Refining Challenges Remain the Focus of Latin American Product Markets
Refining challenges remain the focus of Latin American product markets. Refinery crude runs in the region are expected to be 120 MB/D lower YoY in 3Q17. In Mexico, we project 3Q17 runs to fall 50 MB/D YoY, affected by outages in Salina Cruz and Cadereyta. In Brazil 3Q and 4Q17 refinery runs are set to move higher YoY. Regional gasoline demand is expected to remain soft in 2H17 while distillate demand recovers by 4Q17, driven by Brazilian consumption. Operational issues keep limiting local supply of products.
Fundamentals Warrant a Move to the Upper end of the Range
NYMEX futures continue to be whipsawed — whereby the market has materially vacillated on evolving expectations of supply/demand tightness — with swings in weather expectations heavily influencing sentiment. In addition to weather, the observable “saw-tooth” trading pattern, i.e. traversing up and down the established range, has been driven by volatile weekly EIA storage readings — as conflicting data has done little to highlight any underlying weather-adjusted trends. Altogether, with the contraction of available hydro and wind generation, gas gaining marketshare over coal in EG and the prospects of warmer weather, fundamentals point to tightening balances. Price strength will need to force some demand destruction to reach satisfactory inventory levels heading into winter.
The Curious Case of Mexican LNG Demand
Do not sleep on Mexican LNG demand just yet. PIRA’s somewhat dim view of LNG growth prospects for Mexico remain in place, as the significant expansion of U.S./Mexico pipeline capacity is underway. However, the ability to move the U.S. pipeline gas to places where LNG demand exists is not quite there and will still be a key component of gas balances during periods of maintenance in the years ahead.
Is Transmission Congestion Catching Up to Wind Buildout? Basis Risk for ERCOT and SPP Wind Farms
Transmission congestion in ERCOT and SPP, the two regions in the U.S. that have seen the greatest growth in wind generation in recent years, is resulting in steeper discounts from hub prices to the prices paid to wind generators. These discounts have been growing as installed wind capacity has increased, particularly in the ERCOT Panhandle region and the western part of SPP, impacting merchant wind farm economics, and requiring transmission upgrades to resolve. While some transmission projects are already underway, additional transmission will likely be needed to integrate the expected levels of wind in these regions.
U.S. Stock Deficit to Last Year to Continue Widening
Overall stocks drew 3.9 million barrels this past week led by a strong crude stock draw of 7.6 million barrels, 1.9 million barrels of which was in Cushing. Four week average adjusted product demand increased to 4.1%, or 780 MB/D year on year. Gasoline led the light products with stocks declining 1.6 million barrels while distillate inventories had one of their larger builds of 3.1 million barrels. For next week’s EIA data, crude stocks are forecast to decline sharply by 6.0 million barrels.
Second Quarter Global Activity Data Point to Improvements
In the U.S., retail sales for June disappointed, but consumer spending is still rebounding. Industrial production was solid, as industries in the capital-intensive sector recorded encouraging gains. The latest core inflation data remained sluggish. In the euro area, activity indicators improved in line with a pick-up in economic confidence, and second quarter GDP growth is likely to come in faster than the first quarter’s pace. China, South Korea, and Taiwan all reported a strengthening in exports, and this development bodes well for the global economic outlook.
U.S. Ethanol Prices Advance
Manufacturing margins worsened the week ending June 7 as corn costs soared. RIN prices were steady. Brazilian ethanol prices were lower while European values rose.
Record Short Covering
132.7K corn contracts. That’s the net number bought by Non-Commercials in the week immediately preceding the July WASDE. The previous week’s net of -80K turned into a net long of 50K contracts during a ~20 cent rally that peaked on reporting day (Tuesday, July 11th) in what is being called the largest short covering, volume wise, in just over two years. The immediate reaction Friday afternoon, and Sunday night in the market, was astonishment, and for bulls a fear that the dreaded Funds might actually be long at this point. Given the market reaction after the WASDE, and volume that has traded hands since then, those fears are without merit in PIRA’s opinion.
Is Gas Storage a Wind/Solar Derivative?
The intermittency of wind and solar production is developing into the balancing issue that PIRA has been promising for a long time now. It is leading to ever more volatile within-day pricing that is creating new opportunities for storage. This growing link between renewables and storage represent emerging opportunities to a storage market that has been dogged by complaints of lack of opportunity and a dearth of spreads.
Italian Prices: No Major Surprises so Far, but Signs of Underlying Strength
After a major upward move in June, PUN day ahead prices in Italy have settled slightly below expectations in July, or about €50/MWh. However, with temperatures closer to July 2016 and only 0.7 degree Celsius above normal, spark spreads have been quite robust this month, in line with a broadly bullish underlying fundamental picture.
CA Carbon up Sharply; Awaiting Cap and Trade Vote
Pricing momentum fed off the CA Supreme Court’s declining to review the legality of auctions and the emergence of market-friendly legislative proposals. The benchmark CCA contract moved above $15 in July (well above the expected 2018 auction reserve price). A stronger August auction will clear the way for unsold allowances to be re-offered starting in November. PIRA believes that a return to bank-building in the near term will limit the further upside potential for allowance pricing, even with some increased appetite to hold surplus and take on speculative length. It is still unclear whether the cap and trade extension will pass (by 2/3rd) this year/what form it will take. CARB will need to re-propose Cap and Trade Amendments if they are not adopted by the August deadline. ON linking prospects are also tentative, with elections less than a year away.
Seaborne Coal Prices Diverge, Downside Risks Looming
Coal market prices diverged this week, with CIF ARA and FOB Richards Bay prices falling W/W, while FOB Newcastle prices moved higher. The strength in FOB Newcastle prices likely stemmed from demand strength in Asia, led by China, where hot temperatures and the temporary curtailment of hydro generating capacity bolstered coal-fired generation. However, the announcement that China’s imports declined Y/Y in June illustrates that the downside risks for FOB Newcastle and the global market are becoming more prominent.
Japan Higher Runs and Higher Demand
Japanese runs rose 106 MB/D on the week, as turnarounds continue to lessen. Crude imports eased only slightly to 3.72 MMB/D, and crude stocks built again, by 5.6 million barrels. Again, finished product stocks fell modestly. Aggregate demand rebounded a strong 110 MB/D and the 4-week average trend in demand continued to move seasonally higher. Refining margins were again higher on the week and have continued to improve. Gains this week came from firmer gasoline and middle distillate cracks.
Credit Conditions Improve, Financial Stresses Remain Very Low
A very bullish week, with a big reversal in the emerging market / high yield retrenchment that had been seen the previous week. Financial stresses remain exceedingly low, though the St. Louis financial stress indicator again moved slightly higher. Commodities had a positive week, with energy being particularly strong. The dollar generally moved lower. The reflationary trade appears to have reemerged, at least this past week. The U.S. equity market hit new record highs.
The U.S. Ethanol Market Tightened as Stocks and Production Declined
U.S. ethanol inventories declined for the fourth consecutive week the week ending June 7, falling by 390 thousand barrels to a six-month low 21.2 million barrels. While total domestic output fell 7 MB/D to 1,007 MB/D, production outside of the Midwest rose 5 MB/D to a record 94 MB/D. Ethanol-blended gasoline production sunk 164 MB/D to 9,223 MB/D despite greater gasoline output.
Bean Buying Starts to Impress
An announcement Friday morning that China had purchased 1.3M MT of soybeans for the coming Marketing Year needs some context. While it is the 7th largest daily purchase in history, it’s also important to know that 2017/18 sales have been woefully slow up to this point at less than 4M MT as of yesterday. This lack of buying has less to do with price and more to do with both little concern about the size of the U.S. crop as well abundant supplies produced this year in South America.
Prices Retreat With Lack of Summer Heat
Spot on-peak energy prices were higher y/y (but lower m/m) in most East and ERCOT markets with a few notable exceptions. Loads in the East fell by 3.7% as cooling loads fell from the warmer than normal prior year. ERCOT loads were flat. Henry Hub spot prices averaged near $2.90/MMBtu in June, down ~7% from May levels. Northeast markets saw even sharper declines. In recent trading, the prompt futures contract has rebounded above $3. PIRA has revised down summer energy prices, partly in response to a lower gas price outlook but also due to lower unplanned outage rates with less reliable older coal units having been replaced by CCGTs with lower forced outage rates.
Recent EUA Price Gains Mask Long-Term Bearish Risks
PIRA expects European Carbon (EUA) prices to adjust to the downside from their current range of €5.30-5.50 during the balance of July, although lower auction volumes should still result in an EUA price bump in August. While the potential end to post-2020 market reform talks could offer a degree of support for EUAs in 3Q2017, there is also the possibility that market participants could “buy the rumor and sell the fact” of the reform package, and there appear to be few other fundamental drivers of sustained EUA price gains in the balance of 2017.
U.S. to Become Major Global Crude Oil Exporter with Infrastructure Not a Limiting Factor
The U.S. Gulf Coast will play a growing role as an oil exporter to global markets and will become one of the largest exporters in the world. Its infrastructure will be ready to supply increasing volumes to a thirsty global market. PIRA forecasts U.S. crude oil exports will grow to 2.25 MMB/D by 2020, a four-fold increase from 2016. This growth will be driven primarily by rising light sweet crude supplies from shale production. Proposed capital projects are pointing toward Corpus Christi becoming the primary Gulf Coast export hub once they alleviate logistical constraints and provide access to Permian supplies.
Global Equities Post New Record Highs
Many global equity markets hit new record highs this past week, including the S&P 500. In the U.S., the growth indicator posted a strong gain in momentum. Technology, energy, and materials all exhibited strong performances. Banking, however, lagged and declined. Internationally, the tracking indices generally did even better than the U.S. performance with Latin America, China, emerging Asia, emerging markets all posting robust gains.
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.