Product Markets Healthy Despite Distillate Length

Oil prices moved up to the mid-$50’s to end 2016 and will inevitably, after a period of consolidation, go higher in 2017. Strong global demand growth and OPEC/non-OPEC cuts accelerate the drawdown of surplus stocks. Firm gasoline cracks support margins and runs in 2017 with growing import pull by Latin America/Africa. Gasoline stock coverage of demand/export pull will tighten first but distillate stocks will be more difficult to work off. Spec changes increase upside potential from refinery outages: Tier III gasoline in the United States; 10 ppm diesel in China, 50 ppm diesel in India. Gasoline cracks stay above average over the winter but near term downside risk (Jan is lowest demand month and refinery yields still favor gasoline). Diesel cracks will gradually recover but near-term upside risk if expected European cold snap is long lasting.

Potent Demand Meets Shaky Supply and the Risks Grow

Power and weather have the potential to provide a significantly bullish 1-2 punch. Here’s where the risk to the upside is most acute. Current prices are largely firm based on weather, but PIRA estimates a potential exposure to 100-mmcm/d of additional R/C demand in an extreme colder than normal scenario. While the chances of this type of spike are remote, even a small cold snap could really send the market into a frenzy. Additionally, a greater reliance on inventory will be required in the first quarter due to a lack of availability from certain key suppliers such as the Netherlands. Storage levels are now below last year and the 5-year average, with the U.K. having a particularly acute problem. However, in the Atlantic Basin, where net supply is still down through November by 9-mmcm/d, the U.S./Trinidad dynamic remains in play with U.S. volumes essentially making up for Trinidad losses. Still, growth in U.S. exports is finally offsetting losses in Trinidad output as of October and is a harbinger of the net supply onslaught to come in the AB and Asia, regardless of Trinidad shortfalls.

Frigid Weather Tests Pacific NW Supply

The coldest weather to hit the Pacific Northwest since February 2014 caused power suppliers to crank coal and gas units to near capacity, draft storage hydro, and rely on incremental supplies from BC. December Mid-Columbia prices peaked near $50 at mid-month and averaged in the mid $30s, up $15/MWh from December. Southwest markets saw smaller gains but were still up sharply due to gas price increases and reduced flows from the Northwest. Short-term weather forecasts suggest more of the same in January. Longer term, weak Upper Columbia precipitation and reservoir drafting to meet heating demand may have a lasting bullish impact on the Northwest, while the Southwest basks in a flood of solar power.

Coal Market Rebounds to Finish the Year Strong

Coal prices rallied in December following the swoon in November, on continued strength in Chinese coal demand and thermal coal imports. Additionally, seasonal risks to supply are considerable, particularly in light of the strength in the coking coal market. Over the next month, the risks are asymmetrically skewed to the upside during the peak demand season, and PIRA favors a bullish outlook. However, after the Chinese New Year, the risks rebalance, and with demand structurally weaker on top an expectation of weaker Chinese imports, PIRA shifts to a more bearish outlook in the second half of 2017.

China’s Climate Ambition to Continue Despite Fears of Reduced U.S. Effort

Since their November 2014 agreement, increasing climate policy ambition has been a key area of accord between the U.S. and China. However, President-elect Trump’s stated aim of pulling the U.S. out of the Paris Agreement on post-2020 greenhouse gas (GHG) emissions reductions has raised concerns of how such a move would not only impact American climate ambitions, but would also reduce pressure on China to meet their GHG targets. Unlike what we forecast for the U.S., PIRA’s reference case modeling expects China will achieve their international commitments for GHG reductions. More importantly, we believe that local concerns regarding the health impacts of conventional pollutants will continue to push China toward a cleaner energy mix, with progress on CO2 reduction a byproduct in many cases.

At End-2016, Global Economic Momentum Is Trending Solidly

U.S. GDP growth turned stronger in the second half of 2016. Key sectors appear poised for major gains in 2017. Leading indicators point to a turnaround for business investment, while there are signs of pent-up demand for big-ticket items in the consumer sector. Recent policy guidance by the Chinese government suggest proactive fiscal policy and slightly tighter monetary policy for 2017. All in all, the Chinese economy is very likely to continue expanding at a solid pace. The 2017 outlook is also positive for Europe, the emerging Asia region, and commodity-intensive emerging economies.

Ethanol Prices Tumble

Near record production put downside pressure on U.S. ethanol prices the week ending December 23. Manufacturing margins followed lower. RINs tumbled after Carl Icahn was named an advisor to President-elect Donald Trump.

What the Trump?

While the dust settles on the 3rd tough year in a row for the farm economy, a new Administration is set to take office in 3 weeks, an Administration that was swept into office by rural voters but so far has been sending strange signals to the farming community. Names like Icahn, Pruitt, and Perry are known opponents to certain parts of the RFS while Navarro is a China hawk.

U.S. Stocks Excess Substantially Narrows

This past week’s almost 13 million barrel inventory decline sharply contrasts with last year’s flat stock profile for the same week. The stock decline was all in products with the bulk of it being in NGLs, both because of winter weather and high volumes of exports. Distillate and gasoline had 1.6 to 1.9 million barrel stock declines and distillate stocks are below last year for the first time this year. For next week’s EIA data, weak seasonal demand leads to large light product stock builds; though they will be lower than typical. Crude stocks are forecast to decline, largely because of fog related delays in Gulf Coast arrivals, while Cushing crude stocks build.

Indian LNG Buying Complicated by New Commitments and Imports Subsidies

Nowhere does the ever confusing relationship between spot and contract gas pricing play out better than in India. Only 56% of India's imports were bought under contract in 2016, while the bigger buyers such as like Japan and Korea imported more than 90% of their LNG under contract. India represents the future of LNG buying, which will paradoxically lead to more price convergence but a much greater variety of deals. However, extremely low downstream gas prices remain in place and complicate the issue of how official LNG import prices should be interpreted, given that so much of the cost is not being passed through.

Upside Risks Remain

While German prices have been strengthening to factor in a more bullish fuel complex, most notably coal and EUA, we see some price upsides left for base. The peak dark spreads have now widened and appear quite comfortable, but margins for coal generators outside peak hours along the curve are still too weak, while our balances suggest coal is still somewhat needed during off-peak hours in Germany. France may well run out of luck, as we move toward the months with the highest loads. The probability of extreme weather events are still there and will bring into focus the concerns over nuclear availability, which is still below year ago levels, in spite of a somewhat improved outlook. The back of the French curve is set to remain strong. Even assuming nuclear availability is back to normal, prices will have to remain high enough to encourage fossil fuel units to stay online during the winter.

Large Propane Stock Decline

Propane stocks fell by 5.7 MMB to end at 86.9 MMB for the week ending December 23rd. This steep draw is the largest observed yet for the drawing season. The greatest draw ever recorded occurred in late January 2016, when stocks fell 6.3 MMB week-on-week. The annual deficit of 10.9 MMB is the greatest recorded for 2016. In 2014, deficits had reached upwards of 25 MMB, when cold weather caused steep inventory draws. This year, high exports coupled with colder weather are driving the deficit.

Global Equities Move Lower to end 2016

Global equity markets were mostly lower as the year ended. In the U.S., all the tracking indices were measurably lower, other than utilities which was down only fractionally. The international indices fared better, with emerging markets, Asia, China, and Latin America posting solids gains, but Japan dropped back. For the year, world markets, in U.S. dollar terms, were higher by 6%. The Americas performed the best regionally, up 12%, with the U.S. up 9.5%, while Brazil was up 68%, though their economy remains mired in a deep recession. Asia was also higher on the year, led by Indonesia and Taiwan, while China fell 18%.

U.S. Ethanol Production and Stocks Lower

U.S. ethanol inventories fell by 377 thousand barrels last week to 18.7 million the week ending December 23, near the low for the year. Ethanol production dropped for the second consecutive week, dipping 8 MB/D to 1,028 MB/D. U.S. ethanol-blended gasoline manufacture increased to a 19-week high 9,276 MB/D from 9,126 MB/D in the preceding week.

Mixed Soybean Signals

A New Year of trading starts with some confusion relative to the soybean market. While some have identified recent rains in Argentina as helpful, others are now saying that the holiday moisture dump was too much, too fast. The areas hit by heavy rains over Christmas received more moisture this past weekend with even more on tap for the coming days.

"Happy Holiday" impacts

Crude runs in Japan were little changed as turnarounds have become minimal. Crude imports fell back sharply and stocks drew 5.8 MMBbls. Finished product stocks also drew by 1.2 MMBbls, with good demand leading to draws in all the major products other than kerosene. The finished product stock deficit, relative to last year, was 8.7 MMBbls (12%), while the crude deficit was 15.1 MMBbls (15%). Gasoline demand was predictably higher due to the holiday; stocks drew 0.3 MMBbls. Gasoil demand was surprisingly higher by 91 MB/D; stocks drew 0.7 MMBbls, which if not for a rise in yield, would have been an even deeper draw. Kerosene stocks built contra-seasonally on weaker demand and higher yield. Margins and cracks improved on the week and remain excellent.

"Damage" Undone and Some

Guidance stemming from the stout NYMEX January 2017 contract termination suggest Henry Hub (HH) and other cash prices have more room to run — despite many points having already doubled relative to the their respective mid-November lows. More decidedly cold weather, forecast for early January, is primarily behind the renewed bullish enthusiasm. But the lack of any upside follow through during December, after the month-on-month U.S. production gain posted in November, is also a key consideration, especially with year-on-year storage deficits taking root in all regions thanks to the near record overall U.S. stock draw this month.

Financial Stresses Remain Low

The S&P 500 faded on the week, but financial stresses remain very low. Volatility (VIX) increased on the week, but high yield debt (HYG) was little changed and emerging market debt actually improved. Relative to where stress was in the beginning of 2016, the year ended with very low or near record low stress indicators.

October 2016 U.S. Domestic Crude Supply Rises

EIA recently released its October oil balances. Domestic crude supply, which is domestic crude production plus the balancing item rebounded 470 MB/D after a September decline of -502 MB/D. The year-on-year decline moderated from -953 MB/D to -704 MB/D. Part of the rebound in supply was attributable to an 84 MB/D return of Gulf of Mexico field production that was down for maintenance. Lower-48, non-Gulf of Mexico production, rose 105 MB/D, while the balance item swung from -69 MB/D in September to 168 MB/D in October. Last month, for October, PIRA had assumed a smaller month-on-month rebound of 325 MB/D in domestic crude supply and a year-on-year decline rate of -850 MB/D.

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

EIA released its final monthly October 2016 (PSM) U.S. oil supply/demand data. October 2016 demand came in at 19.622 MMB/D, which was 578 MB/D lower than the weeklies, and 283 MB/D less than PIRA had assumed in its balances, with the variance being concentrated in gasoline and resid. Total product demand increased 0.6% versus year-ago or 122 MB/D, slower than the 446 MB/D growth seen in September. Gasoline underperformed the barrel average. Resid and “other” product demand strongly outperformed. End-October total commercial stocks stood at 1,355.2 MMBbls, 14 MMBbls higher than PIRA had assumed. Compared to final October 2015 PSA data, total commercial stocks are higher than year-ago by 71.7 MMBbls, versus an excess of 76.3 MMBbls seen at end-September.

December Weather: The U.S. Cold; Europe and Japan Warm

December was 1% warmer than the 10-year normal for the three major OECD markets with a loss of 52 MB/D of oil-heat demand versus normal. The markets were 5% warmer on a 30-year-normal basis.

Outlook for Kerojet Demand in the Atlantic Basin Through 2018

Although kerojet demand has been growing robustly on both sides of the Atlantic in recent years, we now see slower (possibly negative) growth in 2017 followed by a small pick-up in 2018. In the U.S., higher oil prices, which constitute a significant share of the cost structure, should lead to higher ticket prices and thereby subtract from growth in the next two years. In addition, the secular improvement in fuel efficiency has reversed direction in recent years, especially in the U.S. PIRA hypothesizes that some of this deterioration in efficiency is really fuel diverted to military operations overseas. Demand is expected to fall back as these campaigns come to end. Kerojet demand in Europe is expected to meet a similar fate as in the United States.

Asian Refiners Face the Challenge of Meeting Tighter Product Specifications in 2017

Tighter oil product quality specifications will be implemented next year in China and India. In China, Nation 5 standards with 10 ppm fuels (Euro 5 equivalent) were required in Jan 2016 for 11 eastern coastal provinces, but will be implemented nationwide in January 2017. In India, 50 ppm sulfur fuels have been in use in 13 major cities since 2010, but a nationwide rollout of the Bharat IV standard (50 ppm or Euro 4 equivalent) will be implemented by April 2017. Refiners in both countries have added significant levels of desulfurization capability to meet these mandates. Thus far, the market seems to be comfortable that refiners in both countries will have the capability to meet their new specifications. However, with tighter specifications, refiners have less flexibility. The impact of refinery outages, even of secondary units, will potentially be more severe.

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.