WILL U.S. OIL OFFSET LOSS OF U.S. NATURAL GAS PRODUCTION, REDUX

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QUARTER OVER QUARTER, OIL DEMAND STILL EXCEEDS NATURAL GAS, CALLING FOR CHANGE IN U.S. ENERGY POLICY (Previously posted April 24, 2012)

Serious Transition In U.S. Gas, Oil Production

For the last couple of quarters, concerns have mounted on natural gas pricing and surpluses. Back in February I wrote on this space “How Do We Burn U.S. Natural Gas Surplus” wherein I describe substantial opportunity for the U.S. in the global LNG export market.

Last couple of days have seen Halliburton and Schlumberger announce results for Q1, which revealed a current state of affairs in North America and future expectations. Halliburton's CEO, David Lesar, described circumstances in the company's April 18 earnings conference call. The CEO pointed out that since the first of the year, gas rigs have declined by 151, or -19%. Contrasting declines in gas rigs, said Lesar, is the rise in oil rigs of 125, or 10%. A net decline in U.S. rig count comes to only -1%.

Lesar describes the different trends between gas and oil as “a significant rig shift that is taking place in the U.S. between natural gas and oil.” He also explained that “the shift from natural gas to oil was dramatic and disruptive to operations.” Disruptive to the extent that company margins were just short of expectations because the drop in gas rigs was more than anticipated.

Paal Kibsgaard, CEO of Schlumberger, in their earnings call on April 20 noticed similar issues. He however took circumstances a step further. Kibsgaard said “we have over the past two quarters, signaled that hydraulic fracturing pricing is starting to come under pressure.”

Between the two company heads, we see that reduction in natural gas production is now greater than expected and faster than anticipated. To the point it is disrupting operations and even effecting overall hydraulic fracturing prices.....indicating dynamics are reaching into creating a surplus of fracturing capacity.

Transition Tells Of Pressure On Oil Production

One would have anticipated such a dynamic on dry gas plays versus rich gas liquids plays (dry gas being simple methane gas versus gas with butane, propane, etc.). Dry gas has been the cheapest, while common expectation is that fields rich in gas liquids would command production given sustained pricing. But....

Under-utilization of capacity on gas in general seems occurring and certainly supported by evidence.

Schlumberger CEO said “during the first quarter, the downward pricing trend seen in the gas basins also reached the liquids-rich basins.” Telling of the natural gas industry, be it dry or liquid gas, is Kibsgaard's remark that “the pricing impact varies by basin as excess capacity is moved around, but we expect to see lower pricing reaching all basins in the coming quarters.”

Halliburton's CEO sees the same dynamic, but to an apparently reduced extent. Lesar said that “the dry natural gas basins will be the most challenged, followed by those more easily accessible oily basins that are located next to natural gas basins...”

Given market dynamics of unexpected and deeper declines in natural gas production, it does appear that vast capacity will have to be moved to North American oil production. Goals are for reductions in natural gas capacity to be offset by increases in demand for North American oil capacity.

Should such a goal not be realized, in North America, people will have to be laid off and production capacity left idle. Attending the proposition are losses on capital expenditures and production income.

I would appreciably enjoy goals of oil production offsetting natural gas production to manifest. We would then see sustained employment, capacity utilization, returns on investment and so forth.

Problems With Oil Production Increases Offsetting Declines In Gas Production

Troubling is the perpetual glut of the Cushing Hub. This glut is now notorious, constitutes no news and in fact a reason for obvious pipeline reversals and additions.

Only in February 2012, the U.S. Energy Information Administration produced a report regarding refinery activities in Northeast markets. Looks as if refineries are struggling in that location and infrastructure requires congruent transition to fix the struggle. Another potential solution is pricing optimization with U.S. production, but this also requires infrastructure changes. In the last year, an unknown quantity of resource has been realized in the U.S. How do we move with this knowledge? It is ultimately knowledge that begs the addressing of transition.

This country has huge potential for growth and a lead on comparative advantage, especially with clean fuels. Clean fuels are advanced products of the basic fuel products this world knows, needs, and currently uses. In this country, our ability is to help emerging economies clean the use of basic fuels.

Retail Gasoline Is Too High Against Crude, Despite Secular Changes In Market Dynamics

Changes in Secular gasoline and crude still has room for price corrections

Last article “Gasoline Price To Stay Firm Against Crude, Based On Foundational Gasoline Market Dynamic” discussed what appears to be a secular change in petroleum markets. Changes support gasoline pricing, particularly where U.S. became a net exporter of refined products in 2011, first time since 1949. However petroleum remains procyclical in correlating with economic conditions, now global conditions in particular.

U.S. presents an interesting situation in that gasoline futures on NYMEX are showing very high demand, resulting in backwardation. Confusingly, existing backwardation in gasoline is confounded by Energy Information Administration (EIA) data. EIA information reveals a counter to backwardation of low demand for gasoline products supplied by refineries, down -6.1% Y/Y on April 6, 2012 and -5.1% as of latest June 15 data. Coincidentally, April happened to see a peak in gasoline pricing of $3.94.

Gasoline and Brent have been in backwardation, but are convincingly looking to flip into contango. Gasoline found backwardation in May and Brent crude since February.

Gasoline and Brent have been in Backwardation, but are tipping into Contango

Backwardation is a commodity market condition opposite of contango. With backwardation, the futures curve goes from high prices today into lower pricing tomorrow. Revealing a market situation where participants are willing to pay more today than wait for a cheaper price later. Shortages and increasing demand are associated with backwardation.

U.S. economic slowing combines with global slowing to ask why gasoline and Brent have been in backwardation for a few months. Backwardation suggests conditions of high demand and low supplies in the two commodities. Data, however, reveals low demand in the world’s largest gasoline consumer, the U.S.  Likewise, world demand for Brent also is in decline told especially in Asian markets with Singapore naphtha pricing at 21 month lows against rising crude stocks according to a June 21 Reuters report entitled “Asia Naphtha/Gasoline –Naphtha price near 21 month low.”

Where gasoline and Brent are in false backwardation amid slowing global demand, a tipping point reaches into contango, and price reversals. Contango is a condition where the futures curve goes from lower prices today into higher price tomorrow. Market suppliers are less willing to accept today’s price and will hold onto their product for higher prices later.

Backwardation is a seller’s market where sellers get more today than expected tomorrow. Contango is a buyer’s market where buyers pay cheap today versus tomorrow.

Central bank influence on refineries and supporting gasoline

Economies of countries drive petroleum prices, and where Q4, 2011 saw gains in U.S. GDP, refineries experienced declines in sales and income. Accounting for divergence appears to be a freezing of bank liquidity and consequent insecurity in European Union countries in Q4. In fact, through Q4 WTI based crack spreads went from a high of $35/bbl in October down to $12.99 in December.

European Central Bank (ECB) responded with a second form of quantitative easing, termed Long Term Refinancing Operations (LTRO). Such ECB second round of cash infusion brought total amounts to nearly 1T euro.

Specifically in Q4, U.S. refineries like Marathon Petroleum Corp. saw sales decline by -6.10%, where net income was a loss of -$80M. Likewise, Western Refining Inc. saw Q4 sales down -5.06% and net income down by some -$62M. Overall, similar circumstances were common among refineries in Q4. But after ECB’s Q1 infusion of cash, refinery results improved.

Q1, 2012 refinery results correspond closely with ECB’s LTRO and witnessed Marathon finding Q1 sales increasing by 4.3% and net income to a positive gain of $595M. Western Refining, as with others, enjoyed similar advances.

Trouble with today, no central bank is committing itself to major cash infusions. Now it looks like central bank ammunition is being saved for hard case scenarios of European banking. So, refineries do what they must to protect themselves.

U.S. inventory declines, increasing refinery production and declining emerging market demand can tip gasoline into heavy Contango

Where gasoline demand declined between 5 to 6% year over year, supplies of gasoline are also in major decline. Crude however has been increasing in surplus inventories.

Starting in March, even prior to retail gasoline’s price spike, gas went into inventory decline. Surprising was gasoline inventory declines with coincident completion of ECB’s LTRO. EIA data tells gasoline inventories went into decline for 15 weeks ending May 31. Retail gasoline prices held substantially firm.

Crude prices meanwhile fell, down some 20% over the period. Refinery capacity utilization ranged in mid to upper 80% while gasoline stocks declined. Gasoline's 15 week inventory decline showed inventories up on June 1 by 3.3M barrels but only at 203M. June 1 results contrast with same period of 2011 which had stocks at 215M barrels. With reduced demand gas retail prices declined but not by much, perhaps recieving support from tight supplies. According to EIA data, gas stood at $3.61 on June 4 and declined to $3.57 by June 11.

Most recent data from EIA as of June 15 tells of gas inventories approaching historically low levels while crude (WTI) goes above 5 year average surplus. Gasoline stands at 202M barrels versus 2011 at 214M. Crude supplies are at 387M barrels versus 2011 at 363M. To burn off some crude and meet peak driving season demand, refineries are currently running above 90% utilization, even though gasoline production is in deep year over year decline.

U.S. gasoline production is down significantly year over year at a time when inventories are short, prices firm and refinery utilization is increasing. EIA data says gasoline production is down -626M barrels against same period 2011. Total refinery production is down -3.3% overall, or- 438M barrels. Retail gas pricing remains resilient at $3.53 versus 2011 at $3.65. At refinery utilization running above 90%, supply can over shoot demand considerably producing significant price declines.

Appears that where crude’s balloon deflated fast, U.S. gasoline pricing remains inflated in comparative terms. Most telling of coming contango are Singapore refinery production, pricing and inventory. It shows surplus in both gasoline and crude, with declining prices at 21 month lows.

Backwardation in U.S. markets, under these circumstances, appears unsustainable and should revert into contango. Risk of markets not going into contango comes from maintaining depressed gasoline supplies against demand.    

Gasoline Price To Stay Firm Against Crude, Based On Foundational Gasoline Market Dynamics

Gasoline price under pressure to decline, but looks foundations of gasoline market sepearate from crude 

Gasoline prices, while having declined, have not experienced the same degree of decline witnessed by crude oil. According to the U.S. Energy Information Administration, West Texas Intermediate (WTI) averaged more than $100/bbl over the first four months of 2012. WTI then went from $106/bbl first of May to $83/bbl in June. Where oil fell some $23, retail gasoline prices have held comparatively firm.

April saw a peak in retail gas at $3.90/gal declining to $3.57/gal by June. This 8% fall in gas price contrasts with crude's 22% fall. Oil falling substantially, but not translating into proportionate if not congruent declines in gasoline seems counterintuitive. Some blame the spread of Brent crude over WTI and its strains on refinery margins. According to this explanation, gasoline tends to price based upon higher costing Brent crude, instead of cheaper WTI. However, Brent has recently declined in similar fashion as WTI, due to concerns of declining global demand.

Brent and WTI price relationships are certainly a part of the puzzle, but puzzle pieces also include declining gasoline supplies despite declining demand. Add to this margin challenges among East Coast refineries, and gas prices look to stay firm against crude decline. What’s more, gas prices appear resistant to correlation with crude pricing, such that declines in crude aren’t flowing into retail gas.

Background on crack spreads, their fall against emerging markets and end of QE1

Decoupling gas prices from crude pricing seems to be a refiner's goal, especially where gas prices can sustain levels even when crude declines. Crack spread is the price difference between a barrel of refined product and a barrel of crude. Resulting difference is the money a refinery is left with to cover production costs and generate profit. For example, with RBOB gasoline trading $2.66 and crude at $83, the crack spread is $28.72 (convert $2.66 into barrel value by multiplying it by 42 gallons in a barrel and subtracting the product from crude barrel price). 

Putting crack spreads into perspective, refineries found themselves taking losses through 2009 and into 2010. Entities were projecting extended losses for American refineries, with refinery closures. Example can be found in 2010, which was easier for refineries than 2009.

July of 2010, crack spread was at $10.41, down 45% from a 15 month high of $18.77. This 15 month high occurred only two months prior in May, indicating a truly volatile market. By August, crack spreads were in serious decline reaching a nine month low of $4.00. These low spreads reached into early 2011. Accounting for decline was weak U.S. refined products demand, perhaps associated with an end to QE1 in March.

Divergence of WTI from Brent oil supporting U.S. gasoline price 

A curious price divergence started between WTI and Brent in late summer of 2010 and became convincing by December. WTI became comparatively cheap against more world oriented prices of Brent. Causation is a wealth of oil plays coming on line in the U.S., generating major gluts at U.S. crude hub in Cushing, Oklahoma.

Where WTI traded equal to or higher than Brent, this convention reversed. Overtime, and with continuing Cushing WTI gluts, Brent pricing exceeded WTI by up to $30 witnessed in 2011, to averaging just under $20 typically, and currently more in the $12 area.

Complicating matters were refineries reliant on Brent priced crude. East Coast refineries were essentially dependent on oil supplied from overseas, which translated into Brent prices, not WTI prices. This was due to no real infrastructure to take American oil (WTI) to East Coast refineries. Given that the U.S. is a heavy net importer of crude, it’s no surprise that U.S. infrastructure is designed for inflow, as opposed to outflow...even with domestic crude flowing from interior locations outward.

When U.S. crack spreads based on WTI were weakening late in 2010 due to declining demand, U.S. Brent based spreads moved negative. All due to pronounced declines in U.S. demand for refined products while both WTI and Brent did not decline in similar fashion.

Emerging markets, however, experienced rocketing demand for both crude and refined products. China experienced a severe diesel shortage. These economies bought crude based on Brent prices, not landlocked WTI.

Emerging market demand for petroleum created disparity with developed country surplus

November, 2010 U.S. crack spreads bottom feed, hurting U.S. refinery margins, while Asian spreads sought nine month highs. Asia hit a spread of $163/metric ton, translating into $23.34/bbl (roughly 7 bbl to 1 MT). Asian high demand compares with U.S. $4.00 spreads. U.S. also had a net petroleum surplus at the time while overheating emerging markets addressed shortages. Brent was setting itself for a serious premium over WTI prices.

Where U.S. demand for crude and refined products waned stateside, WTI albeit landlocked priced higher than U.S. market dynamics, together with gas. Where emerging market demand rocketed, it set Brent prices likewise parabolic versus WTI and U.S. Brent based gasoline pricing.   

U.S. midcontinent refineries closer to Cushing found themselves at a considerable profit advantage over coastal refiners. Not only did a WTI glut disturb market balance, but emerging market petroleum demand lifted Brent prices against WTI, which ultimately lifted all petroleum. For developed countries, lifts in all petroleum weren’t necessarily correlated with real economic demand or supply. Very divergent crack spreads between U.S. and emerging countries evidence deeper fundamental divergence.

Consequences of reversing traditional petroleum pricing

Incongruence between emerging and developed economies and resulting price differentials between WTI and Brent pressured U.S. refineries based on geography. Most stressed are East Coast refiners. Such stress is noticed in refinery closures, idling and hoped for sale.

 According to EIA, Sunoco closed its Eagle Point New Jersey plant on February, 2010, losing 145,000/bpd. September, 2010 Western Refining closed its Yorktown, Virginia 66,300/bpd operation. Idled are Sunoco’s Marcus Hook Pennsylvania 178,000/bpd plant and ConocoPhillips Trainer, Penn 185,000/bpd plant. Looking to sell is Sunoco’s Philly 335,000/bpd facility. All leading to current major concerns of sustained East Coast refinery supply capability.

Recent developments show that Delta Airlines bought the ConocoPhillips Trainer plant….Airline operating a 185,000/bpd facility, story all by itself. Every day now Sunoco gets closer to a deal with Carlyle Group on their 335,000/bpd operation. Earlier this month (June 7), Enbridge opened its reversed Seaway Pipeline. Now it flows crude out of Cushing and into Gulf refineries and export terminals.

Overall, 2011 saw interesting dynamics maturing from 2010, especially with QE2 influences. 2010 events set today’s foundational proposition. Currently, the balance might be turning with declining emerging market demand.

Greek Elections Tell More of Euro Country Bankruptcy Than European Instability

World participants await Greek election results, all with a view to either economic insight or political revelation. Frankly, most economic participants have, or should have, guarded against Greek withdrawal from the euro. Most interesting is the juncture of political policy and asset values coming out of the election.

Should Greece recede from the euro, how much more could asset values really decline. One might be justified in expecting market participants pricing such a result into the current market. Perhaps what is also accounted into the market is the European Financial Stability Facility (or EFM) and IMF will cut unspent capital to Greece, creating cash for others. Or, at least a reduction in bailout money to Greece.

From a realistic perspective, Greek withdrawal could indicate a full default on their bonds. Which brings an ultimate escalation of previous principle reductions on Greek bonds created by the notorious Collective Action Clause. Full default means no more payment. Implicating losses for deeply invested sovereign entities such as ECB, EFSF and the EU.

Greek withdrawal from the euro tells of a sovereign country controlling its own currency. Meaning a sovereign does with its own currency what it wants. Greek bonds issued as a euro country will have no more value than what a new Greek country, under its sovereign currency, will give them.

Such a course will grant Greece its own bankruptcy. Reality is absorbed by knowing that in the EU, no structure exists for a country declaring bankruptcy. Rather, the country reverts to its own sovereign currency status, despite previous euro leverage, and will accept or decline what debts and accounts the sovereign sees fit.

Therein resides the current economic isolation of Greece. No entity wants to counter-party on those terms, save for the existing and dedicated support structures of the EFSF, EU, ECB and IMF.

Some of the supporting funds named above were exempt from previous CAC cuts on Greek bonds.....Should Greece chose to decline further euro currency participation and monetize their debt, even the protected funds could experience total loss associated with a full Greek default.

Unlikely is such a proposition in that Greece, even if on their own currency, will want to maintain EU membership. Sustained EU membership carries considerable value, especially when not a euro currency participant, simply look at Hungarian issues.

Withdrawal from euro currency participation, while maintaining a friendship with EU resources, seems more likely than Greece going it alone. Median propositions are more probable than extremes. Still median propositions require negotiations between Greece and EU on how a new drachma translates into pre-existing euro debts, and new euro versus drachma payments.

Also potentially extreme is the concept of Greece ultimately staying in the euro....Where Greece might consider such an approach, EU is unlikely to see this as realistic. Too much of a chasm exists between Greece's economic declines versus economic stability among leading euro zone countries.

Clashing with economic reality is Greece’s desire to assert itself as a nation, a country with an originating place in Western Civilization. Socially and politically, Greece's decision should be based upon the reason and logic still known as a foundation to civilization.

Overall, election results will not necessarily portend of a Greek exit. Rather time will tell. When time knocks on the door, it makes good reason and logic that Greece will decline further euro participation but will sustain EU membership, with all  implications and sustained benefits.

Austrian Bank Carry Trade Mortgages, What A Way To Leverage Real Estate

Austrian bank downgrades show a unique real estate funding bubble

Last week Moody's downgraded Austrian banks' Erste Group Bank AG, Raiffeisen Bank International AG and Italian bank UniCredit's Bank Austria, while also cutting several German banks.  Overall causes of downgrades were attributed to exposure to Central and Easter Europe (CEE).

A peculiar lending activity occurred among the named banks and the CEE countries. This lending amounted to Austrian banks transforming mortgages into a carry trade proposition funded with Swiss francs. In fact, Hungary’s former central bank governor, Peter Akos Bod, obtained such a mortgage prior to the Lehman collapse in 2008. In a Bloomberg report dated December 14, 2011, reporters Boris Groendal and Edith Balazs explained that the former Hungarian central banker called the loan rational at the time.

Currently, however, with the course of Swiss franc appreciation over years, and depreciation of some CEE currencies, CEE residents have been strained to make their mortgage payments. Hungarian leaders have revolted against Austrian banks and Polish borrowers struggle while underwater on their loans.

To explain unique dynamics between Austrian banks and CEE countries which spawned the carry trade mortgage, history provides a foundation.

Austria’s present relationship with CEE countries emerged naturally from history

Historical background, briefly stated, provides perspective. Austria when an empire was once joined in a duel monarchy with the Hungarian empire starting in 1867. This combination included the Czech Republic, Slovakia, Slovenia, Bosnia and parts of Serbia and Romania. When “balance of power” politics developed in the “Age of Metternich” countries sought territory.

The world aside from an isolationist U.S. was divided between the Triple Alliance powers of Austria-Hungary, Germany and Italy versus the Triple Entente of Britain, France and Russia. WWI eventually started out of the global dynamics experienced by global divisions. Henry Kissinger's book “Diplomacy” (1994) provides an outstanding analysis of this period.

From Austria's historical connection with CEE countries, imaginable was shock in seeing the U.S.S.R.’s descent of its Iron Curtain shutting off Austria from Eastern Europe. But Perestroika and Glasnost brought a new openness which allowed Western European and especially Austrian banks to renew relations. Seeing historical interaction and economic opportunity, Austrian banks started to merge with CEE banks.

Once the Soviet demise occurred, developing nations of the CEE offered existing infrastructure and wider demand relationships among former Soviet nations. What also existed for these unique countries was unstable currency rates and typically high interest, combined with a want of home ownership.

When the global housing boom started last decade, Austrian banks were in a position to put more CEE residents into private home ownership, despite high interest rates of CEE countries. Austrian banks found the carry trade.....only for mortgages this time.

Essence of the carry trade

Carry trades are a good and standard operating procedure, when used right. Essentially, a carry trade occurs anytime an entity sells a cheaper interest bearing instrument to buy returns on a higher interest bearing instrument; or, sells a depreciating instrument to finance an appreciating instrument's purchase. What is difficult with a carry trade is that an entity will have to buy back the sold instrument one day.

Borrowing cheap to loan high is the fundamental concept of the carry trade. Banks function off of borrowing at cheaper rates, which are for the most part short term, and lending at higher rates longer term. They then collect the spread in interest rates as profit.

Currency trading is the same thing. Ultimate goal in currency trading is to find a currency that is cheap, and has a low interest rate, to then take the funds and lend to or buy a currency that is appreciating in value with a high interest rate. An example of such a trade has been the AUD/USD (not so much currently).

Because currencies can dramatically fluctuate given a variety of variables, any carry trade position must have the flexibility of rapid liquidation should the cheap become expensive, or the paradigm of the position reverse. So why not give this a try with 15 to 30 year mortgages?

Where carry trades are subject to potential reversal in their expected patterns at any time, mortgages are long term contracts. If fundamental propositions of the mortgage fail to manifest, obvious default can be a consequence.

Austrian carry trade mortgages to CEE countries

Austrian banks sought to make real estate mortgages cheaper given high interest rates in CEE countries, but with such countries also experiencing appreciating real estate values. To do this, Austrian banks used the euro currency against the franc to make interest rates cheaper. Austrian banks would use their euros to buy francs, or otherwise loan euros in exchange for francs. When it was time for Austrian banks to close out the loan of euros for franks, they needed the exchange rate to be the same, or optimally show franc depreciation. In this way, Austrian banks would either not lose money on the currency swap, or would make money by having to use fewer euros to close the swap.

Once having obtained francs, Austrian banks issued franc denominated mortgages to CEE residents at franc based interest rates, which were much lower than alternatives. To repay the loans, CEE residents must convert their local currency into francs.

Such propositions could have worked well, and did finance housing where otherwise housing might have been unattainable. However, the Swiss franc appreciated substantially following the Lehman collapse of 2008. Carry trade mortgages, and their foundational propositions reversed.

Austrian banks had to use ever increasing amounts of euros to close their franc swaps, leading to losses. CEE residents are paying more than ever to convert their local depreciating currency into highly appreciated francs. Homes are now underwater given currency reversals, compounded by economic circumstances.

A real estate market was created out of alternative and unorthodox funding mechanisms, in so doing long term contracts were put to the volatility of FX exchange rates. Swiss franc is now pegged at 1.20 euro. Still highly appreciated compared with when the mortgages were created.

Spain Requested EFSF/IMF Help, And Hedged Their Sovereign Authority in a Spanish Bailout

Spain finally made the painful but inevitable request for financial assistance. Out of essential need, Spain could no longer afford yields commanded through their sovereign bond auctions. Such yields look to be more a product of systemic issues, as opposed to simply a banking matter. But then, what banking matters aren't systemic.

Spain's Finance Minister Luis de Guindos told reporters that Spain negotiated an assistance package of some 100B euros, directed only to capitalizing banks through Spain's new Fund for Orderly Bank Restructuring. Previously, Spain lobbied for funds to be diverted directly to their banks. Now, Spain has its conduit of European money to its banks for a purpose.

Witnessing the harsh demands placed upon other bailout countries in terms of sovereign budgets banished into austerity and resulting political consequences, Spain wants some sovereign space. They don't want to be told how to operate Spanish sovereign fiscal policy and see potential political disruption.

Consequences of negotiations look very different from previous aid packages to other countries. That is, money is going to Spanish banks through a sovereign conduit. Currently, one can be certain that European and IMF lenders will want to see broad economic benefits from such bank recapitalization. To such an extent that tax revenue will have to be dramatically increased to offset budget deficits.

In other words, it appears Spain has hedged its sovereignty as much as possible, obtained a loan as small as possible, and put the money were they retain control as much as possible.

Spain’s EFSF/IMF loan will alleviate sovereign funds having to be allocated to a recent bank nationalization, being Bania SA. Stress tests show other banks don’t need 100B euro. What does show are Spanish debt yields and high unemployment, together with high budget deficits. Should Latin America decline further, more money could be needed simply to cover Spanish bank losses in that region.

Evidence of Further Economic Q2 Weakness Might Highlight Latitude Offered by Operation Twist

Empire State Index rises but has weakness, Kansas City Fed Index looks good among few

Fed regional indicators are again pointing to softness in Q2. Empire State Manufacturing Index reported May 15 and is showing considerable volatility. February's Empire result was at 19.5, March at 20.1 and in April dove to 6.56. Such a deep dive contrasts with May's steep increase to 17.1

Overall, Empire showed substantial declines in all areas in April. May showed overall business conditions improving, but new orders, unfilled orders and delivery times remained flat, as they have for a year. Driving the Index is a steep increase in shipments, growing trends in inventories and employment. Empire region appears to have a tight supply structure with short lead times. Such a dynamic can perhaps discount delivery times and unfilled orders.

Not good with the Empire Index are forward indicators reflecting expectations six months in advance. All such indicators are down for May versus April, except prices paid being up. Prices received are flat and capital expenditures fell from 31.33 in April to 19.28 for May.

Gains in the Empire Index are betrayed by noted declines in longer term expectations. Technology spending on Empire's forward index, for example, has been in decline since the March to April period. Compare these results with April's Durable Good's report that showed nondefense capital goods, excluding aircraft falling by -1.9%, despite an overall gain.

Kansas City Fed Manufacturing Index is like Empire, but shows more sustainability and greater optimism in the future. Previous Kansas City Index numbers showed an overall result for February of 13, March 9 and April of 3—a progressing decline. May results moderately reversed with an increase to 9, like last March.

Elements in the index revealed very strong increases in production, shipments and new orders increasing from -8 in April to 10 in May. Only elements that still showed decline, but improvement are backlog of orders going from -5 for April to -3 in May and employee work week seeing April at -10 and May at -2. Even forward looking indicators, revealing six month future expectations, picked up considerable strength.

Other regional Fed Indexes remain in decline, if not contraction

Remaining Fed regional indexes continued their downward path of slowing activity. Philadelphia Fed Survey went from decline into outright contraction. March saw the survey at 12.5, April at 8.5 and May showed -5.8. Dallas Fed Manufacturing Survey showed further contraction in its business activity component with it going from -3.4 in April to -5.1 in May. The Dallas Survey’s production component, however, held fairly steady moving from 5.6 in April to 5.5 in May. Previously, the production component declined from 17.8 in February to 10.8 in March. Richmond Fed Manufacturing Index fell in May after exhibiting volatility. Index results for March were 7, April 14 and May revealed a fall to 4.

Economic volatility is demonstrated by these indexes falling substantially followed by a gain, or gaining followed by a marked fall. Philadelphia and Dallas have been in persisting decline, entering contraction. Most concerning is that GDP for Q1 has been revised down to 1.9% from 2.2%. Suggesting current indicators are leads on a disturbing down trend.

Reasons for GDP’s Down Revision, and a Switch in Demand for Cars to Increased Caution

According to the Bureau of Economic Analysis (BEA) declines in Q1 GDP are attributed to “deceleration in private inventory investment, an acceleration in imports, and a deceleration in nonresidential fixed investment that were partly offset by accelerations in exports and in PCE [personal consumption expenditures].”

Also noted by the BEA is motor vehicle output added1.12% to Q1 results while only adding .47% in Q4. Still PCE drove away from consuming autos into a slight rate of increasing nondurable items. Overall, Q1 showed less cash flowing and a decline in growth rates.

BEA said PCE “increased 2.7 percent in the first quarter, compared with an increase of 2.1 percent in the fourth. Durable goods increased 14.3 percent, compared with an increase of 16.1 [in Q4]. Nondurable goods increased 2.3 percent, compared with an increase of 0.8 percent [in Q4].”

Cars have carried the economy but are perhaps experiencing declining demand, what will compensate: QE3 or energy exports with the effects of Operation Twist

While vehicles have lead economic growth in the U.S., it now looks like production of cars have outpaced demand reflected in the 1.8% decrease in rate of durable goods Personal Consumption Expenditure (PCE).

Essentially durable goods consumption by American consumers is declining from their focus on cars to nondurable goods, but not at an offsetting rate of consumption.

Add to this the Durable Goods report showing a decline of -1.9% in its non-defense, non-aircraft capital goods component.

Car production offers upstream and downstream job creation, production and other demand in production. Real estate is very similar with its upstream and downstream ramifications. Real estate, through the country, has remained less than influential.

Natural resource production also offers very broad economic benefit….but it does appear foreign countries are also slowing. Could the U.S. relieve pressure on energy costs and inflation experienced by developing countries by exporting more energy. Such a step would create considerable jobs in the U.S., spur U.S. domestic demand and also foreign exports. American capital and current account balances appear to have the dynamics to absorb increased exports.

Aside from energy, it’s hard to see catalysts for renewed U.S. growth, apart for QE3. In an environment that could teeter on deflation and progressively slowing growth, QE3 seems more and more likely. But with Operation Twist dulling the yield curve, bond purchases could drive down yields. This could tell of what bonds the Fed might have the latitude to purchase, if any.