China’s Refining Landscape is Changing as Independents Take on Expansion Strategy to Fight for Survival
PIRA expects crude prices to move towards $60/Bbl by year-end, but we do not believe prices that high are sustainable with shale growth and high financial net length entering 2018 which will weigh on next year’s prices. The East of Suez condensate market has been tightening since 2015, but it is expected to ease slightly next year as splitter additions take a breather in the region. China’s landscape for the refining sector is changing as state-owned refiners hold back from adding CDU capacity while independent refiners take on an expansion strategy to stay competitive amid many challenges. Australia’s oil demand growth is expected to moderate next year which could lead to some reduction in its net product imports. Asian refining margins will get some support from lower Chinese product exports and as oil demand in India improves.
Strength in Chinese Manufacturing Stands Out in Latest Data
Third-quarter Chinese GDP increased at a slightly slower pace compared to the first half of 2017 (and at a slightly faster place compared to last year). While the headline GDP figure suggested a stable condition, there were dynamic developments in other data. First, based on producer prices, ethylene production, and other data, manufacturing appears to be kicking into a higher gear. Second, a tighter credit condition is resulting in slower investment, particularly in real estate and manufacturing facilities. Third, retail sales and other information suggested healthy gains in consumer spending.
Propane Exports Remain Robust
Propane exports for the week ending October 13th totaled 982,000 b/d, which is in line with the September weekly average. For the week ending October 20th, propane exports are expected to remain in the one million b/d neighborhood based on cFlow data. U.S. propane/propylene inventories had a small draw of 93,000 barrels over the week ending October 13th, according to EIA data. Total propane inventories stand at 78.8 million barrels, which is 8% below the five-year average. The propane inventory draw occurred primarily in PADD 3 due to exports, while propane stocks built in PADD 1 and PADD 2 by 540,000 barrels and 400,000 barrels respectively, which puts stocks in both PADDs 1 and 2 at roughly the five-year average. U.S. raw mix production rebounded by 146,000 b/d last week as Louisiana offshore production was brought back online after being shut in prior to Hurricane Nate’s landfall. PADD 3 raw mix production regained 133,000 b/d or 91% of the total U.S. increase. All the above factors had a dampening effect on NGL prices with ethane, propane and butanes prices falling last week, and only natural gasoline prices increasing.
Ethanol Product Skyrockets
U.S. ethanol production soared by 52 MB/D to 1,019 MB/D the week ending October 13, representing the sharpest weekly spike since 2010 as more plants resumed normal operations following seasonal maintenance. Total inventories remained relatively flat for the third consecutive week, dropping by a mere 43 thousand barrels to 21.5 million barrels. Ethanol-blended gasoline production fell for the first time in four weeks, sinking to 9,131 MB/D, following overall gasoline output lower.
The curious case of the Non-Commercial corn short is commanding some attention after last week’s Commitment of Traders showed a net short of 203K contracts, which has widened to 225K according to some estimates due to late week weakness. The addition of almost 13K net shorts for the reporting week, which ended last Tuesday the 17th and included the WASDE release, is hardly noteworthy but the cumulative position at 76.5% of “max” might be. IF the “current” 225K contract estimate is correct, that would be 84% of “max”. Also of note is the almost 330K contracts in net length held by the Indexers, also 76.5% of “max”.
Kirkuk Oil Fields: At Least 280 MB/D Remains At Risk
Following an October 15 assault on Kirkuk, the Iraqi military and Shia militias have gained physical control of 280 MB/D of production capacity from the Bai Hasan and Avana fields from the Kurds. The fields remain offline, and Kurdish pipeline flows to Ceyhan have fallen by an equal amount to around 200 MB/D. Reports indicate production and exports should return to normal by Sunday, October 22, pending the arrival of crucial equipment and Baghdad-affiliated engineers. However, PIRA believes the market should anticipate a longer outage. Even more notable than the unresolved technical issue is the fact that a deal must be reached between the Kurds and Baghdad, as the KRG controls the only northern export pipeline. This will take time.
U.S. Draws Keep Coming
U.S. commercial stocks declined sharply by 8.7 million barrels this past week led by a 5.7 million barrel decline in crude oil, reflecting Gulf of Mexico production losses (-1.1 MMB/D) from Hurricane Nate. The overall stock decline outpaced last year’s decline for the same week, widening the year on year stock deficit to 56 million barrels, or 4.2%. The two major light products both showed modest stock builds last week but should see significant stock declines in next week’s data with gasoline inventories drawing 2.8 million barrels and distillate, 2.2 million barrels, as demand rebounds. Cushing crude stocks built just 0.2 million barrels last week and are forecast to decline 0.6 million barrels in next week’s report. Overall crude stocks build 1.8 million barrels next week for the first build in five weeks.
October was Hot, Not Mild — and that Distinction Matters
Yesterday, the EIA reported a 51 BCF increase in inventories for the week ended October 13. While the report was within industry expectations, the November NYMEX futures contract still managed to tumble to an intra-day calendar-year low. Though the contract has since managed to convalesce closer to Monday’s opening print, the lackluster recovery suggests traders are still preoccupied by the possibility that continued warm weather will forestall the structural tightness we see ahead. Yet, despite the fact that the weather this month will likely rank as the second warmest since the 1950s (falling just shy of last year’s record), the build in inventories will fall short of year-ago levels as well as the 5-year average.
N.W. European Storage Stock Levels are Causing High Price Dislocations
Europe overall has quite healthy stocks, however the more Northwest you look, the more problematic the storage situation appears to be. Clearly, the U.K. is the focal point of storage deficits at the moment with the retirement of the Rough storage facility. If anything, Rough now moves to the supply side of the ledger, as it continues its decommissioning process with the removal of its remaining supplies. We expect these flows to be price insensitive as it dwindles – so far this Gas Year, it has been relatively stable at between 10- and 12-mcmm/d. Centrica should keep these flows relatively stable, as adding stress on the facility by ramping up and down on its production could increase the risk of physical disruption.
Déjà vu All over Again for Winter JKM
Supply shortfalls in Asia are once again supportive of winter JKM, even as Asian supply additions have surged. JKM strength also has roots in the Atlantic Basin where rising coal prices and steeper Southern European demand have offered strong competition with Asia for incremental volumes in a still supply short Asian market.
Shift in Supply Stack and Pull from France Bullish for German November Prices
After a first half of the month characterized by stronger wind output averaging more than 18 GW, a drop to a mere 2 GW pushed German hourly prices to €83/MWh during the evening of Oct. 18, the first time €80/MWh was breached since February, coupling it with France, Belgium, and the Netherlands and placing it almost €5/MWh above the Swiss price. Hourly prices also hit €80/MWh last year in October, but in combination with reported thermal dispatching of about 5 GW higher, which is to say that the supply curve has shifted by about 5 GW since then, bringing forward the steepest section of the curve. This change is supportive of German prices and is largely due to the closure of or move into the reserve portion of thermal plants.
Exports Remain in the Driver’s Seat
The pace of U.S. thermal coal exports accelerated in August, rising 2.2 MMst higher year-on-year and keeping U.S. coal prices elevated. Over the last month, virtually every prompt quarter and prompt month OTC coal contract in the U.S. markets has ticked up, despite the fact that demand has entered the shoulder season and coal burn declined in September and appears to have fallen further in October.
California Carbon Surplus to Build
California Carbon allowances traded higher in September, while October trades moved higher still. Stronger inflation indicators suggest a 2018 auction floor well below current pricing (final inflation will be released next month). The coming weeks will see Nov auction results, release of bearish CA emissions data and the partial 2016 compliance surrender. PIRA continues to believe that growing surpluses, helped by the return of large quantities of unsold state-owned allowances, will help contain pricing upside. ON sources are joining the program with some free allocations and supply from ON-only auctions and a deferred compliance requirement – limiting incremental secondary market demand. The CA/QC CP2 reconciliation in Nov 2018 will require the surrender of record quantities of compliance instruments and could affect spreads of CP2-valid vintages vs. later vintages. A Scoping Plan Update is to be completed by end-2017.
Japan Refinery Maintenance Continues, Demand Pickup Slow to Develop
Fall maintenance continues, but a pickup in seasonal demand has been slow to develop. As such, finished stocks have increased a bit. The product stock build this week was fairly broad based across all the major products. Crude imports fell back as expected and stocks drew 2 MMBbls, despite lower runs. Kerosene demand rose 71 MB/D and appeared to reflect a pickup in tertiary and secondary inventory pulling on primary inventory as pre-season fill programs finish up. The stock build rate eased back from 178 MB/D to 114 MB/D, while the 4-week build rate rose further from 60 MB/D to 77 MB/D. The deficit position vs. year-ago narrowed to 0.73 MMBbls. Refining margins again eased slightly on the week, but remain good and supportive of a high level of runs, though demand performance is lagging. The indicative marketing margin has begun to improve. For gasoline, it is above statistical norms, but remains below norms for gasoil/diesel.
Credit Conditions Remain Highly Constructive
The S&P 500 continued to set new records, though volatility gained on the week. High yield credit (HYG) moved higher, as did most other debt pricing indicators, other than emerging market debt. (EMB). The commodity space moved lower as the dollar strengthened, but energy bucked the trend and posted a gain. The St. Louis financial stress indicator resumed its downward trend.
Margins for Manufacturing U.S. Ethanol Declines
The cash margin for manufacturing ethanol in the U.S. declined the week ending October 13. RIN prices were stable. Ethanol production in Brazil’s South-Central region jumps. European ethanol prices and manufacturing margin deceases, U.S. biodiesel prices reach a two-week high but manufacturing margins fall for the fourth straight week.
From 80 bpa in Mississippi to 25 bpa in Pratt County, Kansas, harvest reports this week continue to be variable, but the trend is definitely down after the initial filings as expected. Whether it’s 3,000 acres in northern Illinois at 55 bpa vs. 73 bpa last year, yields that are half of last year in SE Iowa, or southern Minnesota reports with a 4 handle in areas that produced 65-75 bpa beans last year, as harvest moves north at a fast pace in front of this weekend’s rains relative disappointment is starting to set in. To be fair, PIRA has seen some 80+ numbers out of select counties in Indiana, but also numbers in the mid 40’s for other parts of the Hoosier state, confirming the variability. While some are still at/near their APH (Actual Production History) yields, those willing to share a year over year comparison numbered 7:1 lower than last year in this week’s reports. These numbers seemingly confirm Crop Tour findings of lower year over year pod counts in states that we surveyed.
U.S. and Nigeria Lead Flourishing Asian Trade that is Not Sustainable
The long-term sustainability of LNG flows from the Atlantic Basin into Asia will come down to a matter of how much buyers value diversity and how much sellers are willing to discount in order to place the volumes. In the short term, however, Atlantic Basin flows to Asia have thrived due to the wider JKM/Henry Hub spread. Overall volumes are up by 56% this year to 16.2-BCM through September.
Prompt Coal Prices Gain Again, Deferred Market Weaker
Coal pricing was mixed this week, with prompt CIF ARA and FOB Newcastle prices rising modestly while deferred prices moved lower, widening already considerable backwardation in the forward markets. The bullish momentum on the front of the curve was not much of a surprise in light of the announcement of the Pacific National railroad strike and risks to the upside for winter demand. However, the market has seemingly become more pessimistic for deferred pricing, perhaps on weaker than expected thermal generation out of China.
EUA Prices Move to Mid-€7 Range, But Where To Now?
European Carbon (EUA) prices have moved to a mid-€7/tonne range following gains in September and early October arising from French nuclear uncertainty and the expectation of a final agreement in negotiations over post-2020 EU ETS market reforms. Although a final agreement in negotiations between the EU Council and Parliament was not reached at an Oct 12th meeting, one is still expected by year-end and possibly as soon as early Nov. However, there may be limited potential for continued price gains this year, as further reductions in French nuclear generation may prove challenging, and given that a positive outcome over a reform package may already be built into the market. Looking ahead to 2018, EUA prices could average slightly higher year-on-year. While continued high auction supply volumes provide downward price pressure to EUAs ahead of Market Stability Reserve implementation in 2019, the ongoing proposal to secure the EU ETS from Brexit may also add some upward EUA price risk.
Asian Oil Demand: Growth Falls Back Again, as Expected, with Further Slowing Likely in 4Q
Our snapshot of Asian oil demand growth continues to show further slowing, as expected. Further easing is likely in 4Q, but then accelerating growth will take shape in 1Q18. Growth in our October snapshot was 852 MB/D, an incremental fallback of -104 MB/D from last month. The key drivers were again slower growth in China and Korea, while India’s growth improved almost 150 MB/D, and Australia/New Zealand growth improved 22 MB/D. Performance generally came in along PIRA’s expectation. At this point, there will be further deceleration in growth in 4Q to about 635 MB/D. Then, improvement is expected in 1Q18 with growth rising to 975 MB/D. Data actuals cover the three month period July-September for China and India, while Japan, Taiwan, and Korea cover data June-August.
Global Equities Setting More Record Highs
Global equity markets continue to set more broad based records in a host of countries and across a host of market indices. In the U.S., the S&P 500 gained almost 1%, with the growth indicator outperforming a largely neutral defensive indicator. Banking and housing were the best performers, while consumer staples was the weakest, and energy fell back -0.5%. Internationally, there appears to have been rotation out of many of those tracking indices and into the U.S. The biggest fallback was in Latin America, -1.4%, though many of the other tracking indices also posted declines.
The information above is part of PIRA Energy Group's weekly Energy Market Recap - which alerts readers to PIRA’s current analysis of energy markets around the world as well as the key economic and political factors driving those markets.