Global Oil Surplus is Mostly Gone
Booming world economic growth to stay strong and durable with credit conditions remaining constructive. Upward oil demand revisions continue. This demand growth together with the OPEC/non-OPEC cuts have substantially reduced surplus stocks in 2017. OPEC’s surplus stock estimate is way too high for it ignores required stocks for both new infrastructure and for increased U.S. crude and product exports. Hence, OPEC is likely to keep the cuts longer than necessary with a resulting positive benefit to prices. 2017’s 1 MMB/D flow deficit together with strong demand growth keep stocks declining in 2018 despite overall supply exceeding demand growth. Crude oil prices are revised up again. The upside risk to prices remains supply interruptions with many countries looking vulnerable while the downside risk is U.S. rig count resuming its upward trend. The call on refining is very strong and will continue to support relatively robust margins, even in the least sophisticated capacity. Gasoline cracks stay healthy while diesel cracks increase further assuming normal weather. WTI-Brent strengthens but stays wide enough to allow U.S. exports. Brent-Dubai generally will have to be weak enough to keep the arb open from the Atlantic Basin to Asia.
U.S. and Europe Ethanol Prices Bottom in October
U.S. manufacturing margins decline. RIN prices jump. Brazil ethanol output in the South-Central region drops in the first half of October as the harvest winds down. U.S. biodiesel output of 149 million gallons in August equals a record high.
Liftoff Delayed – Not Cancelled
More than a few physical traders have commented that this month’s bid-week felt more like a lackluster injection month, rather than the kick-off to the heating season. When considering the direction of winter prices, it is critical to understand that the sub-$3 futures settlements for November are sending a strong message about supply concerns. Yet, we see the market messaging evolving as the industry begins to clear excess supply. Indeed, it bears mentioning that Henry Hub cash prices last December averaged $1 over November, with the arrival of more seasonal temperatures. Should cold weather arrive early, it is easy to imagine a step-change in cash prices unfolding next month.
Fall Maintenance/Summer Heat
The return of extreme temperatures to Southern California in late October coincided with seasonal outages of generation (including Palo Verde 1) and transmission (including the PDCI) along with limitations on gas imports to the region. Prices at Southwest hubs spiked lifting October monthly averages well above projected levels. National gas price forecasts have been revised down, but low storage and pipeline constraints could support renewed upside volatility at the SoCal citygate under colder than normal conditions this winter. Columbia River basin precipitation has begun the new water year slightly above normal. The return of La Niña conditions this winter could result in increased heating demand and a larger, later runoff.
Winter Risks Remain at the Forefront
Seaborne coal prices were again on the rise over the past month, on low stockpiles in China and India, and underwhelming supply. PIRA continues to assert that the risks remain to the upside over the short-term, as seasonal demand has not yet reached peak levels. However, the pricing risks shift to the downside in 2Q18 and beyond as Chinese imports fade and LNG prices become more competitive with coal in the global market.
PJM REC Balances to Tighten in 2018
Prices for PJM tri-qualified (PA, MD and NJ) Tier 1 RECs continued to fall this year, reflecting oversupply. Secondary market trading volumes were strong in the first part of 2017, dropping off after the end of the compliance year; current OI represents about 1/3 of the annual RPS obligation. The REC bank will grow again in 2017, but balances narrow in 2018. Large spot REC procurement needs to satisfy the IL RPS represent a major wildcard. PA legislation limiting out-of-state solar affects supply for that market. Increases in REC requirements taper off after 2020, and a transmission line project could deliver significant renewable energy supply to the region. However, the phase-out of federal tax incentives puts upward pressure on long term REC prices, and PIRA expects extensions to state RPS targets.
Crude Rises as Global Surplus Shrinks; WTI Discount Widens
WTI prices are now over $57/Bbl, as the global oil surplus continues to shrink and geopolitical risks to supply grow. The spread between Cushing and Gulf Coast crudes widened, as PADD III crude stocks fell sharply in October, while Cushing stocks rose 1 MMB. Once local refining maintenance concludes this month, Cushing stocks will fall rapidly, with WTI moving into backwardation, as the wide spreads will incentivize shipments south out of Cushing, while new pipelines in the Permian Basin will take barrels away from Cushing and move them to the coast. Additionally, the Diamond pipeline will begin shipping Cushing crude to Memphis in a few weeks. The increasing volumes of crude reaching the Gulf Coast will both go to satisfy refinery demand and to sustain crude exports at record levels, as the export arb stays wide open through at least year-end. Midland grades have begun to strengthen with the new pipeline additions, and Midland Sweet will likely trade at a premium through the first half of 2018. New oil sands projects starting up in Alberta will cause light grades to weaken from current strong levels, while heavy differentials weaken further and move toward Gulf Coast rail parity.
Rebounding U.S. Jobs, Synchronized Grobal Growth, and Continuing Constructive Credit Conditions
Hurricanes Harvey and Irma caused great destruction during August and September, and created distortions in key U.S. economic data. Distortions remain in recent data, but the dust is starting to settle, and the emerging picture is of an economy picking up steam. Specifically, employment data for October were constructive, and confidence indicators sent encouraging signals. But an increasing tightness in the labor market is not yet resulting in sharply higher wage growth. Meanwhile, Europe, emerging Asia, and commodity-intensive emerging economies are also showing strength – indications are that the positive momentum is spreading globally through trade and other channels.
Mild Fall Weather Leads to a Boost in Propane Inventories
U.S. propane/propylene inventories increased by 726,000 bbl for the week ending October 27 according to the EIA. While propane exports remain strong, domestic res/com demand has been soft due to mild fall weather. In response, propane prices ran counter to crude and gas prices last week with propane prices falling 1.5% to 96.9 cents/gal. In contrast, ethane prices rose 4.4% to 27.25 cents/gal. Ethane is the most economical U.S. steam cracker feedstock but due to rising ethane prices coupled with an 8.6% decline in ethylene prices, ethane’s steam cracker margin fell 11.9% last week to 18.2 cents/lb of ethylene, which is the first time since 30 December 2016 that the ethane steam cracker margin has been under 20 cents/lb of ethylene. Propane exports beat expectations and topped 1.0 million b/d for the week ending October 27. Platts Analytics expects propane exports to drop to about 800,000 b/d for the week ending November 3 based on lower ship activity at Gulf Coast LPG terminals. U.S. LPG cargoes to Asia have been supported by the extension of the October propane Saudi CP of $575/mt into November pricing, which makes landed U.S. propane in Asia cheaper than landed Middle East barrels.
The November WASDE splits this trading week with its midday release on Thursday. Looking over the CFTC Commitment of Trader’s report, positioning appears to be in line with the general consensus that corn yields will be raised while much uncertainty still looms over the size of the soybean crop. The week is also expected to bring improving soil moisture conditions to the main soybean growing areas in Brazil, which should be the market driver late in the trading week after the WASDE release.
Venezuelan Default Saga Evolves
On November 2, Venezuelan President Nicolas Maduro stated intentions to restructure or refinance all future debt obligations, but only after making a final $1.12 billion PDVSA principal payment on November 3. Payments on principal and interest became increasingly delinquent throughout October, indicating a notably higher risk of default in 2018 (when the government and PDVSA owe a combined ~$9 billion). A default could disrupt Venezuelan exports because of potential creditor claims on its cargoes, but with most Venezuelan oil sold FOB this risk appears limited. However, concerns on the part of Western buyers could cause even more crude to head to Asia. PIRA understands 850 MB/D of October’s export program of 1.6 MMB/D went to Chinese, Russian, and Indian buyers, with only 500 MB/D headed to the U.S. Meanwhile, CITGO’s status as an “insulated subsidiary” makes it unlikely to be dragged into PDVSA bankruptcy proceedings, and apparently has only been importing 80 MB/D of Venezuelan crude. Regardless, oil investment is likely to be squeezed, raising downside production risk to PIRA’s forecast. We currently assume 90 MB/D of crude declines between 4Q17 and 4Q18, to 1.8 MMB/D.
Storage is Well Prepared for Short-Term Cold, Less So Seasonally
Optimizing seasonal storage has not been one of the market’s most profitable jobs for some time. One of the main problems has been the low summer/winter spreads that still plague the market – even in the wake of the Rough storage closure. Seasonal spreads have been recently trading at 7.3 p/th on the NBP compared to more than double that for summer’12 /winter’12. With storage entering the month 4-BCM higher than normal and 2-BCM short of record levels, one would think that most storage facilities would be brimming and ready to withdraw. When digging into the numbers, one can see how the market is shifting towards more flexible storage with more cycling ability and away from facilities with longer emptying periods. This coincides well with gas’ future as a more flexible source of supply, as the market moves more towards a balancing role for renewables.
Has India’s Power to Move the Market Been Underestimated?
As JKM takes another giant leap forward this week despite even more bearish fundamental indicators (Wheatstone loads a first cargo for Japan just as Japan demand continues to plunge), our attention turns from China to India. The consensus among traders has been that a series of winter spot tenders for China has tightened up the spot market considerably. Yet as shortages in coal stockpiles at power plants around India register close to historic lows, it may be that India is driving this unexpected price surge, at least in part.
As Wind Blows, Coal-to-Gas Switching Remains a Limited Feature in Germany
The high price volatility observed in recent weeks in Germany is the result of large swings in wind output. Last year the hourly dispatching profiles for coal and gas tracked each other across most of the wind spectrum, suggesting that the two technologies were responding in similar fashion to variations in wind output. By contrast, this year the two profiles overlap only when wind is low, but overall the gas profile is flatter than the coal one. In particular, gas plants do not seem to ramp down as much as coal, most likely the result of already low average dispatching levels for gas.
Reports of Chinese Port Constraints Limits Coal Pricing Upside
Coal prices continued to move higher in the first half of the week, on tight market conditions heading into the winter peak season, although prices shifted lower on news of import constraints at Southern Chinese ports and lowered nuclear generation risks in France. While fundamental pricing risks remain to the upside in our view if Chinese imports are constrained by policy/quotas, FOB Newcastle prices could move closer to $90/mt than $100/mt over the next 90 days.
U.S. Another Stock Decline
Overall U.S. commercial oil inventories declined again last week by 5.8 million barrels as crude oil inventories uncharacteristically declined by 2.4 million barrels, bucking the historical trend, while product stocks drew 3.4 million barrels led by a sharp decline (-4.0 million barrels) in gasoline. Commercial U.S. inventories are now down 75 million barrels versus last year, a testament to global oil market rebalancing and the success of the OPEC/non-OPEC cuts. Demand has been especially weak, except for gasoline and jet, but is forecast to pick up in the weeks ahead. Cushing crude stocks built 0.09 million barrels this past week and probably have one more week to build with a 0.8 million barrel stock build forecast for next week’s EIA report. In sharp contrast, overall crude inventories drop 5.7 million barrels this week as runs increase and imports fall, another counter-seasonal stock decline. All three of the major light products show significant stock decline in this week’s EIA report, rounding out another week of bullish data.
Credit Indicators Perform Well, Amid More Record Highs
Credit conditions remain highly constructive, with the S&P 500 continuing to set new records. Volatility declined about -7.9%. Energy was particularly strong and this spilled over into certain credit indicators. Overall investment grade credit gained about 0.7%, while investment grade energy and high yield energy credit were up about 1%. Overall high yield (HYG), was lower by -0.6%, while emerging market debt was down -0.3%. The dollar was little changed on a DXY basis. The St. Louis financial stress indicator ticked higher on the week.
U.S. Ethanol Output Increases again the Week Ending October 27
U.S. ethanol production rose sharply for the third consecutive week, increasing from 967 MB/D to a near-record 1,056 MB/D over that time. Total inventories built by 440 thousand barrels last week to 21.5 million barrels, nearly erasing the 446 thousand barrel draw during the preceding week. Ethanol-blended gasoline production rose for the fifth time in six weeks, increasing by 3 MB/D to 9,185 MB/D.
The Blame Game
Too often the blame for low grain prices gets set squarely on the shoulders of the Non-Commercials. Fund traders are always wrong when they’re heavily short, like now, but rarely mentioned when they’re long. Too often we hear, “the shorts will get squeezed soon” or “they’ll have to get out at some point” by those dissatisfied with price, which is obviously the farming community that we monitor quite closely. U.S. producers are on the record as saying they will not sell at current prices, in essence trying to squeeze the Non-Commercial shorts in corn, but will a time come when they don’t have a choice?
U.S. Gas Weekly Report
Thus far this week, Henry Hub cash prices have averaged ~$2.75/MMBtu — a slight decline from the prior week’s average of ~$2.85/MMBtu. From the standpoint of total U.S. supply and demand, such declines conflict with balances tightening W/W by ~7 Bcf/d. Yet, beyond ongoing worries about subpar heating demand, bearish sentiment is also being stoked by robust U.S. production. In particular, onshore production averaged a record ~72 Bcf/d, ~0.5 Bcf/d more than the prior week.
Japan Runs Ready to Rise, with Higher Demands Absorbing Supply
The key takeaway in the data last week was a solid demand performance, which drew finished product stocks. If demand continues to perform well, it will readily absorb the increasing refinery output resulting from reduced maintenance. Runs were unchanged, with lower crude imports, which drew crude stocks 2.35 MMBbls. Gasoline demand rose again, last week by 47 MB/D, and beat expectations. Stocks drew on lower refinery output and slightly higher exports. Gasoil demand also rose again and stocks drew 0.44 MMBbls (63 MB/D), similar to the previous week and close to yearly lows. Kerosene demand also again rose, last week by a strong 108 MB/D. Stocks saw an accelerating draw rate of 85 MB/D, with the 4-week build rate easing to 37 MB/D. The deficit position vs. year-ago remained about 1 MMBbls. Refining margins remain strong and supportive of the run rise that will be forthcoming. The indicative marketing margin has again been easing as refining margins have held firm. Both gasoline and gasoil/diesel are below statistical norms, with gasoil/diesel showing the larger variance.
Global Equities Setting More Record Highs, but Some Rotation Noted
Global equity markets continue to set more broad based records in a host of countries and across a host of market indices, but some sectorial rotation was noted. In the U.S., the S&P 500 was again modestly higher on the week, but set new records. The best performing sectors were energy (+1.9%), and technology (+1.65), while housing (-1.9%) and banking (-1.1%) were the laggards. Internationally, tracking indices generally performed better than those in the U.S. Japan was higher by +1.3%, emerging Asia higher by +1.1%, while world, ex-U.S., gained +0.8%. Latin America fell -3.6% and driven by weakness in Brazil and Mexican markets.
U.S. August 2017 DOE Monthly Revisions: Demand and Stocks
EIA just released their monthly August 2017 (PSM) U.S. oil supply/demand data. August 2017 demand came in at 20.161 MMB/D, which is 33 MB/D lower than PIRA had assumed, and 772 MB/D lower than the weeklies had indicated. Total product demand growth slowed and turned modestly negative, -114 MB/D or -0.6% versus year-ago. Even so, the negative performance was concentrated in “other” product demand, a decline of 373 MB/D or -8%. All the major products showed demand gains and outperformed. Middle of the barrel demands continued to post strong growth, with distillate demand higher by 112 MB/D or 2.9%, and kero-jet higher by 47 MB/D or 2.7%. End-August total commercial stocks stood at 1,307.4 MMBbls, which were 6.6 MMBbls lower than PIRA had assumed. Crude came in 5.6 MMBbls lower and products were 1.0 MMBbls lower. Compared to the preliminary weeklies, total commercial stocks were revised down 2.0 MMBbls, with crude lowered 2.4 MMBbls, and product raised modestly. Compared to August 2016 PSA data, total commercial stocks are now lower than year-ago by 63.9 MMBbls vs. 52.4 MMBbls at end-July.
U.S. Production in August Declines on Hurricane Harvey
U.S. crude and condensate actuals for August 2017 came in at 9,220 MB/D, down 32 MB/D month-on-month, up 440 MB/D year-on-year. The drop is concentrated in Texas and the Gulf of Mexico due to Hurricane Harvey. PIRA’s Reference Case outlook calls for U.S. crude and condensate production to grow 420 MB/D in 2017 and 730 MB/D in 2018.
October Weather: U.S. and Europe Warm, Japan Cold
October weather for the three major OECD markets turned out to be 4% warmer than the 10-year normal and the resulting oil-heat demand impacts were 222 MB/D below normal. On a 30-year-normal basis, the markets were 15% warmer.
Aramco Pricing Adjustments: Fundamentally Justified Tightening of Terms
Saudi Arabia's formula prices for December were just released. Prices were tightened on most crudes in the key refining centers. The adjustments were justified by changes in the market drivers that Saudi focuses on when setting prices. Volume is clearly not being pushed, while refiner demand remains high and increasing. Global runs rise 1.8 MMB/D in November vs. October, and then an additional 1.4 MMB/D in December. The adjustments to Asia were in keeping with the change in Dubai market structure, while European pricing was tightened in line with a reduced discount on Urals vs. Dated Brent.
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.