Balances Softer, But Still Constructive

The dramatically bullish narrative in oil markets that kicked off the month tempered some over the past couple of weeks. Yet we still see oil balances as constructive. U.S. sanctions on Iran will really start to bite by November. Political risks to supply are rising rapidly. Our oil balances weakened slightly, with demand forecasts revised slightly lower (mostly on weak Q2 actuals and marginally lower GDP growth forecasts for 2018 and 2019) and higher supply (higher-than-expected Iranian production ahead of U.S. sanctions and faster ramp in the UAE and Russia). Still, crude stocks in the three major OECD markets (U.S., OECD Europe, and Japan) draw substantially in 3Q18 and 4Q18. A jump in August runs support strong crude draws ahead of refinery maintenance period. For 2019, commercial oil stocks in the three major OECD markets remain flat at relatively low levels. Big crude draws in 3Q/4Q18 point to rising Brent prices. WTI differentials stay strong through August with Cushing tight but will weaken again as stocks build back in the autumn. Brent-Dubai weaker due to growth in Atlantic Basin sweet and restrictions on OPEC (Iranian) sour. For 2019, Brent and WTI prices ease in the first half of the year coming out of seasonal winter strength, but impending IMO regulations tighten light sweet markets by 4Q19. Saudi Arabia is actively defending Brent prices in the $70-80/Bbl range. Low spare capacity and strong demand for inventory mean higher prices for longer. Refinery runs are high globally over the summer with healthy margins, particularly in the West. Diesel cracks are firm but gasoline cracks not far behind. Rising trade tensions have become a key issue for the global economic outlook.

North American Gas Regional Short-Term Forecast - July

Incremental demand in the West region, coupled with increased Permian exports to Mexico, have aided Waha prices, with cash basis strengthening as high as $(0.35)/MMBtu on gas day 17 —yielding the strongest cash price since February. In line with higher temperatures and continued restrictions along the Southern Zone, SoCal City Gate next day cash surged to $39.31/MMBtu, representing an all-time high and more than double the previous high of 19.58/MMBtu set in February of this year. The return of Leach’s takeaway outlet, combined with an ongoing storage deficit on Dominion’s system, should continue to provide upward pressure on Dominion South basis pricing through the balance of the injection season.

Supply Length Building After Unprecedented Shortfalls – Australia Surges on Wheatstone 2

After exhibiting the first monthly losses year-over-year since this generation of supply additions began ramping up in 2015, incremental volumes are set for a major resurgence in Q4 that is on par with the record level average daily supply additions of 2017.The addition of Wheatstone 2 to the supplier's roster of new trains and the imminent likelihood of a second train at Yamal next month support a looser supply outlook for 4Q, though market uncertainty regarding first cargos for Prelude and Ichthys are contributing to supply risk this winter. The Asian buyer's response to the unprecedented JKM price surge highlights a certain degree of demand elasticity on the part of some customers, namely India, Pakistan and Bangladesh yet also emphasizes that not all developing buyers are equal: a buyer like China with a clear policy directive to burn more gas and the financial wherewithal to do so is effectively immune.

Cape Freight Rates Have Risen to their Highest Level This Year

Cape freight rates hit their highest level of the year last week with the Baltic’s five-route average pushing close to $25,600/day, with the most important driver being a sharp shrinkage in Chinese domestic iron ore production. Another factor boosting the Cape market has been a rise in Cape port delays, up 20% year-over-year in 2Q18 with notably higher congestion at Brazilian iron ore export ports and Chinese iron ore and coal discharge ports. We look for weaker Cape rates in the near term due to lower Australian iron ore shipments, but recovering to peak for the year around October. We expect the rate to descending again late in the year when China is expected to be enforcing stricter winter steel production controls in its battle against pollution.

Heatwave and Weak Nordic Hydro Triggers Upside for Thermal Generation and Prices

Against a backdrop of stronger fuel pricing – with both coal and carbon setting fresh 7-year highs – the severe drought in the Nordic continues to firm the North Western European markets, while Belgium nuclear remains significantly constrained through at least the end of 3Q and thermal availabilities start being impacted by the heatwave. So far French nuclear has been faring relatively well, some 1 GW above expectations in July, but signs of a 2016-like scenario are emerging on various fronts. While the market appears to be factoring in these risks for France and Belgium, German forward prices for the balance of the year could see further upsides.

European Balances Refuse to Ease with Heat Wave Set to Continue into August

Somewhat remarkably we’re seeing forward curve volatility in retreat, with NW European hub pricing moving sideways since our last report. This is in spite of a heatwave taking hold of Europe, and a significant tightening of power markets, with a similar situation in Japan and Korea leading to stronger Asian LNG demand. Constraint is being provided by a softening of prompt CIF ARA coal prices, off ~7% from highs of $102/mt in early July, as well as Brent, which also moved lower on the month. Balance of summer TTF contracts (Aug and Sep-18) have now been gravitating around €22/MWh since mid-May. Although our base case view for Winter-18 is similar to the curve, price risk remains to the upside. Despite an expected “normalization” of storage stocks, which would be at risk with a further increase in power sector gas demand, NW Europe will fail to balance in a significantly below seasonal normal temperature scenario, which would see prices trade up to compete with Asia for LNG.

U.S. Commercial stocks record a sharp decline

Total commercial stocks last week drew by almost 10 MMBbls, led by crude decrease of 6.1 MMBbls. When compared to the previous week, crude exports increased significantly. As expected, crude imports declined, giving a decisive contribution to the large crude stock draws. Crude stocks at Cushing fell by 1.1 MMBbls dropping to 23.7 MMBbls – having now fallen by 4.0 MMBbls during July. This has been strengthening WTI backwardation in the front-end of the curve. Syncrude announced the restart of its 150 MB/D coker earlier last week; however, due to pipeline transit times, it could be a couple weeks before incremental production makes its way into the U.S. Therefore, for this week we expect Cushing stocks to continue to decline by at most 1.0 MMBbls, likely further steepening WTI backwardation. For this week, we see refinery runs stabilizing and remaining close to 17.3 MMB/D, but we also anticipate crude imports to remain below 8.0 MMB/D, and crude exports to decline to 2.1 MMB/D. As a result, we see crude stocks to keep on declining, but at a slightly slower pace than last week. Products demand continued to show remarkable strength, and this was the decisive factor behind the stock draws in all three major products. For this week, we anticipate gasoline and jet stocks to continue to draw, supported by demand strength. Yet, we expect distillate stocks to build due to an anticipated deceleration in distillate demand, which has been unusually strong for the past month.

U.S. growth is better than expected, but is all well with developed world monetary policy?

The U.S. economy grew at a faster-than-expected pace during the second quarter. All key sectors, including consumer spending and business investment, made positive contributions. There was also a comprehensive revision of historical data, and the household savings rate was revised up significantly. The European Central Bank did not change its communication at this week’s policy meeting, and the Fed is also expected to stay put at its next meeting. But there is significant uncertainty about what the Bank of Japan will do next.

Propane Prices Rally

Front-month non-LST propane prices rose 7.9%, ending the week at 97.5 cents/gal. The propane price strengthened to 60% of crude at Friday’s assessment and raised concern among market players about whether the propane arbitrage to Europe and Asia would remain open. Normal butane prices increased 18% over the past week in response to strong demand from export markets. The EIA reported a decline in propane stocks to 64.5 million barrels, which is the first draw on stocks since late April. Total US stocks remain roughly 1.5 million barrels below last year and over 9 million barrels below the five year average. Propane exports were reported at 1.095 million b/d, which is the highest weekly average since November 2017. Already dismal steam cracker margins slid even lower last week due to an 8.2% decline in ethylene prices.

U.S. ethanol prices rose the week ending July 20

In the U.S. rising corn and oil prices provided support for ethanol. RIN generation was down in June, but up year-on-year. California LCFS prices reached a record high. In Brazil, ethanol prices were lower and hydrous prices were only about 60% of gasoline, the lowest since 2010. European ethanol prices were slightly lower and margins for manufacturing it from wheat were negative.

Heat Returns

A forecasted large temperature reversal to start August has the markets a bit on edge as late July coolness comes to an end. Given the impact of cool temperatures last year, some of the objective modelling that Platts Analytics monitors outside of our own has started to line up with the USDA trend line of 174 bpa in corn. Whether it’s Illinois or Iowa, the second half of the month has seen a dramatic drop in the accumulation of GDD’s. Temperatures have moderated so much from the start of the month that Iowa will actually end the month with average to slightly below average monthly temps. Even though areas in Illinois like Champaign and Decatur have seen over 100% of average rainfall so far in July with temperatures 1.5F below average, Iowa did not show one reporting station with 100+% of average rainfall for the month (Des Moines was the driest at 8%), with the exception of Spencer to the north, while temperatures were very much in line with “normal”. As we’ve been highlighting, the concern remains the speed of the corn crop and with it comes some fear that this late July cooldown did little to slow the crop as excessive heat in early July has taken its toll.

Houthi Attack on Saudi Oil Tanker Highlights Rising Risks of Military Miscalculation

On July 26, Saudi Arabia announced the temporary suspension of all oil shipments through the Bab el-Mandeb Strait, after an attack by the Iran-backed Houthis on two VLCC’s caused “minimal damage” to one tanker. This follows a similar incident in April, as the Bab el-Mandeb off the west coast of Yemen is particularly vulnerable to Houthi missile attacks. We estimate this week’s incident will force ~500 MB/D of Saudi crude shipments to Europe (other than Arab Light) on a longer trip around Africa, effectively requiring an extra 7 MMBbl of working storage at sea. Arab Light can be provided using Saudi Arabia’s East-West pipeline which contains over 3 MMB/D of spare capacity, but can only handle Arab Light. An additional 335 MB/D of non-Arab Light grades will also be prevented from reaching Saudi facilities on the Red Sea, but in the short term these refineries should be able to run Arab Light. The longer shipping time and near-term dislocation should provide a modest boost to alternate grades from the Med and Black Sea, but a more pronounced impact would require other Gulf producers to reroute their ~1.8 MMB/D of additional crude exports through the Red Sea to the Med. This does not look imminent at the time of writing, nor does an escalation of violence in the Red Sea. Even so, the risk of military miscalculation has become even more apparent, as the Saudi-led military campaign in Yemen shows no sign of reaching a conclusion, and Iran looks determined to intensify proxy actions in the world’s largest oil-producing region.

US Gas Weekly Report

Hotter-than-normal weather continued to depress the pace of injections, lending credence to the Platts Analytics October-ending forecast of 3.3 to 3.4 Tcf. Despite such a trajectory, NYMEX prices remain uninspired — with the balance of 2018 trading at ~$2.82/MMBtu or 2% below last year. From a price perspective, the small injection — which was about 10 Bcf less than industry expectations according to the Platts Survey, did not result in a significant price move, with the August NYMEX contract settling less than a penny up on Friday at $2.78/MMBtu.

Nuclear Returns in Japan are Hitting LNG Imports, Despite the Extreme Heat

With peak demand season upon us, LNG demand in Japan has been curiously low recently, down 10% year-over-year, despite some extreme heat that has left more than 40 dead. Recorded temperatures in Tokyo eclipsed 41°C (106°F). This has sent baseload power prices in the country up 36% month-over-month and has recently reached levels not seen since Aug ’13. Despite such buoyant pricing, LNG imports remain very tepid at 265-Mcm/d or down 10% MTD year-over-year. In the chart to the right, one can see how imports into Japan have been relatively temperature agnostic this summer – whereas previous years seem to have quite a common pattern. With temperatures as they have been, we wouldn’t be surprised to see demand in the +300-Mcm/d range. This lost demand has certainly been very key in helping JKM drop nearly $2.20/MMBtu since mid-June. It makes for a very worrying trend for not only world’s biggest LNG consumer, but also a consumer that has an increase in new LNG contracts coming up that may increase its burden.

Weather and wind weigh on ERCOT prices; Upward risks to August intact

ERCOT managed to weather its recent heat wave in no small part because of sustained strong performance from its wind generation, raising questions of whether prices suitably reflected the risk to the system. Despite the heavy load on the system, ERCOT not only managed to avoid issuing any conservation alerts but also saw the largest drops from day-ahead to real-time pricing since August 2015. Forward prices dropped sharply over the course of the heat wave as ERCOT appeared to handle the record demand without incident. But as August approaches, the key components that kept this heat wave from becoming an energy emergency might not be around to help dampen prices.

Bullish May Stock Draw of 0.5 MMst versus 5-Yr Average Build of 3.2 MMst

On July 24, the EIA reported end-May electric power sector coal stockpiles of 128.4 MMst, a draw of 0.5 MMst month-over-month compared with a 3.2 MMst average May build over the most recent five-year period. The stockpile report is a bullish indicator amongst mixed fundamental signals for the U.S. coal market including warmer than normal temperatures, coal retirements, languishing natural gas prices and elevated export levels.

U.S. solar penetration through 2025 driven by cost declines, regional policies, tax credits

Solar PV penetration, including both utility-scale and distributed systems, remains a key element of our view on long-term North American power market balances and prices. With hardware an increasingly smaller share of total installation costs, Section 201 tariffs on PV modules are expected to have a limited impact on solar penetration. PV installation costs will continue to decline onwards from 2018, especially given the longer runway, four-year window for 30% Investment Tax Credit eligibility. State-level procurement targets continue to play a major role, and upcoming build will remain focused on regions with strong policy supports.

Runs March Higher in Japan, Demand Ascending on Trend, Margins Improving

Runs moved higher by 113 MB/D as maintenance winds down. Demand rose 154 MB/D, and is still trending higher on a 4-week average basis. Crude stocks drew 1.8 MMBbls on lower imports and higher runs. Finished product stocks drew slightly, largely due to lower naphtha, jet, and fuel oil stocks. Refining margins continued to improve, but remain soft. Implied marketing margins remain above statistical highs. As we move into August, known maintenance will continue to lessen, runs rise, stocks tend to build, and there is a renewed risk to refinery margins.

Credit Metrics Have Improved

Despite the downdraft at end-week, most of the metrics were positive. The S&P 500 gained 0.6% on the week, while VIX was modestly higher, but oil volatility modestly lower. Overall commodities were higher by 1.38%, while energy gained 2%. The industrial metals complex has begun to rebound, though precious metals still look soft. The Baltic Dry index continues to perform well. The dollar was modestly higher, while the St. Louis financial stress indicator again showed lower stress levels on the week.

U.S. stocks fall to a six-week low

U.S. ethanol production climbed by 10 MB/D to a 2018 high 1,074 MB/D last week. Ethanol stocks declined for the second straight week, falling by 115 thousand barrels to a six-week low 21.6 million barrels. Gulf Coast inventories drew again by 370 thousand barrels to 4.28 million barrels. Ethanol-blended gasoline production jumped with higher gasoline output, increasing by 270 MB/D.

Can Midwest inventories end the summer at normal levels?

Across the eastern US, natural gas storage levels continue to trail historical averages for this time of year, even as production continues to set all-time highs on a regular basis. EIA’s Midwest storage estimate for the week ended July 20 puts current inventories at 524 Bcf, which is 46 Bcf lower than the previous five-year minimum for the week, and 162 Bcf lower than the five-year average. This feature will take a look at the Midwest region, first establishing where things are today, and where they may end up as we move into next winter. We’ll focus on two major pipeline/storage systems in the region—ANR Pipeline and Natural Gas Pipeline of America (NGPL), which will serve as a representative sample of the region’s storage characteristics.

Coal Prices Diverge Amid Hot Temperatures in Key Markets

Near-term seaborne coal prices decidedly diverged last week, with CIF ARA and FOB Richards Bay forward prices moving lower compared to the end of last week, though FOB Newcastle prices rebounded and moved higher. In both the Atlantic and Pacific, key demand centers have experienced warmer than normal temperatures, which has pushed electricity and coal-fired generation higher, and it appears as if demand strength from Japan (see below) and elsewhere in Asia pushed Pacific Basin prices higher. Strength in dry bulk freight rates has allowed for the divergence in Atlantic and Pacific pricing as Atlantic Basin prices need to fall to a greater discount relative to the Pacific to place tonnage into Asian markets. Sweltering temperatures in Japan, most notably in the Tokyo area, have sent electric power demand soaring since late June, however, there is limited upside to coal demand due to the fact that the coal fleet was already operating near capacity.

U.S. Distillation Creep Adds One 100-150 MBD Refinery Each Year

The U.S. Department of Energy (DOE) recently issued their Refinery Capacity Report detailing refinery capacity as of January 1, 2018. Although the DOE stated that U.S. distillation capacity was virtually unchanged from January 1, 2017, this conclusion masks the efforts of U.S. refineries to stretch their capacity through a process known as “creep”. Creep occurs when a known “bottleneck” is removed or when refinery personnel learn to sustain operations at a higher average throughput. In fact, U.S. refiners have been creeping distillation and conversion capacity at a rate of 0.5-0.8 percent/year over the last four years. This corresponds to adding the equivalent of one 100-150 MBD medium to high conversion refinery every year.

Global Equities Post a Positive Week

Global equities had a positive week. The U.S. S&P 500 gained 0.6%, but the broader global performance was higher by 1.1%. Among the U.S. indices, energy was the best performer, along with industrials, while housing was the weakest. Internationally, Latin America gained 3.6%, following a strong gain the previous week. Emerging markets and Japan also outperformed.

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