Refinery Margins Remain Strong
Brent prices approach, and probably exceed, $60/Bbl in 4Q17 but that strength is not sustainable for 2018. WTI – Brent relatively weak but will firm somewhat when Cushing stocks draw.
Refining margins will remain strong through 2018 with regional demand growth and poor refinery operations in Latin America pulling on Atlantic Basin product supply. Sophisticated regional refinery capacity layers are essentially full leaving only less economic options which drive up margins and runs in simpler capacity layers (hydroskimming in Europe) to cover demand/import requirements. Product stocks tighten, pushing prices into backwardation and cracks higher to marginal supply economics. Atlantic Basin gasoline stocks/coverage recover in 4Q from Hurricane Harvey but stay in historical range. Diesel stocks now in the lower half of “normal” range, lowest in over two years. Gasoline cracks seasonally weaker but stay healthy, no deep discounts. Diesel cracks will continue to gradually strengthen assuming a normal winter. Residual fuel oil cracks will remain firm.
In Developed Economies, Synchronized Growth but Unsynchronized Policy Response
U.S. GDP for the third quarter was solid, and September durable goods orders suggested a strengthening in the economy’s momentum. Given the healthy outlook for U.S., the Federal Reserve is expected to stay on the path of gradual policy normalization. The European Central Bank was expected to chart a path for tapering of quantitative easing this week, but it decided not to follow the Fed’s playbook – the ECB announced a scaling down of asset purchases for next year, but it also continued to make the QE program open-ended. In Japan, activity data have been encouraging, but the Bank of Japan is not yet in position to present a roadmap for monetary policy normalization.
Iraqi Kurdistan: Battle for Fishkabur May Be Imminent
Clashes between Iranian-backed Shia militias and Kurdish forces broke out this week 25 miles south of the Kurdish town of Fishkabur, where the pivotal oil pipeline border crossing to Turkey is located. PIRA understands Iranian-backed militias still hope to take the strategic pipeline hub, and thus physical control of all northern Iraqi pipeline exports (over 500 MB/D before the recent turmoil in Kirkuk). This makes a near-term battle more likely than not. The operation appears to be orchestrated by influential Iranian general Qassem Suleimani, indicating Tehran’s growing influence within the post-ISIS vacuum. Notably, the Shia militias have not yet agreed to a ceasefire announced by the KRG and Iraqi government forces on October 27. A battle for the pipeline crossing could place all northern pipeline exports at risk, while Iran’s desire to solidify control in both Iraq and Syria portends greater regional instability.
Supply is Coming…Is Winter?
As discussed at the 38th PIRA Annual Client Seminar, seasonal price recovery this year is dependent on more normal heating demand taking hold in the U.S., in contrast to a year ago. Indeed, the relatively comfortable level of pre-winter inventories (especially in the Midwest and East), coupled with a healthy well inventory, necessitate that the arrival of cold weather occur early rather than later in the season. In order to expand the Y/Y storage deficit in December, the de-stocking would have to approach year-ago levels. Therefore, while PIRA maintains its constructive stance relative to the current forward curve, we downwardly revised prices for the winter by an average of 5¢. Our constructive stance on price is predicated on the expansion of the inventory deficit as the season unfolds. While the impressive call on supply from new structural and export demand growth could reach 3 BCF/D, higher prices still necessitate a return of normal weather.
Back-End of the Curve Upside
Warmer weather helped make the French nuclear shortfall more manageable during October, but the outlook remains highly uncertain. With the extension of the Tricastin outage through the end of November, Y/Y gains for French nuclear appear now unlikely. Sustained exports toward its Southern neighbors, together with ongoing risk of delays in the restart of the reactors, are overall constructive for French prices, and we have revised upward our forecasts for November and December.
In addition to shrinking thermal capacities, a fluid policy framework offers upside for the back-end of the curve. The agreement on the introduction of a carbon floor of €18/MT in the Netherlands should translate into an increase by €1-1.4/MWh on German prices, driven by increased exports to Netherlands. While we’re still far from the formation of a new government in Germany, the resiliency of German C02 emissions is now coming more prominently to the fore, especially as the Greens are part of the coalition talks. Our price forecasts are already above the curve, without factoring in so far any policy change, other than the Dutch carbon floor.
August Coal Stockpiles Draw Less Than Normal on Mild Weather, Stalled Gas Price Rally
The EIA reported end-August electric power sector coal stockpiles of 144.2 MMst on October 24, a decline of 3.9 MMst M/M. That was 1.4 MMst short of the five-year average stock draw for August and less than half of the stock draw during August 2016. Mild August 2017 temperatures, which were centered over the coal-dominated Midwest, lowered coal burn during the month. In addition, coal burn was impacted by Henry Hub spot gas prices that averaged $2.90/MMBtu in August, just $0.08/MMBtu higher than the August average last year.
U.S. Commercial Stocks Drop Slightly
Overall U.S. commercial stocks saw the largest decline in several months, falling by 12.2 million barrels for the latest week led by sharp declines in gasoline and distillate inventory. The pace of decline is outpacing last year, leading to a widening of the storage deficit to 59.8 million barrels. Gasoline stocks fell by 5.5 million barrels, one of the largest weekly declines of the year-to-date placing storage 9.1 million barrels below last year. For the next week inventory continues to draw falling by 1.1 million barrels. Similarly distillate inventory fell by around 5.2 million barrels, placing the deficit to last year at 23.1 million barrels. Distillate continues to decline sharply next week by 2.7 million barrels. Refinery runs bounced back from the impact of Hurricane Nate to reach just over 16 MMB/D, up 590 MB/D for the week. Runs are expected to reach 16.2 MMB/D for the next week, as the peak of the turnaround season has passed. Crude storage added nearly 0.9 million barrels, while Cushing stocks drew by 0.2 million barrels. Crude stocks are expected to draw by over 2.2 million barrels for the next week, while Cushing storage builds by 0.3 million barrels.
Bearish Storage Comes With Higher Upside Risk from LNG and the Power Sector
Warm weather reduced gas demand by over 2.24-BCM across Europe, the second biggest October total in the last 10 years. In addition, wind speeds in Northwest Europe were up 33% Y/Y, leading to higher German wind output of 127% Y/Y or 9.2-GW. Historically speaking, realized wind speeds were relatively normal and upwards of 18% below October highs of the last 10 years pointing to problematic gas consumption for the Octobers to come. Unfortunately, gas is still very much tied to coal pricing, which has been fundamentally buoyed by low stocks and high demand in Asia. PIRA doesn’t see these forces abating till next year.
Cape Freight Rates Stay High but Chinese Cutbacks Loom
Capesize dry bulk freight rates have held on to recent gains, with the five-route rate holding near $22,000/day. However, Chinese demand for dry bulk commodities is set to contract over the winter months due to mandatory cutbacks in several industries, particularly steel and aluminum. PIRA expects Cape freight rates to fall steadily through 4Q17 and 1Q18, underperforming current FFA rates before picking up later in the year.
2016 California Emissions: Lower PowerGen Counters Gains in Transport
The once-a-year release of annual cap-and-trade covered emissions data can be a market-moving event. Even in oversupplied markets, it offers an opportunity to calibrate and quantify the surplus. Similar to previous years, data for the 2016 compliance year in the California emissions market will be available on November 6th at 12pm Pacific Time. PIRA expects overall California 2016 covered emissions to be down vs. 2015 levels, as declining emissions across the power sector (in-state generation, cogeneration, power imports) negate rising emissions from transportation. While prior California data releases did not have a short-term impact on California Carbon Allowance (CCA) prices, the magnitude of the decline expected this year could provide downward price pressure.
Japan Max Turnarounds, Demand Slowly Picking Up
The data this week came in much as expected. Runs were little changed, crude stocks were higher, along with a broad based finished product inventory draw and higher product demands. The impact of typhoon Lan does not appear to have entered this past week’s data, but next week will be another story, along with impacts from tropical storm Saola. Gasoline stocks were little change, while gasoil stocks drew due to higher exports. Kerosene demand remained strong as pre-heating season fill programs continued. Kero stocks resumed drawing at a rate of 60 MB/D, with the 4-week build rate easing to 46 MB/D. Refining margins again eased slightly on the week, but remain acceptable. Indicative marketing margin had improved for the last month, but eased this past week. For both gasoline and gasoil/diesel are below statistical norms, with gasoil/diesel showing the larger variance.
NGL Purity Product Prices Rebound
NGL purity product prices recorded gains last week following increases in crude prices. Propane’s price strengthened relative to crude prices and closed the week at 73% the WTI crude price. Divergent moves in oil and natural gas prices will further pressure high LPG prices into November, while ethane prices should soften with natural gas prices. The strength in propane prices is due to a perception of tight supplies because of relatively low inventories. Propane stocks fell by 1.2 million barrels for the week ending October 20. Propane inventories trail the five-year average by 8.5% and are 23% lower than at this time last year. Propane exports declined 7.8% to 905,000 b/d for the week ending October 20. Propane exports are expected to remain in the neighborhood of 900,000 b/d for the week ending October 27. U.S. raw mix NGL production increased 35,000 b/d for the week. NGL production returned to normal last week after disruptions caused by Hurricane Nate.
Ethanol Prices Slide in U.S. and Europe
U.S. ethanol prices slid the week ending October 20. Manufacturing margins were stable as corn cost also declined. The EPA stated it is not likely to reduce the mandates for 2018 from those proposed earlier this year. RIN values jumped on the announcement. European ethanol prices also declined as beet-ethanol hit the market. U.S. biodiesel prices rose to a three-week high.
Seasonal Rally Underway in Crude Trades but Product Tanker Rates Weaker
After spending a prolonged period near or below cash break-even levels, crude tanker markets registered a strong seasonal recovery on near-record Chinese crude imports in September and earlier than normal delays in the Turkish Straits. In contrast, MR product tanker rates in the Atlantic Basin collapsed as U.S. refineries shut down by Hurricane Harvey resumed operations creating less need for imports while exports were still restrained by fall maintenance.
Kurdish Deal with Baghdad Lowers Risks to Northern Oil Flows
The KRG has reportedly struck a deal for joint control with Baghdad of the border crossings including Fishkahbur. Iraq will monitor oil flows from the KRG, revenues will go to Baghdad, and Baghdad will pay KRG salaries (including Peshmerga) but will do it through the Governorates, not the KRG bureaucracy. This is apparently a preliminary agreement, with the details to be sorted out over the next couple of weeks. The risk of a confrontation over Fishkabur has therefore been substantially reduced.
Credit Markets Remain Constructive
Credit conditions remain highly constructive, with the S&P 500 continuing to set new records, though volatility again gained slightly on the week. Many of the credit indices, such as high yield debt (HYG), emerging market debt (EMB), along with some of the other credit indicators in the energy space lost ground slightly. Total commodities gained despite a strong move higher in the U.S. dollar. Energy was particularly strong and outperformed. The St. Louis financial stress indicator continued its downward trend.
No Pain No Gain for Canadian Producers Challenged by ‘Congestion Pricing’
The routing of Canadian price markers has continued this month. Despite the ongoing development of capacity enhancement projects, commercial behavior and capacity restrictions have pushed AECO-C differentials to marked lows not observed for the last 15 years. With pipeline maintenance weighing more heavily than ever on the long-dated contracts, the market is seemingly putting very little stock in early forecasts of a return to ‘normal’ winter. Yet, continued infrastructure expansions coupled with advantageous contracting on TransCanada’s Mainline should provide basis relief beginning next month.
What do JKM Prices Say about Spot Demand in a World Where Contract Volumes Growth Dominates?
The 40% surge in JKM spot prices over the past month belies the fact that the demand surge in Asia over the past year has been almost entirely (91%) underpinned by long term, take-or-pay oil indexed contracts. While oil-indexed prices too have gotten some support in recent weeks on political risk factors and a move towards rebalancing in 4Q, the 8% increase in JCC prices over Sept. bears little relationship to the current spot market jump. The fact is that the spot market in Asia is comparatively small and fairly illiquid and such volatility is to be expected when there is an unexpected turn in buying behavior, either following an outage of a nuclear plant or a temperature spike, regardless of how small that call on actual cargos may be.
Ukranian Industrials to Receive Price Rise
NJSC Naftogaz of Ukraine from November 1, 2017 will raise the price of natural gas for industrial consumers and other economic entities. This has been reported by the company’s press service. “The prices will be raised by 7.5% in November, comparing with the prices in October of the current year,” reads the report. 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 company reported.
Coal Market Strength Persists, Winter Risks Skewed to the Upside
Despite easing for most of the week, seaborne coal prices finished the week higher W/W, amid a rally in the overall energy complex. Over the next 90 days, the pricing risks remain to the upside in PIRA’s view, with low stockpiles in key markets, upcoming seasonal demand, and underperforming coal supply. However, after the winter peak season passes, the risks become more balanced to bearish, which should see prices fade precipitously over 2Q/3Q.
Fire at Tehran’s Refinery
At this point the fire has reportedly been contained but the magnitude of damages are not yet known. Apparently the fire was caused by an oil leakage in a yet to be identified unit that was undergoing maintenance. According to PIRA’s World Refinery Database, the facility runs mostly medium sour grades, yielding 22% gasoline (50 MB/D), 41% gasoil (85 MB/D), 7% jet-kero (15 MB/D), 13% fuel oil (25 MB/D) and around 3% naphtha (5 MB/D).
Global Equities Setting More Record Highs
Global equity markets continue to set more broad based records in a host of countries and across a host of market indices. In the U.S., the S&P 500 was modestly higher on the week, and again set records. Technology, consumer discretionary, and banking were the best performers, while retail was the laggard. Energy was down slightly. Internationally, Japan performed the best, +1.6%, while Latin America lost a similar amount of ground.
U.S. Ethanol Production rose to Six-Week High
U.S. ethanol production rose by 20 MB/D to a six-week high 1,039 MB/D last week, as nearly all plants have resumed normal operations following seasonal maintenance. The 72 MB/D gain over the past fourteen days was the largest two-week increase ever reported. Total inventories dropped by 446 thousand barrels last week to 21.0 million barrels, led by a huge draw in the Gulf Coast region. Ethanol-blended gasoline production rose for the fourth time in five weeks, increasing by 51 MB/D to 9,182 MB/D.
Mild Weather & Congestion Compresses Supply Hubs — Alongside Henry
While yesterday’s EIA release of 64 BCF is generally in line with the mid-60’s consensus, the re-stocking landed well below both the year-ago and five-year average builds. Furthermore, the growing concerns of a repeat of last season’s mild weather and more pronounced production appreciation this year continue to weigh heavily on the November contract. Indeed, the nearby contract has declined more than 10¢ since entering the month, with the heating season average not far off, down by ~7¢ thus far. Wrapping up October, the HH cash price is on track to end the month 7¢ below September’s level — with broad weaknesses observed across the cohort of supply regions in both the East and West.
Brazil’s Refining Sector Hopes to Welcome Private Investment
Earlier this week the head of Petrobras’s refining branch stated that by the end of the year the company will likely approve the strategy to sell stakes in its domestic refining system.
Saudi Arabia: Foreign Exchange Reserve Draw Tempered in September
Saudi’s foreign exchange (fx) reserves for end-September were just released. They declined -$2.4 billion, a noted improvement from the -$6.9 billion draw posted in August, and the -$6.2 billion draw seen in July. Saudi still needs prices higher than the current Dubai price of $57 ($55.40 Oct mtd), to stabilize reserves. PIRA’s expectation is for an extension of OPEC’s production agreement beyond March 2018, which should favor a continuing improvement in Saudi financials.
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.
