Refinery Margins Healthy Despite Distillate Length

Although oil prices are consolidating now in the low-mid $50s, we expect prices to move higher through the course of the year. Oil demand growth is strong and OPEC/non-OPEC cuts will accelerate the drawdown of surplus stocks despite a gradual return to growth for non-OPEC supply. As stock draws become more visible, we expect prompt prices to increase. The import pull by Latin America/Africa for gasoline and distillate will stay strong. Relatively firm gasoline cracks for the winter will lead into a healthy gasoline season despite initially high stocks. Diesel cracks will only gradually improve as high stocks will be slow to work off. Refinery margins are expected to stay generally healthy.

Mild Weather Halts Recovery

Relatively mild weather this month has pressured cash prices lower at nearly every liquid regional location, with M/M losses roughly in lock step with the drop recorded at Henry Hub. This stands in contrast to last winter, when disappointing February weather led to more exaggerated regional losses. Lack of measured supply growth, especially from Appalachia production, combined with structural demand growth from exports and the industrial sector have helped to set a floor beneath prices.

Running Out of Stocks

German prices will remain supported as nuclear availability sets multi-year lows through end-March. As gas stocks risk going empty within the next two months, German coal units will potentially face lower competition from gas units. In this context, dark spreads could finally see more upside. Upsides for French prices remain, as nuclear continues to be below year ago levels and poor hydro reserves will be reducing the flexibility of the system – not only in France itself, but also in Switzerland/Spain, whose flows are critical during colder days.

Coal Prices Wobbling on End of Winter Peak

Coal prices have been on a roller coaster this month, although there has been a decidedly bearish undercurrent, particularly in the Pacific Basin. The onset of the Chinese New Year without any substantive disruption in the supply chain has alleviated much of the market tightness in Asia, despite continued strong import demand in China. In the Atlantic, cold temperatures and concerns over natural gas storage adequacy has propped up pricing. While pockets of strength will persist, PIRA generally favors a bearish outlook going forward.

U.S. LPG Prices Rally

Prompt U.S. LPG prices continue to soar near multi-year highs. Prompt (Feb) Mt Belvieu propane surged to over 90¢/gal last week, before settling near 88¢ Friday for a weekly gain of 6%. February normal butane ripped 18¢ or 16% to just under $1.30/gal. PIRA projects that butane inventories are very low currently. Similarly, strong demand and exports of propane are drawing stocks at rapid rates, sending prices higher as supplies diminish.

The Bean Market

Bean remained the focal point for traders in both old and new crop. Acreage discussions are in full swing as the market looks forward to the February WASDE and the USDA’s Outlook Forum. While some producers continue to see the advantage of beans over corn, and are acting accordingly in the markets with hedges, others seem content to wait and see what their neighbors will do in the spring.

U.S. Ethanol Values Bottom

Manufacturing margins dropped to the lowest level in a year because of record production and soaring stocks. RIN values plunged after the EPA delayed implementation of the 2017 mandates, pending review. Brazil South-Central region is in its inter-harvest period with few mills still operating. European values surged to the highest vales in over a year as mandates increased in over a dozen countries.

This Week’s Growth and Inflation Data Checked All Boxes

The latest indicators of the U.S. economic momentum (nonfarm payrolls and the ISM manufacturing index) were better-than-expected. Meanwhile, indicators that send warnings about possible economic overheating (example: the employment cost index) were surprisingly benign. This week’s U.S. data on growth and inflation, overall, hinted that the Fed may not be in such a hurry to tighten policy. European data on growth and inflation were constructive. Japan’s latest industrial production data pointed to stronger economic growth. Brazil’s industrial production turned positive for the first time in nearly three years.

Ontario Carbon Market Balances: Less Length, Possible Short

Ontario’s cap and trade program officially started on January 1st and a link to the other WCI markets (California and Quebec) is scheduled for 2018. This report outlines PIRA’s view of Ontario emissions, with implications for broader WCI markets. Historic reported emissions data for Ontario are only available through 2014, and there is no baseline data specifically for all sources covered under the program, which leaves 2017 emissions as a wildcard. PIRA expects the Ontario carbon market will be considerably more balanced than either California or Quebec.

Pipelines Ramping Up to Handle Production Growth

Pipeline expansion announcements last month, along with an increasing likelihood of pipeline regulatory approvals, are closing the gap between forecast production growth and takeaway capacity over the next 2-3 years. PIRA’s Midcontinent production forecast has been revised upward, particularly in the Permian Basin. Import and export arbs clearly favor reduced net crude imports at least through March, with Dated Brent prices well above WTI. Stock draws at Cushing are likely to continue. Spare pipeline capacity generally supported regional grades, with light crudes in Midland, Guernsey, Clearbrook and Hardisty all trading at a premium to WTI in January.

Storage Stocks Are Emptying Too Quickly

High gas-to-power demand brought on by weak nuclear output, wind output, low Rhine levels, low hydro levels, and low solar output are making it very hard for natural gas to price itself out of the power stack regardless of price levels. This is causing a relentless draw on storage since the beginning of November, which has not been only to satisfy increased heating and power demand, but also to supplant lost LNG supplies. Without a serious shift in sensitivity to temperature, storage supplies are set to go empty – starting with medium range supplies. More than half of these facilities are mostly empty in Germany and this presents a high spiking risk as we head towards the middle/back-half of the quarter. Facilities get pickier with how they dispense their remaining supplies.

GOP Tax Reform: Headwinds for Solar Projects

The GOP’s comprehensive tax reform plan would present financial headwinds for the U.S. solar sector – including a lower supply of tax equity financing, greater need for project debt, increased cost of debt, reduced tax advantage compared to conventional power plants, and a potential increase in the cost of imported solar products. If fully enacted, PIRA anticipates a downgrade in its U.S. Solar Market Outlook, which projects 54 GW in total installations from 2017 to 2021 (35 GW utility-scale, 19 GW distributed). However, ongoing cost declines, federal and state incentives (assuming the ITC is retained), and corporate procurement limit the potential downside.

Raising CY17 Prices on Higher NG, Tightening Stocks

We are increasing our forecast for NG price and EPS coal demand in CY17. The resulting call for additional production year-on-year will support pricing above forward expectations, especially in the ILB and PRB. We introduce our 2018 outlook this month and expect coal-fired generation to decline Y/Y in CY18 and for prices to fall back from 2017 levels.

Stress Remains Low

The S&P 500 continued to test breaking through the 2,300 level, but again was unsuccessful. Financial stresses remain exceedingly low. Volatility (VIX) was fractionally higher on the week, but remains very low. High yield debt (HYG), was fractionally lower, but emerging market debt (EMB) moved higher. The U.S. dollar has continued to weaken against many currencies.

U.S. Ethanol Production Reaches a New High

U.S. ethanol production reached a new record high the week ending January 27, climbing 10 MB/D to 1,061 MB/D. Inventories built for the fourth consecutive week, reaching a 39-week high 21.9 million barrels. PADD II stocks (7.7 million barrels) are the highest in the seven years that the DOE has published weekly inventory data. Ethanol-blended gasoline manufacture was relatively flat, increasing slightly to 8,309 MB/D from 8,302 MB/D.

China Back from Holiday

All eyes are on China as their return from the New Year’s holiday brought a relatively heavy volume trade in soybeans. The main focus is on the traditional New Year’s edict. The abandonment of certain language in the so-called “No. 1 Document” is getting the most attention as the term “self-sufficiency” is missing in relationship to food and food production. This term is absent for the first time in 10 years.

Mexican Gasoline Imports to Remain High Despite Softer Demand

Latin American product demand is expected to soften in 1Q17. Gasoline consumption will fall year-on-year, driven by higher pump prices in Mexico and a weaker economy in Venezuela. 1Q17 Mexican and Venezuela crude runs remain under pressure. Combined with diesel import incentives in Brazil, Latin American product imports are expected to be higher year-on-year. Colombian crude exports are projected to fall below 500 MB/D in 2017 while PIRA estimates imports of 40 MB/D of light oil to optimize the Cartagena refinery.

Egypt’s “Rescue” Act for Global Gas Balances May Be Coming to a Close

In a banner year for LNG supply growth, the biggest problem in 2016 was how to place the incremental volumes in a world that was unwilling to pay for it. The problem was somewhat alleviated by the supply problems throughout the Atlantic Basin and stronger demand in Europe due to power sector woes (nuclear and hydro). Outside India and China, the market was, for the most part, experiencing severe demand losses for LNG. Many countries ended up importing more LNG despite having downstream gas prices beyond the import terminal that strongly implied a financial loss for every cubic meter imported. Countries like Jordan and Pakistan were glaring examples of this commercial disconnect. The Egyptian situation was a bit murkier and continues to cloud up by the day now that the country’s long-dormant exports have awakened.

UK Capacity Auction for 2017/18 Surprises for Low Clearing Price

The UK Capacity Market Early Auction, which procured 54.4 GW of capacity for the winter 2017/18, has cleared at a price of £6.95/kW. Questions are arising whether the majority of plants allowed to participate in the auction really need a capacity contract to remain online and, for those that actually need it, if the price is a sufficient incentive to prevent their closure.

Global Equities Post a Mixed Week, as More Records are Tested

More record highs were tested. The U.S. market was only modestly changed, yet remained near record highs. Domestically, the best performing sectors were consumer staples and utilities, while industrials, materials, and housing moved lower. Internationally, emerging markets and emerging Asia performed the best. Many of the equity trends retain a bullish bias.

Stocks Lower on Winter Demand

November 2016 electric power sector stockpiles came in at 172.1 MMst according to the EIA, but PIRA’s projections show that stockpiles have since declined to reach 141.8 MMst as of end-January.

U.S. Stock Build Was Smaller than Last Year: A Silver Lining?

Overall commercial inventories built 5.3 million barrels with a large crude stock build (6.5 million barrels) overwhelming a modest product draw (1.2 million barrels). Excess stocks versus last year narrowed by 4.3 million barrels to 41.2 million barrels (3.2%) because last year’s stock build was even larger. Reported product demand recovered by 670 MB/D, led by the four major products, reducing their build by roughly one third compared to the week earlier.

Weather Worries Overshadowing U.S. Production Weakness

NYMEX futures are facing increased downward pressure that is now pushing the March 2017 contract closer to the psychologically important $3/MMBtu mark. That is notably below the recent high of ~$3.50/MMBtu that was brushed just a few days ago. The renewed weakness is primarily the result of ongoing weather updates, which continue to prompt markdowns to the gas-weighted heating degree-day (GWHDD) tally for February. Indeed, over the past week or so, this outlook for the month as a whole has dropped from more than 800 GWHDDs to less than 715, based on the forecast through February 17 and normal weather thereafter.

California Hydro Glut Threatens Spring Markets

On-peak spot prices saw small m/m declines at all Western hubs except SP15 which edged up by ~$1/MWh. The largest drop (only $1) occurred at NP15 as California hydro output rose to its highest level since June and its highest January average since 2011. Gas prices declined m/m consistent with weakness in Eastern spot prices as mild weather returned. However, gas production has yet to turn higher and new pipeline projects to move Marcellus/Utica gas may face delays. As a result, gas price forecasts have been revised up. Second half 2017 power price forecasts are higher compared with last month’s report reflecting the impact of upward revisions to gas prices, but spring Southwest prices have been reduced. Mid-day prices will be especially weak as low loads combine with high hydro output and the daily peak in solar generation.

Atlantic Basin Prices Rise on Forecasted Colder Weather

Despite a nearly $1.50/mt decline on Friday, CIF ARA forward prices increased by approximately $2.00/mt this week, moving in line with European natural gas prices. With weather models predicting another slug of cold weather next week, natural gas, electricity, and coal prices and Europe pushed higher in anticipation. FOB Richards Bay forward prices followed a similar trajectory to CIF ARA, rising by $1.10/mt at the front of the curve, with even larger gains in the deferred market. For FOB Newcastle prices, the lack of Chinese buying activity in association with the Lunar New Year pushed 2Q17 prices lower W/W, although deferred prices made notable gains. The Atlantic Basin market continues to be focused on near-term upside risk, with cold temperatures and concerns regarding natural gas storage dominating market psychology. However, the Pacific Basin market seems to have moved beyond this risk, searching for a pricing equilibrium for 2017 after a very tight conclusion to 2016.

Japanese Demand Continues Higher, Product Stocks Draw Again

Japanese crude runs again eased a bit. Crude imports rose, but stocks still posted a modest draw. Product demand remained strong and gained further on the week, thus drawing finished product stocks 4.5 million barrels following a draw of 3.3 million barrels the previous week. Gasoline demand firmed with rising exports such that stocks drew. Gasoil demand eased, but is still seen as strong. Refinery output fell and stocks drew a strong 1.6 million barrels. Kerosene demand jumped to near its seasonal peak. Margins were slightly lower on the week, although not for naphtha and gasoil. Levels are still seen as good at a time when runs are running close to max throughput.

End of Summer Storage Expectations and Implications for Winter 2017

PIRA is expecting not only a historically high draw from storage this winter, but also a relatively low storage build come October/November of this year. The major question mark is whether LNG will come to Europe in larger volumes. Every major global pricing and production indicator suggests it will happen – surging U.S. and Australian LNG production, weaker seasonal demand in Asia, and an European price premium over Asia – but making such an assumption last year turned out to be incorrect. The possibility of a low storage build in 2Q/3Q suggests that Winter ’17, currently at 51p/th and 8p/th below the prompt, may be undervalued if we get a repeat performance from Mother Nature, although a return to normal weather next winter from this one will mean a major decrease in gas demand.

U.S. November 2016 DOE Monthly Revisions: Demand and Stocks

EIA released its final monthly November 2016 (PSM) U.S. oil supply/demand data. November 2016 demand came in at 19.7 MMB/D, only 20 MB/D lower than the weeklies and 16 MB/D less than PIRA had assumed in its balances. Total product demand increased a strong 2.7% versus year-ago or 511 MB/D, compared to the November 2015 PSA data. There was strong performance in the middle of the barrel. End-November total commercial stocks were marginally less than PIRA had assumed. Despite total commercial stocks being revised higher vs. the weeklies, both crude and product excesses narrowed relative to last year by a combined 10.1 million barrels.

Potential Impact of Proposed U.S. Border Adjustment Tax Changes

Several different changes to U.S. tax law have been proposed. We studied the implications of a Border Adjustment Tax on oil prices and refinery margins. There are two fundamental facts that need to be considered: 1) the U.S. is a large net oil importer; 2) Prices are always set on the margin. The need for the U.S. to continue to import crude through the medium term at least implies that the effective price for crude oil would increase for U.S. refiners. Those refiners who import crude would try to buy lower tax domestic grades, bidding its price higher until they are in parity. Similarly, for products that are imported, the price would be increased (e.g., East Coast gasoline). But the U.S. is a major net exporter of diesel, NGLs, petcoke and other products. The domestic prices of those products would not directly increase due to the tax change. They would only increase if supply-demand shifts to tighten their markets.

Saudi Arabia: Less Draw on Foreign Exchange Points to Better Balance

Saudi Arabia released their end-December foreign exchange reserves. The monthly draw rate lessened to only $2 billion and is indicative of an improving balance on their financial situation. Higher oil prices, a successful $17.5 billion debt issuance last October, tighter domestic spending, and a reduced prompt-forward fx spread has meant less draw required on their foreign exchange reserves. Saudi Arabia continues to improve its domestic and international financial position.The initial public offering of Saudi Aramco in 2018 will further build its financial cushion.

Fracking Policy Monitor

As the Obama administration came to a close last quarter, policy developments were noticeably negative for industry. Key developments included the blocking of the Dakota Access Pipeline and the EPA reversing course in its final report on the connection between fracking and drinking water contamination (the report now concludes fracking can affect drinking water). The new Trump administration, combined with Republican control of Congress, suggest a much friendlier regulatory environment for industry. We expect a roll back in energy regulations (some of which has already started) and streamlining of federal approval processes in the coming months (and years). However, the production impact of the Trump presidency will likely be muted as states remain the primary regulators of fracking on private lands and there is minimal overlap between federal lands and major shale plays.

January Weather: U.S. Warm, Europe Cold and Japan Normal

January’s heating degree days were equal to the 10-year normal for the three major OECD markets with a composite net oil-heat demand effect of 7 MB/D. On a 30-year-normal basis, the markets were roughly 4% warmer.

Aramco Pricing Adjustments: Playing it By the Book…

Saudi Arabia's formula prices for March were released. There were increases across the board for all the key destinations. The largest increases were for NWE Europe and the MED. Light crudes were increased more than heavies. The increases for Northwest Europe were deemed more aggressive than suggested by the narrowing in the Urals-Dated Brent discount. This suggests Saudi wanted to be less accommodative to these markets (i.e., lower volume). Pricing in Asia was tighter in line with a lessening contango in Dubai structure.

November 2016 U.S. Crude Production Registers Second Monthly Gain

The EIA released U.S. crude and condensate production actuals for November. Production came in at 8.9 MMB/D, up 100 MB/D month-on-month, down 420 MB/D year-on-year and 69 MB/D above PIRA’s forecast. The bottom of U.S. crude and condensate production is evident, with production up 350 MB/D from the low in September. The EIA’s weekly supply data suggest further increases in domestic crude production in December and January, which in combination with the higher November actuals, implies an upward sensitivity to PIRA’s Reference Case production forecasts.

Are we about to have a Shortage of Frack Proppants?

U.S. shale operators have dramatically improved well productivity through longer lateral lengths and increased proppant concentrations. Proppant intensity has more than doubled since 2012, causing proppant demand to surge relative to well completions. PIRA expects proppant demand to return to 2014 levels despite 35% fewer horizontal well completions. With an estimated proppant capacity of 160 billion pounds, no outright shortage is expected; however, prices have already begun to increase and further increases are likely given tight supply/demand dynamics. Nevertheless, higher proppant prices will be offset by better IPs and higher oil prices.

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.