Oil Balances Tight, But Manageable. Expect More Volatility

Global economic growth remains strong, but forex and financial risks for 2018 are still building. Balances continue to look tight. Oil demand growth forecasts revised slightly lower due to recent weather events (Hurricane Florence in US and Typhoon Mangkhut in China), but remains above trend. We raised our expectations for Iranian export losses (now assumed at 1.7 MMB/D in reduced exports from May to November), although increases in Saudi Arabia as well as UAE, Kuwait, Iraq, and Russia are coming early and in a material way. We forecast substantial draws in oil inventories in the three major OECD markets (US, OECD Europe, and Japan) for 4Q18. And crude stocks on a days supply cover basis are at the very low end of historical ranges. Yet while balances are tight, they remain within manageable ranges. Brent appears to be pricing in much Iran risk. Risks to supply are building around the world. On other hand, we must not overlook potential for much higher output from Saudi Arabia and Neutral Zone. Risks to demand are also skewed slightly to the downside. But in a world of low stocks, low spare capacity, and high geopolitical risks to supply, the stage is set for more price volatility.

Energy's Impact on Consumer Inflation in Major Economies

In key economies including the U.S., China, the euro area, and Japan, year-on-year increases in oil prices have had major effects on headline consumer inflation. Based on Platts Analytics' latest price forecast, this situation will persist for some time. Excluding energy and food prices, however, core inflation has generally been benign, and in the case of Japan, still very sluggish. Recent manufacturing confidence surveys in the U.S. have been constructive. In the euro area, however, confidence data pointed to a continuing slump in industrial production.

Propane stocks rise, but forwards point to pending withdrawals

US propane/propylene stocks rose by 111,000 barrels during the week ended September 14, according to EIA data. Production hit a new high of 2.02 million b/d, with PADD 3 production reaching nearly 1.1 million b/d, a 12% increase over January production levels. Total inventories stand at 74.8 million barrels, or 35 days of supply inclusive of export demand. The EIA reported propane exports of 975,000 b/d for the week ended September 14, compared to Platts Analytics' estimate of 1.09 million b/d based on ship tracking data. For the week ending September 21, exports are expected to be 1.1 million b/d. Spot arbitrage margins from the US to Asia have been largely positive over the past few weeks, as prices in demand markets rise in anticipation of winter heating season. October propane in LST storage at Mont Belvieu flipped from backwardation to contango against September propane. The October product was assessed at 25 points over September product on a trade at that level, compared with a 12.5-point discount Thursday.

US Gas Short-Term Forecast – September

The expectation of tighter balances in 4Q19 are coloring our view for 2019 prices, as total demand growth, led by exports and power burn, are expected to outpace supply gains by more than 2 Bcf/d. The November through March price forecast is down from last month in response to production growth coming earlier than previously anticipated.

Bullish Factors Dominate in the Short Term, but 2019 Outlook Remains Bearish

With seaborne coal prices likely to be supported in the short term, and US exports likely to run at historically elevated levels into CY19, we continue to expect little downside for US Eastern coal prices in the short term. However, our view on 2019 US coal prices remains bearish.

U.S. Federal Regulatory Calendar

The Trump Administration continues to advance its deregulatory agenda as federal agencies come closer to repealing or significantly revising some of the highest profile and most impactful rulemakings from the Obama Administration. Key recent updates include the federal light and heavy duty vehicle emissions standards rollbacks, the Clean Power Plan repeal and replacement, as well as revisions to regulations of methane emissions in the oil and gas industry and criteria air pollutants from the power sector.

Expect crude stocks to build, as refinery outages ramp up. Products stocks should stay flat, as clean fuels demand weakens slightly in the aftermath of Hurricane Florence

Total hydrocarbon inventories were virtually unchanged last week. Crude stocks dropped by 2.06 MMB, which aligned with our expectations. Aggregate clean products' inventories were almost flat, as gasoline stocks dropped as expected, but distillates and jet inventories built. “Other products” stocks built by 2.1 MMB. Crude stocks at Cushing decreased by 1.3 MMB (vs. 1.1 in our forecast), with very high outbound flows to the Gulf Coast offsetting both higher inbound flows from Canada and lower local demand from refineries. Refinery maintenance in PADD 2 and inbound flows to Cushing are expected to continue to rise, but they will be offset by even faster outbound flows into the USGC. As a result, we expect Cushing inventories to decrease by 0.3 MMB for this week's report. EIA reported crude output of 10.5 MMB/D for the L48 and 470 MB/D for Alaska (from 452 MB/D during the previous week).

U.S. Ethanol Prices fall, following corn prices lower

U.S. ethanol prices declined last week following the USDA's forecast of the second largest corn crop ever (14.827 billion bushels). The summertime restriction on selling E15 in much of the country ended yesterday. Ethanol manufacturing margins were slightly higher last week because the decrease in corn cost outweighed the reduction in ethanol and DDG values. In Brazil, mills continue to focus on ethanol production which is more profitable than sugar manufacture.

More Tariffs

Another negative start for soybeans as this week's trade talks with China were cancelled late last Friday afternoon. As “promised”, the U.S. implemented a 10% tariff on an additional $200 billion of goods overnight, to which the Chinese have promised retaliation, to which President Trump has promised another tariff on an additional $267 billion of goods in very short order. Round and round we go, where we stop no one knows. With the yearly United Nations General Assembly, otherwise known as Gridlock Week in NYC, set to get underway, perhaps some side deals will be made. Already “announced” is the signing of a trade agreement with South Korea sometime this week as world leaders meet in Manhattan.

North American Gas Regional Short-Term Forecast - September

Platts Analytics is forecasting Chicago basis to be $0.03/MMBtu weaker than last winter. This is based on the expectation of stronger supply influx from the Northeast with both Rover and Nexus online. Such gains will offset low storage inventories and force the Midwest to export 0.6 Bcf/d to the Southeast, which would be about 0.2 Bcf/d more than it did last year.

Low LNG sendouts through the summer leave September LNG stocks at a 6- year high in NW Europe: what does this mean for the winter ahead?

In spite of the dismal level of LNG deliveries into Europe this summer, total LNG stocks in NWE are at historical highs as sendouts have been restrained. These LNG stocks could provide much needed flexibility this winter, but looking at forward prices, the gas is more likely to be reloaded and sent to other regions. Although US/China tariffs may lead to a change in Asian LNG flow dynamics, we expect their impact on LNG to Europe to be limited, with US LNG available to Europe marginally higher.

Korea is Fighting an Uphill Battle to Compete as Little as Possible with China this Winter

Korean gas demand is picking up this month as Chinese demand wanes. Demand in Korea is up 66-Mcm/d month-over-month while Chinese demand is down 40-Mcm/d month-over-month. Hot conditions in August forced strong LNG demand across northeast Asia, with temperatures in Korea being pushed to nearly 30 degrees Celsius. Rather than solely relying on the spot market for supplies, South Korea sourced significant volumes from storage, which prevented a bidding war with neighbors China and Japan for supplies. Korea has a significant advantage over China in that its storage capacity is 78% higher than that of China, with demand that is 16.5% lower – making it a far more flexible spot player.

German coal and lignite phase-out adds price risks tied to technology substitution

One of the co-heads of the German coal commission has proposed to transfer 5-7GW of capacity into a power reserve by 2020 and a complete phase-out of coal and lignite by 2035-2038. Although rejected by other members, and pending official recommendations, such capacity reductions appear quite aggressive, especially in the short-term. Export levels would bear the largest impact in such a 2020 scenario, followed by coal and gas in that order. Nevertheless, periods of particularly low wind can see gas reach the upper end of the technology stack. This leads to higher volatility in power prices but also higher volatility on the gas network, with increased use of gas interconnectors and storage. As a result, LNG will continue to play an important role in the gas price formation, especially in the winter. Increased dependence on the gas network would bring also other types of risks (think of the Baumgarten explosion last December) and these retirements could further expose them.

Coal Pricing Mixed, Focus on Building Inventories Ahead of Winter

Coal pricing was both volatile and mixed last week, with the market initially shedding several dollars per metric ton, then rebounding over the second half of the week. CIF ARA prices increased by the largest extent, likely due to continued strength in European coal demand expectations as NBP gas prices are testing the 80 p/th threshold for the winter period. Aside from Indonesia, Russia has been the largest source of incremental supply into the international market over the past 12-18 months, driven by a sizeable expansion in domestic production, which continued in August.

U.S. Total Cost of Vehicle Ownership: Low Resale Values Keep BEVs Expensive

Battery Electric Vehicles (BEVs) have the potential to displace large quantities of oil demand, ramp up power needs, and reduce carbon emissions. This analysis consolidates state-level incentives into a total cost of ownership (TCO), or a single price point that represents the life cycle cost to own and operate a vehicle based on its drive-train. BEVs achieving TCO parity with internal combustion engine vehicles (ICEs) is a critical step towards achieving mass-market adoption.

Currently, the higher purchase price and rapid depreciation of BEVs are not being offset by reduced maintenance and fuel expenditures within a typical vehicle's first operational lifetime, making it unlikely that BEVs will reach TCO parity with ICEs in the US until after model year (MY) 2030. Lagging TCO parity will stunt the demand side of the US EV market. Stronger resale value, high-mileage use, or an extension of federal subsidies would accelerate BEV TCO parity.

Pre-Holiday Buying Disappoints on Gasoline Demand in Japan, Runs Decline

The data last week reflected the lead up to the holiday and in that context, gasoline demand disappointed in falling 136 MB/D. Runs declined as expected and crude imports rose, which built crude stocks 1.5 MMBbls. Aggregate demand gained modestly on strong jet and fuel demand, while the 4-week average also gained. Refinery margins have continued to ease, and are again acting weak, while marketing margins have also been softer.

Credit Conditions Positive, Reflation Trade Returns

Last week was fairly significant in that many of the credit metrics built on their positive performance of the previous week. The S&P 500 hit a new record high last week, while emerging market debt has continued to look better. There was solid performance in the key banking indices, along with steepening in the yield curve and an uptick in implied inflation. Also confirming a possible return of the reflation trade was that copper, energy, industrial metals, and palladium all surged. The dollar weakened by about 0.8%.

U.S. Ethanol Production rebounds, though stocks decline

U.S. ethanol production rebounded last week, increasing by 31 MB/D to 1,051 MB/D. Several plants remained offline for maintenance and/or poor margins. Stocks fell for the third time over the past four weeks, dropping by 148 thousand barrels to 22.7 million barrels. The largest draw occurred in PADD I, which was hit by Hurricane Florence.

US Gas Weekly Report –Week Ending Sept 21

Concerns over further increases in the already massive inventory deficit led to a rally last week in cash and futures. Henry Hub cash and futures were up the week-ended September 20, making gains of $0.13/MMBtu and $0.21/MMBtu (October contract), respectively. The NYMEX futures winter strip's gains trailed the October contract's, growing by $0.17/MMBtu to $3.02/MMBtu – coincidentally matching Platts Analytics forecast. The fundamental driver behind the rally was power burn, which broke a record on September 18, marking the highest daily September burn in review of data to 2005. Moreover, seven of the top ten September demand days for power in the data set go to 2018, which is clearly on pace to set a monthly record as well.

Asian Oil Demand Growth Improves as Expected, with Further Gains Likely

Major Asian oil demand growth accelerated in our latest snapshot from 38 MB/D to 386 MB/D. The biggest driver was the rebound in Chinese apparent demand growth, which performed as expected, along with a lesser decline in Japan. Before the impact of typhoon Mangkhut, a further improvement in Chinese apparent demand had been expected in the October snapshot, with major Asian product demand growth accelerating further to 800 MB/D and another gain in November. Mangkhut demand losses are estimated most recently at 250 MB/D, with a potentially larger loss of 450 MB/D if key Chinese provinces were significantly impacted. Those losses are only expected to be short-term, with rebuilding and a resumption of economic activity boosting demand growth back to trend after a few weeks. Strong growth in major Asian product demand is still expected to be maintained in December, with slowing towards 500 MB/D as 2019 begins to unfold.

The Cape Freight Rate Slump Bottoms Out Giving a Platform for a Q4 Rally

Dry bulk freight rates have declined of late, with the Baltic's 5TC rate falling to the lowest level since early June, although there has been a slight rebound of late. Rates would have fallen further were it not for higher bunker fuel prices. Escalating rhetoric and actions on tariffs have taken their toll on the freight market and sentiment. However, we believe that the market is back on track for another Q4 rally similar to what occurred in both 2017 and 2016.

Global Equities Post Another Positive Week

Global equities gained 1% on the week, while the U.S. market gained 0.4% and the S&P 500 set another record high. In the U.S., the best sectorial performers were materials (+1.9%) and energy (1.1%), while utilities fell 2.3% and housing dropped back 1%. Internationally, all the tracking indices gained and outperformed the U.S. Latin America gained 5.9%, China 4.2%, with the other tracking indices gaining 2-3%.

Slower U.S. Rig Growth to Stay until Second Half of 2019

U.S. oil and gas land rig growth has slowed down significantly as a result of takeaway capacity concerns in the Permian and capital discipline being practiced by most operators. The U.S. fleet grew by about 27 rigs/month from the trough in May 2016 until July 2017. Since then the growth has averaged 13 rigs/month. Most recently, the rig count dropped by 7 last week. This is happening despite higher and steady oil prices. Drilling permits, a good lead indicator of rig activity, have also slowed down since June of this year signalling further decline in rig growth. We forecast U.S. rigs staying fairly flat until the 2H of 2019 when new oil pipelines are in operation in the Permian thus allowing producers to resume more robust drilling activity.

Proposition 112 a Threat to Colorado Oil Production

One of the biggest concerns facing Colorado production is Proposition 112 (formerly Initiative 97), which intends to increase the setback requirement for new oil and gas development from 500 feet to 2,500 feet from any occupied structure or vulnerable area. According to the Colorado Oil and Gas Conservation Commission (COGCC), if the measure were to pass on November 6, it would render 78% of Weld County's surface land off-limits to new oil and gas development, a county that currently accounts for over 95% of production in the Denver-Julesburg (DJ) basin (currently at about 400 MB/D of oil and 1.8 BCF/D of natural gas). If the proposition were approved, drilling activity is likely to continue (as is) for the next two years, exhausting the backlog of approved permits. But by 2021, output would start to be impacted. We estimate the setback could reduce the number of wells drilled by 78% and DJ oil production would fall by more than 50% below the forecast, or 300 MB/D and gas production would drop 40% below the forecast, or 1.5 BCF/D, by the end of 2023. Recent polls indicate a 50/50 chance of the proposition being approved.

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