Downstream Markets Will Remain Strong

Brent prices bullish for now with available excess commercial inventory essentially eliminated, increasing Chinese runs, and investor exuberance in general helping Brent despite high non-commercial net length. WTI discount to Brent will narrow as Cushing drains. Brent premium to Dubai will narrow with higher U.S. exports. Margins will generally stay healthy through 2018 with strong demand growth for refined products and poor refinery operations in Latin America. Although higher crude runs/lower imports of product blending components in China due to tax changes will hurt gasoline and diesel cracks and ultimately European runs, relatively high utilization rates are still needed in Europe to balance Atlantic Basin product markets. Downstream focus shifts back toward middle distillates for now with stronger demand growth for middle distillates than light distillates in 2017/18 reversing the trend seen in 2015/16. Gasoline cracks seeing near term support for the season from importers. Expect a healthy 2018 gasoline season come March/April though not as strong as in 2017. Diesel cracks stronger with a cold start to the winter, will ease in weeks ahead but remain stronger than last year. Residual fuel oil cracks will remain firm.

Winter Cold Snap: NOPRoblem So Far

Spot on-peak energy prices in Northeastern locations were mostly higher y/y due to higher gas prices and cold weather driven loads. . For Midwest and Southern locations, gas prices were mostly lower y/y and hence power prices were lower too. January prices are more likely to be higher y/y across the board. Eastern Interconnect average raw loads increased 2.1 % y/y in December. The frigid temperatures which drove up demand across several eastern markets at the end of December extended into the first week of January, sending total Eastern Interconnect electricity demand off to a strong start in 2018. This weather related demand and well-head freeze-offs pushed Henry Hub cash to a multi-year high of $6.88/MMBtu on 3rd January. Despite inventory expectations pointing to an end-season carry around 1.3 Tcf, the forward curve for 2018 remains below $3.00/MMBtu. Therefore, with injection season production gains already earmarked at ~7.0 Bcf/d y/y, the need for demand side rebalancing is increasing — potentially setting the stage for upward pricing pressure relative to the NYMEX strip.

2018 To See Surplus Build; Cap and Trade Amendments, ON Linkage are Key Wildcards

Pricing for WCI carbon allowances declined again in December, and the new V-18 Dec 18 benchmark contract has lost ground in January. PIRA continues to expect upside pricing to be limited in 2018 by the allowance bank build and the return of unsold allowances at auctions. The triennial CP2 surrender for CA/QC will take place in November 2018, and could prompt incremental buying and affect spreads for allowances that can be used for CP2 vs. later vintages. ON will not need to turn in allowances for its extended first compliance period (2017-20) until 2021 - the status of ON linkage and the first release of covered emissions data are wildcards for the market. Also critical for pricing expectations are the cap and trade amendments to align with AB 398. CARB must address cost containment, offsets limits and overallocation and banking concerns. In particular, CARB is facing pressure to mitigate the effect of the large allowance bank - a “RGGI-style” banking adjustment would be bullish for pricing.

Product Tanker Markets Stronger in December but Crude Tanker Markets Suffering from Excess Supply

Crude tanker markets finished 2017 on a sour note and weakened further heading into New Year as OPEC production cuts and excess supply continued to weight on rates. Bunker costs are also rising, putting additional pressure on tanker margins. But clean product tanker rates in the Atlantic Basin have been the exception, as U.S. crude runs have risen to unusually high levels for this time of year causing product exports to soar.

What Will Happen to U.S. Inflation In 2018?

During 2018, changes in U.S. core inflation will have a huge bearing on the Fed monetary policy and the economic growth outlook. Historical drivers of core inflation, such as oil prices and the non-fuel import price index, suggest somewhat faster price gains in 2018. But these drivers have behaved erratically of late as leading indicators, and uncertainties are high. Global news on economic growth continues to be positive. Both the U.S. and the euro area reported better-than-expected activity data for the fourth quarter. India became the fourth largest vehicle market in 2017, surpassing Germany.

Propane Prices Continue to Run Counter to Crude Prices

Propane prices fell last week, which is the second week in a row that propane prices have run counter to crude prices. While propane inventory draws are at a seasonal high and exports remain robust, propane inventory levels appear sufficient and contribute to the softening of prices. For the week ended January 5, U.S. propane inventories fell by 6.3 million barrels to stand at 61.7 million barrels and exports totaled 1 million b/d. Movement in steam cracker feedstock margins were mixed last week.

Weekly Ethanol Supply Report

U.S. ethanol production declined an unprecedented 94 MB/D over the past two weeks, falling to a thirteen-week low 996 MB/D. Ethanol-blended gasoline production has also dropped sharply, sliding to a two-year low 7,913 MB/D, down 1.5% year-on-year. Total inventories built by 100 thousand barrels last week to 22.7 million barrels as Gulf Coast stocks climbed to a record 4.7 million barrels.

Trump Sanctions Waiver Deadline Imminent, Raising Risks to Iranian Nuclear Deal

The outbreak of economic protests in Iran comes at a delicate time for the landmark nuclear agreement (JCPOA), given a January 12 deadline for the U.S. to issue oil export sanctions waivers (separate waivers are due through January 17). The Trump administration has responded to the Iranian unrest with unambiguous support for the anti-government demonstrations, further raising uncertainty over the president’s plans for the nuclear deal. PIRA’s Reference Case assumes Trump will reluctantly grant the oil waivers this week for a third time, as most top advisors prefer to maintain the JCPOA while Iran remains compliant, but he is likely to demand a change in Iran’s regional behavior. However, even insiders remain unclear of his plans at this point, so a failure to issue the oil waivers is certainly possible. This would technically bring unilateral U.S. sanctions back into force, requiring third countries to “significantly” reduce oil purchases every 180 days, or see their companies forced to choose between the Iranian and U.S. financial systems. In reality, the immediate aftermath of a JCPOA rupture could go in a number of directions. The U.S. could refrain from implementing the sanctions on foreign buyers of Iranian crude, in exchange for certain concessions, while some foreign firms with little U.S. exposure may simply ignore them. But clearly, most scenarios would raise the difficulty for Iran to sell its oil.

Four for Four

Against an already building chorus of “it will never happen five years in a row”, corn and soybean markets are digesting the “fact” that according to NASS enumerators and the less than 63% of U.S. farmers that actually returned their production surveys, both yields were above trend for the fourth year in a row. As if that wasn’t enough, the most aesthetically unpleasing corn crop that we’ve seen since 2012 yielded the third record in the past four years at 176.6 bpa, which followed 174.6 last year and 171 in 2014, due to adequate moisture at planting and a prolonged fill period thanks to relatively benign August temperatures and a late first frost for many. The record corn yield trend would certainly bring “hope” to farmers that they can still produce their way out of this price slump, but doing so will also bring the obvious risk of over-supplying a market.

U.S. Gas Weekly Report

As cold weather slowly dissipated across the eastern U.S. Henry Hub cash pulled back by $1.25/MMBtu (-29%) W/W to a seven day average of $3.14/MMBtu for the EIA week-ended January 11. Cash spiked in the Northeast last Friday, January 5, lifting the weekly average for premium demand hubs such as Algonquin and Transco Zone 6 NY, which spiked to a high of $78.35/MMBtu and a record high of $140.92/MMBtu, respectively. Coming off the heals of the acute cold weather and the resultant all-time record weekly storage withdrawal, Henry Hub February and March 2017 future contracts have increased by 29 cents/MMBtu (10%) and 18 cents/MMBtu (7%), respectively, from last Friday. On the news of the strong EIA storage pull, the prompt month settled at $3.08/MMBtu —~18 cents/MMBtu higher than the previous day’s settlement. This renewed strength has lifted the February contract beyond last week’s highs.

Japan Welcome to 2018, Performance as Expected

In the first report of the New Year, we got a closing view of 2017 and the first glimpse of 2018. Lots of anticipated holiday impacts played out in the data. Runs changed little with no scheduled maintenance for the next several weeks. Crude stocks drew towards record lows, while finished products stocks drew at year-end due, in part, to a sizeable and seasonal gasoil build. Crude stocks begin the new year -8.2 MMBbls below last year, while finished product stocks are lower by -3.9 MMBbls. Gasoline demand didn’t show the holiday uplift we had been hoping for, perhaps due to the impact of a protracted rise in pump prices. Gasoil demand predictably plunged due to the holiday. Kerosene demand ended the year on a strong note and then predictably fell back. The average draw rate over the last two weeks was 82 MB/D, with stocks beginning the year slightly under year-ago. Implied refining margins remained strong in December, based on actual production data. Retail prices continue their rise and the indicative marketing margin has again been softening. Gasoline remains above norms, while gasoil/diesel is below norms by a slightly greater degree.

Financial Stresses Remain Low, Inflationary Bias Evident

The S&P 500 continues on a seemingly parabolic trajectory, with it now stalking down the 2,800 level as its next milestone. Credit remains constructive, though the divergence that has developed and visible in certain key charts remains baffling and cautionary. The U.S. dollar continues to weaken noticeably, while commodities had a solid performance, particularly energy. The reflation trade and strong economic growth thesis remains on track with aluminum, copper, energy, and palladium, all doing very well. The St. Louis financial stress indicator again moved lower.

Seasonal LNG Pulls and Pushes Create Feast or Famine Potential for Europe

High spot gas prices in parts of North America and Asia continue to pull LNG away from Europe in a manner that supports the idea that additional levels of European storage injections will be incentivized in the years to come. The more storage in place, the less vulnerable Europe will be to its growing dependence on imports come wintertime. LNG availability will not be a problem in 2Q and 3Q in the years to come. In fact it may become more of a burden given how much we are now seeing that the current LNG demand spike in China is more an R/C-related weather and coal restriction play and not necessarily an issue of underlying demand growth.

Cove Point LNG Delay in Symptomatic of a Project with an Uncertain Future

The delay in start-up at the 7.2-BCM/Y. Cove Point to March -- originally from November, then to year end and this week to end 1Q’18 -- comes as no surprise. Last week’s surge in Transco Zone 6 - from which Cove LNG sellers would likely need to source the gas - was another nail in the coffin for a winter commissioning. A key source of delay for Cove Point has been delays on both the 17-bcm/yr. Transco Atlantic Sunrise pipeline as well as 13.4- BCM/Y. TransCanada WB Xpress line, which means that the attractively priced Marcellus shale gas that underpinned the export project economics can get bottlenecked on its way to the terminal. While we did see some indication that more feedgas was flowing to the plant in anticipation of a commissioning, it was not quite enough to confirm that a first cargo was imminent. Regardless of the day to day issues, a lower capacity utilization has been built into the PIRA balance for Cove Point than for other projects based on feed gas sourcing issues. It’s our view that once the terminal is commissioned, it could still be more vulnerable to winter US price spikes than US Gulf terminals.

Drop in February French Prices Reflects Market Expectations for Higher Hydro Output, Wind, and Temperatures

The French contract for February has dropped from 58.6/MWh at the end of December to €50.5/MWh on Jan. 11. This large correction has come, as gas prices (PEG Nord) have declined by only €0.5/MWh during the same period, from €20.3/MWh to €19.8/MWh. While we believe that the assumption of sustained hydro output next month has merit, the strong sensitivity of demand to temperature means there is still some upside for prices. The margin of error on the temperature and nuclear output provides still potential upside risk to February.

U.S. Commercial Stocks Continue to Draw

Overall commercial stocks drew by 5.5 million barrels in this week’s EIA data on the back of higher crude run rates and strong product demand with the latter up 4.3%, or 855 MB/D, in the last four weeks versus last year. The stock draw is atypical for this time of year and reflects tight global oil markets. Crude inventories declined 4.9 million barrels with Cushing stocks falling 2.4 million barrels. The ongoing pull from the Gulf Coast together with maintenance on the Basin pipeline will cause Cushing crude stocks to decline 4.2 million barrels next week, accounting for the nationwide forecast draw, and representing the largest weekly Cushing stock decline ever reported. Stay Tuned! Major light products built substantially last week and while gasoline is forecast to show another large build next week, cold weather and a rebound in deliveries pull distillate inventories significantly lower.

U.S. Ethanol Begins 2018 on a Bearish Note

U.S. ethanol assessments continued to fall last week, pressured by stocks building to the highest level since June and the lowest consumption in gasoline in almost a year. The U.S. exported 94.9 million gallons of fuel grade ethanol in November, up from 89.6 million in October. Shipments to Brazil increased as more plants in the Latin American country shut down for the season. U.S. biodiesel prices reached a 12-month high, while D4 RIN values slumped to 75¢.

Chinese Gas Producers under Pressure to Cut Usage

China has ordered the country’s biggest explorers to cut their use of natural gas to divert more of the fuel to the north, where a harsh winter is causing shortages. China National Petroleum Corp., China Petrochemical Corp. and China National Offshore Oil Corp. should reduce the consumption of natural gas in their refineries, oil drilling and liquefied natural gas factories to secure more supplies for residential use, National Development and Reform Commission official Meng Wei said at a press briefing in Beijing. The three companies should collectively cut gas consumption for their own use including to petrochemical factories by 15-mmcm/d, he said.

Coal Prices Remain Elevated in Quiet Week

Coal market forward prices were relatively calm this week, with prompt prices trading within a tight range of +/- $0.50/mt. Seasonal coal demand remains elevated, and the drive to preserve or rebuild inventories in Asia continues to be strong. At the same time, weather disruptions to Indonesian supplies are persisting, keeping the front of the market supported. The seaborne coal market remains exposed to further upside over the very short-term, if the weather either provides incremental heating demand or more considerable supply disruptions at a time when stockpiles remain relatively low. However, the market would do well to eye approaching downside risks, as Chinese import demand will likely contract considerably in 2018, aided by the resumption of import restrictions (set to be put back into place in February), along with another year of demand declines in Europe.

Weak Power Sector EUA Demand to Start 2018; Non-ETS Policies Impacting EUAs

A weaker fundamentals situation should lead to lower European Carbon (EUA) prices through mid-2018, although an increase in implied carbon prices from coal-gas switching may help support EUAs. While monthly EUA auction volumes will be above power sector EUA requirements for most of 2018, more substantive EUA price gains could come in 2H2018 ahead of the start of the MSR next year.

While recent policy discussions directly addressed the EU ETS (post-2020 market reforms, post-Brexit U.K. participation), the past month served as a reminder that the EU ETS does not exist inside a vacuum, and external policies can impact the carbon market longer-term. This can range from agreement on post-2020 non-ETS targets that may explicitly call on EUAs, to new emissions standards for coal plants and renewables targets that can impact future EUA demand.

U.S. Refinery Turnarounds: January 2018 – December 2018

PIRA has just completed its latest comprehensive survey of the U.S. refining industry’s planned downtime for the year ahead. This suggests a fairly active maintenance period whether for crude or upgrading units. Average outages for the first half of 2018 for crude distillation towers are around 270 MB/D higher than that indicated for the comparable period of 2017’s initial survey.

Equity Markets Sets More Records

Global equity markets continued to set many new records. The U.S. market was higher by 1.6%, with the S&P 500 beginning to stalk the 2,800 level. The strongest gains were registered in banking (+4.6%), retail (3.7%), energy (+3.3%), and industrials (+3.3%). The utility index was again the only tracking index to decline, lower by -2.1%. All the international tracking indices gained, with again, more new records set in a host of markets. China and Japan led and were higher by 2.2% or so.

Calm Emerges as France Flexes its Power Muscle and Dutch Supply Issues are Largely Ignored

Changes in the power market are also easing supply tensions on the Continent. At the center of this change is France, where daily nuclear output exceeded 57 GW on Wednesday and Thursday this past week, a level last reached in Jan. 2016. The availability is set to increase by another 0.7 GW from the current 58 GW until the middle of February, and slowly reduce thereafter, but the output has a good chance to exceed last year’s averages in both January and February. Gas use in French power is back down to trivial levels, but more significantly for the market, French power exports are beginning to undermine CCGT use in neighbouring countries.

World Bank to Cease Financing Oil and Gas Exploration by 2019

The World Bank Group announced on December 12, 2017 that it would cease new financing of upstream oil and gas projects after 2019. The World Bank indicated that under exceptional circumstances, such as in the poorest countries where there is a clear benefit to energy access, it will continue to offer financing for upstream gas projects. Current projects in the portfolio will also continue as planned. The World Bank’s decision, which was announced at the One Planet Summit in France, aligns the organization with its commitment toward advancing the goals of the Paris Climate Accord. The cutback in funding is insignificant in the overall global upstream spending picture and it is unlikely to change our balances.

China’s Crude Imports to Rise Substantially in 2018, with Stronger Growth in Refinery Runs

China’s crude imports averaged ~8.46 MMB/D during the first eleven months of 2017, up by 0.93 MMB/D year-on-year. Much of China’s incremental crude imports over the past two years have been driven by independent refineries, and buying from these “Tea Kettle” refineries is likely to increase further in 2018 due to higher crude import quotas. Independent refinery runs are expected to improve further this year as a result. The expected extension of the consumption tax to imported mixed aromatics and light cycle oil was just announced and it will cut product blending component imports. It will likely be backfilled by higher refinery crude runs. Overall, PIRA believes China’s refinery throughput growth will be stronger in 2018, with an increase of ~0.8 MMB/D, and with demand growth still healthy at ~0.5 MMB/D, net key product exports could rise by some 0.3 MMB/D this year. China’s net crude imports are estimated to have averaged ~8.4 MMB/D last year, and will rise to 9.2 MMB/D in 2018 due to higher refinery runs and marginally lower domestic crude output, coupled with some commercial crude stock build (both actual and related to new commercial facilities). On top of commercial crude imports, SPR imports could add up to roughly 200 MB/D to crude import demand in 2018; 100 MB/D more than in 2017 . Hence global crude markets, especially sweet crude, will benefit from increased runs and crude import requirements in China.

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

At midmonth, January looks to be warmer than the 10-year normal by 1% for the three major OECD markets with oil-heat demand weaker than normal by 48 MB/D. The markets are roughly 6% 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.