Global Bunker Fuel Spec Tightens in 2020 with Wide-Ranging Implications

The new tighter marine specifications in 2020 will be one of the most disruptive changes to ever affect the refining and shipping industries. It will have a global impact in excess of $1 trillion over 5 years. Non-compliance will have limited impact by volume and the majority of the shipping industry will become price takers to the new fuel with few being capable to switch to LNG or install scrubbers. Refiners will maximize coker utilization among other steps but will be unlikely to produce enough distillates without increasing simple runs resulting in stronger crude demand which conservatively will uplift crude prices by an average of $7/Bbl. LS residue and VGO will be pulled into bunker blends, reducing FCC gasoline production and increasing reformer margins to make up for the gasoline short-fall. Clean product cracks will consequently all strengthen leading to very strong refinery margins. Light-heavy crude differentials will widen. Over time, LS segregation, expanding conversion capacity, and increasing scrubber penetration will return product cracks back toward historical norms. There will most likely be a remaining surplus of up to 500-600 MB/D of HSFO in 2020 which will need to find dispositions in storage supported by strong contango and power generation competing with gas/coal on the margin. Forward curves have priced in some of the HSFO weakness but other products and structure in 2019 outwards underestimate the impact. The higher cost of fuels (not only bunkers) will impact consumers globally by over $1 trillion over 5 years. Higher prices will also reduce demand growth and ultimately help to alleviate some of the supply-demand tension.

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Hints of Load Growth in the East; ERCOT Summer Margins Tight

Spot on-peak energy prices in most Eastern and ERCOT locations were higher year-on-year due to weather driven loads. March prices are likely to be mixed year-over-year across the board with some cold weather in northern parts of the country, while there are lower nuclear refueling outages. Temperatures averaged above normal in February, with the exception of the Northern Plains, but loads increased by over 5% from the even milder prior year period. In ERCOT, which was significantly colder year-over-year, loads climbed by over 12%. Estimated weather-adjusted loads also showed a strong gain in February, rising by 2.5%. Gas-weighted heating degrees for March are trending close to ~8% above the ten-year average. End-March storage outlook is now firmly below ~1.45 Tcf. Fundamentals remain supportive with power burns up on a per-degree basis, production remaining below 78 Bcf/d, and Dominion receiving FERC approval to place Cove Point LNG into service. The April-October NYMEX strip has also rallied up to ~$2.87/MMBtu from the recent 12th February low of $2.66/MMBtu.

WCI Carbon Prices Falter Amidst Ongoing Regulatory and Political Uncertainty

WCI carbon allowance prices declined in Feb, with post-auction Mar pricing lower still - remaining below the expected 2019 auction floor. Trading volumes on ICE declined in Feb. Although WCI-wide cumulative balances are in surplus, the full CP2 compliance surrender in Nov 2018 (for CA, QC) and could prompt buying needs. ON entities need not surrender allowances until 2021. The release of ON covered emissions data confirms a starting point below the program cap but annual balances quickly tighten. ON's elections and WCI linkage remain a pricing wildcard for the market. CARB has floated a Cap and Trade regulatory proposal to align the program with AB 398. Decisions on implementing price containment, offsets limits and other design features will determine long-term pricing expectations.

As Shoulder Season Approaches, Lower Price Trend Begins

As spot Henry Hub gas prices came in lower year-on-year and U.S. coal burn declined by 0.9% year-on-year, U.S. coal prices slid over the last month. With shoulder season approaching and the export arbitrage window for U.S. Eastern coals shut, Platts Analytics expects further price weakness.

Asian Refining Margins to Remain Strong in 2018

As oil supply growth momentum catches up with demand in 2019, the crude market will tighten and prices will rise in mid-2018. In 2019, the market should be more balanced with increasing supply growth, but inventories stay relatively low. Impending IMO bunker fuel sulfur regulations will lift crude prices towards end-2019. Asian oil demand is expected to remain robust, with growth of ~1 MMB/D this year, driven by LPG, gasoline and gasoil/diesel. Asian LPG demand growth is expected to moderate from 0.23 MMB/D last year to ~0.19 MMB/D this year, with imports easing. Australia’s net product imports are expected to stay steady at ~0.56 MMB/D in 2018 unless there are unplanned refinery outages, and competition for product market shares in the country will remain intense. Asia is expected to account for half of global kero/jet demand growth this year, up from 30% last year, as India’s consumption rebounds. Overall, Asian refining fundamentals should continue to be moderately supportive this year, with Singapore cracking margins averaging ~$6.40/Bbl for 2018.

More Good News on Economic Growth, but No Signs of Faster Inflation

Chinese activity data for the first two months of 2018 were better than expected, suggesting an upside risk to the GDP growth outlook. U.S. retail sales disappointed in February, but industrial production registered large gains – the latter development is probably more significant for the outlook than the former. In the euro area, the pace of job growth has accelerated. On the inflation front, the U.S. core CPI rose at a faster pace in early 2018 compared to 2017. But this was large a result of noisy data in several sectors. Inflation in Europe remained subdued.

Propane and Ethane Prices Rebound

Propane and ethane prices rose last week 5.8% and 3.0% respectively, which were greater than increases in WTI crude price gains. However, normal butane prices lost 1.6% week-on-week. Propane prices were supported by stock draws and low inventory levels. Ethane prices were supported by the introduction of feed at the new build CP Chem steam cracker and the outage of the Mariner East 1 pipeline. Propane stocks shed 2.6 million barrels and fell 22% below the five-year average. Propane exports rebounded to 809,000 b/d after fog delays muted shipments in February. Steam cracker feedstock margins weakened significantly last week due to the combination of rising feedstock prices and declines in olefin prices.

RIN Values Tumble as the U.S. Reviews Biofuels Policy

U.S. ethanol prices rose the week ending March 9, as increasing corn values and higher ethanol-blended gasoline production outweighed the bearish impact of higher output, building stocks and collapsing RIN values. D6 RIN prices were sharply lower for the second straight week, falling below 40 cents. Brazil’s South-Central region crushed 730.9 thousand tons of sugarcane during the second of February, down 37% year-on-year. Around 93% of the cane was used to make ethanol. U.S. biodiesel prices sunk to a four and a half year low.

Bumpy Ride Ahead

Whether it was moisture from the skies over Argentina and Kansas or three-point shots from hardwood basketball courts throughout the U.S., it was raining this weekend. While the debate over whether or not any amount of moisture, present or future, can help Argentine crops continues, the same cannot be said for the HRW crop as beneficial rains this past weekend stretched from the Oklahoma panhandle north and east through sections of Kansas, with more on the way. The amount of rain that actually fell on Argentina over the weekend however is being debated this morning with one major commodity weather shop calling the weekend totals “better than expected” while another said this morning that totals were “disappointing”. Something for everyone to start the week.

New U.S. Secretary of State Adds to Pressure on Iranian Nuclear Deal

On March 13, U.S. President Trump announced that Secretary of State Tillerson will be replaced by CIA head Mike Pompeo. The move was expected for several months, but Pompeo’s staunch opposition to the Iranian nuclear deal (JCPOA) raises pressure on the agreement at a delicate time. Pompeo was a public critic of the JCPOA as a Republican member of Congress, and amid reports of his imminent nomination to the CIA in November 2016 he stated on Twitter “I look forward to rolling back this disastrous deal with the world’s largest sponsor of terrorism.” We already assumed the odds were greater than 50/50 that the U.S. will pull out of the deal by May 12, the next 120-day deadline for U.S. sanctions waivers on Iranian oil exports. After today’s change atop the State Department, the odds look marginally higher.

4Q17 U.S. Producer Survey: A Strong Finish for 2017

U.S. gas production increased significantly in the fourth quarter of 2017, as the momentum built over the course of the year in terms of drilling activity culminated in an upsurge in well completions at the end of the year. Production growth was strong on both sequential and year-over-year terms — 3.7% and 6.8%, respectively —with contributions from both Appalachian and diversified independent producers. The former survey group reported a weighted average of 6.5% (1.63 Bcf/d) Q/Q growth, the group's strongest showing since 1Q16. The liquids-focused members of the survey group rallied 2.8% (0.4 Bcf/d) as well, despite limited gas pipeline capacity in the Permian basin. Overall, US production activity finished the year on a strong note, with the increased drilling activity that began in late 2016 finally showing substantial volumetric impact.

A Small Trade in the Alps Foretells of an Avalanche of Change in Trade Flows

Another unusually cold weather front is expected to move across Northern Europe in Week 12. This cold spell hits at a time when the European market is particularly vulnerable, as the prior cold front had severely depleted the gas stocks across Northwest Europe. As a result, the approaching cold spell comes, as gas stocks have reached their lowest level of the past 7 years, which is to say that the gas network faces another stress test. In fact, the window to reroute any more LNG cargoes to meet the surging gas demand is now virtually closed and the potential swing sources are reduced to essentially one choice, Russian gas. The impact of potential gas shortages is already visible across the price movements in major European gas hubs, in particular with the Central and Northern hubs trading at a premium of €3-4/MWh versus the Southern ones.

The Second Biggest LNG Growth Market this Winter is at Risk of Slowing

Turkey has grown into a key market in the global gas balance, given its role as a buyer of pipeline gas (now Russia's second biggest customer) and LNG. In the short run, exports of LNG to Turkey this winter are up by over 2bcm year-on-year or roughly 38%, as of the end of February, making it the second largest growth market in volume after China for this period. This growth is before the FSRU Challenger (the world’s largest FSRU), currently sitting outside Dortyol, has even taken a cargo. Looking at longer run trends, Turkish overall gas demand growth since 2013 has been running at around double overall European gas demand growth rates – 4.4%/yr. Additionally, the country sits in a very advantageous physical position relative to much of Europe from a gas import perspective going forward. Relative to the rest of Europe, the country is closest to the quickly growing Eastern Mediterranean gas basin and Qatari supplies, but is also positioning itself as a gateway to Europe for pipeline gas supplies from the Caspian and Middle East.

Higher Thermal Availability and Hydro Limit the Upsides for Italian 3Q CSS

Another unusually cold weather front is expected to move across Northern Europe this week. This cold spell hits at a time when the European market is particularly vulnerable, as the prior cold front had severely depleted the gas stocks across North-Western Europe. As a result, the approaching cold spell comes as gas stocks have reached the lowest level of the past seven years, which is to say that the gas network faces another stress test. In this context, it was intriguing to see TTF moving above PSV, a condition rarely seen in the past, which highlights the limits of the European gas network, primarily designed to flow from North to South. While Italian power is still somewhat mirroring the bullish trends in the other Continental markets via power imports, we are generally unimpressed with the Italian power price developments.

Coal Prices Shift Lower, Weakness in Chinese Demand Lies Ahead

The seaborne thermal coal market continued to drift lower last week, with prompt forward prices falling by ~$1.25/mt week-on-week, while deferred prices faded by an even greater extent, widening already-prevalent backwardation. Fading seasonal demand (particularly in Asian markets), rising Indonesian output, and recovering stockpiles are rightly weighing on coal pricing, pushing FOB Newcastle prices to just above $92/mt while CIF ARA is now hovering just above $80/mt. Even after dropping by approximately $10/mt since the end of February, there continues to be additional downside to the prompt market as producers remain incentivized to push as much supply onto the market as possible. Despite extremely strong Chinese electricity and coal-fired generation growth in January/February due to cold temperatures, the magnitude of the growth in renewable and nuclear generation in that period suggest that coal-fired generation will decline over the balance of 2018. This will weigh heavily on balances and prices.

EUA Price Gains Continue in March, but Downside Risks Remain

Generally poor EU ETS supply-demand fundamentals in 2017-2018 cannot justify the recent European Carbon Allowance (EUA) price gains (€3 since the start of 2018, €1 since the start of March). The market appears to be looking toward the upcoming annual shorts starting in 2019 with implementation of the Market Stability Reserve. Bullish coal-gas fuel switching economics are also a more influential price-setting mechanism than they have been in recent years.

EUA prices should move lower based on seasonal patterns in the next few months, although compliance-related purchases could help support demand during April’s 2017 compliance period. Farther out, recent EUA price increases may limit the price increases required in the years that the MSR is operating. If EUAs rose too fast too soon, then a downward price correction to place them on a more sustainable trajectory is possible.

U.S. Commercial Stocks Drop Sharply

Overall commercial inventories declined 4.5 million barrels this week, led by the largest weekly declines of the year in gasoline (6.3 million barrels) and distillate (4.4 million barrels). Crude stocks built 5.0 million barrels for the seventh weekly build in the last eight weeks, while Cushing crude inventories had its first build (0.3 million barrels) in eleven weeks and a similar sized modest build is forecast for this week. Crude stocks should be relatively flat this week as runs tick up to 16.4 MMB/D, imports stay low at 7.5 MMB/D and the erratic balancing item falls to 100 MB/D. Both major light products continue to see inventory declines in this week’s EIA data with gasoline down 1.3 million barrels and distillate drawing 2.4 million barrels.

Cross Currents Evident, but Financial Stresses Low

Cross currents continue, while the S&P 500 eased 1.24% on the week, and VIX volatility was correspondingly higher by about 5.7%. Oil volatility eased, while the energy commodity sub-index gain. Overall commodities and the ex-energy sub-index eased. There continues to be noted divergences in some of the credit metrics. The dollar was modestly higher, but lower against the British pound and yen. The St. Louis financial stress indicator again blipped marginally higher.

U.S. Ethanol Stocks Soared to a Record High

Ethanol inventories soared to a record 24.3 million barrels the week ending March 9, surpassing the 1 billion gallon plateau for the first time ever. Stocks in both the Midwest and Gulf Coast regions reached record levels. Ethanol production continued its saw-toothed pattern, falling 32 MB/D to 1,025 MB/D after rising in the preceding week. Ethanol-blended gasoline output jumped to an 11-week high 9,058 MB/D from 8,874 MB/D as overall gasoline production increased.

Dollar Depreciation a Modest Tailwind to Oil Demand Over the Past Year

In the twelve months from January 2017 through January 2018, increases in global retail fuel prices did not keep pace with those of crude. Average demand-weighted gasoline prices over this period rose by 13% to $3.31/gallon, while diesel increased 15% to $3.54/gallon. However, the price hikes consumers saw at the pump were roughly half of the 27% rise in Brent to $69/Bbl. Various factors contribute to lower volatility of retail fuel prices vs. crude, including fixed taxes and relatively stable refining margins, which combine to insulate demand from some of the price effect of strengthening crude markets (conversely, this dynamic acts as a headwind to demand when crude prices fall). Moreover, currency appreciation vs. the dollar in the past year has also supported demand growth. Demand-weighted gasoline prices rose 9% in local currency terms, while local-currency diesel prices rose by 8%. Collectively, these factors provided modest support to global oil demand growth of 1.9 MMB/D in 2017.

U.S. Gas Weekly Report

The NYMEX April futures gave back some gains this week, as prices fell below $2.70/MMBtu on Thursday —following a modestly lower than expected inventory draw. The declining price action was at odds with storage expectations, as colder weather guidance on Monday (relative to Friday) called for further reductions in end-March storage. The April-October NYMEX strip was sent back below $2.80/MMBtu on Thursday. The move lower comes despite end-March inventories trending below 1.4 Tcf. Summer prices signal a market unconcerned over replenishing inventories this summer, as expectations of strong production growth remain —despite the lack of production momentum evident this quarter.

Will the Trump Tariffs Trash US Pipeline & LNG Export Prospects?

The tariffs imposed on steel and aluminum imports after much controversy will clearly hurt the economics of U.S. LNG export projects, but are they steep enough to squeeze already tight margins to the point of no return? The answer lies in the appetite globally for U.S. LNG and regionally in Mexico for more U.S. natural gas beyond those projects that have made FID. For US LNG, the competing crop of proposed projects around the world has yet to be formally seeded, even in East Africa where the first FIDs on next generation LNG has been made. Therefore, future buyers of LNG post 2021/22 still have to seriously consider US LNG as a primary opportunity, even at slightly higher costs.

Untangling Ontario’s Covered Emissions Data

In late January, Ontario’s Ministry of Environment and Climate Change (MOECC) quietly released new estimates of historic emissions that are covered by their cap-and-trade program. While estimates of Ontario’s covered emissions have been a key wildcard in estimating total WCI market balances (with Ontario’s linkage to the broader Western Climate Initiative market having started this year), MOECC did not issue a press release notifying market participants of these data. These files imply that Ontario’s covered emissions in 2016 were lower than the initial cap level in 2017, but are also higher than the initial cap less reserve allowances. While Ontario’s continued participation in the WCI market remains in question, this starting point for covered emissions suggests that the Ontario market could see a substantial cumulative short through 2020, particularly without taking advantage of offsets – which will ultimately need to be met through allowance purchases from California or Quebec, or abatement.

Another Crude Stock Build in Japan, but Gasoil Stocks Set a New Record Low

Runs increased 56 MB/D and crude imports moved sufficiently higher to cause a 4.34 MMBbls crude stock build. Product stocks also built by 1.18 MMBbls as demand declines seasonally. Balances remain constructive to cracks, though demand is tending to underperform expectations and is below year-ago. Gasoline stocks drew slightly, but gasoil stocks drew more strongly and set a new record low. Kerosene demand was again seasonally lower, with a stock build rate of 54 MB/D, while the 4-week average transitioned to a modest build rate of 16 MB/D. The implied refining margin eased by $0.20/Bbl, but still looks very acceptable. Low product stocks are providing support. Retail prices were modestly lower. The indicative marketing margin remains very strong and near statistical highs. The overall downstream value chain looks healthy.

Global Equity Markets Ease on the Week

Global equities eased about 0.5%, but the U.S. was lower by twice as much. Among the domestic tracking indices, utilities outperformed and gained 1.8%, while materials, banking, and consumer staples all lagged and lost 2.5-3.5%. Internationally, China, was higher by 0.6%, while emerging Asia was little changed and Latin America lost 2.7%.

Proposed Bankruptcy Settlement will Eliminate PES’ Past RIN Debt

The U.S. Department of Justice on behalf of the EPA filed a proposed settlement agreement between the U.S. and PES, which had filed for Chapter 11 bankruptcy protection in January with the intent of canceling its significant RIN cost. The proposed settlement was published in the Federal register and is subject to a 10-day comment period.

Injection Season Coal-to-Gas Sensitivities

With end-March inventories set to come in below 1.45 Tcf, ~600 Bcf less than the year-ago figure, attention is turning to how inventories will evolve throughout the 2018 injection season (Apr-Oct). Power demand will play a crucial role in influencing US balances, and thus price — as it remains one of the most elastic components within the natural gas market. That being said, factors in play in this sector continue to impact the extent of elasticity each year.

RGGI Auction in Line with Market; Decline in Spec Interest Continues

The March 2018 RGGI carbon auction cleared at $3.79, one cent below last December’s auction, well below the September auction clear, and in line with secondary market pricing the day of the auction. RGGI pricing had been declining leading up to auction day. The coverage ratio was very strong; however speculative buying interest continued the declines noted at the December auction. With the full CP3 allowance compliance surrender deadline having passed in March, after this auction, less than half the allowances in circulation are now held for compliance purposes. Emissions are expected to be higher YOY in 2018, although there is still a significant cumulative surplus in the market.

Chinese Crude Oil Futures Contract to Debut March 26

China will launch its first crude oil futures contract on March 26 on the Shanghai International Energy Exchange ("INE"). Deliverable crudes will be a mix of seven medium sour crude grades (six Middle East, one domestic China), denominated in RMB while overseas investors may use USD or offshore RMB (CNH) as margin. All trade prices will be quoted net of custom taxes or VAT. The Chinese crude futures are designed to help domestic Chinese refiners and other companies hedge more effectively, to better reflect regional supply and demand dynamics, and to promote the use of China’s currency.

Participation in the early days will be dominated by Chinese players, especially Sinopec given its position as the largest refiner in China. We will also see some early involvement by financial market participants for use as an investment vehicle and hedge. Vibrant retail participation could initially make up a large percentage of the volume which will bring with it volatility. Overseas trading companies and trading arms of major companies will be reluctant to be involved, waiting on liquidity to grow and watching Chinese government actions given its history of market interventions, capital controls, and regulatory involvement. Moreover, the limited size of delivery, double handling costs and lack of a robust delivery system into refineries will make it difficult for the contract to gain traction with these important players.

March Weather: U.S., Europe Cold; Japan Warm

At midmonth, March looks to be 7% colder than the 10-year normal for the three major OECD markets, with a composite net oil-heat demand effect of 208 MB/D. The markets are roughly normal on the 30-year-normal basis.

Canada Oil Sands Heading into Very Heavy Maintenance Season

Spring maintenance is a regular occurrence for the Canadian oil sands, but outages this year are expected to be much larger than the 2014 – 2017 average. Two major turnarounds will occur at Scotford and Syncrude. These two turnarounds and other smaller shutdowns are expected to drive volume losses of 330 MB/D in March, 660 MB/D in April, 570 MB/D in May, and 450 MB/D in June. On a quarterly basis, this amounts to 165 MB/D in Q1 and 560 MB/D in Q2.

Asian Oil Demand: Still Strong and Better than Forecast

Our monthly snapshot of major country Asian oil demand growth remained strong at 972 MB/D and exceeded our expectation of 735 MB/D. In addition, the data snapshot for the previous month has now been revised up about 100 MB/D to 1,089 MB/D. Looking forward, demand growth in the April snapshot should improve to 1,250 MB/D. Our annual average 2018 demand gain for total Asia remains about 1 MMB/D, slightly slower than the 1.1 MMB/D seen in 2017. The major country demand growth for 2018 is slated at 815 MB/D vs. 875 MB/D seen in 2017.

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. To read PIRA’s Market Recap first, subscribe to PIRA Perspectives here.