Global Flow Deficit and Positioning to Lift Oil Prices
Global economy is in a synchronized expansion, which is bullish for oil demand. Oil demand growth continues to be much faster than supply increases, creating a large flow deficit in 2017 which is drawing down surplus stocks. 2018 will require sizable increases in both OPEC and U.S. shale crude production to keep inventories from falling to inordinately low levels. Recent declines in financial net length render positioning much more supportive to prices. Refinery runs and margins will stay strong through the summer. Gasoline cracks will be healthy with declining inventory coverage and will outperform slowly recovering distillate cracks. OPEC cuts and U.S. shale growth drive Brent-Dubai crude differentials narrower, increasing Atlantic Basin sweet crude arbitrage movements to Asia.
Competition for Storage Heats Up
Tepid supply recovery and the possible need of price-driven demand destruction is clearly playing a role in the gas futures price recovery underway. From a regional cash price perspective, the possibility that a significant inventory deficit will emerge in advance of the heating season suggests the physical market will align with this bullish sentiment.
Lower Hydro Offsets Nuclear Recovery
Spring will see an unusual turnaround in nuclear availability patterns, as German nuclear returns to full availability by June, while French availability will move to multi-years highs in May-June. However, hydro generation in March was down by 14% year-on-year across Western Europe, with a steeper contraction factored in our balances for 2Q17 (-18% year-on-year in April, -16% on average in 2Q17). Within Western Europe, Spanish and Italian prices offer the most upside for the upcoming months. A recent study by the German TSOs projects reserve capacity margins in the next three winters will shrink. This conclusion is quite bullish, considering the TSOs assume coal capacity to stay flat, while more coal closures have been already announced since the study was published. Germany is set to rely on imports during the winter peak.
Trump Puts into Motion Rollback of Obama Climate Policies
President Trump’s Executive Order directs federal agencies to take steps to reverse Obama climate policy efforts. Not directly addressed were EPA’s GHG Endangerment Finding, the Paris Agreement, and the EPA’s waiver allowing California to set GHG auto standards. Repealing the Clean Power Plan and the NSPS for new fossil fuel plants will require time-consuming notice and comment rulemaking - with the difficult choice ahead of how (and whether) to replace them. The Order’s focus on reviewing oil & gas fracking regulations was less expected, though PIRA believes the impacts will be limited. Controversial Obama regulations of criteria air pollutants (ozone, PM) – presumably closer to the Administration’s view of EPA’s core mission - were not explicitly called out for review. Rolling back other climate policies (Social Cost of Carbon, GHG NEPA reviews, coal leasing moratorium) is more easily done with the stroke of a pen.
Cyclone Lifts Coal Market Bearish Pricing Awaits
While Cyclone Debbie disrupting coking coal output in Queensland has grabbed headlines, the thermal coal market has been highlighted by the removal of several key upside risks over the past month. Warm weather in Europe and a more flexible approach in enforcing coal production capacity cuts in China have taken away some upside pricing potential. However, weather-related disruptions to supply in Australia and Indonesia, coupled with strength in Asian coal demand should give FOB Newcastle prices some upward momentum. In the Atlantic, weak European coal demand will continue to be a drag on CIF ARA.
That $100/acre futures revenue advantage enjoyed by those intending to plant soybeans instead of corn a short time ago when the SX7/CZ7 price ratio was 2.7:1 totally evaporated after Friday’s Plantings report which suggested a record 89.5 million soybean acres will be planted by U.S. farmers in 2017. At the closing 2.45:1 ratio Friday, the advantage actually swings towards corn a bit. In the end, it’s all about the weather over the next month. If it dries out, corn plantings will jump to 91.5-92 million in our opinion, while soybean acreage could fall to 88 or so million. If it stays wet, the pendulum will swing back to soybeans, despite the ratio, as they can be planted later than corn.
U.S. Ethanol Prices and Margins Climb
U.S. Ethanol Prices and Margins Advance during March. RIN values shot up after it was clear that the higher biofuels requirements for 2017 would not be rolled back. Hydrous ethanol values are becoming more competitive in Brazil. European ethanol prices tumbled during March.
U.S., Euro Area, and Japan All Appear to Be Doing Fine
This was a busy week for economic growth and inflation data releases in major developed economies. In the U.S., inflation data for February were about as expected, and did not point to a strengthening in the underlying price pressure. Consumer spending was disappointing in January and February, but other data indicated that the underlying pace of growth remains solid. Inflation slowed unexpectedly in the euro area. Japan’s economic momentum is shifting to a higher gear, according to industrial production data.
Propane Supply Pulled from Midwest to USGC
Propane exports out of the USGC remain strong despite alarmingly low inventories. In order to account for the large volumes coming out of PADD III, PIRA believes that PADD II production is flowing to the USGC to keep inventories afloat. While PADD III stocks moved down by 13 MB last week, PADD II stocks fell materially by 920 MB. In the total U.S., high exports and a slight hike in demand both contributed to the large 1.5 MMB draw in inventories. U.S. stocks ended the week 20.0 MMB below 2016 levels and were 42.8 MMB.
U.S. Stock Excess to Last Year Continues to Narrow
Overall commercial stocks drew 3.9 million barrels this past week with the entire draw in products led by another week of strong withdrawals from gasoline and distillate inventory. With crude runs ramping up 425 MB/D to 16.2 MMB/D, crude stocks were up just modestly even though imports were elevated. Now that crude runs are rising, supported by refiners returning from maintenance and strong margins, PIRA sees substantial crude stock declines ahead with next week’s EIA data showing a 530 MB/D crude inventory decline.
Warmth Creates Breathing Room for Next Winter
Continued warm weather that started in mid-February sends European demand into a tailspin with demand across major gas consuming nations falling by over 50% from mid-February to late-March. Adding to demand woes, the warm weather also brought increased renewable production. Wind production has been especially prominent with combined output from France, U.K., Germany, and Italy up nearly 10.8 GW year-on-year. The production masks underlying vulnerabilities due to still low hydro reservoirs and nuclear output. With demand hitting the breaks this winter far faster than normal, not only has a storage crisis been averted this winter, but storage facilities have also been able to shift to injection mode up to 3 weeks earlier than in some recent years. The gas savings (lower draws) from the unusually warm weather across Europe has been upwards of 6.5 BCM in the last 6 weeks. PIRA now sees gas stocks entering November at just below the 5 year avg. – 12% higher than our forecast last month.
Columbia basin precipitation remained much above normal in March boosting Apr-Sep runoff projections to over 120% of normal. Strong project inflows boosted March generation, prompting another sharp (~$10/MWh) drop in Mid-Columbia pricing. NP15 saw a similar decline. Smaller price reductions occurred at SP15 (-$6) and Palo Verde (-$1) where hydro plays a smaller role. While developments in the past month are unambiguously negative for Mid-Columbia prices, at southwest hubs, incremental inflows from the northwest will be largely offset by stronger gas prices. Mid-Columbia prices have been revised down through September, but southwest markets are little changed. Note that a new table has been included summarizing CAISO wind and solar curtailment data.
Stockpiles Rationalized in Jan., But Rise Over Balance of Winter
The EIA reported that U.S. coal stockpiles rationalized in January, falling to 157.4 MMst. PIRA’s models indicate that stockpiles rose over February and March as weather was generally warmer-than-normal and gas prices have at times traded under $3/MMBtu.
2016 EU ETS Emissions Declines Driven by Grid-Connected Power
European ETS verified emissions data for 2016 will be released April 3rd, one of the few official data points each year to assess EUA demand and market balances. PIRA expects 2016 EU ETS emissions (excluding aviation) will be down, driven by lower grid-connected power emissions across Europe, with particularly large losses in the U.K. and Spain. Increases in non-grid combustion emissions, especially in Germany and Poland, could moderate the overall drop, while expected changes to industrial emissions are relatively minor. PIRA does not expect major EU Carbon Allowance price gains in 2017, and this release could provide another bearish price indicator. However, data showing more market oversupply could also focus the attention of policymakers (in the midst of coordinating post-2020 reform efforts) on the need for additional supply-side market changes, offering EUA prices longer-term support.
U.S. Ethanol Prices and Margins Climb
U.S. ethanol production rose 10 MB/D to 1,054 MB/D the week ending March 24, equaling the third highest rate ever. Stocks increased for the first time in a month, building by 662 thousand barrels to 23.3 million barrels. PADD II stocks climbed to another record high 8.6 million barrels. Ethanol-blended gasoline manufacture dropped slightly to 9,023 MB/D from a 12-week high 9,075 MB/D in the preceding week.
Global Equities Shift Momentum Back to the U.S.
Following a couple of weeks of rotation out of domestic equities into international sectors, the momentum shifted back. The U.S. tracking indices were broadly higher, with growth outperforming defensive indices. The strongest performers were technology, retail, and banking. Energy posted a solid 2% gain on the week and performed more than twice as strong as the overall market. Internationally, Latin America did the best, along with Europe. Emerging markets, emerging Asia, Japan, and China eased.
Japanese Higher Demand Draws Product Stocks to New Low
Japanese crude runs continued to ease on the week in line with our maintenance schedules, while crude imports remained exceedingly low. Crude stocks drew 2.9 million barrels, but finished product stocks also drew 1.4 million barrels on higher aggregate demand. Finished products stocks moved to a new low. Kerosene demand rose moderately against seasonal tendencies, in an end-of-season effort to clean out inventories. Stocks drew at a rate of 79 MB/D. Without the yield rise and higher refinery output, the stock draw rate would have been even greater.
Weather Buoys Exports, But Upside Still Limited
The relatively restrained growth that took place during the fourth quarter belies the strength we see ahead for Canadian production. Yet, on balance, we are becoming increasingly less constructive on marketing opportunities for the upcoming injection season. Thanks to exaggerated heating demand gains in the U.S. Northeast and Midwest, net Canadian exports will be higher this month compared to year-ago levels. The underlying increase in trade was aided by WCSB production growth (that should continue based upon this winter’s robust drilling program) as well as hefty storage draws. Looking ahead, slow U.S. production recovery should enable Canadian supply to head south of its border. Yet, truth be told, more expansive export opportunities (envisioned back in January) will likely be limited by emerging cross-currents.
Harder for Public Oil Companies to Grow Oil Volumes
Public oil companies own nearly 40% of current crude and condensate supplies of ~80 MMB/D and its share is expected to remain at that level for the next twenty years. They operate mostly smaller assets with higher base decline rates. As a result, they require more volume growth to increase production. In addition, the cost to develop new volumes is much higher than for state companies. However, higher growth volumes from state companies are unlikely due to the political and economic constraints that they face.
More Tanker Capacity and LNG Supply Raises Question of Spot Rate Direction
Asia will renew its downturn in April and Henry Hub support – domestic demand growth outpacing supply growth – will squeeze margins on U.S. LNG exports. U.S. selling to Atlantic Basin markets will become more of an imperative, even if the volume largely avoids N.W. Europe.
Market Sentiment Drives Up Cape Freight Rates
The 5TC Capesize tripcharter rate surged to $18,000/day, helped by high levels of Cape fixing and optimism regarding China’s bulk demand. The strength in the Cape market leant strength to the smaller vessel markets, with both Panamax and Supramax rates tracking higher over the past month. There has been a considerable rise in booking Capes on one-year time charters over the last month which has driven period rates higher. PIRA expects the Cape market to cool in the short term but rebound in 2H17.
Imminent Shuaiba Shutdown Will Make Kuwait a Gasoline Importer
Kuwait National Petroleum Corporation (KNPC) is preparing to shut down the 190 MB/D Shuaiba refinery in April 2017. With the ensuing reduction in crude runs, Kuwait will become a marginal gasoline importer, while cutting heavy fuel oil exports to near zero and reducing the volume of other products available for export. The shutdown will also effectively allow for additional crude exports without violating the recent OPEC production agreement.
More Demand and Less Supply — a Recipe for Higher Prices
The onset of “Big Three” demand gains affords producers a long-awaited outlet for supply growth, but the challenge of rapidly transitioning from discipline to growth cannot be ignored. To be sure, Appalachian production will be capped by drilling limitations this year, even in the face of potentially 5 BCF/D of new pipeline infrastructure set to come on in the second half of the year. Given the slow convalescence of domestic production, increased industrial and export demand will have to be augmented in the near-term by demand destruction in the electric generation sector. Looking ahead, the possibility that a significant inventory deficit will emerge in advance of the heating season adds considerably to already increasing bullish market sentiment — keeping the 2017-2018 heating season prices firmly supported above ~$3.50/MMBtu.
January 2017 U.S. Crude Production Rises But Below Estimates
U.S. crude and condensate actuals for January 2017 came in at 8.83 MMB/D, up 60 MB/D month-on-month, down 359 MB/D year-on-year and 113 MB/D below PIRA’s forecast. The miss relative to PIRA’s Reference Case appears to be the result of pipeline freeze-offs and a longer than expected lag between drilling and completion activity, delaying the impact of a rising rig count.
Injection Season Commences with Supply in Decline
U.S. natural gas futures closed out 2016 at a calendar year high, making it the best-performing investment among major commodities last year. By the end of February, seasonal demand losses transformed the commodity into the worst year-to-date performer. Yet, with the winter heating season now officially coming to a close this week, the outlook for returns appears much more promising. To be sure, natural gas futures have already managed to gain ~15% this month, with the potential shortfall in storage threatening further upside ahead.
U.S. January 2017 DOE Monthly Revisions: Demand and Stocks
EIA just released its final monthly January 2017 (PSM) U.S. oil supply/demand data. January 2017 demand came in at 19.234 MMB/D, 296 MB/D lower than the weeklies. Total product demand increased 0.9% versus year-ago or 179 MB/D compared to the January 2016 PSM data. It was slower than the 1.9% gain posted for December. Kero-jet demand was the best performer, gaining 144 MB/D or 9.9% vs. year-ago. End-January total commercial stocks stood at 1,357.6 million barrels. Compared to final January 2016 PSA data, total commercial stocks were higher than year-ago by 43.5 million barrels, versus an excess of 46.1 million barrels seen at end-December.
Chinese Industry Feeling Gas Price Pain
Industrial gas users in south China’s Fujian province are unsatisfied with the local government efforts to shield them from a wholesale price hike, pointing out they are already paying significantly more than a year ago. Fujian’s capital Fuzhou, along with the cities of Quanzhou, Xiamen and Zhangzhou, passed on hike in citygate prices – which was driven by the rising cost of LNG imports – to end-users in December. Three ceramics producers in Fuzhou and Quanzhou told Interfax Natural Gas Daily the tariff hike increased their production costs by more than 15% in January.
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.