Shale Growth Accelerates

The first quarter marked the first time since 2014 that the shale industry, in aggregate, reported positive net income. The quarter saw Eagle Ford production stabilize following seven quarters of declines, Bakken production recovered following a harsh winter, and Permian growth accelerated on continued activity additions. Guidance from public shale operators for 2017 points to a 60% year-over-year increase in capex and an 18% year-over-year increase in production. As activity quickly ramps, service price inflation is taking hold. Most operators are budgeting for cost inflation between 5-15% year-over-year. However, offsetting part of this inflation is continued efficiencies as operators structurally reduce cost and improve well productivity.

Natural Gas Curve Poised to Steepen

At present, the front of the futures curve appears fairly valued based on fundamentals, with further gains during the peak cooling months dependent on help from weather. Moreover, we acknowledge the possibility of short-term setbacks should cooling demand fail to significantly materialize. In contrast to our cautionary stance on near-term prices, we remain steadfast in our expectation that more significant price recovery will unfold during the upcoming winter.

First Wave LNG Gathers Force

Do not read too much into the first U.S. cargo scheduled for N.W. Europe. It is unclear whether it means the so called “market of last resort” is receiving a cargo due to length elsewhere or because the cargo is being used as leverage against other sellers, including pipeline suppliers. U.S. cargoes have proven time and again over the past year that multiple agendas are driving destinations beyond profitability.

Stocks Lower Year-over-Year on Higher Coal Demand

March 2017 electric power sector stockpiles came in at 163.9 MMst according to last week's EIA press release, 15% lower than last year. This was in line with PIRA’s estimates of March stockpiles between 163 and 164 MMst. PIRA forecasts that stocks in April and May will remain below last year’s levels on higher year-over-year coal demand.

Market Sentiment Slips Along With Cape Freight Rates

The Capsesize freight market dipped this month amid a backdrop of weakening iron ore pricing and bearish sentiment in China. There has been a large recovery in Brazilian iron ore exports, although vessel supply has been growing modestly. PIRA expects that the cape market will cool in the short-term, but rebound strongly later in the year.

Canadian Exports Restrained By Local Demand

Emerging cross-currents should serve to keep a lid on Canadian exports through the remainder of the injection season. Although low-cost Western Canadian sedimentary basin (WCSB) gas held in storage is well-positioned to bolster flows stateside, a more pronounced uptick in cross-border trade will remain dependent on cooling degree days across the Lower 48 this summer. Moreover, for the balance of the injection season, local demand is set to show big gains — mostly from the Canadian oil sands — limiting available pipeline flows into the U.S. Producer guidance remains positive, with renewed optimism pointing to summer production gains. Certainly, an uptick in capital flows alongside enthusiasm for WCSB pure-play gas producers should keep a floor under U.S-bound export volumes this summer.

U.S. Commercial Stocks Draw, Demand Increases

Overall commercial stocks drew by 3.5 million barrels for the latest reporting week, with crude oil stocks leading the way, falling by 4.4 million barrels. While overall product inventory added 0.9 million barrels, the four major products declined by about 1.8 million barrels. Adjusted product demand rose sharply for the latest week moving 840 MB/D higher, with four-week average demand up 4.7% year-on-year, the highest gain seen since earlier in the year. Continuing firm refining margins certainly contributed to a further 160 MB/D increase in refinery runs to 17.28 MMB/D, one of the highest levels over the past decade.

Fed Data Show Healthy Growth, Moderate Inflation, and Low Debt

Activity-related indicators have been positive for the growth outlook lately: the GDP tracking estimate has pointed to fast economic expansion during the second quarter, and manufacturing surveys project a major strengthening in business investment. Data on household debt continue to look non-threatening for the growth outlook. Inflationary expectations remain well-anchored. An alternate measure of underlying inflation corroborated the Core CPI’s recent finding about a softening in inflationary pressure.

Extension of OPEC Cuts Will Exacerbate Seasonal Rate Decline

The steady decline in VLCC rates seen since the beginning of the year was interrupted in April, but resumed in May as the tonnage queue swelled to a nine-month high. The extension of OPEC cuts in 3Q17 (and beyond) and fleet growth will put added pressure on tanker rates during the summer months.

U.S. Ethanol Prices Bottom

U.S. ethanol prices bottomed the week ending May 19 and manufacturing margins improved. April D6 RIN generation was lower, and values soared. Brazil South-Center region sugarcane harvest is ramping up slowly. Hydrous ethanol is competitive with gasoline in Sao Paulo and Mato Grosso. European ethanol prices peak.

Opening Print

With almost all of the severe weather this weekend limited to the southern fringes of major corn-producing areas, there appears to be nowhere to hide for prices as traders return from the long holiday weekend.

Time is Passing Quickly on Storage Injections

The opportunity cost associated with consistently low injection rates is starting to put Europe at risk of feeling a supply pinch come winter time. Such risk may not fully temper the slide of prompt prices but will add to the justification for not selling off the back of the curve any time soon. Assumptions on climate change aside, lower than normal stocks often create more fourth quarter price volatility, as even the hint of colder than normal weather can create risk. With U.K. storage already sidelined and Dutch swing production compromised by aging fields and policy changes, pockets of lower than normal storage on the Continent will only add to the anxiety.

3Q Italian Prices Continue to Climb, Factoring in Exceptionally Low Hydro Output and Hotter Weather

While Italian spot prices have been fairly supported this month, 3Q contracts have been more buoyant. In fact, with gas prices trading sideways, low hydro reservoirs are pushing power prices above €51/MWh, widening the gap with spot levels for June contracts and pushing the spark spreads to new highs. While we have pointed out for a while that there are bullish risks for Italian prices, the market may have now gone too far, as current 3Q prices assume extremely low hydro together with higher demand.

Beginning of the End or One-Off Spot Trade?

Potentially flooding the near-term Atlantic Basin balances even further, the second quarter outlook for the NBP forward curve reveals an extended tie with U.S. Gulf LNG variable costs through the summer – an immediate discount that could be detrimental to flows to NBP in the short term. U.S. sees better netbacks in other summer demand peak markets.

PJM REC Market Balances Tightening

Oversupply continues to weigh on PJM REC markets, and pricing has continued to slide in 2017. A number of factors point to potential pricing upside going forward, including accelerating demand helped by recent policy developments. Corporate renewable buyers have played a large role in recent wind new build and their associated RECs may not be fully available to the compliance market. That said, the pace of RPS requirements from state RPS targets slows considerably after 2020, even as the phase-out of the federal wind PTC leads to significant escalation of effective new wind project costs. Additional market risks stem from transmission projects that could flood the market with RECs after 2020.

Japan Demands Higher, While Runs Continue Lower

Runs continued to decline amid increasing turnarounds. Crude imports rose about 1 MMB/D and produced a 2.2 million barrels crude stock build. Finished product stocks also built, almost 1 million barrels, but there were draws in gasoil and fuel oil stocks. Major product implied demand rose 136 MB/D on the week and the trend rate should begin to turn irregularly higher over the next few weeks. Refining margins were unchanged on the week and remain soft. The implied marketing margin fell for the second straight week. Despite the decline, those spreads remain above their statistical mean.

Financial Stresses Remain Very Low, Credit Conditions Constructive

In general, financial stresses remain extremely low. The S&P 500 continued its climb above the 2,400 level. Commodities had a negative week, particularly energy, but high yield debt, emerging market debt, and high yield energy debt all posted positive performance. In the case of energy, both investment grade credit and high yield credit, are outperforming the physical barrel.

U.S. Ethanol Inventories Decrease

U.S. ethanol inventories declined by 730 thousand barrels last week to 22.7 million barrels, the second largest weekly drop this year. Domestic ethanol production fell 17 MB/D to 1,010 MB/D, erasing most of the gains achieved in the previous week. Ethanol-blended gasoline manufacture declined to 9,394 MB/D from a 40-week high 9,408 MB/D in the preceding week.

If Realized, Summer Weather Guidance Bullish for Price

Since becoming prompt, the June NYMEX contract has traded between $3.14/MMBTU and $3.43/MMBTU, with a majority of trading in the lower half of the range. Last week’s report, which came in above consensus (again), likely raised further concerns about the relative looseness in the balances. Interestingly, demand accommodations in the power sector are already allowing for a steady rate of injections of late. Yet, warmer than normal weather could markedly alter this outcome. Expressly, if summer temperatures were to align anywhere close to last year, prices would likely rise ~20 to 25% above our Reference Case to illicit enough baseload gas-to-coal switching to offset higher loads. At ~$4.0/MMBTU NYMEX realizations, gas power generation in the Midwest and in parts of the Eastern seaboard would concede market share to higher cost coals — a reality that was on display during the 2014 injection season. With this in mind, the possible significant change in the weather ahead should keep the market from retesting seasonal lows, with the stalled rally likely to restart with a little encouragement from Mother Nature.

Bullish Rally Runs Out of Steam, Coal Market Waiting on Seasonal Demand

The bullish rally that prevailed the week of May 15th spilled into the following Monday, with prompt prices rising $1.00/mt over the first session of the week. However, the market could not hold on to the gains, with prices falling consistently throughout the balance of the week. CIF ARA forwards were able to post a modest week-over-week gain, while FOB Richards Bay and FOB Newcastle forwards finished Friday below week-ago levels. The relative strength in CIF ARA prices compared to other pricing points over the past several weeks is largely misplaced in PIRA’s view. Until the brunt of summer demand kicks in, seaborne coal prices are expected to be largely range-bound with a modest downside bias.

WCI Carbon Auction Back to Full Subscription

The May WCI current vintage auction returned to full subscription and cleared above the floor price. Should the August auction also clear above the reserve price, November 2017 will start to see the (gradual) return to auction of the considerable volumes of unsold state-owned allowances. Although significant additional buying is necessary at the remaining 2017 auctions, these results, along with the large offset issuance on May 24th, help to reduce the risk that sources will not have adequate holdings of CP2 compliance instruments for the November 2018 reconciliation (weakening the justification for a premium for CP2 vintages). PIRA does still expect that some unsold allowances will be moved to the reserve should the cap and trade amendments be finalized.

Global Equities Still Setting Record Highs

Many of the benchmark equity indices continue to set record highs. The U.S. S&P 500 continued its climb above the 2,400 level. Utilities, technology, and consumer staples performed the best on the week, while energy was the clear laggard. International indices also did well, with emerging Asia, China, and Latin America doing the best.

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.