PIRA Energy Market Recap for the Week Ending December 4, 2017

15PIRALogoGlobal Supply/Demand Balance Continues to be Supportive

Clear sailing for the booming global economy. The resulting strong oil demand growth together with OPEC cuts have accelerated rebalancing, virtually eliminating the global surplus. OPEC continues to overestimate the global surplus, ensuring the cuts will stay longer than required. In PIRA’s view, the market’s focus on duration of cuts is misplaced; the OPEC cuts are perpetual. Non-OPEC cuts, which have been minimal, will fade in 2H 2018. The vulnerability for crude prices in 2018 comes during the weak seasonal first half when stock builds undermine backwardation causing some financial length to exit oil markets. Strong demand for refined products is outstripping refinery capacity growth, increasing utilization rates in swing refineries and raising refinery margins. U.S. crude exports will trend higher and inland U.S. differentials will firm as Cushing draws crude stocks. Middle East tensions are rising and supply vulnerability is ever-present.

Any Way You Slice It, It Is Difficult to Locate Trouble Spots in the Global Economy

Growth in world trade rose at its fastest pace since 2011 during the third quarter. Based on leading indicators, trade will continue to expand at a solid pace. Recent global industrial production has similarly been strong. Labor markets are tightening in the U.S., Europe and Japan, but core inflation figures have not been accelerating. India’s growth slowed in the first half of 2017 after disruptions from major policy changes. But key data pointed to a rebound during the third quarter. A historical relationship between world GDP and a number of economies having difficulties suggests faster global economic growth in 2018.

Propane Stock Draws Muted by Increases in Propane Production and Imports

Propane exports topped 1.1 million b/d for the week ending November 24, but the effect on stock draws was muted by increases in propane production and propane imports. Propane production increased 50,000 b/d to a record high 1.92 million b/d, and propane imports from Canada jumped 85,000 b/d to 231,000 b/d. The net impact on inventories was a moderate draw of 560,000 barrels. Propane prices fell 1.25% last week settling at 98.875 cents/gal. However, propane price strength has closed the Asian arbitrage window, and shipment cancellations are reportedly on the rise in early December. Increasing NGL production is having a bearish impact on ethane prices as steam cracker demand remains relatively stable at present levels until the next wave of steam crackers come online next year. There are no scheduled Gulf Coast steam cracker turnarounds this winter. Declines in ethane prices last week supported ethane steam cracker margins, which increased 1.7% to 22.1 cents/lb ethylene production. Ethylene and propylene prices fell last week as producers are clearing year-end inventories, which led to a decline in all other steam cracker feedstock margins.

U.S. Ethanol Manufacturing Margins were Stable in November

RIN values declined. Ethanol output increased in the South-Central region of Brazil in the first half of November. European ethanol prices were lower. U.S. biodiesel prices rose.

Argentina Weather

Dryness in Argentina has the soybean market’s full attention entering the first full week of December after forecasters had started to warn that a relatively dry month was a possibility for growing regions as the calendar turned to the final month of the year late last week. For a market that’s starving for any sort of input, and probably won’t get any non-weather data until the January WASDE, a dry weekend to go with a forecasted dry week was enough to gap higher by a few cents on Sunday night and push prompt bean futures to their highest level since the end of July.

U.S. Gas Weekly Report

The long holiday weekend helped Henry Hub fall below $3/MMBtu for the first time since November 6. The national benchmark has averaged $2.93/MMBtu over the past seven days, down 9 cents/MMBtu (3%). The December 2017 future contract whipsawed through the last week of trading, reaching as low as $2.81/MMBtu on November 24 before settling at $3.07/MMBtu on its last day of trading on November 28 —its last day of trading. In spite of surging production, expectations of cool weather for the first half of December sparked the rebound. U.S. weather forecasts remain in flux, favoring relatively warm conditions then cold and then back to warm. Today, the nearby NYMEX is again rallying following yesterday’s sharp selloff, suggesting yet another shift in demand expectations.

Walking a Tightrope, Little Slack Without Mild Temps

Winter-like weather arrived early in November after a significantly warmer than normal October, and December is beginning with frigid temperatures that are raising German demand by 15%. While this additional demand will likely lead to some price appreciation, there will be limited ability to balance gas through the power market as inefficient coal power is cheaper than efficient gas power. Additionally, LNG re-export activity is worrying a market that already feels tight after TTF spot has increased upwards of 42% from summer lows, however, export activity YTD has been relatively muted historically speaking. Despite this, the coming months show significant re-export risks, as global spreads have widened – meaning upward European price pressure.

Germany Tightens, French Restarts Loom

In France, all 12 reactors under review this year for the Le Creusot Forge irregularities have been cleared, but only six have officially restarted, after lengthy delays (14 days). While output in November set a new historical minimum, we assume that the December output will be 49.8 GW (only 0.5 GW above year ago levels), with January assumed to average 54.7 GW, up 0.7 GW Y/Y. In other words, we see upsides for French prices, as we still have output 1 to 2 GW below the 5-year average. In Germany, scarcity prices are increasingly emerging – even at relatively higher temperatures and/or wind output levels. While there is still no agreement in sight to form a government, the hypothesis of additional lignite closures is now shaping up, either to allow Germany to move closer to the carbon targets or as a result of tougher emission standards mandated under the updated LCP BREF. In a scenario where 3 GW of additional lignite units are retired on top of the climate reserve, German 2020 prices should be up by €1.1/MWh, but that impact increases to €1.9/MWh, when 5 GW of lignite unit retirements are assumed. The introduction of a minimum carbon price – or equivalent increases in the EUA prices, assuming the current reform of the EU ETS tightens the market successfully – could potentially have a larger impact.

Downstream Markets will Remain Strong

The Brent price outlook remains bullish in December but is more vulnerable in 1H18 as stocks draw in December but build in 1H18. Nevertheless, the available commercial inventory excess net of working stocks has essentially been eliminated in the OECD. WTI’s discount to Brent will narrow as Cushing drains in 1Q18. U.S. crude exports are expected to trend higher with USG pricing remaining in export parity.

Refinery margins will stay strong as strong demand growth for refined products, limited growth in available refinery capacity outside China, and poor refinery operations in Latin America will require high utilization rates in Europe even in some less economic capacity to balance Atlantic Basin product markets. This will support margin strength through 2018.

SP15 Rockets Higher as Gas Curtailments Loom

With gas market tightness boosting late November SoCal Citygate spot gas prices above $5/MMBtu despite mild weather, December gas prices soared to $6 amid talk of curtailments, driving local power markets higher. We have increased SoCal citygate gas basis forecasts for December and January to $1.50/MMBtu and $1.10/MMBtu, respectively, equivalent to $4.70 and $4.50, so there is clearly upside risk from these levels. Higher gas prices will lead to downward pressure on implied heat rates, particularly in January as transmission availability from the Southwest improves. November SP15 implied heat rates averaged in the low 9,000s and we expect December to be in the high 8,000s before a sharp drop in January (~8,000). That would result in December on-peak just under $50 compared with market forwards about $10 higher. Other Western markets are in line with previous forecasts, but downside risk is growing as runoff projections are beginning to climb. This may be countered in the near term by colder than normal weather in the Northwest.

Coal Prices Range Bound…For Now

International thermal coal prices faded over the first three weeks of the month, only to regain most of the ground lost in the final week of November. The market was clearly uneasy with the pace of pricing declines at the start of the peak demand season. Short-term prices retain upside risks due to seasonal demand issues as well as potential supply disruptions from intensifying la Niña conditions. However, 2018 prices will face heavy bearish pressures from weaker coal demand in China, and more intense competition with LNG on the global stage.

MA Announces Exempt Loads for RPS

Exempt loads play a large role in determining the Solar Carve-Out compliance obligations for the MA Renewables Portfolio Standard. MA DOER has updated prior exempt loads projections and for the first time has provided loads served by contracts before the SREC II May 8, 2016 cut-off date. PIRA’s updated RPS demand estimates show lower SREC I obligations in 2017 vs. 2016, with SREC II much higher. 2018 will see significantly higher solar requirements. The Clean Energy Standard, finalized in August 2017, effectively raises the Class I RPS obligation beginning 2018.

Product Tanker Rates Stronger as U.S. Refiners Restore Full Operations

VLCC and Suezmax markets weakened in November and will likely head lower in December as excess supply and OPEC cuts weigh on tanker markets. But product tanker rates recovered as U.S. refinery runs and product exports ramped higher over final months of year following completion of October maintenance and recovery from residual effects of Hurricane Harvey.

Financial Stresses Move to a New Low

The S&P 500 extended its gains above the 2,600 level and tested 2,650, for the first time, setting more records along the way. Volatility (VIX), however, increased significantly, though oil volatility (OVX) was lower. Other credit metrics, such as high yield debt (HYG), and emerging market debt (EMB), weakened. Commodities were modestly lower, but industrial metals and precious metals lost notable ground. The dollar was modestly higher. The St. Louis financial stress indicator moved sharply lower to a new cyclical low.

U.S. Stock Draws Resume

Overall commercial stocks fell 7.6 million barrels this past week as imports declined and demand increased, widening the year on year stock deficit by 8 million barrels to 89 million barrels, or 6.6%. Both gasoline and distillate showed substantial inventory builds because of weak seasonal demand and high run rates (+720 MB/D Y/Y). Crude stocks drew 3.4 million barrels last week with Cushing crude drawing 2.9 million barrels, the largest weekly draw this year reflecting the Keystone outage. With the Keystone outage largely continuing for next week’s EIA report, Cushing draws 2.8 million barrels of crude while the overall crude stock decline is forecast to be 6.4 million barrels because of higher runs and a sharp reduction in SPR barrels, now that the latest sale is virtually complete. Gasoline and distillate show another large inventory build next week while a rebound in jet demand pulls its stock lower.

Stocks are up 3.6 Million Barrels from this time Last Year

U.S. ethanol production fell to 1,066 MB/D last week, dropping 8 MB/D from the record high 1,074 MB/D set during the preceding week. Despite the decline, output during the holiday-shortened week was still the second highest on record. Total inventories built by 147 thousand barrels to a 19-week high 22.0 million barrels. Stocks are up 3.6 million barrels from this time last year, with Midwest stocks 1.8 million barrels higher. Ethanol-blended gasoline production decreased by 34 MB/D to 9,077 MB/D.

Short-Term Forecast Shows Next Major Supply Push Extended to 2019

PIRA has extended the short-term supply/demand forecast through December 2019. The short-term JKM, NBP, and HH forecasts have also been extended. While we see the market loosening up considerably in 2Q’18, the next major slug of incremental supply is likely to be extended out to 2019. This assumes a much slower ramp-up of the Australian Wheatstone, Ichthys, and Prelude projects over 2018 and an extended ramp-up to full capacity in the US of Cove Point over 2018.

Ukrainian Industrial Gas Prices on the Rise

On December 1, 2017 Naftogaz Ukrainy increased the price of gas sold to industrial consumers on a prepayment basis by 2.4% compared to November. According to the company, this price is relevant for consumers buying gas on a prepayment basis in the amount of more than 50,000 cubic meters per month if there are no debts to the company – this price also applies to 100% subsidiaries of Naftogaz. For other buyers the price, which already was higher, increased by 2.3%.

ISONE 2021/2022 Capacity Auction: S&D Bearish for Price

Our expectation of a $3.60-$4.20/kW-month clearing price in the upcoming Forward Capacity Auction (FCA 12) for the 2021-22 capacity commitment period (CCP) is below the FCA 11 clear of $5.29/kW-month due to looser supply and demand factors. Weaker peak demand expectations have lowered the demand curve and installed capacity requirement (ICR). The linear part of the demand curve also moved further to the left due to a lower adjustment related to the transition to the Marginal Reliability Impact (MRI) curve. Supply also looks higher with more existing Demand Response (DR) resources and state policies favoring clean generation additions.

Japan Still Higher Runs, but Rising Prices Might be Hurting Demand Performance

The key takeaways are that runs continue to rise, and while kero demand has kicked up, other demands look lackluster. On the week, crude imports eased back and crude stocks drew 3.43 MMBbls, while finished product stocks drew slightly due to a good draws in gasoline and kerosene. The market remains largely balanced, for now, but demand performance needs to step up so to absorb higher runs. Implied refining margins eased slightly, but remain decent. Retail prices continue to rise and that “push through” again accelerated last week, with the indicative marketing margin taking another jump higher.

Global Equities Set More Records

Global equity markets set more records this week, with the S&P 500 trying to test the 2,650 level for the first time, and gaining about 1.6%. The strongest domestic sectorial performers were banking (+5.9%), retail (+4.8%), and housing (+3.3%). Energy also outperformed, higher by 2.7%. Internationally, most of the tracking indices lost ground, with the weakest being China, emerging Asia, and emerging markets, all lower 4-5%.

EPA Sets Final Mandates for Biofuels for 2018 and Biomass-based Diesel for 2019

The requirements and standards are similar to what was proposed in July, but the requirements for advanced biofuel was much lower than what was originally specified in RFS2

U.S. September 2017 DOE Monthly Revisions: Demand and Stocks

EIA just released their monthly September 2017 (PSM) U.S. oil supply/demand data. September 2017 demand came in at 19.581 MMB/D, which is 284 MB/D higher than PIRA had assumed, but 635 MB/D lower than the weeklies had indicated. Total product demand “growth” slowed further and became somewhat more negative at -176 MB/D or -0.9% versus year-ago. However, Gulf Coast hurricanes were a headwind and hampered performance, particularly impacting petrochemicals, where NGL demand was down -3.4%. Key transportation fuel drivers such as the American Trucking Association’s “for-hire” truck tonnage index continues to post accelerating growth into October, with gains vs. year-ago reaching 7.3%, while the Federal Highway Administration’s vehicle miles travelled growth pattern has slowed since May and stood at only 0.3% vs. year-ago in September. End-September total commercial stocks stood at 1,304.7 MMBbls, which were 12.6 MMBbls higher than PIRA had assumed. Compared to the preliminary weeklies, total commercial stocks were revised higher by 10.5 MMBbls, with crude raised 4.5 MMBbls and product raised 6.1 MMBbls. Compared to September 2016 PSA data, total commercial stocks are now lower than year-ago by -51.4 MMBbls vs. -63.9 MMBbls at end-August. While the end-Sept crude deficit narrowed vs. Aug, the product deficit grew.

World Biofuel Output to Reach 3.4 MMB/D by 2030

Ethanol production to grow at a 2.8% CAGR. Bio-mass based diesel is projected to make up 3.5% of the world diesel supply by 2030.

November Weather: U.S. and Japan Cold, Europe Warm

November weather for the three major OECD markets turned out to be 10% colder than the 10-year normal and the resulting oil-heat demand effects were 191 MB/D above normal. On a 30-year normal basis, the markets were 1% colder.

Saudi Arabia: Big Gain in Latest FX Reserve Data Could Be Misleading

Saudi Arabia just reported its latest foreign exchange reserve holdings for end-October, which showed a huge month-on-month uptick of $8.1 billion. This was the best month-on-month gain since October 2013. The three month average draw rates slowed to only $0.4 billion, the best since October ‘14. The sudden improvement, however, probably reflected a booking of proceeds from the $12.5 billion bond sale that occurred in late September.

Texas Leads September Production Growth

U.S. crude and condensate actuals for September 2017 came in at 9,510 MB/D, indicating growth of 300 MB/D month-on-month and 950 MB/D year-on-year. Texas growth leads the production surge, with the U.S. reaching volumes not reported since March 2015. PIRA’s Reference Case outlook forecasts U.S. crude and condensate production growing 360 MB/D in 2017 and 730 MB/D in 2018.

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. To read PIRA’s Market Recap first, subscribe to PIRA Perspectives here.