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PIRA Energy Market Recap for the Week Ending December 11, 2017

Keystone Leak Pulls Down Canadian Differentials and Cushing Stocks

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The Keystone pipeline was shut for most of the second half of November following a leak in the line in South Dakota. This caused crude stocks to rise in Western Canada and to fall in Cushing. As a result, Canadian differentials weakened, while Cushing WTI moved closer to backwardation. The 7 million barrel Cushing stock draw in November will be followed by similarly large declines in December and January, with stocks likely approaching 40 million barrels by February. The Canadian stock surplus will stick around for a while, as Keystone is now operating at reduced rates and new oil sands projects are causing a surge in production. Rail transport of dilbit is growing, and weak Canadian differentials are likely to remain through the first quarter of 2018. Rig counts and production are still rising in the Permian Basin, but takeaway pipeline capacity is keeping pace. The year-end start-up of several pipeline projects has boosted Midland differentials to a premium over Cushing WTI – a condition likely to continue well into 2018.

NGL Prices Lower and Steam Cracker Margins Higher

All U.S. NGL prices weakened this week, with C3+ prices following crude futures slightly lower and ethane prices weighed down by US steam cracker outages. However, as a percentage of WTI crude futures, propane prices remained steady week-over-week. US propane inventories increased by 1.3 million barrels during the week ended December 1. Propane production once again reached a new record high, increasing by 50,000 b/d from the previous week to 1.97 million b/d. Lower propane export volumes contributed to the inventory build as well: EIA data show 681,000 b/d was exported during the week, a sharp decrease from the previous four-week average of 968,000 b/d. LPG exports for the week ended December 8 are expected to be about 800,000 b/d, with propane comprising 700,000 b/d of the total. Cargo cancellations due to poor US-Asia arbitrage economics are likely to impact export volumes through year-end, with at least four cancellations reported for December to date. Steam cracker feedstock margins gained across the board on the back of falling NGL feedstock prices and rising olefin prices. LPG fundamentals remain strong for the time being, but longer term, the value gap between propane (~$10/MMBtu) and natural gas (<$3/MMBtu) this winter is likely to cause some permanent substitution of propane by natural gas, where conversion is possible.

Little Change in December WASDE

Late last week in Chicago we had the opportunity to attend an annual meeting of, and present to, a wide ranging group of 50 Ag professionals made up of farmers, commercials, and input suppliers from all over the U.S. More information “changed hands” in that meeting than will be disseminated in tomorrow’s December WASDE, but that’s the nature of the beast for the last report of the calendar year. Last year not a single change was made to the U.S. supply and demand calculations between November and December for the three major crops while expected farm gate prices were tweaked ever so slightly.

U.S. Coal Stocks Draw in September, Add Bullish Momentum to Market

On December 1, the EIA reported end-September electric power sector coal stockpiles of 139.5 MMst, a draw of ~2.1 MMst M/M as compared a 1.7 MMst average build over the most recent five-year period. September stockpiles were 12% lower Y/Y and 10.5% below the most recent five-year average. The EIA also revised August stocks lower by a material amount. In sum, the August stockpile adjustment and the September stock draw should be taken as bullish signals by the market.

U.S. Commercial Stock Decline Moderates But Deficit Widens

Overall commercial stocks declined 2.5 million barrels last week, widening the year on year inventory deficit by roughly 5 million barrels to 93 million barrels which is 6.9% below year ago levels while four week average demand is 3.0% higher (585 MB/D) than the year earlier. Gasoline stocks built sharply last week (6.8 million barrels) and will likely show another sizable build (4.6 million barrels) in this week’s data as the Christmas demand pickup is a couple of weeks away. Distillate stocks built a moderate 1.7 million barrels last week and are forecast to be roughly flat in this week’s data. Crude stocks continued to decline last week, falling 5.6 million barrels and widening the year on year deficit to 38 million barrels (7.7%) while the prior week’s crude runs were 780 MB/D (4.7%) over last year. This week, crude stocks decline another 6.0 million barrels which includes another sharp Cushing crude stock decline of 3.0 million barrels after last week’s 2.8 million barrel decline.

U.S. Job Growth Remains Healthy, but Where Is Wage Growth?

According to the latest U.S. labor market report for November, wage growth was modest in spite of healthy job gains and the tightness in the labor market. Industry-level data offered some clues to this puzzle. Certain industries, such as finance and business services, have indeed experienced fast increases in both jobs and wages in recent periods. But a slump in retail trade has apparently weakened the earnings power of low-skill workers, and there are also signs of technological advancements holding down wage pressures in certain industries. As for activity data updates, there were upward revisions to major industrial economies’ third quarter GDP. November trade data for China were better-than-expected.

U.S. Gas Weekly Report

Henry Hub cash has averaged $2.86/MMBtu over the past seven days, 7 cent/MMBtu (2.4%) below the prior week. Month-to-date, cash has underperformed the December index of $3.08/MMBtu by 22 cents/MMBtu.•On the news of a net U.S. storage build for the week-ended December 1, Henry Hub prompt weakened further, ultimately falling 16 cents/MMBtu for the day to $2.76/MMBtu. This drop widened the NYMEX 12-month strip decline to 18 cents/MMBtu relative to the start of the month, with the latest settle of $2.79/MMBtu the lowest since late May 2016.

As Supply Builds at Record Levels, Banner Year for Newbuild Tankers Fails to Completely Mitigate Soaring Winter Spot Charter Rates

As global LNG supplies continued their steady build this year, adding some 111-mmcm/d of new volumes on average to date, so too has the tanker fleet added new capacity. Still spot charter rates have soared to upwards of $70,000/ day now from $35,000/d in Sept. indicate that the large jump in shipping capacity is still slightly under the growth rate of the even larger slug of liquefaction capacity.

As Flows Shift, Several Interconnectors Close to Completion in North Western Europe

Emerging market tightness across Western Europe in the past few weeks highlights the growing role of interconnectors in price formation, especially at times of low nuclear, renewable, and/or hydro output. While November was the first month to produce the UK in a net exporting to France on a monthly average basis since Feb-12, French imports from Germany and Belgium in a given hour have also reached 8.9 GW, a new record for December and not far off the all-time high of 9.2 GW reached in November. The near term will see important developments on the interconnector front across Western Europe, starting with a new 1.5-GW link (Doetinchem-Niederrhein) between Germany and the Netherlands, set to be commissioned in 3Q 2018, and the 0.4-GW connection (Combined Grid Solution) between the Kriegers Flak offshore wind farm in Denmark and the Baltic-2 one in Germany also expected by the end of 2018.

Soaring Carbon and Weak LNG Could Lead to South Korean Coal-to-Gas Switching

Despite Platts JKM prices of nearly $10/MMBtu currently, the potential for significantly looser natural gas balances and prices in 2018, combined with high carbon prices, could see the advent of coal-to-LNG switching in South Korea – a first for the Asian power sector. While gas-fired generation costs are expected to fall relative to coal, the sizeable mark-up from wholesale LNG pricing to end-user pricing will need to be scaled back to facilitate coal-to-gas switching. With global LNG supply expected to surge, this price reduction may be necessary to accommodate South Korea’s LNG contract obligations.

Credit Prices Rising for the California Low Carbon Fuel Standard

Tighter balances in California’s Low Carbon Fuel Standard program, along with increasing regulatory certainty from proposed program amendments, have lifted credit prices from spring lows. Program data are showing a reduction in the bank/surplus of credits (although most EVs will not be credited until year-end). As PIRA expected, the proposed post-2020 LCFS targets acknowledged the expected tight balances by maintaining the 2020 CI reduction requirements through 2022. LCFS program amendments will be finalized next year. Potential future weakening of key federal complementary policies, such as the RFS and vehicle GHG standards could impact LCFS compliance costs.

Japan Yet Still Higher Runs, but Demand Rebounds

The key takeaways are that runs continue to rise, while a resumed increase in product demand is allowing for absorption of higher refinery supply. A big jump in crude imports on the week, led to a large 5.7 MMBbls crude stock build. Finished product stocks drew slightly with solid draws from jet and gasoil. The market remains largely balanced but demand performance needs to be carefully monitored over coming weeks at the time of max seasonal crude runs. Implied refining margins eased slightly, but remain good. November production actuals boosted margins vs. preliminary stats. Retail prices continue to rise. After a period of “push through” and margin expansion, the indicative marketing margin was modestly mixed.

Ethanol Prices Fall in the U.S.

U.S. ethanol prices continued to fall last week, reaching the lowest point since March 2016. The rate of output was the second highest ever and stocks are up nearly 3.6 million barrels from last year. The EPA released its final renewable fuel mandates and standards for 2018 and the biomass-based diesel requirements for 2019. RIN prices were relatively flat following the announcement.

Financial Stresses Remain Low

The S&P 500 managed to close above the 2,650 level for the first time. With such new record highs have come lower volatility and positive high yield credit metrics. However, there is a certain level of divergence that has been noted in equity performance (S&P 500) and credit (HYG) . Commodities declined broadly on the week, both energy and non-energy, with industrial metals again posting the largest decline. The dollar was again modestly higher. The St. Louis financial stress indicator bounced higher from the record low set the previous week.

Anatomy of a Price Spike: Early Winter Volatility Holds Back Storage

Reluctance to withdraw gas from storage ahead of winter is not a new behavior in Europe, but it’s been a long time since this type of behavior has had this much of an impact on prices. After all the penalty for running out of gas at the end of the season is significantly greater than being skimpy on the front end, so the behavior is logical. With Mediterranean hub spot pricing upwards of 40% above JKM pricing, one would think that storage (both LNG and conventional) would be withdrawing full blast this December. The combination of the shape of the prompt and the opportunity cost of drawing heavily from storage has restrained supplies. To put it simply, if prices are so volatile and high now, imagine what they could be later in the winter – which does figure in to storage optimization models.

December RGGI Auction Reflects Lower Pricing

The December RGGI auction cleared at $3.80, somewhat below secondary market pricing the day of the auction and much lower than the September auction. RGGI secondary market prices have fallen in December to below $4. The auction coverage ratio of 2.2 was lower than in September’s auction and speculative buying interest declined. The full RGGI compliance surrender for 2015-17 emissions due in March is not currently translating to tightness in the market. Sharply lower 2017 emissions contribute to slacker balances. On the policy front, RGGI partners are soon expected to release a final Model Rule for states to adopt.

Aramco Pricing Adjustments: Predictably Tighter in Asia and Europe

Saudi Arabia just released their pricing for January liftings. Prices were predictably raised in Asia and Northwest Europe, but lowered in the U.S. The adjustments in Asia and Europe were in keeping with the changes in key market drivers, namely increased backwardation in the Dubai price structure and a narrower discount on Urals vs. Dated Brent in Northwest Europe. In the U.S., the reduction was seen as trying to make Saudi crude a bit more competitive with competing domestic grades. Even with the U.S. reduction in pricing, Saudi crudes are still seen as priced at a premium, relative to domestic grades, by roughly $1.50-1.75/Bbl, though incrementally that premium was lessened from what it had been.

Global Equities Set More Records

Global equity markets set more records this week, with the S&P 500 closing above the 2,650 level for the first time. The strongest domestic sectorial performers were retail (+3.2%), industrials (+1.5%), consumer staples and discretionary (+0.7%). Utilities lagged badly, losing -1%. Internationally, most of the tracking indices underperformed the gains seen in the U.S, and were modestly mixed.

Ethanol Production Soars to Record High

U.S. ethanol production soared to an astonishingly high 1,108 MB/D, eclipsing the previous record set two weeks earlier by 34 MB/D. Total inventories built by 500 thousand barrels to a six-month high 22.5 million barrels. Stocks are up 4.0 million barrels from this time last year.

Coal Pricing Rebounds on Higher Oil Prices, Coal Demand Strength

Seaborne coal prices rebounded notably this week, amid a backdrop of stronger oil and LNG pricing. Fundamentally, the market remains relatively tight, particularly as the peak of the heating season is kicking off in earnest. The announcement that Chinese policymakers are easing the restrictions on coal heating, coupled with strong coal-fired generation levels in South Korea due to underperforming nuclear and high LNG prices, illustrates how difficult it can be to displace coal in the energy mix quickly.

Fire at Singapore Shell Refinery at Pulau Bukom

According to press reports, a fire broke out at Singapore Shell’s 430 MB/D refinery on Pulau Bukom on Sunday (Dec 10) at about 10am. This was confirmed by a Shell spokesperson. The fire was caused by a thermal gas unit located within the plant. The fire had been extinguished by the site’s firefighters by around noon, and all personnel at the site were accounted for, with no injuries reported.

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.

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