Asia Embraces Diversification with Rising Crude Imports Spanning the Globe as OPEC Cuts Continue

Crude oil prices have come off recent highs due to the upcoming refinery maintenance season, rising US rig counts, and jittery financial markets. However, they are likely to rise sharply again to supply peak summer crude demand. Asian oil import dependence is expected to rise further this year as regional oil output is set to decline again while refinery runs will continue to grow. Although the Middle East will remain the dominant source of supply for the region, Russia and the United States will increase their crude oil sales to Asia. Asian oil demand is expected to remain robust and increase by 1.0 MMB/D this year. Asian product markets look reasonably constructive in 2018 as regional net exports of key products are expected to remain fairly steady (only marginally higher inclusive of blend component trade). Overall, Asian refining fundamentals should continue to be moderately supportive.

Rising Loads Lift All Prices

Spot on-peak energy prices in most Eastern and ERCOT locations were higher year-on-year due to higher gas prices and cold weather driven loads. SPP South hub was the only exception. Eastern Interconnect average raw loads increased 12.5 % year-on-year in January. Weather adjusted gains were limited to 3% year-on-year. Gas-weighted heating degree days for February are expected ~ 3% below the 10-year normal. Given the bearish re-rating of weather, our end March inventory expectations have crept higher — rising to 1.45 to 1.5 Tcf. With prices now below ~$2. 75/MMBtu, gas dispatch economics suggest burn per degree day should improve, potentially providing a floor to price should weather normalize. With multiple pipeline projects set to commence service in 2018, there are concerns in market that Northeast production will ramp considerably higher in 2018.

Plunge in CIF ARA Prices Adds Confidence to Bearish CY18 Price Outlook

The recent plunge in CIF ARA and U.S. natural gas prices has added to downside risks to CY18 U.S. coal prices as the arbitrage window for Eastern coal exports to Europe has closed. S&P Global Platts Analytics reasserts its bearish view on 2H18 prices and has also made a modest downward revision to most 2Q18 coal marker prices. Additionally, we introduce our 2019 forecast in this report, which points to higher U.S. coal burn next year.

California Carbon Lower in February as Auction Nears

California/WCI carbon prices have fallen further in Feb, but remain above the 2018 auction floor. Uncertainty over Ontario’s upcoming elections and linkage status is weighing on the market. The upcoming auction offers a record quantity of allowances - should it be undersubscribed, more California unsold allowances will be moved to the APCR, tightening balances. Otherwise, 2018 should see a large bank build. CARB has kicked off a regulatory process to amend the Cap and Trade in accordance with AB 398. Recent legislative hearings suggest a high level of scrutiny, and a focus on addressing “over-allocation.” With federal regulations at risk, CARB adopted the Obama EPA’s Phase 2 medium- and heavy-duty vehicle GHG standards. Passage of cap-and-trade legislation is less likely this year in OR while carbon tax legislation has advanced in WA State.

U.S. Gas Short-Term Forecast - February

The price forecast has been lowered modestly versus a month ago. This is in response to the extension of widespread above-normal temperatures into late February across much of the U.S., which is forcing upward revisions to the outlook for U.S. storage. The price forecast for the balance of 2018 (March-December) is down to $2.88/MMBtu, $0.07/MMBtu lower than the January forecast.

Does the U.S. Have an Inflation Problem?

In January, the U.S. consumer price index increased at a faster-than-expected pace, but details of the data showed no signs of an imminent inflation breakout. The underlying pace of core inflation still remained subdued from a historical perspective. Going forward, core inflation is expected to accelerate gradually; however, inflation uncertainty is elevated, and a wide range of outcomes (both upside and downside surprises) remains possible. This week’s activity data releases from the U.S. and Europe were constructive.

Ethanol Manufacturing Margins Flat the Week Ending February 12

Ethanol’s discount to gasoline narrowest since October 2017. Exports soared in 2017 and RIN values jumped last week. Brazil’s South-Central Region is in its inter-harvest period with only six mills continuing to operate. European ethanol prices hit a three-month low.

U.S. Commercial Stocks Resume Decline

Overall commercial oil inventories declined 2.7 million barrels last week, widening the year on year stock deficit to a whopping 153 million barrels (11.3%). Adjusted demand growth improved as expected in the latest four weeks, rising 5.8% (1.14 MMB/D). Cushing crude inventories fell another 3.6 million barrels and are now just 32.7 million barrels, less than half last year’s peak, and are set to decline by another 2.4 million barrels in this week’s data despite a forecast huge 1+ MMB/D build in the US overall. With crude runs forecast to fall below 16 MMB/D, because of peak refinery downtime, product stocks are expected to generally decline with this week’s EIA data showing 300- 400 MB/D decreases in both gasoline and distillate inventories.

NGL Prices Rise with Crude Prices

Propane prices closed up 0.6% week-on-week and were 57% of the crude price. Raw mix NGL production settled over 4 million b/d. Propane production increased to 2.0 million b/d, which held propane inventory draws to 3.3 million b/d for the week ended February 9. The EIA reported implied propane demand of 1.5 million b/d, which is a normal winter demand level. LPG exports of 1.1 million b/d were reported for the week ended February 9. Due to heavy fog conditions on the Houston Ship Channel, Platts expects LPG exports of 820 thousand b/d for the week ending February 16. Steam cracker feedstock margins fell last week for all feedstocks except ethane. Ethane prices slid lower last week and are waiting on news of the startup of two new build steam crackers that are in the commissioning phase.

The More Things Change…

Not a gap higher like last week, but yet another explosive move in prompt meal overnight as Argentina’s weekend rains failed to soothe the nerves of European end users. While rains were “as forecast”, the next 10 days show little in the form of measurable precipitation. The only bright spot would appear to be moderate temperatures for the same period in both Argentina and Brazil. In the U.S., massive rains are expected this week throughout the areas that need it the most, specifically in Missouri and Illinois, possibly wiping out the Drought Monitor by Thursday. With the USDA’s Outlook Forum also on tap later this week, traders will be struggling to assess how to trade the obvious short-term dryness in Argentina against a recharged U.S. Midwest.

U.S. SPR Sales an Increasingly Popular Budget Tool

On February 9, Congress passed the Bipartisan Budget Act of 2018. Unsurprisingly, the bill will be partially funded through 100 MMBbl of SPR sales between fiscal 2022 and 2027. This follows four other pieces of legislation passed since 2015, which collectively mandate another 156 MMBbl of sales between fiscal 2017 and 2027 to fund non-energy related items. 14 MMBbl hit the market in October and November 2017 alone, and the SPR balance is now set to fall to around 415 MMBbl by end-2027, down from 695 MMBbl in early 2017. However, even more SPR drawdowns appear likely in future budget legislation. Rising shale production and declining net oil imports have turned the decades-old view of U.S. energy security on its head.

Production out of the Permian continues to Grow with Limited Relief in Terms of Market

Concerns around sufficient gas takeaway capacity out of the Permian continue to surface as the pipeline corridors out of the region begin to fill, without any significant near-term projects planned to alleviate constraints. Platts Analytics estimates that total Permian dry gas production has grown by over 1.0 Bcf/d since this time last year and will increase another 1.0 Bcf/d to 7.4 Bcf/d by the end of 2018. This growing production and limited takeaway capacity situation has created substantial downward pressure on cash and future prices at Waha Hub – West Texas’s main supply hub.

European Hydro Balances are Pushing Back LNG Demand in a Big Way

While weather is generally only thought to have instantaneous effects on gas demand – there are longer term ones as well. In other words, when it is cold, you turn on the heating and when it is windy, gas plants get displaced. At the moment though, it is raining and snowing so much across Europe that it is drastically impacting energy balances for the short- and medium term, in turn reversing one of the most supportive aspects for gas in the European energy landscape.

Italian System to be Tested in Upcoming Cold Spell. Upside Risk Left for the March Contract

Italian prices have been settling well below expectations since the beginning of the year, with the price softness this year in net contrast with the patterns seen at this time of the year in the past. As a result of warmer, wet and windy conditions, we had a 1 GW year-on-year decline for residual thermal demand in both January and February, which is a too small number relative to the large year-on-year price decline. More importantly, a major shift appears to have been occurring in the supply curve of the thermal dispatch, with power prices implying significantly lower marginal costs.

EUA Prices Jump on Fuel-Switching Prices and Next Year’s Supply Cut

Recent European Carbon Allowance (EUA) price gains of €2 since the start of the year come during a generally poor EU ETS fundamentals situation during 2018. There are no EUA supply policy controls in place this year. Power sector EUA demand is continually being knocked lower, due to increasing renewables generation, a warm January, and more coal retirements.

However, thermal fuel prices have offered price support for EUAs, and there may be increased allowance buying ahead of the MSR-impacted short market next year. With reduced price upside from upcoming policy drivers, the question is whether next year’s picture can drive continued EUA price gains this year. There may be some compliance-related buying in the next few months (with 2017 obligations due by May), but the risk of a sell-off remains, if recent price gains are seen as an opportunity for profit-taking.

Japan Crude Runs Recover, Product Stocks Draw Yet Again to Record Lows

Impacts from the Foundation Day holiday were limited. Runs recovered 111 MB/D on the week, while crude imports fell back, which resulted in a 2.77 MMBbl stock draw. Finished products also drew by 2.78 MMBbls, underscored by solid draws in the jet-kero complex, a good draw on gasoil, and naphtha. The seasonal inventory pull has been more aggressive than typically seen this time of year and finished stocks hit a new record low. Balances remain very constructive to cracks, though they slipped on the week. While the kerosene stock draw moderated from -234 MB/D to -141 MB/D, such draws are still more aggressive than normal, with the stock cushion for the remainder of the heating season becoming pretty thin. The implied refining margin slipped on the week and has become mediocre. Low product stocks should provide support for a reversal. Retail prices were little changed. The indicative marketing margin popped higher and remains above norms helping to offset some of the slippage in refining.

Financial Stresses Have Risen, but Have Stabilized

The S&P 500 rebounded about 4.3% on the week, with a lot of cross currents evident. Some credit metrics still looked damaged, while others notably improved. VIX and oil volatility eased. Most importantly, the industrial metals complex remained strong, along with the spot commodity and total commodity indices. That is particularly encouraging. The U.S. dollar was weaker by 1.46%. “Skew/VIX” began to improve meaning tail risk has begun to recede. The St. Louis financial stress indicator moved increasingly higher on the week and saw a sharp rise in momentum.

Ethanol Output and Stocks Decrease

U.S. ethanol production plunged 41 MB/D last week to a five-week low 1,016 MB/D. Stocks fell in all five PADDs, dropping by 604 thousand barrels to 22.9 million barrels. The largest draw occurred in PADD I, 394 thousand barrels. Ethanol-blended gasoline output increased for the third consecutive week, rising to 8,768 MB/D from 8,634 MB/D in the preceding week.

U.S. Gas Weekly Report

NYMEX Henry Hub futures prices continued to decline this week, as weather forecasts continue to proffer above-normal conditions. The March contract is below $2.60/MMBtu —down more than $0.60/MMBtu from the January 30 settlement of $3.20/MMBtu. The market is now within pennies of key support in the area of $2.50/MMBtu. As of February 15, injection season prices are averaging ~$2.69/MMBtu, levels not seen since the end of December 2017. Lackluster withdrawals and the resultant end-March inventory creep has weighed on forward looking sentiment. However, market forward prices suggest stronger power burns are in the making going forward.

Weather Reversal Snaps Market Out of its Bearish Funk; Power Sector Gas Use Remains Vulnerable, However, and Limits Upside Gas Price Risk

The levelling off of the spot market in the past week portends a more cautious outlook for the balance of the quarter. Momentum to the bearish side will remain in place if normal weather is assumed, but at this point the outlook is decidedly colder than normal due to a change among key weather forecasters. The influential NCEP forecast of the North Atlantic Oscillation Index is becoming firmly negative during late February. The S&P Global Platts Analytics 10-day daily demand outlook is showing some hefty above normal demand figures tied to weather, so the risk of a downside price move seems minimal at this point. The key question is how much upside risk are we now facing.

PJM 2021/2022 Capacity Auction: Bouncing Off the Bottom?

We expect the forthcoming 2021/2022 PJM capacity auction to clear $80-$90/MW-day at RTO, hence higher year-on-year. As expected, another round of downward peak load revisions put downward pressure on demand curve. However, counterbalancing impact of upward revision to Net Cost of New Entry (Net CONE) and potential Energy Efficiency (EE) add backs put our estimates of demand curve higher year-on-year. The estimated supply curve still remains quite flat and relatively unchanged with tempered enthusiasm for new entry at these price levels. We expect EMAAC and COMED LDA prices to be lower year-on-year, though they are still likely to be higher than their parent LDAs. DEOK LDA could again break-out higher and is likely to price higher year-on-year. Stakeholders could not agree on market rules to accommodate state policies in time for this auction, but a lot of uncertainty remains for the subsequent auction (2022/2023).

Coal Pricing Rebounds on Tight Prompt Fundamentals

In last week’s International Coal Markets Scorecard, we warned that while a downward market correction was warranted given the overall level of pricing, the impending end of the heating season, and approaching Chinese New Year, the market likely declined too sharply in light of low stockpiles in key markets. The coal market indeed rebounded this week, with forward prices pushing between $4.00-$5.00/mt higher week-over-week. The market (correctly) seems to remain concerned regarding China’s potential pull on the seaborne market to cover for low stockpiles and high demand, despite assurances from the NDRC about domestic supply and the kick-off of the Chinese New Year on Friday.

Asian Oil Demand: Rebound in Growth Exceeds Expectations

Our monthly snapshot of major country Asian oil demand growth rebounded to 982 MB/D from 738 MB/D. Performance exceeded S&P Global Platts Analytics’ expectation for a rise about 840 MB/D. Looking forward, demand growth in the March snapshot should fall back to 735 MB/D and then rise up to 950 MB/D in the April snapshot. The influences of the Chinese New Year are beginning to distort some of the patterns, but the comparisons are against year-ago and S&P Global Platts Analytics has largely built any possible impacts into our assessment. Our annual average 2018 demand gain for total Asia remains about 1 MMB/D, similar to what was seen in 2017. This month, the key drivers of the 244 MB/D incremental gain in demand growth remain China and India. Chinese demand growth accelerated an incremental 240 MB/D to 667 MB/D, while India’s demand growth accelerated an incremental 95 MB/D to 327 MB/D.

Equity Markets Stage a Solid Rebound

Global equity markets posted solid gains with all the tracking indices gaining for both domestic and international categories. In the U.S., the rise in the S&P 500 was about 4.5%. Technology, banking, and industrials all outperformed. Energy lagged and gained only 2.2%. Internationally, the strongest performers were China (+7.8%), emerging markets (+6.7%), and emerging Asia (+6.0%).

The Summer 2018 Conundrum: Steep Regional Basis Differentials May Incentivize Too Much Power Burn

An ongoing supply push from the Permian Basin, as well as the Northeast, is threatening to crush basis markets in Texas, the Southwest, Rockies, Northeast and Midcontinent this summer. Waha, SoCal, PG&E, Opal and Dominion South are all trading between $0.50 and $1.00 behind Henry Hub this summer while Chicago is holding roughly $0.30 back. This implies fixed prices as low as $2 in potentially large power consuming markets. Weak cash prices would stimulate robust burn this summer (as much as 2 Bcf/d higher than Platts' base case forecast) at a time when the market will need to inject more than 2 Tcf of gas just to get back to a 3.5 Tcf carry out heading into the winter of 2018-19. These strong burns would likely lift the Henry Hub summer strip as prices are bid up to destroy gas burn in the Southeast in order to offset stronger burns across the rest of the country and replenish the US storage deficit.

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

At midmonth, February looks to be 5% colder than the 10-year normal for the three major OECD markets with oil-heat demand stronger than normal by 180 MB/D. The three major regions are roughly 2% warmer on a 30-year-normal basis.

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.