California Low Carbon Fuel Standard Study Released

California’s Low Carbon Fuel Standard is designed to reduce GHG emissions in transportation fuels. PIRA’s just-released study The Impact of the LCFS on the California Transportation Fuel Market concludes that the standard can be met by 2020 with a fuel mix less reliant on traditional hydrocarbons, a drawdown of banked LCFS credits and higher costs of compliance. Even assuming only a gradual tightening of requirements post 2020, PIRA finds that the surplus of LCFS credits will run out. Reductions now are generally being achieved by biofuels such as ethanol and renewable diesel but other fuels (electric vehicles, gas/biogas) will play a larger role over time.

Asia’s Oil Dependence on the Middle East to Remain High

Asian oil demand is expected to remain fairly robust this year, with the “Big Four” (China, India, Japan and South Korea) contributing to 80% of that regional growth. Asian oil import dependence is expected to rise further as regional oil production declines. The Middle East will continue to be the dominant source of supply for the Asia-Pacific region despite the recent decision by OPEC to cut production in 1H17 which is causing a pickup in movements from alternative Atlantic Basin suppliers to Asia. Asian refining fundamentals should be moderately supportive this year as demand growth is expected to outpace incremental refinery throughput.

Mild Weather Reduces Seasonal Premium

This heating season appears to be shaping up to be another “winter that wasn’t,” limiting near-term price recovery. Expectations for February gas-weighted heating degree-days (GWHDDs) have ratcheted down dramatically — falling from a projected ~800 at the start of the month, to a mere 652 as per the latest forecast. That is 15-20% milder than normal, and almost 8% below last February’s paltry total.

As Nuclear Moves Lower, Focus in Germany Returns to Higher Part of the Stack

While German day ahead prices have come off multi-year highs reached in January, February-to-date baseload price has averaged €51.0/MWh, with the average peak price reaching €60.8/MWh, well above PIRA’s expectations, and in stark contrast with the ultra-low price settlement of February 2016 (only €21.9/MWh). With the shutdown for maintenance of Brokdorf and Gundremmingen B, German spot prices are settling in a very steep section of the generation stack, or where a small change in thermal dispatching has an exponential effect on the price.

Coal Market Returns to Bearish Trajectory

The coal market moved decidedly lower this week, reversing the gains posted last week. For the front of the curve, CIF ARA prices fared the best, likely due to continued strength in prompt coal demand. For more deferred pricing, FOB Richards Bay prices generally held up relative to the other forward markers. FOB Newcastle prices continue to languish, with forward prices trading at a discount relative to FOB Richards Bay through Cal-18. Over the next 90 days, weakening seasonal demand will be a heavy weight on pricing expectations. However, PIRA’s models continue to show notable growth in China’s coal-fired generation, which will underpin persisting year-on-year growth in import demand. Additionally, the impending return of the working day cap at Chinese coal mines (slated to go back into force April 1) adds further upside potential to China’s import demand.

Corn Rally Intact

Success and failure in the grains on Friday, February 10 as wheat was able to tag its $4.50 psychological objective in March futures while December corn came oh so close to $4.00 with a $3.9975 high. Offers at $4.00 remain fairly chunky Monday morning as the average crop insurance price after the first eight trading days of the month stands at a somewhat attention-grabbing $3.95. The floating insurance ratio of 2.58:1 still favors soybeans by about $40/acre based solely on futures prices, but a 4 handle in December futures will “buy” more corn acres than previously estimated, despite the financial advantage still enjoyed in beans.

Encouraging Trade Data from U.S. and China, but with Asterisks

The U.S. trade deficit widened markedly during the fourth quarter of 2016, and subtracted from GDP growth. But the underlying picture in trade is starting to become more encouraging: export growth has recently turned positive, and imports of capital goods are pointing to stronger capital expenditure activity. Chinese trade data for January were better than expected, but recent data on foreign exchange reserves indicated relatively large capital outflows from China. The unexpected weakness in December German industrial production was most likely an outlier.

U.S. Ethanol Prices Rebound

U.S. ethanol prices increased the week ending February 3. Manufacturing margins also bounced off of very low levels. D6 RIN prices bottomed. Brazil’s ethanol imports were the highest in five years in January. European ethanol prices soared as the market tightened because of higher mandates and delayed imports.

Huge U.S. Crude Stock Build Overwhelms Data

Surging crude imports pushed up crude stocks to 13.8 million barrels, while a pop in reported product demand of 1.5 MMB/D caused product inventories to decline 12.4 million barrels. Overall stocks came up 1.4 million barrels on the week which was about 1 million larger than last year’s increase. Gasoline demand was particularly strong, especially if you add some 485 MB/D to the reported EIA figure to reflect EIA’s inflated export estimate. Cushing crude stocks increased 1.1 million barrels because of the Seaway Legacy Pipeline outage. Overall crude stocks should continue to build as runs decline due to seasonal maintenance, which has already reduced runs 1.5 MMB/D from their winter peak.

What Stopped the Sharp Ascent in Pricing and Turned It Around

It does look like rapidly weakening Asian LNG pricing sharply cut off the recent ascent of European gas, however, that may be just a distraction from what is actually happening on the ground. It appears that global LNG pricing is having an increasingly influential impact on European pricing, by way of Global LNG’s biggest swing supplier – Qatar. However, while the LNG story is still emerging, the sharp rise in pricing has already achieved some real and significant demand destruction. The erosion of gas-to-power demand was an early indication that European spot prices were reaching fundamentally unjustifiable levels.

Mild Winter Dampens Markets

Eastern raw loads were down by over 5% year-on-year during January as heating degree days for the Eastern Interconnect and ERCOT fell by 24% year-on-year. Gas prices declined from December levels at most regional hubs (the Mid-Atlantic region was an exception) as heating loads faded. PIRA expects CY17 prices to average above CY16 at all major power hubs, but in nearly every case, price gains will fall short of increases in gas prices. Despite the mild winter, gas prices remain up year-on-year on the strength of lower production and rising exports which have sustained much of the storage deficit seen at the end of December.

California Carbon up as Auction Nears; Compromise Needed on Policy

Boosted by the auction legal hearing, the benchmark CA carbon allowance price moved above the 2017 auction floor of $13.57. March delivery pricing is aligned with the floor price. If the February auction fails to clear, unsold tons could move to the Price Containment Reserve. Latest reporting shows lower power emissions (with strong hydro), but increased transportation emissions. For Compliance Period 2, sources still need to procure compliance instrument volumes. PIRA expects continuing legal, legislative and regulatory uncertainty to limit the upside potential for allowance pricing. The final Scoping Plan will see delays - a compromise must emerge that addresses Environmental Justice concerns and incorporates additional analysis. While cap and trade may be part of the final strategy, offsets could be limited or eliminated.

Production Decreases From Record High

U.S. ethanol inventories built for a fifth consecutive week the week ending February 3, surpassing 22.0 million barrels for the first time since April 2016. PADD II stocks led the way, increasing by 118 thousand barrels to a record 7.8 million barrels. Domestic ethanol production dropped 6 MB/D to 1,055 MB/D, still the second highest mark on record. Ethanol-blended gasoline manufacture soared to 8,685 MB/D from 8,309 MB/D, the largest weekly jump over the past year.

WASDE Offers Little

The February WASDE was probably more interesting for what was not changed rather than what was changed. In our WASDE Preview, we overused the word pace for emphasis. While the World Board paid attention to the pace of ethanol crush, it ignored the pace of both corn and soybean exports. More interesting to us was that despite the export pace in the U.S., and given the lack of change in the U.S. S&D, there were only minimal changes to global export expectations. In the end, wheat, yes wheat, stole the show and garnered the most interest.

Global Equities Continue to Post Broad Gains

More record highs were set this past week. The U.S. market moved to new record highs with the strongest performing sectors being retailing, industrials, and housing. Energy was little changed on the week. Internationally, China, emerging Asia, and Latin America performed the best and outdid the U.S. gains. Many of the global equity trends retain a bullish bias.

No Big Surprises in Japanese Oil Stock Data

Japanese crude runs rose back to near steady-state rates. Crude imports increased slightly, more than covering the run rise, and stocks built slightly. Finished product demand fell back by ~330 MB/D, but finished product stocks still drew almost 1 million barrels for a third straight week. Gasoline demand eased back ~100 MB/D, lower supply drew stocks modestly. Gasoil demand was fractionally changed and still seen as strong. The supply side was largely balanced and stocks were unchanged. Kerosene demand fell back and the draw rate slowed from a strong 185 MB/D to 150 MB/D. Margins were slightly higher on the week. Levels remain healthy.

Lower Costs Will Drive LNG Growth, Not Higher Prices

Growing portions of the LNG industry are hyper focused on cutting costs throughout the value chain in order to create an environment where lower delivered prices can produce a decent return. The conveyance of this idea seems particularly important among the majors, which are sitting on vast amounts of stranded gas and growing portfolios of existing supply that need to clear at a lower price.

Mozambique Chooses Yara and Shell

Mozambique’s domestic gas tender, launched on 26 August, offered bidders up to 2.8 MMcm/d of gas at from the Rovuma Basin, which will be available when Anadarko’s 12 mtpa LNG project comes online around 2022. Bidders negotiated up to an additional 8.5 MMcm/d directly with the Area 1 and Area 4 consortiums, putting a total of 11.3 MMcm/d on offer. However, the allocations announced by MIREME amounted to 12.2-13.1 MMcm/d.

U.S. Propane Stocks Plumb Multi-Year Low Levels

U.S. propane inventories fell by 6.9 million barrels to 55.8 million barrels, below both 2016 and 2015 levels. These stocks were 19 million barrels below last year’s levels. Last week’s 6.9 million barrels draw was the second largest for the current drawing season. If inventories continue to draw at the average weekly rate of the drawing season thus far, stocks could fall to near 40 million barrels, which would be near 2014 levels.

Weak Start in January Portends Challenging Year

Tanker markets are off to slow start in 2017 and are expected to weaken further as the year progresses. Production cuts promised by both OPEC and non-OPEC producers during 1H17 are being enforced, reducing cargo volumes and tonnage demand. Meanwhile new tankers are being delivered at a rapid pace. Fleet capacity growth in 2017 is estimated at 5.9%, up moderately from 5.8% in 2016. There were 42 new tankers added to the fleet in January alone.

S&P 500 Reaches Record High

The S&P 500 broke through the 2,300 level and set another record high on the week, as did many other indices. Financial stresses remain exceedingly low. Volatility (VIX) moved lower while the price of high yield debt (HYG) moved fractionally higher, but emerging market debt (EMB) posted more substantial gains. The U.S. dollar reversed course on the week and strengthened against many currencies.

Stronger Fourth Quarter Onshore Stock Draw

The latest preliminary data on commercial stocks in the three major OECD markets—United States, Europe, and Japan—and now show a 61 million barrel (660 MB/D) inventory decline in the fourth quarter 2016, more than double the previous estimate. This is in sharp contrast to the year earlier 23 million barrel stock increase (250 MB/D). The year on year fourth quarter inventory reversal of 84 million barrels caused end-year 2016 stocks to fall slightly below the year earlier for these major markets.

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.