Improving Economic Outlook, Determined OPEC and Tightening Balances Should Improve Prices
An improving global economic outlook, determined OPEC, tightening supply/demand balances and constructive positioning should lift oil prices. Market sentiment has been extremely bearish, unduly so in PIRA’s opinion because we do not see oil markets flooded with shale oil, China’s economy is not declining but continues steady growth and OPEC’s decision to extend cuts will substantially reduce supply. With global crude demand increasing sharply while supply grows modestly, substantial offshore and onshore crude inventory declines are forecast which should lift oil prices. Global geopolitical risks to supply remain elevated. Global refinery runs are outpacing capacity additions, tightening utilization and supporting generally healthy refinery margins in 2017.
Recovery Stalls on the Weather
Cool Kickoff to Cooling Season Impeding Price Appreciation — While U.S. temperatures this month were close to normal in May, such conditions failed to counter bearish factors (including gas-to-coal switching in the east, as well plentiful hydro out west). Moreover, near-term weather forecasts that extend to mid-June are weighing on Henry Hub (HH), and other prices as they favor decidedly lower temperature readings than those of a year ago — and also cooler than normal.
Prices Heat Up Ahead of Summer in a Parched Europe
While weather has been keeping demand at year ago levels, hydro generation during May has been a more bullish price driver, with our balances showing sizeable declines across France and Southern markets (over 33% down year-over-year combined) setting multi-year lows. Our modeling has been based on almost 6 GW of additional nuclear year-over-year for France in 3Q 2017, but the current poor water levels exacerbate the risks of cooling-related unavailability, even at relatively lower air temperatures. Spanish 3Q 17 prices have increased to a level that implies that about 10 GW of combined coal and gas will be needed to run in the summer, about 1 GW above expectations. The back of the French curve has also rebounded, as the outlook for firm capacity (nuclear and coal) in France is looking increasingly uncertain, following Macron’s election and his appointment of Hulot as Energy Minister. As Macron’s government defines its energy policy, there are risks that the French system will further tighten – especially during the winter months.
Following two very weak months in the low 6,000s, NP15 on-peak implied heat rates increased to the 8,000 mark in May thanks to market tightness during the evening hours of two heat waves amid ongoing generation outages. June on-peak prices have been revised up reflecting near-term weather risks. Positive adjustments for Palo Verde extend across the curve. While projections for Cal hubs beyond June are little changed, we note upside risks associated with weather, fire-related transmission outages, and SoCal gas supply.
Ethanol Prices Climbed in May
Manufacturing margins improved. Ethanol sold at a discount to gasoline in Chicago and New York. D6 RIN values soared at the end of the month. The 2017/2018 sugarcane harvest in Brazil’s South-Central region ramped up slowly due to heavy rain. European ethanol prices peaked during most of May but plunged at the end of the month.
Rebalancing Begins as U.S. Crude Stocks Decline in May
The rebalancing of oil markets has begun, with tangible signs of declines in the large surplus that developed in North America over the past two years. U.S. crude oil stocks declined some 20 million barrels in May, on the heels of a smaller draw in April. Larger crude stock draws are coming this summer. U.S. crude production is growing again, primarily in the Permian Basin. But that growth is being absorbed by higher refinery runs and increasing crude exports. Western Canadian supplies are recovering from the recent Syncrude fire, with more growth in bitumen output expected by year-end from several oil sands projects. More pipeline projects are being planned, following the recent start-up of the DAPL pipeline in North Dakota.
Hydro and Seasonal LNG Work Against Injection Needs
Gas-to-power demand has been supported by a power market with weak nuclear and hydro production for much of the year. Now that nuclear production is back to a seasonally normal 57 GW, the focus turns more squarely onto hydro production, where PIRA anticipates output to be 23.4% lower than normal this year, which should provide strong support for gas demand from power generators. Even though nuclear production has normalized, there is a serious risk for the low hydro situation to bring nuclear production back in the focus through cooling water needs for these generators, as we saw in 2003, when nuclear power production was forcibly reduced by 3 GW over July/August.
Coal Prices Hold Up, Bearish Moves Lie Ahead
The coal market has found some support from robust coal demand in Asia and a weaker U.S. dollar. However, some of the key pillars of strength on the demand side will soon weaken, which will force the supply side to choose between volumes and price. China’s import demand is expected to remain above prior-year levels in May and June, although rebounding domestic production, adequate stockpiles and fading demand growth should pull imports (and price) lower.
Busy Week for Data, Some Surprises but No Changes to Outlook
The recent pace of job growth in the U.S. was disappointing, though hardly alarming. The most eye-catching part of the May labor market report, in fact, was the fourth consecutive monthly decline in the unemployment rate. In spite of a tighter labor market, however, there are few signs of economic overheating. In Europe, the labor market continues to improve, but inflation remains subdued. In Japan, evidence for faster growth continued to pile up. Business confidence in China declined in May, and hinted at a modest slowing in activity going forward.
Propane Stocks Increase at Largest Volume of Current Injection Season
Propane stocks increased by 3.4 million barrels, which is the largest weekly build of the current injection season. Propane exports dropped to 586 MB/D. The decline in exports was expected due to the number of reported cargo cancellations. Stocks in PADDs I, IV and V are in good shape being in the mid-range of the 5-year average. Stocks in PADDs II and III are still relatively low being at the low of the 5-year average for this time of the year. Propane imports soared to 208 MB/D, which implies increasing Canadian propane field production. Propane demand increased to 927 MB/D.
RGGI: States’ Least Common Denominator Effort?
Pricing for the benchmark RGGI contract is low, and the June auction will introduce more supply. There are enough allowances in circulation to cover the full Compliance Period reconciliation in March 2018, but compliance players must acquire allowances by participating in auctions and/or engaging the secondary market. The RGGI Program Review continues, with stakeholders awaiting Policy Case modeling. RGGI seems to lack ambition for anything more than a “least common denominator” approach for linked carbon efforts. PIRA expects resistance to further significant price drops as there is only limited additional downside left before the floor price is reached. PIRA does not see moves toward higher allowance pricing until clearer policy signals emerge later this year.
Algeria Comes Face to Face with Emerging LNG Surplus
The emerging global LNG supply surplus is already rearing its head in Asia, influencing everything from LNG spot prices to long-term negotiations between Qatar and Japan, which are becoming testier by week. The recent surge of LNG imports into the Mediterranean will continue to be a major headache for Algeria, which does not have the marketing flexibility of a Norway or a Russia. Already underway, the surplus will increasingly spill into the Mediterranean in the second half of 2017, as Qatar needs to reposition volumes in order not to undermine Platts JKM prices in Asia, and the best place to do so from a pricing standpoint at the moment is in the Mediterranean.
Japan Maintenance Continues on Track
Runs continued to decline amid increasing turnarounds. Crude imports fell back about 1 MMB/D and that produced a 3.4 million barrel crude stock draw. Crude stocks are again closing in on their record low. Finished product stocks drew a modest 0.2 million barrels. Implied major product demand was fractionally change, with strength in gasoline, kero and jet, offsetting weakness in fuel oil. Refining margins were higher on the week by $0.35/Bbl, but remain soft. The implied marketing margin fell for the third straight week, and are now just under their historical mean levels. What had been a helpful cushion and offset to weak refining margins has now largely evaporated.
U.S. Ethanol-blended Gasoline Manufacture Jumps
Ethanol-blended gasoline manufacture increased to a nine-month high 9,421 MB/D the week ending May 26 from 9,394 MB/D during the preceding week. This was the fifth highest volume on record. Inventories built by 79 thousand barrels to 22.8 million barrels, up 2.0 million barrels (9.6%) from this time last year. Domestic ethanol production rose 10 MB/D to 1,020 MB/D.
Iberia is Quietly Linking More and More with the Rest of Europe
Europe will be buying more LNG to replace declining production in N.W. Europe. In this context, Iberian gas balances will be gaining sway over the broader European landscape, as Spain tends to be the most desirable location to first deliver LNG. For now, logistical constraints will keep the Spanish step towards a broader role at bay, which is why Spain tends to have the most expensive pricing among Central and Western European hubs. Iberia remains relatively isolated from the rest of the Continental market making the Spanish hub susceptible to price spikes, when LNG is not readily or cheaply available.
ERCOT Market Design – Putting the NRG/Calpine Proposals into Perspective
Market design has been garnering increasing attention in ERCOT as low power prices resulting from weak natural gas prices and increased renewables penetration continue to challenge owners of merchant generation. NRG and Calpine on May 10 filed a jointly commissioned report with the Public Utility Commission of Texas (PUCT). The report contains suggestions for changes to the market design in ERCOT, ranging from tweaks to the Operating Reserve Demand Curve to an overhaul of the transmission planning and cost allocation process in Texas. Generally, these proposals are intended to improve price signals, in particular offering more support for generators located near load centers and congested areas of the grid. The proposed changes will likely be discussed at the PUCT as well as in ERCOT stakeholder committees.
Trump’s Paris Decision Underscores Policy Trajectory of Past Five Months
President Trump formally announced on June 1 that the U.S. would pull out of the Paris Agreement covering post-2020 greenhouse gas (GHG) emissions. The tone of the statement was rather clear – offering signals to both his supporters and to the overwhelming majority of the world’s countries that had signed the agreement and support coordinated climate action. While resonating strongly in the broader media, the symbolic decision is not necessarily milestone news for energy sector fundamentals. Rather, this announcement highlights a consistent trajectory of Trump’s energy/environmental policy activities of the past five months – with a number of key detailed policy decisions still ahead.
U.S. Commercial Stocks Again Below Last Year But Now Will Stay Below
U.S. oil demand (adjusted) in May has been very strong with the latest four weeks up 5.0% (or 950 MB/D) versus last year. High runs and strong demand pulled overall stocks 5.2 million barrels lower last week with crude stocks falling 6.4 million barrels, showing its eighth consecutive weekly draw and the largest of the year. Gasoline inventories drew again last week, declining 2.9 million barrels. This week has another large crude stock decline of 5.5 million barrels with Cushing crude stocks decreasing 1.2 million barrels.
Despite Weaker Energy Markets, Financial Stresses Remain Low
In general, financial stresses remain extremely low, as the St Louis Fed stress index again moved sharply lower and the S&P 500 continued its climb above the 2,400 level, with it again setting new record highs. Commodities had another negative week, particularly energy, but investment grade, high yield, and emerging market debt all posted positive performances, though the price on high yield energy debt fell.
When the markets think about the Dakotas they typically envision spring wheat (Minneapolis contract) along with some specialty crops like sunflowers, flax, and others. The market also sees low corn and soybean yields along with poor cash basis as has historically been the case, making this area more of an afterthought that anything else. However, as the traditional corn and soybean Belt becomes more and more redefined towards the west, it would be foolish to just write off this area as an add on.
EIA Affirms Higher Baseline, but Nixes Subsequent Growth
The NYMEX futures selloff continued yesterday in the wake of the latest EIA storage report which detailed far greater injections than industry expectations. The price response was likely amplified by reactions from speculators which have been sitting on large and growing net long positions this year. From a fundamental standpoint the most recent EIA Monthly Crude Oil and Natural Gas Production (914) report — updated to March 2017 — affirms the higher baseline of U.S. production established in last month’s report (for Feb 2017) but fails to show follow-through for March. The higher baseline of production reaffirmed by the EIA this month results in greater impact on the year-over-year comparisons, or, as is the case, smaller deficits. Yet, the lack of momentum following February’s production numbers adds uncertainty on the timing of the production recovery.
Split of German-Austria Price Zone to Shift Flows, but Limited Impact on Germany
E-Control and BNetzA, the Austrian and German regulators, agreed to the introduction of a congestion management scheme at the border between the two countries. The new scheme, starting from October 1, 2018, limits the long-term cross-border capacity to at least 4.9 GW. This decision would lead to a considerable shift of the flows in and out of Austria. On balance the impact on the German pricing dynamics should stay fairly limited. A large amount of German commercial flows toward Austria are to be considered transit flows toward Switzerland or Czech Republic, so those markets should be able to import directly from Germany, when needed.
Coal Pricing Bucks Weaker Oil Market, Shifts Higher on Asian Demand
Despite the downshift in oil and gas prices, seaborne coal prices rallied this week, with FOB Newcastle prices leading the charge, rising by $2.50/mt across the forward curve. CIF ARA and FOB Richards Bay forwards increased by $1.50/mt at the front of the curve, however, while backwardation in the CIF ARA forward curve widened this week, backwardation in the FOB Richards Bay curve narrowed slightly. Strength on the demand side continues to underpin the front of the market, particularly in Asia. However, PIRA believes that import demand from China and elsewhere in Asia will soon fade, particularly if summer weather is not as supportive as the July/August heatwave last year.
U.S. March 2017 DOE Monthly Revisions: Demand and Stocks
EIA just released its final monthly March 2017 (PSM) U.S. oil supply/demand data. March 2017 demand came in at 20.0 MMB/D, which was 427 MB/D higher than the weeklies. Total product demand grew 2.1% versus year-ago or 417 MB/D, compared to the March 2016 PSM data. It reversed the year-on-year demand decline seen in February, which had been the first decline seen since July 2016. End-March total commercial stocks stood at 1,341 million barrels. Compared to final March 2016 PSA data, total commercial stocks were higher than year-ago by 14.6 million barrels, versus an excess of 36.3 million barrels seen at end-February.
Global Equities Still Setting Record Highs
Many of the benchmark equity indices continue to set record highs. The U.S. S&P 500 continued its climb above the 2,400 level. Housing, consumer discretionary, and materials performed the best on the week, while energy was again the clear laggard. International indices also did well, with Japan doing the best, while Europe and global, ex-U.S., also outperformed. Latin America fell back on the week.
Saudi Arabia: Despite Higher Revenues, Its Financial Cushion Continues Falling
Saudi’s foreign exchange reserves for April showed a continuing decline that has averaged about $8 billion/month since 4Q16. Many of the other financial indicators that we track remain stable. Since the joint OPEC / Non-OPEC agreement was negotiated at the November 2016 OPEC meeting, Saudi oil revenues are estimated to have risen by $26 billion annualized, or 22%. In this context, the agreement has been effective in boosting top line revenues, along with reducing global supply and inventory overhangs. Even so, it has yet to reverse the drain on Saudi financial reserves, though a significant financial cushion remains.
March 2017 U.S. Crude Growth Decelerates
U.S. crude and condensate actuals for March 2017 came in at 9.1 MMB/D, up 62 MB/D month-on-month, down 76 MB/D year-on-year. Texas production grew only 3 MB/D month-on-month, and may be signaling bottlenecks that are slowing growth.
Are Companies Paying Too Much for Permian Acreage?
The Permian has seen a frenzy of M&A activity. Over $17B of deals have been made so far this year at an average price of $24M/acre, with some transactions seeing valuations in excess of $50M/acre. The prolific nature of the Permian with its multiple stacked intervals and high EURs appears to justify these high acquisitions prices. PIRA analysis shows that based on the average transaction price of $24M/acre, only three wells per 320 acre spacing unit are needed to achieve a land acquisition laden 10% IRR after tax at $50 WTI. In much of the play, up to 12 wells could potentially be placed on a 320 acre unit. However, an important key variable is the pace of development, with rapid development necessary to achieve acceptable rates of return.
Aramco Pricing Adjustments: Clearly Discouraging Liftings
Saudi Arabia's formula prices for July were just released. PIRA analysis of those terms concludes that liftings are clearly being discouraged in all regions. Terms were raised in the three major markets more than our regional drivers would have suggested. In addition, Saudi direct burn of crude peaks in summer, meaning there is less available for export. Lastly, the pricing terms are consistent with the decision coming out of the most recent OPEC meeting to extend the production cuts through 1Q18, and do whatever it takes to continue cleaning up the global excess.
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.