Surplus Stocks Substantially Reduced but Paper Supply Limits Upside
The global economy is accelerating. Oil demand is strong, helping to substantially reduce surplus stocks. Third quarter surplus stocks are expected to decline significantly, and much of it will be crude oil. But the largest surplus stock decline will be behind us after the third quarter because of increased U.S. shale oil production. Surplus stocks will stay a feature of the market through 2018, limiting the ability of crude oil prices to be backwardated. This particularly applies to WTI but much less so for Brent.
Tanker Rates in Crude Sector Stuck Near or Below Cash Breakeven Levels
Strong compliance to OPEC production agreement and fleet capacity growth have pushed crude tanker rates down to seasonal lows near cash break-even levels.
As Buyers Sharpen Pricing Terms, Suppliers Stall
The U.S. is the primary progenitor (with 80%) of the 53-mmcm/d of new volumes to appear in the Atlantic Basin to date in 2017, and concerns about the ability of buyers to keep buying at this level are growing. The third round of delays announced by Sempra recently on the 18.6-bcm/yr. three train U.S. Cameron project may well be more than just routine.
September RGGI Carbon Auction to Rebound vs. June
The August WCI current and future vintage auctions returned to full subscription, clearing at historic high prices. Auction pricing failed to reach highs seen in July, but is above the expected 2018 reserve price. Coverage ratios were strong and the number of registered bidders increased significantly. Compliance entities secured most of the winnings. Secondary market reaction to the results has been decidedly bullish. With August the second consecutive auction to clear above the reserve price, unsold allowances can start to be re-offered beginning with the November auction. This will increase supply and allow for the surplus/bank to build.
Economic and Market Data Both Suggest Healthy Growth for Trade
This week’s calendar featured crucial data releases from the U.S., Europe, and Asia. U.S. durable goods shipments and orders pointed to a strengthening in business investment, and the German IFO index hinted at solid growth in economic activity. Industrial production from Taiwan, however, was somewhat disappointing. Meanwhile, growth in global trade volume continued to accelerate in recent periods. Based on historical relationships, trade activity is likely to remain healthy in the second half of the year.
U.S. Stock Deficit Continues to Grow
Overall U.S. commercial inventories were flat last week, but nevertheless widened the year on year stock deficit by another 6.6 million barrels to 65.0 million barrels, or 4.8%. Four week average adjusted demand is inexplicably weak, given the strong U.S. economy, with demand essentially flat year on year. With refinery runs remaining very high, light product inventories were basically flat, though gasoline stocks did decline by 1.2 million barrels. For next week’s EIA data PIRA sees light product inventories modestly declining as demand strengthens. High runs cause crude stocks to substantially. All eyes will be on Tropical Storm Harvey since it could substantially impact refinery operations and trade.
Steam Cracker Margins Increase with Olefin Prices Outpacing NGL Feedstock Prices
NGL prices closed the week lower, except for propane, following the lead of declines in crude prices. On the other hand, propane prices increased 0.8% week-on-week due to seasonally strong demand and exports. With strength in olefin and aromatics prices, steam cracking margins increased from 13% (ethane) to 66% (normal butane) The Asia LPG arb remains closed, and current movement in Asian prices suggests no improvement in the export outlook. Reduction in domestic petrochemical demand and in export loadings due to Hurricane Harvey will likely outpace production shut-ins, leading to a strong storage injection of propane this coming week, pressuring propane prices, compared to crude.
U.S. Ethanol Prices Tumble
U.S. margins for manufacturing ethanol improved the week ending August 18. D6 RIN prices fell. A Federal Court vacated EPA’s denial of Sinclair Oil’s request for a small refiners exemption from the Renewable Fuel Standard. Brazilian ethanol prices rose as ethanol manufacture became more profitable than sugar production. European ethanol prices dropped to a four-month low.
Big Week of Corn Pricing Ahead?
With Crop Tour over, corn is looking at a big week of pricing with these so-called deferred pricing (DP) contracts rolling off as the Marketing Year comes to a close on Thursday. While it’s impossible to quantify exactly how many bushels need to be priced this week, a country elevator operator in Kentucky told us over the weekend that his operation alone has about 1.5 million bushels to price before Thursday and confided he’s a “bit nervous” about how many other elevators are in a similar situation.
The U.S. to Become North America Oil Independent by 2019
PIRA forecasts the U.S. to become a net oil exporter by 2023, as rising shale liquids output continues to outpace oil demand growth. In the meantime, rising Canadian imports will make the U.S. a net oil exporter to the world outside North America by 2019. Lower oil import dependence will likely have political implications, including a growing temptation to use SPR sales to fund non-energy items. Calls for a reduced military presence in the Middle East could also grow louder.
Cash Prices Retreat Amidst Unseasonably Mild August
Yesterday’s EIA lighter-than-consensus build in the mid-40s failed to stimulate NYMEX buying. Following yesterday’s decline, the nearby contract is now back trading toward the lower end of the weekly range at ~$2.90/MMBtu. In the context of the general trend in prices this summer, the season has thus far proved disappointing for gas bulls. Despite the fact that the population-weighted cooling degree days (CDDs) from June to August will likely register in the top twenty hottest on record, the heat has been restricted to the West. Moreover, the numbers are beginning to fade with August stand-alone CDDs now on track to be down Y/Y by ~20%, thanks to the likely ~10% shortfall versus the 10-year normal tally. As a result, physical prices are already facing downward pressures ahead of the normal seasonal falloff.
Newer Small Markets Come to LNG’s Rescue
Could we look on Pakistan, Thailand and Bangladesh for 2017-18 to be the Kuwait, Egypt and Jordan of 2016? How far will they go in trying to balance the market with the issues we have raised in our recent publications – slower Indian demand, the full force of Australian supply, and Japan and Korea trying to get rid of destination clauses? They will go far, especially in the short term though Dec. 2018.
As German Thermal Stack Steepens, More Bullish Risks Emerge for September
German baseload prices have been generally on a bearish trajectory so far in August, with month-to-date base prices well below our expectations. However, the hourly pricing has displayed great volatility, with hour 12 on Aug. 11 reaching €61.4/MWh, the highest level for August since 2013. Such an extreme settlement comes less than two weeks after the plunge to -€67.1/MWh, an all-time low for 3Q, while a repeat of negative hours occurred again on Aug. 19 and 20. While negatively priced hours are a rare occurrence in the summer months – the latest being in 2014 – the high price settlements seen throughout the month are perhaps more surprising and warrant closer attention.
Unusual Storage Inflexibility Driving High Prices
If current trends in storage nominations persist, it would be highest ever month-on-month change in injections and some of the highest ever seasonal injections. These injections have been surging, as German spot has been converging on local and British first quarter pricing. As you can see in the chart below, in the €3.50/MWh to €4/MWh range, injection sensitivity to pricing was relatively comparable to last year, but from there on, divergence only grows as pricing for spot and 1Q converges – making for a somewhat puzzling situation. The logic in evaluating this spread is that Germany is an important balancing market for peak winter across N.W. Europe, combined with the fact that the U.K. will be an important market draw for Continental storage with the loss of the Rough storage facility.
Bullish Momentum in the Coal Market Eases
Coal prices were relatively tame this week compared to the past several weeks of active bullish momentum. While CIF ARA prices tacked on $1.00/mt at the front of the curve, price gains moderated further along the curve. Prompt FOB Newcastle forward prices declined W/W this week, after rising by over $3.00/mt last week. The market seems to be looking for signs that tightness in the prompt is easing after such an extended run. PIRA continues to caution that after an extended period of tightness, prices remain susceptible to spikes if there are unforeseen interruptions in supply or if the Northern Hemisphere summer ends with a heat wave. However, PIRA believes that as the calendar turns into 4Q17, bearish price risks will surpass bullish ones.
WCI Carbon Auctions Clear at Historic Highs
The August WCI current and future vintage auctions returned to full subscription, clearing at historic high prices. Auction pricing failed to reach highs seen in July, but is above the expected 2018 reserve price. Coverage ratios were strong and the number of registered bidders increased significantly. Compliance entities secured most of the winnings. Secondary market reaction to the results has been decidedly bullish. With August the second consecutive auction to clear above the reserve price, unsold allowances can start to be re-offered beginning with the November auction. This will increase supply and allow for the surplus/bank to build.
Japan Holiday Impacts Noted, Gasoline Disappoints
Two weeks of data were reported due to the holiday period. Much of the data performed along seasonal trends. Runs continue rising post-turnaround with almost all capacity back onstream. Crude imports were very low and then surged, so stocks drew sharply and then built. Finished product stocks rose along seasonal lines, with middle distillate builds being the driver. Aggregate demand fell both weeks and was a bit weaker than seasonal norms. Gasoline demand failed to exhibit holiday uplift and declined both weeks. Gasoil demand held up reasonably well the first week and then predictably plunged. Refining margins have continued to perform strongly and remain supportive to rising runs, for the moment.
Generally Positive Week for Credit and Financial Stress
It was generally a constructive week for financial stress with the S&P 500 gaining week-on-week, along with lower volatility (VIX), positive performance on credit pricing and commodities, and a lower U.S. dollar. The St Louis financial stress indicator posted a third straight rise, but stress indicators remain very low.
U.S. Ethanol Production and Stocks Fall
U.S. ethanol production declined by 7 MB/D to 1,052 MB/D the week ending August 18, though output was still the sixth highest ever reported. Total inventories fell by 319 thousand barrels to 21.5 million barrels, with draws in the East Coast, Midwest and Gulf Coast. Ethanol-blended gasoline production was relatively flat, increasing slightly to 9,392 MB/D from 9,383 MB/D in the preceding week.
Crops Need Some Time
Both legs of the 2017 Tour, which had a record number of scouts pull a record number of samples this year, ended Thursday night in Rochester, Minnesota with a general consensus that soybeans were the story and many areas from Ohio to Minnesota need some sunlight and heat to finish or risk getting smaller. While a cool “break” was welcomed in August, a continuation of that pattern along with cloudy skies for an extended period of time, may have a negative effect on the yield estimates made this week.
RGGI Announces Program Changes
RGGI announced a consensus on “draft program elements”, seeking comments in advance of an end of September stakeholder meeting to discuss a revised Model Rule for adoption by individual states. It will help inform participants in the upcoming allowance auction. Agreement on a “full” banking adjustment starting in 2021 provides bullish sentiment, while PIRA believes that the size of the price-supporting Emissions Containment Reserve may not be large enough to ensure a strong impact on pricing, at least initially. The proposed approach will work to narrow the allowance surplus, but does not require dramatic emissions reductions vs. expectations.
Greater Weight to Developing Countries Lifts World GDP Growth Rates
PIRA has updated the global contribution of all the 142 individual countries it covers to reflect the new purchasing power parity results from the World Bank’s 2011 International Comparison Program (ICP). By incorporating those results, the impact raises the importance of developing countries, relative to the traditional OECD basket of countries. The overall impact raises global GDP growth going forward about 0.1%, each year. It does not impact the actual forecast of individual country GDP growth, nor the energy consumption figure associated with that growth. It also changes regional global aggregates to the extent those regions have greater contributions from developing countries, relative to developed countries.
Global Equities Post a Positive Week
Global equity markets generally rebounded on the week. In the U.S., among the tracking indices, retail and banking did the best and outperformed. Consumer staples declined and underperformed, while energy was a slight outperform, up 1.1%. The international tracking indices did even better than the U.S., with China, emerging markets, and emerging Asia were the best performers.
First Take on Hurricane Harvey Market Implications
Without knowing the duration of market disruption it is hard to judge its lasting impact but here are some initial thoughts. With a substantial amount of Texas refinery capacity shut down, crude demand in the United States will fall, backing up U.S. and Canadian supplies feeding the USG into northern storage in Cushing, other PADD II and Canada. Offshore crude inbound to the USG will stack up on the water. This will weaken WTI time spreads, and weaken WTI and Canadian grades relative to offshore crude (Brent). With some crude pipelines shut down, especially from Eagle Ford and West Texas, production will likely also face temporary losses, particularly in Eagle Ford, but not as much as crude refinery capacity closed. As the storm moves east more Texas, and perhaps Louisiana, refineries are possibly at risk.
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.
