Asian Refining Margins to Remain Healthy as Product Balances Look Constructive into 2018
Global oil surplus declined sharply in the first three quarters of 2017 and will be completely eliminated by the end of the year. India’s oil demand is expected to grow by ~300 MB/D next year on a better GDP outlook with the government stepping up its efforts to boost economic activity. China’s net crude imports are expected to increase by ~400 MB/D next year due to higher refinery runs and lower domestic crude output. Asian refining fundamentals should generally be constructive next year as demand growth is expected to outpace incremental refinery runs. Furthermore, key Asian product balances, such as for gasoline and gasoil/diesel, are also constructive into 2018. Overall, Asia’s net exports for gasoline and gasoil (including blending components) are expected to be slightly lower next year.
November U.S. Gas Short-Term Forecast
S&P Global Platts’ outlook calls for higher prices through the winter, as well as next year relative to NYMEX Henry Hub futures. Upside price risks remain through 1Q 2018 in particular. The extent of tightness U.S. balances face this winter, though, will influence the magnitude of downside price risks that loom next year.
Elevated Exports and Producer Discipline Push Prices Up
U.S. coal exports that hit their highest levels since 1Q14 in September and falling 3Q17 Eastern coal production kept prices supported over the last month. With export margins positive through 1Q18 and price risks to the upside on the potential for continued elevated exports, PIRA is either in-line with or bullish to most forward U.S. coal prices. However, CAPP rail coal prices may need to pull back modestly to allow for continued exports to the Atlantic Basin, barring another leg up in CIF ARA prices.
Four Biggest Economies in the World Send Reassuring Messages
China, the U.S., Europe and Japan reported key data this week. The bottom line was that solid and synchronized global economic growth appears very likely to keep going. In China, there were signs of slowing in housing and investment, but other data pointed to resilience and strength. U.S. activity data for October showed solid gains. This partly reflected a rebound from Hurricanes Harvey and Irma in August and September, but the underlying pace of activity has also apparently strengthened. This was particularly the case in the industrial sector. European GDP data were healthy across the board. Japan is benefiting from the positive global wind, and its trade sector substantially boosted economic growth during the third quarter.
Propane Prices Run Counter to Crude Prices
All NGL purity product prices except for propane declined last week in line with weakening crude prices. In contrast, propane prices rose 3.5% and closed the week at 99.9 cents/gal. Average U.S. raw mix production pushed past its recent highs, increasing 15,000 b/d last week. PADD 3 production continues to increase and reaches 1.958 million b/d with average weekly production increasing by 3,000 b/d. Propane inventories fell 2.5 million barrels and settled at 74.5 million barrels. Stocks in PADD 3 fell by 1.8 million barrels to 38.6 million barrels, which is 20% below the five-year-average and 38% below levels at this time last year. Tightening inventories are responsible for the rise in propane prices when crude prices are falling. Three steam crackers planned for 2017 commissioning have been delayed until 2018, which reduces ethane demand by 195,000 b/d and places downward pressure on ethane prices. The three steam crackers are Indorama Ventures Lake Charles 370,000 mt/year cracker, ExxonMobil’s new Baytown 1,500,000 mt/year cracker and Chevron Phillips Chemicals’ new Cedar Bayou 1,500,000 mt/year cracker. All three steam cracker plants are expected to begin commissioning in the second quarter of 2018.
Latin American Gasoline & Diesel Imports to Stay Strong Thru Year End…And Beyond
Latin American refiners continue to struggle. Regional crude refinery runs are projected to stay subdued in 4Q17 at around 4715 MB/D, 175 MB/D lower year-on-year and be flat year-on-year in 1Q18. Mexican 4Q17 runs should see some support from the restart of Salina Cruz, but are projected to stay relatively low at 565 MB/D, 215 MB/D lower year-on-year. Brazilian crude throughput seems to be on the rise, 4Q17 runs are forecast at 1765, 80 MB/D higher year-on-year; 1Q18 runs also projected higher year-on-year. Refinery outages are keeping refined product import volumes high.
Ethanol Prices Mixed the week Ending November 10
U.S. Ethanol values steady but manufacturing margins climb due to lower corn cost. Ethanol production and sales in the South-Central region of Brazil jump during October. European ethanol prices reach one-month high. U.S. biodiesel prices rocket to a six-week high. Manufacturing margins more than double.
November U.S. Gas Regional Short-Term Forecast
Despite a massive surge in production and limited capacity additions heading into the month, prices at US Northeast supply hubs posted impressive gains in early November. This relative price strength should persist through the winter. A tight supply and demand balance in Southern California (SoCal) and ongoing restrictions at pipelines and storage facilities supplying the region favor significant volatility in SoCal pricing this winter, barring mild weather conditions in the West.
Korea High Retail Gas Prices Curb Consumption, Hampering 2018 Balancing Act
The relatively high retail gas prices that Korean power generator Kepco is currently estimated to be paying to secure LNG for EG, has totally dis-incentivized gas consumption in favor of coal this year. As Korea runs out of storage space in an effort to honor surging LNG contract obligations as well as of course prepare for winter, this backlog will hamper the need to maintain contracted levels of imports in 2018.
Higher Call on Hydro Reservoirs and Imports from UK So far Offsetting French Nuclear Shortfall
The average delay of the already cleared seven plants from their original restarting schedule is 17 days. The restarts of the other five still not cleared have been delayed by already 13 days on average, so they face potentially even lengthier delays. While the limited amount of restarts so far keeps the outlook extremely fluid, it’s interesting to note that, at the current levels of French demand, the interconnectors have been playing an increased bearish role to soften the nuclear shortfall, with the UK flows directed towards France more often than last year during on-peak hours. The improvement in the nuclear availability in the neighboring markets should allow France to import more power, but weather will remain the major price driver as we head toward the peak of the heating season.
VA Approves RGGI Proposal
Virginia released draft regulations for a power sector carbon cap and trade system with a proposed link to RGGI on Election Day, as Democratic Candidate Ralph Northam won the Governor’s race. The Virginia Air Pollution Control Board approved the proposal for public comment in a 7-0 vote. The program design includes plans to allocate allowances to covered entities and require consignment to auction. It is aligned with RGGI program design elements and calls for participation in the RGGI-wide “full” banking adjustment, effectively reducing the state caps/allowances available to allocate for 2021-2025. VA DEQ modeling shows a binding program, although adding VA to RGGI lowers allowance prices. However, PIRA’s Reference Case (which had assumed no carbon price for VA), sees emissions below the caps, at least through the first compliance period.
Pessimism on Chinese Coal Demand Drives Prices Sharply Lower
The coal market dropped sharply this week, on weaker oil/gas prices, and easing concerns regarding tightness heading into the winter. 1Q18 forward prices declined by ~$5.00/mt W/W, while Cal-20 prices shed at least $3.00/mt. For prompt pricing, FOB Newcastle prices declined by a slightly larger extent than CIF ARA and FOB Richards Bay, while the opposite was the case for more deferred prices. Much of the downward momentum was due to developments in China, following the release of weak thermal electricity generation statistics for October on top of growing concerns that coal quality and port quota restrictions will dampen import demand considerably. Additionally, power sector coal stockpiles in both China and India moved higher W/W, alleviating some of the shortage risks in the market. On the supply side, the South African labor union NUM deferred a labor strike that was set to begin on November 18. While seasonal risks still cannot be ignored at this time of year, the market is softening structurally ahead of previous expectations.
U.S. Shale Operators to Start Living within Cash Flows
The third quarter saw continued growth in U.S. shale crude and condensate production and a plan from most operators to start to live within operational cash flows.
Some Noted Cross Currents in Credit Conditions
A mixed week, with some “rotation into and out of” different asset classes being the overall theme. The S&P 500 was modestly lower, but showed a jump in volatility. Investment grade credit was modestly lower, while high yield and emerging market credit indicators were higher. Commodities were lower by -0.59%, and energy underperformed, but precious metals moved higher. The dollar was weaker by -0.78%. The St. Louis financial stress indicator moved to a new cyclical low.
U.S. Ethanol Output fell for the First Time in Five Weeks
U.S. ethanol output fell for the first time in five weeks, dropping by 3 MB/D to 1,054 MB/D. Total inventories built by 152 thousand barrels to 21.5 million barrels, despite large draws in the Midwest and the Gulf Coast. This was the first draw in the Midwest since early September. Ethanol-blended gasoline production declined 14 MB/D to a seven-week low 9,100 MB/D.
Given the fact that December corn had shown gains of 6.5 cents only twice in the past four months, Friday’s rally of that magnitude was a bit of a surprise with the absence of any new data. Not to be outdone, soybeans had their own “hold my beer” moment, posting the largest single day price gain since the October WASDE lowered yield to 49.5 bpa, a level still maintained today. Corn was the leader though as rumors of the Chinese sniffing around the corn export market permeated through trade desks as well as additional talk that the Chinese are interested in importing U.S. ethanol.
U.S. Gas Weekly Report
Over the past seven days, Henry Hub cash prices rallied to average ~$3.11/MMBtu —up 16 cents/MMBtu (6%) compared to prior the seven day average. Despite strengthening cash prices—prompt month December futures slumped. Uncertainty over the 6-10 and 11-14 day weather forecasts appear to be to blame.
Are Prices Firm From a Lack of Supply?
Spot prices across Europe have experienced a steep ascent over the last several months despite significant bouts of warmer than normal weather. One may come to the conclusion that perhaps Europe is starved of supply and that is what has been driving continued price ascent. After all, the news regularly reports about continued declines from Dutch Groningen, how low British supplies are compared to peak production levels, and how LNG continues to avoid Northwest Europe. In fact, there is plenty of supply. It turns out though that contract pricing has stepped up significantly – forcing the full gas curve to shift upwards with the assist of a thirstier Asian market for LNG and Brent pricing that has risen 44% off of June lows.
Inflation Data Release Sets 2018 CA Carbon Auction Floor
The CA carbon cap and trade program auction reserve price, by design, escalates each year by 5% plus the rate of inflation. The BLS 12-month Oct-Oct inflation release (the inflation indicator used for this calculation), came in at 2.04% - implying a 2018 reserve price of $14.52, though it could move up to $14.53, depending on rounding practice. The formal CARB announcement of the official price will come December 1st. This compares to an inflation rate of 1.64% that was used to set the 2017 auction reserve price of $13.57. Inflation indicators started 2017 well above 2%, but came down over the summer before increasing again last month (to 2.2%). Today’s 12-month inflation figure is lower than last month’s, but in line with expectations.
U.S. Inventory Declines Temporarily Interrupted
Softer product demand caused product stocks to build while a jump in crude imports led to an increase in crude inventories to take overall commercial inventories up 2.8 million barrels this past week. The year on year stock deficit, nevertheless, widened another 4.3 million barrels to 81.1 million barrels (6.0%) below the year earlier, while four week average adjusted demand is up 3.4% (670 MB/D) versus last year, a constructive combination illustrating global oil market rebalancing. Runs increase another 360 MB/D in next week’s EIA data to 17.0 MMB/D, up 1 MMB/D in three weeks. Higher runs cause gasoline stocks to build but distillate and jet inventories still manage to decline because of continued strong demand.
Global Equities Ease Modestly
Global equity markets eased on the week, having been unable to breach the 2,600 level. Retail (+3.8%), banking (+2.7%) and housing (+1.7%), posted solid gains and outperformed, while energy was one of the weakest performers (-3.2%). Internationally, Latin America, emerging markets and emerging Asia posted good gains on the week.
The Fund Game
In essence, the short Funds are playing alongside the farmers and not against them as is common belief. The December short that they’ve accumulated will soon be rolled to March (3 months) at a 3.3% “profit” given market structure. A 5 month roll to May currently offers a 5.5% return, while a 7 month roll to July offers 7.6%. A 1.1% monthly return on a commodity investment in this extremely low volatility environment is nothing to ignore and the Funds are taking advantage of the situation with one major exception; no storage costs. Yes, there is the “cost of money” for the shorts but with margin levels around $800 per contract price and a price depreciation of roughly the same amount in little more than a week since the November WASDE, a vast majority are playing this carry game with “house money”.
Japan Runs Rising, but Higher Demands Absorbing Supply
The key takeaway this week was the continuing return of capacity previously down for maintenance, with a strong uptick in demand that helped absorb the rising supply. A drop in crude imports and higher runs drew crude stocks 2.75 MMBbls, while finished product stocks drew 0.38 MMBbls. While gasoline and jet stocks rose, all the other product stocks drew in varying degrees, with gasoil and kerosene leading the pack. Aggregate product demand rose 314 MB/D on the week, with the 4-week demand growth accelerating to 103 MB/D. Implied refining margins were modestly higher on the week and remain decent, though they are lower than their September peak. Retail prices continue to rise and the indicative marketing margin remains under pressure as higher prices have been unable to be fully passed through on a retail level. The margins on both gasoline and gasoil/diesel are below statistical means, but still above statistical lows.
November Weather: U.S., Europe and Japan Cold
At midmonth, November looks to be 14% colder than normal on the 10-year-normal basis for the three major OECD markets. On a 30-year-normal basis the markets are 4% colder. The November forecast takes into account first half actual weather and the current forecast for the rest of the month.
Asian Oil Demand: Faster Growth in Evidence
Our snapshot of Asian oil demand growth improved on the month to 980 MB/D vs. 852 MB/D seen last month. The December snapshot should remain strong, most likely over 1 MMB/D, before some slowing back to 840 MB/D in Jan/Feb. In Mar/ Apr there is expected to be a reacceleration back towards 950 MB/D. This month, the key drivers of the 128 MB/D improvement to demand growth were gains in China (a gain from last month of +60 MB/D), India (+24 MB/D), Taiwan (+35 MB/D), and a lesser decline in Japan (+8 MB/D).
Price Differentials as New Product Specs Introduced
Complying with tighter environmental specifications for refined products comes at a cost, which can be seen by the price differential between the new product and the previous one. Looking at three key changes that have occurred over the past several years, there is a distinct difference between prices at the implementation date of the new specification and in the months following. In all three cases analyzed here there was not much of a discernible pace of pre-buying activity leading to an early price spike, but spikes did occur during initiation and afterward. The situation for the bunker fuel specification change is likely to be very different given the daunting nature of the challenge faced by refiners.
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