Commodity Watch: Fragility behind the pump

<div class="grid grid--33-66-col"><div class="col"><img loading="lazy" src="/getContentAsset/061c994a-a452-418f-bfa0-f2cf3cf5c577/cb87803a-320c-480f-ab75-7b9029eaaf79/Ahmad-Al-Sati-new.png?language=en" alt="Ahmad Al Sati - insights" title="Ahmad Al Sati - insights" style="width: 180px" class="fr-fic fr-dii"></div><span style="font-size: 12px"><div class="col"><strong>AHMAD AL-SATI<br></strong>PORTFOLIO MANAGER<br><br><p>Ahmad is the President and Portfolio Manager for Gemcorp Capital Advisors LLC, based in New York.&nbsp;<br><br>Ahmad has spent most of his career in the global credit markets. Prior to Gemcorp, Ahmad was President of Pandion Mine Finance and RiverMet Resource Capital, LP - a fund focused on investing in precious metals, where he was responsible for managing the investments and the day-to-day operations of the registered investment adviser.&nbsp;</p></div></span></div><hr><p>A “hellish cloud” descended on Los Angeles in 1943. The city smelled like bleach, causing breathing problems and stinging eyes. Eventually, scientists realized that the exhaust from cars was trapped in the Los Angeles bowl, cooked by sunlight, creating smog. Since then, regulations successfully reduced smog by 99%. Yet the benefits to the state from an increasingly strict regulatory regime may now be plateauing, or worse. Clean air is good, but the pendulum may have swung too far.&nbsp;</p><p>A case in point is gasoline. Gas prices in California rose by approximately ~10% last month (75% more than the national average) driven by lower refining capacity and higher transport costs. Stricter CA rules are causing refiners to leave. One refinery shut down in October, and another will in April. By then, CA will have only seven operational refineries (down from 40 in 1991). The shutdowns may cause CA’s refining to decline by 35% with a commensurate price spike. Total gas consumption has not changed since 2001 and the state has 31 million cars. In addition, state oil production has declined by 75% in the last 40 years (even though CA still ranks 5th in US crude reserves).</p><p>Importantly, the world’s 4th largest economy is isolated from the increasing oil production in North America. Despite CA having a significant in-state pipe network, there is no major interstate pipeline connecting CA to other states (even as Texas, for example, ships 4 million barrels/day). Thus, 95% of CA’s inbound hydrocarbons is delivered by sea (56% imported from non-US sources). This maritime trade places pressure on CA’s fuel supply chain, increasing costs, lowering reliability and imperilling security (the US military is a large consumer of CA’s fuel). Bloomberg reported that CA imported 12% from Bahamas last year. But that fuel was Texas refined product, routed through Freeport to circumvent the Jones Act (for another post). The circuitous routes increase the costs and fragility to the detriment of consumers.</p><p>The dynamics described are not limited to gasoline or California. Rather they illustrate two increasingly important themes. First, mid-stream matters more. Across commodities, there is a focus on upstream (mining cobalt) and downstream (batteries), but less focus on midstream (refining cobalt). That part of the chain is becoming more important as economies move into resource intensive activities (electricity) to meet their essential needs. Second, trade matters. No country can simply lift the draw bridge. There is a slew of products that are essential for everyday and which must be moved from point to point. That cannot be changed without upending the laws of nature.</p><p>The lifeblood of both themes is capital. A resilient supply of commodities requires investment in the entire supply chain through working capital and project finance which in turn facilitate the production, refining, transport and storage of these products.</p>