Asian Refining Margins to Remain Healthy as Product Balances Look Constructive into 2H17

Oil markets are rebalancing slowly, hindered by higher output from Libya/Nigeria and weaker demand from China and Venezuela. Indian oil demand rebounded in 2Q17 with growth of 3.3%, but expansion in June was weaker at 1.5%. Despite demand slowing in China and India, the two populous countries will remain as the twin engines of Asian oil demand growth. Asian refining fundamentals should generally be constructive this year as demand growth is expected to outpace incremental refinery runs. Key Asian product balances, such as for gasoline and gasoil/diesel, also are constructive into 2H17.

Take-away Capacity to Lift Canadian Prices

Plummeting Canadian natural gas prices have raised concerns about the prospect for recovery. To be sure, benchmark prices hit an annual low last month and retested close to those levels this month — as a combination of pipeline maintenance and limited outlets for supply amplified the regional surplus. These developments and the resulting exaggerated cash weakness have cast a long shadow on deferred pricing. Yet, the worst of the summer-time blues for the producers might be in the rear-view mirror as pipeline expansion plans should help alleviate congestion-related blowouts. Moreover, completion of oil sands related turnarounds and evolving structural tightness stateside might provide further relief before year-end.

Asian Buyers and the Emerging Role of Storage

U.S. LNG capacity that has been bought and paid for by Asian utility and portfolio buyers will have major implications for the global LNG trade. It will provide a form of virtual storage for Asian importers, but will also create an enhanced need to trade. With the lackluster performance of NBP, Dutch TTF has a lot in its favor to replace NBP as a key European benchmark and balance 2Q/3Q markets – more storage, declining domestic production, close borders with Germany (Europe’s biggest gas consumer), and a highly evolved LNG import terminal.

Weather & Gas Disappoint, But Production Disciplined

June temperatures came in lower than normal and the year-over-year increase in gas prices at Henry Hub shrank from 65% in May to 16% in June, but slowing production helped keep markets in balance. 2Q17 PRB production came in at 76 MMst, down 9.6% Q/Q. With a gas price outlook above the forward curve, PIRA maintains its bullish bias on PRB.

Refinery Margins Remain Strong

Healthy refinery margins are expected to continue through year end. Net refinery utilization rates will stay high in both the U.S. and Europe but autumn maintenance will push runs lower. Product cracks will average stronger than last year. Atlantic Basin gasoline cracks are getting a boost from refinery problems in Latin America. Residual fuel oil cracks are getting a boost from refinery conversion capacity, lower Russian/other exports, and a lighter crude slate on the margin. Diesel cracks are slowly improving as inventory levels decline.

Cape Demand Prospects Dip While Cape Supply Expands

After sliding in early July, capsize dry bulk freight rates have recovered to over $9,000/day. However, the outlook for freight rates have dimmed over the past month as demand side prospects have faded, partially due to potential cuts in U.S. steel imports in response to the Trump Administration’s Section 232 investigation. The capsize fleet also continues to grow, which has dampened PIRA’s freight rate outlook. Despite these downward adjustments, rising bunker fuel prices along with year-over-year demand growth will see freight rates continue to rise from current levels, and generally outperform FFAs.

California Cap and Trade Extension Passes

AB 398, the bill to extend cap and trade through 2030, passed the CA Legislature with a two-thirds majority. CARB will now take up the Cap and Trade Amendments at the July Board Meeting and announced a new rulemaking process to implement AB 398. Apart from new limits on offsets, other Environmental Justice concerns dealing with toxic and criteria pollutants have been moved to separate legislation. AB 398 has provisions to set a hard price cap and also intermediate cost containment “speed bumps.” It also directs CARB to address banking and over-allocation. The handling of unsold allowances is a key lever to control supply of allowances and measures to address oversupply have the potential to significantly affect balances and pricing. Otherwise, industrial allocations are continued under this legislation and local air districts are prohibited from regulating GHGs from sources covered under the Cap and Trade.

Seasonal Decline in Tanker Rates During Summer Likely to be Steeper than in 2016

The seasonal decline in tanker rates during the summer will likely be steeper this year than in 2016, as vessel supply growth and OPEC reductions reduce fleet utilization rates.

China’s Economic Momentum Is Better-Than-Expected

China’s GDP growth was better-than-expected in the second quarter. The industrial sector was a source of strength, and recent machinery orders by Chinese businesses was a positive sign for the sector’s outlook. Consumer spending growth accelerated, in spite of a higher vehicle sales tax. This sector is expected to keep its momentum, given healthy job gains and recent signs of improvement in various spending data. Investment activity was softer during the second quarter, and spending on infrastructure showed a marked slowing. Growth in credit is decelerating gradually.

NGL Prices Post Week-on-Week Gains

The Mont Belvieu prices of all NGL purity products posted week-on-week gains for the week ending July 21st. Waterborne LPG exports remain relatively robust even with challenging Asian and European arbs. U.S. propane stocks appear to be well positioned going into the last half of the stock build season. The latest EIA stock data for the week ending July 14th report a propane inventory build of 3.5 million barrels, which brings total propane stocks 65.7 million barrels. The Dow Chemical 1.5 million tonnes per year steam cracker in Freeport, Texas continues operate in commissioning mode and is expected to begin commercial operation in August.

U.S. Stock Deficit to Last Year Will Continue to Grow

Stock deficit to last year continues to widen, increasing to almost 30 million barrels this past week, all of which is in products which is supporting strong refinery margins. Four week average adjusted demand is up 3.3%, or 640 MB/D, with gasoline and distillate contributing approximately half of this growth. Both gasoline and distillate stocks drew sharply this past week and another week of significant draws is anticipated. Crude stocks drew 4.7 million barrels this past week and is forecast to decline further next week with a pick-up in exports. Cushing crude stock draws had a respite this past week but should resume its substantial weekly declines in next week’s data.

Margins for Manufacturing Ethanol in the U.S. Improve

Margins for manufacturing ethanol in the U.S. rose the week ending July 14. RINs prices were sharply higher the week ending July 14. The Sugarcane Harvest in the South-Central region of Brazil ramped up, but ethanol production still lagged prior years. European ethanol manufacturing margins were lower due to higher wheat prices.

The Rains Came

With all the focus on Iowa and Illinois, Friday night’s rain event was the obvious talk of the weekend, and the driving force in a lower opening Sunday evening. In critical NW Iowa we’ve spoken with as many farmers who said they got rain as those who said they got nothing. According to one metrological source, western Iowa generally got 30% coverage. How many inches fell in that 30% coverage area is still being debated.

TTF Should Emerge as the New LNG Benchmark

Europe’s fickle relationship with LNG comes not only from an uneven record in providing enough demand, but also lack of clarity on how to price it. While NBP seems to be the benchmark of choice for Atlantic Basin spot trade, its emerging detachment from Continental prices is a cause for concern among sellers looking for protecting netback value in a low-priced environment. Enter TTF as the emerging long-term solution, as the Dutch market faces lower domestic production while also possessing one of the most flexible and innovative LNG import terminals in the world.

Pace of July Injections Imply Build Ahead Likely to Disappoint

The NYMEX nearby rallied more than 20¢ from the lows plumbed earlier in the month. Yet, the initial surge in buying has stalled keeping the August contract anchored near the $3 mark. With the climatological temperature peak traditionally occurring next week, the market appears to be looking beyond the current tightness to heftier injections ahead. While more normal weather ahead might enable incremental restocking, the aggregate additions will likely fall short of levels seen in recent years. This would more easily allow the market to shift attention beyond shoulder-season looseness to the more noted structural tightness that looms later this year.

Germany: Lower Renewables Support July Prices; Bearish Risks for August

With overall wind output so far in July averaging below expectations, or only 6.4 GW, and nuclear still below full capacity, German fossil fuel generation has been relatively more supported this month. However, even with lower renewables and nuclear, day ahead prices have been settling generally in line with forecasts, or in the mid €30/MWh. While gas units have been reported to be ramping up more significantly this month, both wind and nuclear are set to improve next month, providing some downward risks to prices.

Pacific Basin Coal Prices Rise Along With Asian Temperatures

Seaborne coal prices, led by the Pacific Basin, pushed notably higher this week, with 3Q17 FOB Newcastle prices surging by nearly $3.50/mt, despite slipping on Friday. Gains in FOB Richards Bay and CIF ARA prices were more muted by comparison, rising by $1.70/mt and $0.80/mt, respectively. The rise in pricing was driven by tighter Asian fundamentals on both the demand and supply side. Hot temperatures across Asia over July-to-date extended bullish energy demand in China, while both Australian and Indonesian exports have been underwhelming due to labor and weather issues. This tightness in the prompt market takes away some of the fundamental bearishness that is likely to occur later on in 2017, as restocking for the Northern Hemisphere winter will be more pronounced.

Upcoming Auction to Determine MA SREC Demand

The Massachusetts Solar Clearinghouse Auctions for compliance year 2016 will be held next week, for two Solar Renewable Energy Credit (SREC) programs. Quantities indicate a modest surplus for SREC I and a significant surplus for SREC II. Should the SREC II auction not clear in the first two rounds, the 2018 compliance obligation will be adjusted upward by the auction offering, tightening balances significantly and affecting market pricing. Current market pricing for SREC I is close to the fixed auction bid price after a spike in 2015/16 related to the 2013 auction, though this maxed-out program is now largely in balance. The SREC II program has a declining auction bid price schedule that may drive down SREC II prices over time. Pricing is currently lower in this market compared to SREC I, and in anticipation of the auction results. Emergency regulations were filed in June 2017 to support the SMART successor solar program that will replace SRECs as the chosen solar incentive program starting next year.

Japan Limited Holiday Impacts

The Sea Day holiday had limited impact on the data this past week. Japanese runs rose 53 MB/D on the week, as turnarounds continued to lessen. Crude imports were surprisingly low at 2.98 MMB/D, and crude stocks drew 1.05 million barrels. Finished product stocks rose a modest 0.3 million barrels. Aggregate demand was a modest 28 MB/D higher, with gasoline demand falling below expectations, but gasoil demand exceeding expectations. The 4-week average trend in demand continued to move seasonally higher. Kerosene demand fell back, but is within seasonal norms and the 4-week stock build rate remained just under July norms. Refining margins were lower on the week, but remain acceptable.

Financial Stresses Still Lower

Another very bullish week, with good performance on investment grade debt, emerging market debt, high yield debt, along with energy and high yield energy debt. Financial stresses remain exceedingly low, with the St. Louis financial stress indicator moving lower. Commodities had a positive week, though energy underperformed. The reflationary trade appears to be reaching a point of decision, as to whether it can continue momentum, or slips back into disinflation mode. The U.S. equity market continues to set new record highs.

Production and Inventories Rise

U.S. ethanol production rose 19 MB/D last week to a nine-week high 1,026 MB/D the week ending July 14. Inventories increased for the first time in five weeks, building by 956 thousand barrels to 22.1 million barrels. Ethanol-blended gasoline production fell 90 MB/D to 9,133 MB/D, the third consecutive decline after having reached a record high.

What’s Corn Really Worth?

With so many corn yield numbers being thrown around and some weather forecasters seemingly skewing their forecasts to meet some sort of subjective narrative, PIRA took a step back from the noise and added up the numbers as another critical weekend looms. Last week’s Crop Progress report showed that 40% of the corn crop nationally was silking, up 21% from the previous week. PIRA expects a similar 20% increase, if not more, occurred during the current week.

More Equity Records Being Set

More records are being set in world equity markets. In the U.S., a new record was set, while the strongest performers were utilities, retail, technology, and consumer discretionary. Energy eased -0.3% on the week, and underperformed. Banking was even weaker, dropping -1.5%. Internationally, most of the indices posted gains. Japan did particularly well, up 1.4%.

Significance of Mexico’s New Discoveries for Crude Production

Mexico’s crude production prospects are now brighter after two new discoveries. ENI and Talos each reported that Mexico’s historic decision to open exploration and production to foreign investment has resulted in new large shallow water discoveries and that each hold promise of over 1 billion barrels of oil in place. This was a surprising result because the major upside to future production was expected from deepwater and secondarily from shale while shallow waters close to shore were thought to be much less likely to yield large finds. PIRA has estimated that each new find could produce slightly over 100 MB/D at peak.

Asian Oil Demand: Achieving Peak Demand Growth, but Only a Minor Falloff Expected

Our snapshot of Asian oil demand growth continues to show broad based improvement. Growth in our July snapshot reached 1,093 MB/D, an incremental gain of 378 MB/D from last month. The key drivers were accelerating growth for China and India, a small gain in Korea, and a lesser decline in Japan. The profile was along the lines that PIRA expected. We specifically mentioned last month that growth should average 900 MB/D through August, which so far, it has.

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.