Downstream Markets Strong in Lead Up to IMO 2020

Our Brent price outlook is bullish through 3Q18 with strong demand growth and tightening crude balances despite U.S. shale crude expansion. Excess commercial stocks were essentially eliminated at end 2017; Current stock build is less than normal, setting the stage for a tight summer.

Refining margins will stay generally healthy through 2018. Poor refinery operations in Latin America will continue to pull on Atlantic Basin product supply. High utilization rates are still needed in Europe to balance Atlantic Basin product markets. Downstream focus is returning to gasoline with change to summer specs but middle distillate cracks will remain stronger than last year and residual fuel oil cracks will remain firm in 2018.

IMO 2020 will affect markets beginning in 2H19 as global bunker spec change in 2020 will probably be one of the most disruptive events for refined product markets, refiners, and shippers since at least the 1980’s. Middle distillate cracks, sulfur spreads, and light-heavy differentials will all widen sharply as high sulfur fuel oil cracks fall sharply. This will begin in earnest in mid-2019 as stakeholders empty out high sulfur crude/products and seek lower sulfur replacements. IMO 2020 spec change will effectively result in a net transfer in excess of $1 trillion over 5 years from consumers to refiners, sweet crude producers, and others.

US Gas Short-Term Forecast - March

The price forecast has been increased slightly for the summer in response to colder-than-normal weather depleting inventories more than originally forecast. Loss of elasticity in the power sector is an important contributor to upside risk to price in the coming months. Yet, remaining coal-to-gas switching provides US balances (and prices) downside protection. Taking Stock: End-Winter Storage Levels Send a Mixed Message to Suppliers

Western European markets have relied on LNG in tank over the past couple of months and the result has been a draw on stocks to record low levels. Underground storage levels are also likely to reach six-year lows by the end of the heating season. Cargo diversions into the region now will be used to bulk up LNG stocks and help safeguard against a late winter cold spell. Europe’s pull on the global LNG market is set to be stronger this summer as it looks to recover its storage levels. Asia is better positioned to hold off on stock replenishment until May/June, particularly as Japan is seeing movement on the nuclear restart front.

Cape Freight Rates Slump with the Onset of Trump’s Trade War

The Cape market has now moved below levels seen last year in the same period. There is a great deal of uncertainty as to how Trump’s trade war will play out and what will be the impact on commodity trades and the freight market. One thing is clear, buoyant Chinese market sentiment has been reversed. We remain concerned about the underlying level of Chinese domestic steel demand given that Chinese iron ore stockpiles have continued to rise despite a slowdown in shipments by the Mining Majors.

Trump Regulatory Roll-Back Continues

The Trump energy and environmental regulatory roll-back continues, through traditional rulemaking and stays of rules, guidance and policy memos, with various degrees of pushback from the courts. In 2018 so far BLM has finalized the rescission of the Fracking on Federal Lands Rule and proposed a repeal of the Venting and Flaring Rule. EPA has issued guidance altering emissions accounting under NSR and repealed ‘once-in always-in’ policy for major source MACT. Comments on EPA’s replacement of the Clean Power Plan passed, while the comment period on the CPP repeal was extended until April. DOI’s plan to expand lease sales to 90% of federal waters faces significant legal and commercial obstacles. EPA has an April deadline for its review of light duty vehicle GHG standards and may weaken them and separately revoke California's waiver. Over the next few months (1) EPA expects to finalize stays of NSPS oil & gas sector methane emissions regs, and is court mandated to (2) complete 2015 Ozone Designations, and (3) finalize NO2 NAAQS. Greater clarity on priority actions will come with the upcoming 2017 Spring Unified Agenda.

U.S. Commercial Stocks Have Large Decline -Widening Deficit

Commercial oil inventories drew 7.0 million barrels last week with both crude oil (-2.6 million barrels) and especially products (-4.3 million barrels) contributing. Product demand (adjusted) in the latest four weeks is up 7.1%, or 1.4 MMB/D, versus last year while crude runs in the latest week are around 1.0 MMB/D higher than last year. Gasoline yields have shifted lower as demand has picked up, pulling stocks lower with the latest week down 1.7 million barrels. This week gasoline inventories are forecast to be relatively flat, while absorbing a huge slug of imports which will substantially drop off in subsequent weeks. Distillate stocks drew 2.0 million barrels last week and are forecast to decline another 2.9 million barrels in this week’s EIA report as weather remains colder than normal. Cushing crude stocks built 0.9 million barrels last week and are forecast to build another 0.5 million barrels this week, but the inventory cushion looks lean with demand turning much stronger in April because of refineries coming back and Ozark/Diamond pipes pulling more.

Fed Changes its Outlook; How Will Trade Friction with China Impact Economic Outlook?

Last week’s Fed policy meeting was the first one Jay Powell presided over as Fed chair. The policy interest rate was hiked, as expected. Economic growth projections were revised higher, while the inflation forecast was basically left untouched. Regarding the interest rate outlook, policymakers turned slightly more hawkish. Trade frictions continued to be on the rise, as the U.S. announced new tariffs at Chinese imports. Economic costs of frictions are small for now, but they may escalate. Key activity data releases, such as U.S. durable goods orders, were constructive.

NGL Purity Product Prices Rally across the Board

Prices for each of the NGL purity products advanced last week and were buoyed by higher crude prices. Mount Belvieu non-LST propane gained 2.8% week-on-week, and Mount Belvieu non-LST ethane settled 4.5% higher. As a percent of crude, propane declined to 52% as the crude rally outpaced propane. NGL production was mostly flat on the week, settling at 4.01 million b/d. U.S. propane/propylene inventories fell 2.1 million barrels to 36.8 million barrels during the week ended March 16. Implied demand was reported at 1.2 million b/d, down 20% from the previous week. The EIA reported propane exports of 1.04 million b/d, the highest since early February. For the week ending March 23, exports are forecast to be 1 million b/d. Steam cracker feedstock margins were fell off sharply last week with the combination of feedstock price increases and weak co-product prices.

U.S. Ethanol Prices Peaked March 13, but have Weakened Since

D6-RIN values bottomed on March 13, but have rebounded since. D6 RIN generation was lower in February, but D3, D4 and D5 registration rose. Brazil’s RenovaBio policy was progressing. The goal is to reduce carbon emissions by 37% in 2025 in accordance with the Paris accord. European ethanol prices and manufacturing margins tumbled. U.S. biodiesel prices strengthened.

Tariffs and Exports

At this point everyone is exhausted by Trump’s tariff talk, especially those brave enough to check the value of their retirement account at the end of last week. For now the retaliation from the Chinese is in the form of pork tariffs with the obvious fear that soybeans are next. Soybeans are an “easy” target for Ag media looking for a story. Through our editorial on The Hill a few weeks ago, Platts Analytics is on the record as stating that “US agriculture can ill afford a trade war with China”, a sentiment that’s now being echoed by every Midwest politician, but would a soybean tariff on US origin supplies make a difference? The fact remains that China will import 100M MT of beans this year, regardless of origin. Can they 100% shun U.S. supplies? Absolutely not, but the fear is that the U.S. becomes a secondary supplier, much like what’s happened in the wheat market. The difference is in the global balance sheet as bushels will be removed from somewhere in order to satisfy the Chinese. The market knows this while analysis points to the Fund positioning in beans and meal as more of a price negative than all the tariff talk.

U.S. SPR Update: Omnibus Spending Bill Adds 10 MMBbl of Sales in Fiscal 2020-2021

On March 23, U.S. President Trump signed a $1.3 trillion omnibus spending bill, funding the government through end-September 2018 and preventing another government shutdown. Unsurprisingly, the legislation requires 10 MMBbl of total SPR sales in fiscal 2020-2021, becoming the sixth bill passed since 2015 to mandate SPR sales to fund non-energy related items. Collectively, this will result in a total of 266 MMBbl of such sales from fiscal 2017-2027 (24 MMBbl already completed), with more required drawdowns highly likely in future budget legislation. Declining net oil imports have turned a decades-old view of U.S. energy security on its head, making SPR sales more politically palatable than tax hikes. Separately, ~6 MMBbl from the SPR will hit the market in April and May 2018, with the proceeds to be used for SPR infrastructure upgrades. After that, no further SPR sales are expected until fiscal 2019, which begins in October 2018.

North American Gas Regional Short-Term Forecast - March

Waha forward prices have responded to the Permian production growth by showing more weakness for the balance of 2018. Midwest prices face added downward pressure this summer amid added supply inroads from the Northeast, as well as from the western half of the US, largely due to supply displacement needed to accommodate Permian Basin production growth.

Europe Needs More Storage Injections and the US Possesses More Supply

The looming surge in US LNG production and the looming shortages in European gas storage throughout the summer are two fundamental factors made for each other. With JKM spot prices in Asia set to plunge below $7/MMBtu this week and Argentina lifting only eight out of two dozen cargos tendered for the second quarter, US LNG exports will be more sharply focused on Atlantic Basin destinations in the months to come. In the European context, the divide will be between Mediterranean and NW European deliveries. Last summer, Mediterranean deliveries were preferable to NW Europe due to the shorter distances and higher netbacks in most cases.

The upcoming six months tells a different and more nuanced story, when the absence of US flows into Europe would lead to a considerably more bullish story than last year due to the rapid demise of the storage surplus over the first quarter. Now staring at record low stocks coming out of winter, LNG becomes more of a necessity than a choice, as will reliance on higher than normal Russian flows amid ever-increasing political tensions that threaten to bleed into the commercial realm.

Australian Spot Prices Face Off with JKM –Potentially Affecting Exports

While global LNG pricing has been dipping, Australian domestic pricing hasn’t – and indications are that there may be some export implications to that. Australia’s southern and eastern interconnected gas markets has a gas deficit, which impacts cargo shipments from Curtis Island. Utilization of these coal seam plants this winter seems to be responding to local pricing. With Sydney being the premium market, one can see how an eroding foreign premium might be encouraging some domestic production to be consumed in Australia rather than exported. This supply diversion emerges as a counter seasonal balancing item in the aftermath of quickly declining Northeast Asian demand – along with growing South Asian, Middle Eastern, and South American demand.

Ukrainian Gas Prices Set to Rise in April

Naftogaz of Ukraine on April 1, 2018 will raise the price of natural gas for industrial consumers and other economic entities by 7.4-9.8%, the company’s press service reports. The proposed prices for natural gas from the company's resource have been differentiated depending on the volume of purchases, terms of payment and the state of previous settlements with Naftogaz. The prices of natural gas sold to industrial consumers were reduced by 12.3-14.1% in March 2018 from the prices set in February 2018.

Bullish Risk remains in 2Q despite Major Recovery in Spanish Hydro Stocks

Spanish day ahead prices have plunged to almost €42/MWh this month, or over €7/MWh below our expectations, as the Iberian Peninsula has been battered by strong winds and heavy precipitation. Since the beginning of the month, reservoir levels have gone from the bottom-end up to 1/3 of the 16-year range, the first time such a surge happened in such a short timeframe. The dispatch observed this month, coupled with the strong wind output, might have steered the market towards a comfortable outlook for 2Q but history shows that current hydro stocks are unlikely to result in an output recovery stretching into the summer.

Coal Prices Continue to Slip on Weaker China Fundamentals

Despite a bullish turn early last week, seaborne coal prices continued to move lower last week. FOB Newcastle FOB Richards Bay prices declined by the largest extent at the front of the curve (close to $2.00/mt), while CIF ARA faded by $0.80/mt. The blast of cold temperatures in Western Europe likely played a role in the relative strength in CIF ARA pricing. With the brunt of seasonal demand strength largely past, the market is searching for a new equilibrium after the return of $100/mt pricing in early 2018. The level of Chinese import demand will be perhaps the most influential factor in setting short-term coal pricing, which is looking increasingly bearish with stockpiles at key coal-fired power plants now at the highest levels since late-2014.

2017 EU ETS Emissions Up Slightly on Industrial Gains

EU ETS verified emissions data for 2017 will be released April 3rd, one of the few official data points each year to assess EUA demand and market balances. 2017 EU ETS stationary emissions are expected to be in a 1,755-1,765 MT range, a year-over-year gain of under 1%. Grid-connected power emissions were down across Europe, although this was offset by emissions gains from non-grid combustion. Industrial sector emissions changes are all expected to be positive year-over-year on higher production. Increases in European jet fuel demand imply a 2-4 MT rise in covered aviation emissions during 2017, to 64-66 MT. With post-2020 market reforms and the strengthening of the Market Stability Reserve in 2019-2023 now finalized, this data release could act as a stronger EUA price driver than in previous years. The possibility of increasing emissions during 2017 could act as a bullish near-term indicator. This data release also takes on added significance this year, as these data will be used to calculate the volume of allowances to be placed in the MSR starting next year. However, higher emissions in the 2017 data would also directionally reduce the volume of allowances to be placed in the MSR in 2019.

Japan Finished Product Stocks Moving Higher, as Demand Ebbs Seasonally

Runs eased 62 MB/D, while crude imports were sufficiently low to draw crude stocks 1.05 MMBbls. Product stocks built for the third straight week at an accelerating rate as demand continues to decline seasonally. Balances are a little less constructive to cracks, though levels remain decent. The implied refining margin eased by another $0.25/Bbl, and is now near the average seen in February. Rising product stocks are taking some of the lift to refining margins. Retail prices were modestly lower. The indicative marketing margin remains above statistical highs. The overall downstream value chain looks healthy, with marketing doing comparatively better.

Financial Stresses on the Rise

Financial stresses are increasing on a host of fronts, though cross currents remain. The S&P 500 closed below 2,600 for the first time since early February, while VIX volatility jumped 64% on the week to almost 26. Oil volatility (OVX) didn’t jump nearly as much (+12%), and energy commodities had a strong week, up 3.1%. We have added the Libor-OIS spread as an indicator of stress (charts 16 & 17). It has been rising notably, but remains well below extreme levels seen back in 2008-2009, though is now slightly higher than during the European debt crisis in 2010 and 2012. It will continue to be monitored as a stress and liquidity indicator. The St. Louis financial stress indicator was fractionally lower.

Total Stocks and Inventories in the Midwest and Gulf Coast Drop from All-Time Highs

Ethanol inventories fell by 532 thousand barrels to 23.8 million barrels, dropping from a record high in the preceding week. Stocks in both the Midwest and Gulf Coast sunk from all-time highs. Ethanol production continued its saw-toothed pattern, rising 24 MB/D to 1,049 MB/D after falling in the prior week. Ethanol-blended gasoline output increased to a 12-week high 9,098 MB/D from 9,058 MB/D despite a dip in overall gasoline production.

Colombia Takes More Steps to Rejuvenate Oil Production

New steps by the Colombian government have significantly increased the potential for crude oil production growth, mainly in the longer term. New exploration blocks are to be offered next month for the first time since 2014, and routine offerings are planned afterwards. We do not expect these new steps will have a significant impact on near term production. We see Colombian crude output of 860 MB/D in 2018, rising modestly to 900 MB/D in 2019. Longer term, we think non-shale onshore crude will continue to decline because of maturity of the resource base and because most new oil is likely to be small fields and heavy crude and thus likely relatively higher cost. A small amount of shale crude continues to be on our forecast. In recognition of the new emphasis on offshore, we have added offshore oil production to our forecast.

Global Equity Markets Hit a Down Draft

Global equities fell -4.5% on the week, but the U.S. was lower almost -6%. Among the domestic tracking indices, technology and banking were weaker than the averages and down almost -8%, while energy performed the best, down only -0.8%. Internationally, China, was lower by -7.6%, while Latin America did the best, down only -1.6%.

U.S. Shale Oil Industry Moving Towards Positive Cash Flows

With the recent scrutiny from Wall Street for shale operators to return value to shareholders, most companies have pledged to live within cash flows. We forecast free cash flow (FCF) for the shale oil industry in 2018 to be reached at $59/Bbl (WTI) before considering interest payments, dividends and stock buybacks ($67/Bbl if these factors are included). Most producers have guided that they will achieve FCF in 2018 anywhere from the low-$40s/Bbl to $60/Bbl (WTI). Most producers have also indicated that excess cash flow will be spent on strengthening their balance sheets, increasing dividends, or buying back shares. Realizing FCF in 2018 for the entire shale oil industry will depend on capital discipline (sticking to their guidance of keeping rig counts flat or slightly increasing them) and oil prices staying above $60/Bbl WTI.

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.