The Gathering Storm

Oil markets face significant tightness ahead. Despite recent volatility in risk assets, the global macroeconomic backdrop remains solid. Crude stock builds since the start of the year have been substantially smaller than normal, and stocks are well below 2011-2014’s relatively low levels after adjusting for higher required inventory given new infrastructure and supply/demand logistic changes. In this environment of very little stock cushion, global refining runs are forecast to rise by 2.5 MMB/D between March and July/August. And we see huge crude stock draws ahead, though there is some short-term indigestion absorbing prompt crude oversupply, particularly WAF. Geopolitical risks to supply are formidable (Iran, Venezuela, Yemen, Libya) and something is likely to go wrong over the next few months. We believe OPEC cuts will persist beyond 2018, as Saudi Arabia takes the lead in assuring market management will continue into the future. U.S. shale crude and condensate is forecast to grow strongly, but upside in the short term is limited given that producers are focusing on strengthening balance sheets and have hedged at lower prices. For 2019, global supply outpaces demand by 1.1 MMB/D, eliminating 2018’s flow deficit. But stocks will remain at relatively low levels. Refining margins are strong in 2018. Bunker spec changes in 2020 will be very disruptive. Changes in operations and prices will accelerate in 2H19 with much wider clean-dirty product spreads and crude quality differentials.

U.S. Ethanol Followed Corn Prices During March

U.S. ethanol prices followed corn values lower during most of March until last Thursday when a bullish USDA Prospective Plantings report caused prices to spike. D6 RIN prices have been on a rollercoaster ride since mid-February and are currently around 45¢ after falling below 40¢ earlier in March. To the dismay of the U.S. biodiesel industry, Congress’s $1.3 trillion spending package did not reinstate the biomass-based diesel blending credit that expired at the end of last year. Brazil’s South-Central region officially began its new harvest on April 1. Higher mandates in some EU countries contributed to an increase in biofuel imports and a decline in exports.

Gas Markets Scrape Their Way Out of Winter, with Impact of Empty Storages to Reverberate

Winter-17 has not moved gently into April, and European gas markets will be feeling its impact via bone dry storage facilities for many months to come. As the dust begins to settle we take a look back to identify how we’ve found ourselves in this position, before looking forward through summer-18 to work out how to get out of it. What’s clear is that we’ll need to start injecting aggressively very soon if we’re going to rebuild stocks before winter returns. Higher gas prices and stronger renewable generation will help reduce demand year-over-year, but we’ll also need to see a step up in supply to fill the gap. Here we expect Russia to step up further, and LNG deliveries to return to Europe, with markets somewhat thankful that Groningen’s more aggressive permit reductions are confirmed to be weighted toward 2020 onwards. Refilling storage deficits is quite a task, with failure meaning that prices next winter could look very similar to those seen over recent weeks.

Bullish Gas and EUAs Support Power, but Hydro Recovery Limits Short-Term Upsides

With March data confirming that hydro output will remain at multi-year maxima (+2.5 GW year-over-year in 2Q and 2 GW in 3Q), we believe short-term upsides for French prices will be more limited. However, our fundamentally-derived prices maintain a fairly large premium over the market quotes, as we factor in risks of delayed nuclear restarts. German forward prices have found support in surging EUA prices, with the recent rise in price anticipating the trend we expected from 2019 onwards as a result of the Market Stability Reserve. Short-term coal-gas fuel switching economics have been acting as the price-setting mechanism in the EU ETS market, more than what we have seen in the last few years. With gas prices buoyant due to extremely low stocks and with lower coal prices, coal-to-gas switching economics have been underpinning EUA prices and a potential continuation towards higher carbon prices is possible, based on fuel-switching economics. An upgrade to our renewable forecasts, based on recent dispatching trends, has left our German forward prices largely unchanged relative to our prior outlook, but we’re still above the market, as we still see coal largely in a setting position during baseload.

Southwest Summer Tightens While Northwest Braces for Hydro Glut

Falling gas prices led to month-over-month power price declines at most Western hubs in March, overcoming the bullish impact of colder than normal weather and lower hydro output. Rising Permian basin supply weighed on Western gas markets with most hubs recording price declines even though Henry Hub was nearly unchanged. While California hydro output will remain down year-over-year going forward, upward revisions to Columbia basin hydro generation will lead to weaker prices and heat rates this summer. Forecasts of above normal precipitation during the next two weeks have pushed April-September runoff projections to 115% of normal. Water releases in April will also be inflated by the need to reach falling flood control elevations at storage reservoirs. In the Southwest, in addition to lower hydro, retirement of Etiwanda 3 and 4 along with the previous shutdowns at Mandalay and San Juan imply the region will head into summer with 1.8 GW less dispatchable capacity.

Coal Prices Correct Downward on Weakening Chinese Fundamentals

Coal prices shifted considerably lower of March as coal demand fundamentals in China faded, and seasonal demand eased. Chinese import demand over the balance of 2018 is expected to shift considerably lower due to rising renewable generation and weaker load growth compared to last year. Despite the downward correction in prices, prices remain exposed to further weakness in 2018 and 2019.

U.S. Commercial Stocks Continue to Draw

Overall commercial inventories declined 1.6 million barrels last week as a modest crude stock build (1.6 million barrels) was more than offset by a product draw led by gasoline and distillate. Four-week adjusted total U.S. oil demand continues to be very strong up 6.9%, or 1.3 MMB/D. Cushing crude stocks built 1.8 million barrels this past week with Basin flows up, ongoing refinery downtime and Cushing outflows restricted by pipeline maintenance and while another big build occurs this week (2.2 million barrels), April should bring stock declines to Cushing. Overall crude stocks are forecast to decline 3.4 million barrels this week as runs increase and imports substantially decline. Continued inventory declines are forecast for the two major light products next week with gasoline down 1.8 million barrels and distillate stocks falling 3.4 million barrels.

What Global Car Sales Hint About Gasoline Demand Growth; U.S. GDP Data and Energy Supply / Demand

Data on vehicle sales are a timely and useful indicator of economic activity. Given that the world economy improved markedly during 2017, vehicle data should have shown corresponding strength. The actual picture, however, was mixed. Vehicle sales are also a driver of gasoline demand, and a gasoline demand regression model using vehicle sales yields a high R-square. In the U.S., GDP data showed that while consumers recently faced high energy prices, demand stayed resilient

Propane Prices Slide Lower as Winter Heating Season Winds Down

Propane prices fell 1.2% week-on-week as res/com demand decreases with the approach of warmer spring weather. Ethane prices increased 3.5% last week as steam cracker ethane demand firms with the commissioning of two large crackers. Isobutane’s premium to normal butane flipped into the black as market looks toward summer gasoline blending demand. U.S. raw mix production gained 24 Mb/d to remain over 4 million b/d for the fourth consecutive week. Propane inventories continue to decline with a draw of 1.2 million barrels according to EIA data. Implied propane demand remains strong at 1.3 million b/d as late-season winter weather impacted the Northeast. The EIA reported propane exports of 886,000 b/d for the week ending March 23. Platts Analytics forecasts propane exports of 860,000 b/d for the week ending March 30 and a stock draw of 500,000 b/d. Steam cracker feedstock margins rebounded last week for all NGL feedstocks with ethane remaining the most economic feedstock.

Stocks Don’t Matter?

Last Thursday was a very good day for the American farmer, and perhaps more importantly his/her banker, as grain and oilseed markets shrugged off some very bearish Quarterly Stocks numbers focusing instead on the extremely preliminary Prospective Plantings data which was based on farmer surveys. Those same farmers that were surveyed by ag-centric brokerage houses and large Commercial entities in early March presumably gave the government very different numbers than the privates as combined corn and soybean acreage came in at 177 million acres, down 3.3 million from last year and well below the 180-181 million expectation for this year. The only estimate that was even remotely correct was that soybean acreage would be 1 million acres higher than corn, a small consolation.

High Korean Imports Belie a Conflicted Demand Story for 2018

The final hold out from high winter import levels is still showing no signs of breaking. Korea has been an odd player in the LNG market, with several distortions in the last year that have perhaps made LNG imports more robust than underlying demand fundamentals would suggest. In the wake of a very tight winter, South Korea has maintained high imports of 186-Mcm/d (flat month-over-month) as Japanese (-14% month-over-month) and Northern Chinese (-37% month-over-month) demand has sharply waned this month. Until recently, heating degree days have been a good indicator for Northeast Asian LNG demand, however Korea has recently deviated from this blueprint – a theme that has made forecasting Korea both short- and long-term tricky in terms of storage management, nuclear production, weather, and coal developments.

End-January U.S. Coal Stockpiles Draw by More than Double the Five-Year Average

On March 23, the EIA reported end-January electric power sector coal stockpiles of 123.5 MMst, a drawdown of 13.7 MMst month-over-month. That was more than double the 6.4 MMst average January draw over the most recent five-year period (2013-2017) and is a bullish indicator for U.S. coal market prices.

Japan Strong Crude Stock Draw, Gasoline Balances Tighten

Runs eased 43 MB/D, while crude imports were very low and crude stocks drew 4.18 MMBbls. Product stocks were fractionally lower, with gasoline and naphtha posting strong draws. Gasoline balances have tightened, with demand particularly strong last week. Other product balances are performing within expectations. The implied refining margin continues to be acceptable, along with above average implied marketing margins.

Financial Stresses Lessen, but Still Elevated

Financial stresses still seem a bit elevated, but the S&P 500 rebounded 2% and climbed back above the 2,600 level (closed at 2,640). VIX volatility fell back from about 25 to under 20. Oil volatility also eased. Commodities were largely neutral, but oil gained 0.25%, with industrial metals gaining 0.64%. The metals index remains right at its support with respect to its uptrend and remains a key indicator. The U.S. dollar gained 0.9% on the week, with implied inflation in the U.S. tending to edge lower along with nominal longer-term interest rates. The St. Louis financial stress indicator jumped to its highest level since late June ‘16, but the overall stress level remains low.

Inventories Decrease from Record High

Ethanol inventories continued to slide the week ending March 23 after reaching a record high two weeks earlier. Stocks fell by 968 thousand barrels last week to 22.8 million barrels. Ethanol production continued its saw-toothed pattern, falling 10 MB/D to 1,039 MB/D after rising in the prior week as some plants began seasonal turnarounds. Ethanol-blended gasoline output dropped to 8,929 MB/D from a 12-week high 9,098 MB/D. May ethanol futures were up 0.2¢ today to $1.448 per gallon as of 11:40 AM CT, despite falling corn prices.

Saudi Arabia: Latest FX Reserves Take a Noted Drop, but Should Prove Temporary

Saudi Arabia just reported their end-February foreign exchange reserves. The $1.9 billion draw on reserves that was witnessed in January accelerated in February to $7.2 billion USD. We still think the Kingdom has achieved better fiscal alignment with Dubai averaging $62.75/Bbl in February and March. However, additional financial resources (fx reserves) were probably used to defend the dollar-riyal peg in a period of rising U.S. interest rates. So far, 12-month forward dollar-riyal exchange rates have not shown any undue stress and debt insurance quotes reflected in the credit default swap market have been well contained. Domestic Saudi interest rates have recently been allowed to rise, which means financial resources necessary to defend the dollar peg will lessen in March. This implies any reserve drawdown that might occur in March should not be as significant. We do not envision a return to fx reserve draw down rates seen in 2017, when Dubai averaged $53.15/Bbl. The improvement in the 2018 average Dubai price to $69/Bbl, should result in much less financial pressure, which will make the latest reserve draw appear temporary in nature, though tighter U.S. monetary policy is complicating the policy options for the Kingdom.

Global Equity Markets Rebound

Global equities recovered about 1.7% on the week, while the U.S. gained 2%. Among the domestic tracking indices, consumer staples, retail, and utilities, all outperformed and gained 3% or more. Energy lagged and gained only 1%. Internationally, Japan did the best and gained 4% on a weakening yen. Emerging Asia was higher by 3.1%.

January Freeze-offs Keep Production Flat as Some Gulf of Mexico Volumes Return

U.S. crude and condensate actuals for January 2018 came in at 9,986 MB/D, flat with December and 1,124 MB/D higher year-on-year. Texas and New Mexico pulled down production while Oklahoma continued to grow and some disrupted volumes in the Gulf of Mexico returned. Our Reference Case outlook forecasts U.S. crude and condensate production growing 1,110 MB/D in 2018 and 760 MB/D in 2019.

U.S. January 2018 DOE Monthly Revisions: Demand and Stocks

EIA just released their monthly January 2018 (PSM) U.S. oil supply/demand data. January 2018 demand came in at 20.461 MMB/D, which was a year-on-year gain of 1.23 MMB/D or 6.4%. Demand was 541 MB/D higher than the strong growth Platts Analytics had assumed, while the final demand figure was revised lower by -331 MB/D from the weeklies. Distillate was revised higher by 247 MB/D vs the weeklies and posted year-on-year growth of 613 MB/D or 16.2%! Many of the transportation /diesel fuel related indicators that we track suggest that positive momentum continues into 2018. Final end-January total commercial stocks stood at 1,215.2 MMBbls, which were 1.4 MMBbls lower than Platts Analytics had assumed. Compared to January 2017 PSM data, total commercial stocks are now lower than year-ago by -142.4 MMBbls vs. -102 MMBbls seen at end-December.

March Weather: U.S., Europe Cold; Japan Warm

March weather for the three major OECD markets turned out 5% colder than the 10-year normal, bringing the month’s oil-heat demand in these markets to a positive 137 MB/D versus normal. They were warmer than the 30-year normal by 2%.

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.