Stock Draws Counter Paper Selling Pressure

Global liquidity remains very supportive to economic growth and is leading to strong oil demand growth. Global supply/demand balances are tighter in the middle quarters but weaker in 4Q17 and 2018. The 3Q 2017 decline in surplus inventory will be mostly in products. The momentum or initiator for financial length has moved from the buyer to the seller of paper, undermining traditional oil price appreciation from increased financial length. Lower forecast inventory should allow prices to hold onto most of the recent gains, but a strong demand for inventory is required to offset the negative impact of increased paper supply. Geopolitical risks to supply are helping inventory demand despite supply disruptions falling. Refining margins will stay healthy through year end with distillate cracks taking the lead as demand increases and stocks continue to fall. Residual fuel oil cracks will stay firm due to supply side factors. Global crude quality is getting lighter.

Structural Limits to Shoulder Season Weakness

The call on U.S. supply this month will register a Y/Y gain for the first time this injection season — marking a key turning point in balance formation. Narrowing Y/Y losses in gas EG should facilitate continued overall growth for the remainder of the season — placing increased emphasis on supply growth to support storage injections ahead of the heating season. Even so, the ensuing restrained build in inventories has failed to elicit much NYMEX buying interest. That said, critical for the price recovery we see ahead is the timing of when the market puts the injection season in the “rearview mirror.” With this in mind, the market will likely look ahead to the next season before the air-conditioners are completely switched off. Nevertheless, this month’s failure to launch on patently lean inventory builds has forced reconsideration of our immediate price outlook.

Bullish Surprises Abound

Hotter and drier than normal weather boosted Mid-Columbia average on-peak prices to $30/MWh in July, nearly double June’s level. California on-peak prices recorded moderate gains, rising to the low $40s, but Palo Verde sank below the $40 mark as loads faded during the second half of the month. Alberta markets firmed as strong loads and outages led to several price spikes toward the end of the month. Sustained heat over much of the West will continue to support prices and implied heat rates in August but we look for heat rates at U.S. hubs to move toward the lower end of the historical range during Q4/Q1 squeezed by higher gas prices that lead to a temporary rebound in coal unit market share.

Coal Pricing Stays Hot, Along With Asian Temperatures

Seaborne coal prices, particularly in the Pacific Basin, continued to rally over the past month, stimulated by sweltering weather conditions in several Asian markets, and labor-related supply disruptions in Australia. In light of the stronger-than-expected coal demand, the prompt market will remain well supported, delaying the inevitable downward adjustment in pricing. However, pricing support from supply/demand fundamentals is expected to fade over next several months, and PIRA retains a bearish outlook for 4Q17 and beyond.

NGL Prices Continue to Advance with Crude

All Mont Belvieu NGL purity product prices advanced for the week ending July 28th and generally followed the lead of crude price increases. Ethane gained the least at 1 ¢/gal to close the week at 26.1 ¢/gal. Propane stocks were virtually unchanged at 65.9 million barrels. Propane stock builds were restrained by strong propane demand from wholesalers building winter stocks and steam cracker feedstocks. LPG exports remain robust at 768 MB/D. Steam cracker feedstock margins declined 2-6% as feedstock prices outgained olefin prices. Ethylene prices declined 1.9% to close the week at 19.6 ¢/lb, and propylene prices increased 2.1% to close the week at 28.5 ¢/lb. Two PDH turnarounds, Dow’s Freeport, Texas plant and Flint Hills Houston, Texas plant have supported propylene prices, and both plants will be back in full operation by the end of August.

Lack of News

The last trading day in July opened with corn in the same price range as posted on June 30th, although that was a major report day. Soybeans on the other hand were a good 50 cents above the June 30th price, continuing to be a much better story than corn for the bulls. Chicago wheat, which had the most movement during the month of July, is down roughly 30 cents. While the soybean market is respectful of its demand component, fully realizing that any sizeable loss in production could result in an extended rally, corn continued what could be described as a mindless walk due to onerous supplies both in the U.S. and Brazil.

Storage Deficits and Power Support Gas Pricing

Hydro and nuclear power production each down 5+GW YTD versus normal levels, which is heavily supporting gas demand. Gas demand across Europe’s biggest consuming nations is up by 47-mmcm/d YTD versus the past four years. While we see nuclear availability at/above normal levels by 4Q’16, PIRA is lowering forecasted hydro production for the balance of the year and will lend significant demand support throughout the winter. Meanwhile, Dutch storage stocks are entering August 3-BCM below last year. Thanks to a strong prompt, the Netherlands is being limited in its abilities to max inject this summer, which is particularly worrisome for a U.K. market that is increasingly reliant on imports. Stepping in to help balance Europe through discounted pricing and flexible supplies across Central Europe, Russia is cementing itself as a bigger baseload supplier of gas to much of Continental Europe. Contracted Russian supplies have been discounting similar Norwegian ones by €2/MWh since the beginning of the gas year in October.

Gas-Fired Output Surge Limits Summer Price Recovery

With nuclear setting a new multi-year minimum and hydro heavily down Y/Y, gas-fired output has surged across the board, with the five major markets (U.K., Spain, Italy, Germany and France) showing a gain by 18% Y/Y. However, the increase in gas-fired generation did not translate into a major power price surge, especially in Spain and Italy.

Going forward, we continue to see upside risks for the French market. In spite of recovering nuclear availability, hydro generation continues to disappoint. While not factored into our balances, policy risks remain constructive for the back of the curve, with Spain also impacted through lower French flows.

An increase in nuclear and wind availability over the next few months poses bearish risks for German prices, but stronger marginal costs for coal and lower-than-expected coal dispatch will be bullish, especially if gas units do not ramp up as often as in July.

U.S. Coal Stocks in May Decline Counter to Pattern Over Much of Last Decade

EIA coal stockpile data was released on July 25, showing that end-May stockpiles declined to 164.9 MMst, which ran counter to the five-year average May stock build of 3.6 MMst. MSHA data is trickling out and showing that 2Q17 production declined with the seasonal fall in demand, indicating some producer discipline that is supportive of prices.

U.S. Deficit to Last Year Widens

Commercial oil inventories again declined sharply this past week, falling 9.5 million barrels and bringing the year on year stock deficit to almost 42 million barrels (or 3.0%). Demand was also strong with adjusted product demand up 5.2%, or 1.0 MMB/D, in the latest four weeks. Crude oil stocks fell 7.2 million barrels this past week and for the first time this year are below year ago levels by 7.1 million barrels. Cushing crude stocks fell 1.7 million barrels for the tenth consecutive weekly decline. Next week’s EIA data will show another substantial crude stock decline (5.0 million barrels).

Global Economy Is on Solid Ground

As expected, U.S. GDP growth rebounded in the second quarter. Core inflation decelerated, while wage growth stayed subdued. Underlying data for consumer spending and business investment trended solidly. In China, evidence for the industrial sector rebound continued to accumulate. July survey results from Europe were generally encouraging. Data for global trade and vehicle sales were positive.

Ethanol Manufacturing Margins Improve

The cash margins for manufacturing ethanol improved the week ending July 21 due primarily to lower corn costs. D6 RINs were sharply higher. Brazilian based Petrobras raised the taxes on gasoline and ethanol manufacture in order to generate much needed revenue. European ethanol prices move lower.

What’s Normal?

This time of year agricultural analysts like ourselves are obsessed with normal, particularly in July for corn and mid-August through mid-September for soybeans. Whether it is temperature or moisture, our models are reliant on normal weather as the key to producing trend line yields. If you went away on holiday/vacation a week ago Monday when corn was trading at $3.90 and soybeans at $10.00, paid no attention to the markets, and then returned the past few days to look again, you’d think everything was normal as markets have strayed little from those price points. In fact, the situation is far from normal.

Shoulder Season Weakness Sets In

NYMEX futures are rounding out the month on a softer note, with the September contract establishing a new calendar-year low today — falling ~15¢ relative to Friday’s close. While milder forecast revisions have hastened the month-end sell-off, the market appears to be looking beyond the current tightness to heftier injections ahead. The drag on cash prices that has traditionally occurred as the industry enters the shoulder period probably is feeding such a bias.

Australia Provides a Bullish Sliver of Hope for LNG Markets this Winter

Heavier buying interest by Asian end users in the past week can be traced to growing concern over supply availability out of portions of Australia. If the Australian government goes through with it, the cuts could start as early as Jan 2018, which is the peak demand period for the Asian winter, when seasonal prices typically reach high points.

Japan Higher Runs and Higher Demand

Japanese runs continue to march higher, up 89 MB/D on the week. Crude imports rose sufficiently to build stocks 0.5 million barrels, much less than expected. Finished product stocks posted a second straight increase of 0.3 million barrels. Aggregate demand was again modestly higher, but is generally rising in sync with the run profile. Refining margins were higher on the week and are supportive to rising runs.

Stresses Remain Very Low

Another very bullish week, with the St Louis financial stress indicator moving to a new cyclical low, more record highs in the equity space, along with positive gains in commodities and also some of the debt pricing indicators. Energy had a solid week, with energy debt pricing doing well. The reflationary trade has been moving higher the last two weeks, with some traction being noted as the dollar has tended to weaken.

U.S. Ethanol Production and Stocks Drop

U.S. ethanol production dropped 14 MB/D the week ending July 21 to 1,012 MB/D, but remained above 1 MMB/D for the fifth consecutive week. Inventories decreased for the seventh time over the past ten weeks, falling by 608 thousand barrels to 21.5 million barrels. Ethanol-blended gasoline production jumped 234 MB/D to 9,367 MB/D, rebounding from a three-week losing streak.

Above-Normal Heat Fails to Support $3 Price

Yesterday, the Aug’17 natural gas futures contract exited the board below $3/MMBtu, despite the light build reported this week by the EIA. On balance, this month’s failure to launch on patently lean inventory builds suggests that prices might remained anchored in the current trading range, particularly as the industry transitions into the shoulder season. Taking stock of daily cash prices this month, Henry Hub (HH) barely rose relative to the June average of $2.93. This was largely the case in many regions given the large Y/Y declines in cooling degrees seen in most areas outside of the West.

Louisiana Offshore Oil Port (LOOP) to Offer Export Option

The Louisiana Offshore Oil Port (LOOP) is the only VLCC port in the United States. It announced on July 24th that it will be offering exports from their facility by early next year. This is a welcome optimization but not a transformation for the U.S. export industry. It will allow exporters to avoid reverse-lightering fees (roughly $0.50/Bbl) when packaging up VLCC lots and it will probably help sour exports more than sweet.

Still Setting Record Highs

More records are being set in world equity markets, though on the week, the U.S. market was unchanged from the week before. In the U.S., the strongest performing sectors, where the two sectors, which had been taking a beating. Retail and energy were the top performers, while housing was the laggard. Internationally, China and emerging Asia posted solid gains for the week.

Just Taking What the Market Allows

Saudi Arabia's formula prices for September were just released. The important take-away is that despite greater avails in September due to reduced domestic burn, Saudi generally tighten pricing in all the key markets. Most of the adjustments were in alignment with market drivers. Clearly, there is no impetus to push volume, despite available volumes that could be pushed.

U.S. Production Returns to Sequential Growth

U.S. crude and condensate actuals for May 2017 came in at 9184 MMB/D, up 89 MB/D month-on-month, up 302 MB/D year-on-year, and 24 MB/D below PIRA’s forecast. The miss relative to PIRA’s Reference Case was primarily due to the Gulf of Mexico coming in below forecast.

U.S. May 2017 DOE Monthly Revisions: Demand and Stocks

EIA just released its final monthly May 2017 (PSM) U.S. oil supply/demand data. May 2017 demand came in at 20.021 MMB/D, which is 79 MB/D higher than PIRA had assumed. Total product demand grew 4.3% versus year-ago or 819 MB/D, and the strongest performance since July 2015. Over the last three months, growth has averaged 500 MB/D. Among the components, gasoline demand was the only laggard, but still up 1.6% or 154 MB/D. The other products all had growth 6%, or higher. Compared to the weeklies, demand was lowered 194 MB/D, with distillate being lowered 109 MB/D.

Mexico’s Downstream Infrastructure Projects Set to Redefine the Country’s Supply and Distribution Landscape

A number of downstream infrastructure projects have been developing in Mexico in the context of the country’s energy reform. Somewhat less publicized than its upstream counterparts, these projects will change the landscape of fuels supply and distribution in Mexico in the next 1-3 years. So far the ventures have focused on increasing product imports and distribution, not on local refining.

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.