of China’s control. However, the task is proving difficult.
Another recent theme we have discussed is that the joint goals of reindustrializing America (and the industrial working class) and meeting climate targets may be in conflict. Emphasizing the former will lead to higher costs, while focusing on the latter may lead to more imports which would not help the U.S. industrial sector. Balancing these policy goals is difficult, but if the leadership sides with meeting climate goals over the goals of labor, the political costs could be large.
In the U.S., solar power additions to utility capacity are expected to grow sharply by year’s end. Meanwhile, China is investing in pumped storage in conjunction with wind and solar power. Pumped storage allows power to be provided when the sun doesn’t shine and the wind doesn’t blow.
U.S. utilities are warning that the Biden administration’s plans to restrict carbon emissions are unworkable.

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Bi-Weekly Geopolitical Report – The Economics of National Defense in Great Power Competition (August 7, 2023)

Posted on August 7, 2023August 21, 2023 by Amanda Ahne

Patrick Fearon-Hernandez, CFA | PDF

Tensions between the United States and China continue to worsen, with the two nations hurtling toward each other in a geopolitical game of chicken that, in a worst case scenario, could potentially end up in war. In the distance, a few possible off-ramps still hold promise, but the two powers are charging at each other so fast that it will be tough to make the turn onto any of them. If war comes, it will most likely start with a Chinese grab for Taiwan. However, the war wouldn’t really be a fight for control of a subtropical island slightly bigger than Maryland, some 100 miles off the southeast coast of China. Taiwan would only serve as the immediate excuse for war. The war would really be a contest for the world’s future. The war would pit the vision and fundamental interests of the U.S. and its geopolitical and economic bloc against the vision and interests of the China/Russia[1] bloc.

If war comes, the spoils of victory would be what we call the three Ts: Territory, Technology, and Trade. To the victor would go the territory of Taiwan, or for the U.S., the assurance of Taiwan’s territorial integrity. Keeping Taiwan unshackled would preserve the global space for democracy and freedom and ensure that Taiwan remains a bulwark against the authoritarian rule of the Chinese Communist Party. To the victor would also go Taiwan’s unique factories and workers producing the world’s most advanced semiconductor technologies. Finally, the victor would secure the ability to restrict or keep open the vital sea lanes and trade routes feeding key U.S. allies like Japan and South Korea.

Since both the U.S. bloc and the China/Russia bloc could deploy masses of highly destructive weapons and concentrate them on a limited objective, a war over Taiwan could be relatively short—days or weeks, rather than months or years. All the same, properly preparing for such a war would require a long-term effort. The military buildup that has given China the world’s largest navy and put it in position to possibly win such a conflict has continued for far more than a decade. As the West has learned in its struggle to arm Ukraine against Russia’s invasion, “Great Power” military preparedness requires full-scale exploitation of a country’s national resources and a large, advanced defense industry. In this report, we discuss the economics of defense in today’s Great Power competition and what it means for investors.

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[1] Given the increased geopolitical and economic cooperation between China and Russia, we now refer to their bloc jointly. However, we still believe China is the main driver of this bloc.

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The podcast episode for this particular edition will be available later this week and posted under the Confluence of Ideas series.

Weekly Energy Update (August 3, 2023)

Posted on August 3, 2023August 2, 2023 by Amanda Ahne

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF

Oil prices challenged the upper end of the trading range but so far have failed to breakout above that level.

(Source: Barchart.com)

Commercial crude oil inventories fell a massive 17.0 mb, well above the 2.3 mb draw forecast. The SPR was unchanged.

In the details, U.S. crude oil production was steady at 12.2 mbpd. Exports rose 0.7 mbpd, while imports increased 0.3 mbpd. Refining activity fell 0.7% to 92.7% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories. Last week’s large decline has put inventories below their seasonal average.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $65.79. Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in late 1985. Using total stocks since 2015, fair value is $94.97.

Market News:

Analysts expect the Kingdom of Saudi Arabia (KSA) to extend its voluntary production cuts. However, the continued loss of revenue is probably not sustainable. We do note that production from OPEC+ fell sharply in July.
Rating agencies are threatening to downgrade PEMEX bonds due to its high debt load. There is a growing likelihood that PEMEX will default on its bonds, but given the government’s close relations with the company, a massive restructuring is also likely.
The U.K. is easing environmental restrictions in a bid to boost North Sea oil and gas production. Although the Sunak government is being criticized by environmentalists, this sort of behavior isn’t uncommon. Most voters support environmental measures until standards of living are threatened.
Managing pollution is a textbook economics problem. Pollution is an externality; in economic terms, it’s a bad outcome that isn’t reflected in the market price. Without outside intervention, the cost is shifted to society and away from the parties to the transaction. Gasoline consumption does trigger air pollution. In addition, insofar as gasoline is refined from foreign oil, there is a potential geopolitical externality that isn’t captured by the price at the pump. The most efficient way to address this problem is to estimate the externality’s cost and apply a tax. It’s also the least politically popular. For this reason, Congress and regulators have used other means to achieve this goal instead. Specifically, the government has applied mileage standards to automakers, called the Corporate Average Fuel Economy (CAFE) standards. This leads to automakers selling small, fuel-efficient cars at a discount so they can sell more of the popular larger vehicles. The EPA is looking to raise the CAFE standard to 58 mpg by 2035, which will likely force automakers to sell more EVs to meet this standard. A standard of this level would likely lead to lower gasoline consumption.
Brazil and Guyana are expected to increase oil production over the next few years. The latter has turned out to be a very promising find. However, it’s unlikely that this new production will do much more than merely offset the impact of depletion.
China and India have been driving global coal consumption. At the same time, China is running a broad-based energy policy. We note that it is building 23 nuclear reactors, accounting for 42% of global reactor construction.
- The U.S. has completed its first new nuclear power station since 2016. The 2016 plant was the first in two decades. The plant, in Georgia, was seven years overdue with cost overruns of $17 billion.
Due to rising costs, the 6.0 mb planned injection into the SPR has been postponed.

Geopolitical News:

The Trump administration’s diplomatic breakthrough in the Middle East, which led several Arab states to normalize relations with Israel, is starting to stall. The key goal was a normalization of relations between the KSA and Israel. The Saudis’ demand is a two-state solution with the Palestinians, which the Abraham Accords essentially undermined. It’s not clear just how much progress would be required in order to implement a two-state solution, but the Netanyahu government would probably have to take the Palestinians’ goals into account. The benefits of normalization would be significant. Israel could potentially develop military relations with the KSA, which would help both nations contain Iran. From the U.S. perspective, it could allow for a smaller American security footprint in the Middle East. Pivoting to China requires the U.S. to reduce its attention in other parts of the world, including the Middle East.
Last week we reported that the U.S. had blacklisted 14 Iraqi banks from transacting in dollars due to their relations with Iran. The U.S. feared the banks were facilitating sanctions avoidance. The move sent the IQD plunging and triggered protests in Iraq.
- Iran and Iraq have a complicated energy trade which is mostly designed to evade sanctions.
Iran has continued to escalate tensions in the Persian Gulf and the Gulf of Oman. This action has led the U.S. to send military resources to protect shipping.
Pakistan is trying to import oil from Russia. However, it is struggling to make payment in CNY.
Although most EU nations have either ended or curtailed Russian natural gas purchases, Austria is still importing a sizable amount of Russian gas. Before the war, Russia provided almost 80% of Austria’s natural gas. It still provides more than half, and in March, Russia supplied 74%. Austria, a bit like Switzerland, is officially neutral as this was the agreement reached in 1955 to end Soviet occupation. Like Germany, Austria was divided into four occupied zones after WWII. However, unlike Germany, this occupation didn’t evolve into two separate states. The occupation ended in 1955 with Austrian neutrality, and as such, the country isn’t a member of NATO, for example.
Mongolia, wedged between China and Russia, is attempting to tread an independent policy path by seeking closer relations with the U.S. Mongolia is a major producer of energy transition minerals. We doubt the country will be able to make this goal work, but its attempt is worth watching.
The KSA has become an aggressive investor in the mining industry. This action is likely an attempt to diversify its economy from its dependence on oil and gas. The entrance of Saudi Arabia into the industry intensifies the race to secure these metals.

Alternative Energy/Policy News:

As EV sales rise, China is aggressively expanding its EV industry across the globe. So far, the U.S. is trying to fend off Chinese EV imports in order to build the domestic industry. The problem for the U.S. is that protecting domestic producers will slow the achievement of climate goals. Europe, on the other hand, appears to be more open to buying China’s EVs.
- China is also expanding its overseas efforts to secure EV metals.
- China’s main EV producers are setting new sales records.
Several automakers are collectively trying to build out EV charging stations. Some of this drive is to create an alternative charging network to Tesla’s (TSLA, $255.71).
Research by Capital Economics projects that EVs will displace 7.5% to 8.0% of global oil demand by 2050.
The Swiss solar company Meyer Burger (MYBUF, $0.65) is postponing plans to expand a solar plant in Germany and opting for a new plant in Colorado to take advantage of U.S. subsidies.
Commodity production throughout history has often been a dangerous pursuit. Turns out, mining for the metals needed for the energy transition is not exempt from this issue.
China and the KSA have effectively gutted attempts to apply greenhouse gas emissions targets. Essentially, China is signaling that it will not comply with global attempts to curtail fossil fuel consumption.
- The lack of international compromise increases the odds that geoengineering will be tried as a solution to climate change.
Hydrogen offers promise as a replacement fuel for hydrocarbons. By separating out the “carbon” part, the gas could be used directly with no pollution. However, the method by which hydrogen is created is complicated. The “greenest” hydrogen, using only renewable energy to split water, for example, is very expensive and difficult to scale. Energy groups want to tap the subsidies available for making hydrogen but use less “clean” methods in order to lower costs.
Germany’s attempts to ban boilers in favor of heat pumps have been unpopular. Now, a controversy has emerged over the use of hydrofluoroolefins in heat pumps. Germany wants to prohibit the use of such gases in German heat pumps, meaning U.S. and other EU heat pumps would not be allowed. Foreign providers of heat pumps are arguing against the exclusion of hydrofluoroolefins.
Offshore wind projects are in trouble due to rising costs of construction and key metals needed for the windmills.
During the 1970s, oil companies, flush with cash, ventured into other businesses. Some bought coal companies, while others tried to diversify in other ways from oil and gas. For the most part, these investments didn’t do much for the oil companies. We note that oil companies are looking to invest in lithium production as extracting lithium from brine is a similar chemical process to petrochemicals. Whether this foray proves fruitful is another matter.

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Asset Allocation Bi-Weekly – #103 “Part-Time Troubles” (Posted 7/31/23)

Posted on July 31, 2023 by Amanda Ahne

Asset Allocation Bi-Weekly – Part-Time Troubles (July 31, 2023)

Posted on July 31, 2023July 28, 2023 by Amanda Ahne

by the Asset Allocation Committee | PDF

The job market has greatly surpassed the expectations of leading experts so far this year. Back in December, a Bloomberg survey found that economists predicted that monetary policy tightening by the Federal Reserve would push the country into a recession in the first half of 2023. They estimated that payrolls would decline in the second and third quarters and the unemployment rate would rise to 4.9% by 2024. However, these predictions have proven to be decidedly premature. Against all odds, the economy has added 1.29 million jobs in the first six months of the year, well above its historical average. Meanwhile, the unemployment rate currently stands at 3.6%, nearly a 50-year low. While these labor market indicators inspire optimism, we suspect that the economic situation may be a bit more complex.

Last month, the rate of underemployed individuals experienced a significant acceleration and reached its fastest pace since the onset of the pandemic. Part-time employment for economic reasons rose 15.4% from the prior year, raising concerns about the true state of the labor market. The only other time the underemployment rate has risen at this speed without an economic downturn was in 1967, when swaths of workers went on strike. Comparatively, part-time work for noneconomic reasons has increased by only 2.96% in the same period. Hence, the increase in underemployment may not be explained by workers choosing to work part-time for personal reasons, such as caring for children or elderly relatives.

The rise in the number of workers resorting to part-time work might be indicative of households facing financial hardships. Despite the Federal Reserve’s attempt to tighten monetary policy to curb the level of debt accumulation, household liabilities have reached new heights. According to the most recent quarterly report on household debt and credit from the Federal Reserve Bank of New York, consumer debt has surged to reach a 20-year high. This suggests that borrowers are relying on costlier forms of debt to cover their everyday expenses.

An abundance of job openings could possibly be concealing the growing financial distress. In the aftermath of the pandemic, there was a sizable drop in the labor force as many older workers retired, which left a gap in the labor force. In May, there were nearly 4 million more job openings than there were workers available to fill them. However, this surplus of available job opportunities was not evenly distributed as many of the new openings have come from industries that offer below-average wages. According to the Bureau of Labor Statistics, sectors like leisure and hospitality and retail trade collectively accounted for a quarter of the job openings in May. So, just because jobs are being created does not mean financial conditions are improving.

Looking beyond job openings, it becomes evident that firms are actively seeking ways to reduce their overhead costs. Some firms have begun cutting work hours, while others are considering layoffs. A report released by Challenger, Gray & Christmas, a global outplacement and business and executive coaching firm, found that businesses issued 458,209 warning notices for job cuts in the first six months of 2023. This is a 244% increase from the 133,211 cuts reported during the same period in the previous year. These cuts have primarily targeted the technology and financial sectors, suggesting that the increase in part-time work may be related to workers facing challenges in their job searches and potentially settling for lower-level positions until they can secure more suitable employment.

While the sudden acceleration in the rate of workers taking on part-time work for economic reasons is indeed troubling, it is crucial not to draw too strong of conclusions. Examining other indicators of labor underutilization reveals that even when factoring in part-time workers, the job market remains resilient. Additionally, while debt-to-income and debt-service ratios have risen from their pandemic lows, they are still well below the levels seen prior to the Great Financial Crisis.

However, it is important to pay attention to deviations from historical norms, such as the unprecedented change in the rate of people taking on part-time work. These divergences can provide insights into future shifts within the business cycle. As the data continues to offer mixed signals about the health of the U.S. economy, we will continue to broaden our approach and remain attentive for possible signs of trouble or improvement.

History shows us that investors who become overly confident that a recession has been successfully avoided are often tempted to take unwarranted risks that can ultimately harm their portfolios. As John Kenneth Galbraith’s book, The Great Crash, 1929, reminds us, identifying an impending recession is not always straightforward even for experts. In the book, he describes how the Harvard Economic Society went from being mildly bearish in early 1929 to bullish by the summer:

“By wisdom or good luck, the Society in early 1929 was mildly bearish.

Its forecasters had happened to decide that a recession (though assuredly

not a depression) was overdue. Week by week they foretold a slight setback

in business. When, by the summer of 1929, the setback had not appeared, at

least in any very visible form, the Society gave up and confessed error.

Business, it decided, might be good after all.”

The events leading up to Black Thursday on October 24, 1929, demonstrated how even an apparently strong economy, characterized by low unemployment and a thriving stock market, can still be susceptible to an unforeseen downturn.

While we are not currently predicting a major recession, we are cautious about ruling out the possibility of an economic downturn altogether. The significant increase in part-time workers due to economic reasons is one example of potential vulnerabilities within the labor market. Additionally, the mounting debt burden of households and rising borrowing costs could foreshadow challenges ahead. In light of these uncertainties, we advise investors to approach recent strong and positive economic data with cautious optimism. While the current indicators may appear promising, it is essential to remain vigilant and recognize that the future remains uncertain.

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Business Cycle Report (July 27, 2023)

Posted on July 27, 2023July 27, 2023 by Amanda Ahne

by Thomas Wash | PDF

The business cycle has a major impact on financial markets; recessions usually accompany bear markets in equities. The intention of this report is to keep our readers apprised of the potential for recession, updated on a monthly basis. Although it isn’t the final word on our views about recession, it is part of our process in signaling the potential for a downturn.

The Confluence Diffusion Index continues to improve but is still signaling a possible recession. The June report showed that six out of 11 benchmarks are in contraction territory. Last month, the diffusion index rose from -0.2121 to -0.1515, slightly below the recovery signal of -0.1000.

Tech stocks, particularly those associated with artificial intelligence, provided a boost to equities.
Construction activity waned; however, other measures of the real economy remained mixed.
Employment indicators suggest that the labor market is tight.

The chart above shows the Confluence Diffusion Index. It uses a three-month moving average of 11 leading indicators to track the state of the business cycle. The red line signals when the business cycle is headed toward a contraction, while the blue line signals when the business cycle is in recovery. The diffusion index currently provides about six months of lead time for a contraction and five months of lead time for recovery. Continue reading for an in-depth understanding of how the indicators are performing. At the end of the report, the Glossary of Charts describes each chart and its measures. In addition, a chart title listed in red indicates that the index is signaling recession.

Read the full report