Calm Before the Storm

A strong global economy is providing substantial positive backdrops for oil markets. Oil markets will soon start to look past the current soft patch. March will see a substantial crude stock build but after that crude markets will get progressively tighter. Geopolitical production risks are clearly greater to the downside with substantial risk to Iranian, Libyan, Nigerian and Venezuelan output in particular. Refining margins stay generally healthy in 2018 with high utilization rates required in swing refineries. U.S. crude price differentials will stay close to Asian parity with export volumes substantially growing. Refiners, blenders, logistics systems and prices will start to change in mid-2019 to prepare for tighter global sulfur specs sending clean-dirty product spreads and crude differentials wider.

U.S. Ethanol Prices Strengthened in February as the Market Tightened

U.S. ethanol prices reached a four-month high at the end of February. Demand was drive by rising exports. Manufacturing margins approved. Brazil’s South-Central was in its inter-harvest period and ethanol output was the lowest in the first half of February was the lowest since 2015. European ethanol prices remained weak. The European Commission reopened its investigation on U.S. anti-dumping of U.S. ethanol.

North American Gas Five-Year Forecast

S&P Global Platts Analytics’ forecast calls for average annual prices at Henry Hub to remain under $3/MMBtu through 2020 and rise to $3.22/MMBtu by 2023. Strong investment focused at the drill-bit should enable continued supply growth over this period, with additional pipeline capacity easing current upstream constraints. Lower 48 supply is expected to increase by 2023, led by Appalachia dry gas and Permian associated. By far, global export demand represents the largest sink for domestic supply, with newly minted LNG export capacity enabling the uptick in trade. On the domestic front, new manufacturing capacity and power plants will lift demand through 2023.

Demand Spike Stretches European Gas Infrastructure to Limits; Prompt Skyrockets

European gas markets came back to life in February with cooler weather to start the month and already stretched pipeline supply infrastructure meeting the test of a late February/winter freeze. In our last weekly report we warned that supply has not fared well against past extreme weather situations and noted a high likelihood of seeing issues re-emerge. With TTF and NBP DA prices hitting 12 years highs today, assessed at €44/MWh and 116ppth respectively, this warning has proven to be well advised. Storage stocks (both gas and LNG) are delivering close to record highs and we now see stronger injections starting from April supporting our near-term forecast. Further out however we note how quickly things can change, and continue to see a number of bearish factors coinciding in Summer-18.

Arctic Cold Front Brings Freezing Temperatures, but Sunny and Windy Conditions

While we’re conscious that French 2Q and 3Q contracts may be undermined by expectations of higher hydro levels, we still see risks of downward corrections for nuclear tied to Le Creusot probe. A first look at the French nuclear availability in 2019 suggests that generation may be moving closer to 2017 levels. We assume the closure of Fessenheim at the end of this year, with the start-up of Flamanville-3 most likely happening in 4Q-19. In addition, 8.6 GW will be renewing their license in 2019, of which the 0.9-GW Tricastin-1 will be the first reactor of the fleet to extend its lifetime beyond 40 years. Assuming gas prices at €17.5/MWh, our modelling suggests France should be pricing in the mid €40/MWh in 2019.

Better Late Than Never? Winter Arrives in the Southwest!

The arrival of below normal temperatures in the Southwest during the second half of February and a short unplanned outage at Palo Verde 1 allowed both SP15 and Palo Verde on-peak markets to hold near January levels. NP15 turned in a weak performance falling by more than $2 despite continued dry conditions and the start of a refueling outage at Diablo Canyon 2. Mid-Columbia prices also declined as hydro supplies rose and gas prices fell. Columbia River basin runoff projections (Apr-Sep) have increased to 111% of normal resulting in upward revisions to Northwest hydro generation forecasts. California precipitation has been well below normal this month and snowpack readings are close to record lows (~20% of normal). At present, the net effect appears to be a small decline in overall Western hydro output in 2018. Platts Analytics’ basis forecasts for much of the western markets are bearish to current NYMEX pricing on the expectation of continued length across the West. The Permian’s ongoing push into western markets given the lack of takeaway capacity to the north, south, and east is expected to drive Waha to new lows. Inland Southwest gas units should benefit, but competition with abundant mid-day California solar and Northwest hydro generation should cap margins.

Pacific Pricing Stays High After Volatile Month, Weakness Lies Ahead

Seaborne coal prices were volatile in February as the market grappled with the transition from tightness during peak winter demand to more balanced conditions. Cold weather conditions have propped up Asian coal demand over much of this past winter, and a blast of arctic air in late February over Europe limited year-on-year losses there. With Chinese coal demand fading seasonally and structurally over the next several months, Pacific Basin prices will be facing heavy bearish pressures.

Gulf Coast Crude Differentials Tighten as Cushing Drainage Continues

Cushing crude stocks declined another 8 million barrels in February, dropping below 30 million barrels for the first time since 2014. This decline has helped narrow Brent and LLS premiums to WTI by $3/Bbl since December. Cushing stocks will likely increase near term, but renewed declines this summer will lead to stronger backwardation, sending WTI prices above $70/Bbl. Canadian heavy crude discounts weakened further in February, but light grades strengthened in advance of upcoming oil sands upgrader maintenance. Midland differentials to WTI weakened as Gulf Coast premiums narrowed, closing the arb for shipping spot barrels from the Permian Basin to Houston and Nederland. Midland differentials will remain choppy through next year, as periodic pipeline capacity additions struggle to keep pace with rapidly growing production.

End-December Stockpiles Continued Push below 5-Yr Average

On February 27, the EIA reported end-December electric power sector coal stockpiles of 137.2 MMst, a draw of 6 MMst m/m as compared to a 0.8 MMst average December build over the most recent five-year period (2013-2017). End-December stockpiles were sitting 31 MMst or 19% lower than the most recent five-year average (2013-2017) and 15% below prior-year levels.

New England REC Market Outlook

High value NEPOOL Class I REC prices started higher this year, but dropped significantly in Feb - similar to the patterns of early year drops in prior years. V-18 vs. V-17 spreads widened last summer - consistent with the banking restrictions from the MA Clean Energy Standard (CES). While the bank has been building, S&P Global Platts Analytics expects pricing to start responding to bullish fundamentals in the near term. The MA Clean Energy Standard significantly raises Class I REC needs. MA solar SMART units will provide supply in the near term, and NYSERDA wind units remain a key wildcard. After 2020, massive CES-eligible 83D supplies come into play – and the selected large hydro projects would not generate Class I RECs. Once such projects come online, Class I REC market dynamics would detach from the CES dynamics and State RPS policy targets will drive longer term REC pricing.

Propane Prices Fall as Spring Approaches

Prices for March barrels of propane have fallen sharply from February highs as market concern regarding propane supply appears to be waning as springtime nears. The EIA’s implied demand for propane was reported at 1.05 million b/d for the week ending February 23, which is the lowest weekly demand since October and 50% lower than typical winter demand levels. Propane inventories fell by 380,000 barrels according to EIA data. Propane exports rose 23% to 961,000 barrels for the week ending February 23. The full complement of U.S. steam crackers is operating, and the commissioning of two new build steam crackers is progressing as planned. The sharp decline in propane and normal butane prices generated a healthy rebound in steam cracker feedstock margins.

Ethanol Stocks Down Year-on-Year

U.S. ethanol inventories built for the first time in three weeks, rising 226 thousand barrels to 23.0 million barrels. Despite the increase, stocks are down year-on-year for the first time in 50 weeks. Domestic ethanol production continued its saw-toothed pattern, falling 24 MB/D to 1,044 MB/D after rising in the preceding week. Ethanol-blended gasoline output declined to 8,701 MB/D from 8,776 MB/D as overall gasoline production decreased.

What a Time to be in Ags!

So far the wheat market has been able to kill a dormant winter wheat crop in February, typically a feat reserved for later in the spring, while ignoring the fact that U.S. has absolutely no standing globally and has become a niche player. The Argentinean soybean crop has seen year-over-year yield estimates reduced by almost 30%, for those calling on a 40M MT crop, something that even the devastating Drought of 2012 in the U.S. could not accomplish with its less than 6% drop in y-o-y yields and 2.5% drop in total production. Possibly even more remarkable is the very recent staying power displayed in corn and soybeans given the fact that the White House has been the host to three meetings on changing the RFS just last week while announcing steel and aluminum tariffs possibly aimed at the biggest importer of U.S. soybeans, setting the stage for possible retaliation.

U.S. Gas Weekly Report

The prompt April NYMEX contract averaged ~$2.69/MMBtu last week, up 5% relative to the YTD low of $2.56/MMBtu registered February 12. The market tested the 50-day moving average (~$2.72) three times last week.Currently, the market appears to be in consolidation mode, with higher highs and higher lows occurring in recent trading sessions. Henry Hub cash averaged $2.58/MMBtu for the week ended March 1, six cents/MMBtu (2%) higher week-over-week.

Surprisingly, Japan is the Biggest Spot Buyer of the Big 3 this Year, Not China

In past years, we were looking to the 2018 calendar year as a year when Japan really gets overwhelmed with contracted LNG supplies, which leads to a painful selloff in LNG pricing as the country is forced to leave the buy side of spot markets. We particularly originally saw this shift really taking shape come April ’18, as that is when Japanese LNG contracts tend to start, however excess Japanese contractual supplies look to be pushed yet another year. The combination of delayed liquefaction projects, delayed restarts of nuclear reactors, and cold weather is putting increasing pressure on global gas balances – forcing Japan to reassert its power in global LNG. Imports in February are stronger by 6% year-on-year and 12% versus seasonal normal. These days one would expect a headline about spot buying to include China’s dominance, but not so far this year. To give you an idea of scale, Japanese LNG demand this month has been 400-Mcm/d, which is more than Chinese and South Korean demand combined. The year-on-year growth is close to France’s total imports this month.

Despite European Freeze, Coal Prices Shift Lower

Coal prices moved decidedly lower last week, with near term CIF ARA prices dropping more than $6.00/mt week-over-week despite the extremely cold temperatures in Europe. FOB Newcastle prices did not fare much better than CIF ARA, with prices falling by nearly $5.00/mt from the end of last week. As S&P Global Platts Analytics has previously noted, with prices so much higher than production costs, a decline of this magnitude was always an eventuality, as the market was always going to move from tightness to balance after the peak of the winter demand season in Asia concludes. While the extremely cold conditions in Europe certainly raised European coal demand above previous estimates, coal-fired capacity retirements have taken away much of the upside to demand during extreme weather situations such as this.

Fully Subscribed WCI Carbon Auction, Close to the Floor

The February WCI auctions, including ON for the first time, saw the current vintage fully subscribed, but with V-21s going unsold. The current vintage clearing price of $14.61 compares to $15.06 from November 2017 and was 0.6% above the 2018 auction floor price and 1% below the comparable secondary market price on auction day. Pricing in the secondary market has increased, gaining about 15 cents since the auction. Given unsold allowances returning, and CA emissions below the cap, 2018 should see a large build in the allowance surplus held by sources. CARB remains under pressure to address “overallocation.”

U.S. Commercial Stocks Build

Overall commercial oil inventories built 3.7 million barrels last week, most of which was in crude oil. Stocks are down 147 million barrels (11%) on last year, the bulk of which is crude, which is 97 million barrels (19%) lower, while overall product demand (adjusted) for the last four weeks is up almost 700 MB/D (3.5%). Cushing crude stocks drew for the tenth consecutive week, falling to 28.8 million barrels, and are set to decline again this week by 1.0 million barrels. Gasoline seasonal stock build is about over and this week inventories are forecast to decline 1.1 million barrels; March inventories should benefit from higher gasoline demand and decreased yield as many refiners switch to lower vapor pressure gasoline production. Distillate inventories drew almost 1.0 million barrels last week and are forecast to continue declining by 2.3 million barrels in this week’s EIA report. Crude stocks build again this week with a 3.4 million barrel build which is less than half last year’s increase for the same week.

Financial Stresses Remain Elevated

Lots of cross currents continue. The S&P 500 fell 2% on the week, while VIX volatility rose 18.6%, but oil volatility increased only 6.9% despite very poor performance in the energy sector. Commodities eased, with energy being the weakest performer. On the week, high yield credit eased -0.75%, while emerging market was lower by -0.5%, and investment grade was only modestly lower by -0.2%. The dollar was modestly higher. The St. Louis financial stress indicator eased again for the second straight week, after its spike.

Japan Trifecta: Record Low Finished Products, Gasoil, and Crude Stocks

Japanese oil markets hit the trifecta last week with record lows for finished products, gasoil and crude being set. Runs eased marginally, but crude imports remained low enough to induce a 4.16 MMBbl crude stock draw. The seasonal inventory draw in products has been dramatic compared to past years. Balances remain very constructive to cracks and they did improve on the week. Gasoil balances tightened further and stocks set a third straight record low. Kerosene demand was again disappointingly lower by -23 MB/D, while jet fuel demand was also weak. The implied refining margin improved on the week by $0.35/Bbl and looks very acceptable. Low product stocks are providing support. Retail prices were little changed. The indicative marketing margin remains very strong and above statistical highs. The overall downstream value chain looks pretty healthy.

Global Equity Markets Retrench on the Week

Global equities broadly fell back on the week by about 2.3%. In the U.S., the S&P 500 lost 2%, with the weakest sectors being housing (-5.2%), materials (-3.9%), and industrials (-3.3%). Energy was lower by 1.8%. Internationally, China lost 4.4%, emerging markets were lower by 3.2%, and Europe was down by 3.1%.

India's Economy and Oil Demand are Strengthening

India’s GDP growth slowed sharply in the first half of 2017 due to several internal economic shocks. But recent data on GDP, industrial production, vehicle sales, and oil demand pointed to a solid rebound. For over a decade, the pattern of air travel growth in India has closely followed China’s earlier pattern. If this relationship continues to hold, India’s jet fuel demand will start to grow very rapidly. In the U.S., disposable personal income recorded a sharp month-to-month increase in January, reflecting the impact from the December 2017 tax cut legislation.

U.S. Shale Operators to Start Living within Cash Flows

U.S. shale crude and condensate production grew by 14% in 4Q17, a substantial quarter-on-quarter increase driven by accelerated completion activity, especially in the Permian. While completions often lagged behind drilling activity for most of the year, new well tie-ins picked up towards the end of 2017, resulting in 5,300 MB/D in shale crude and condensate production during the fourth quarter.

Saudi Arabia: Latest FX Reserves Decline Only Slightly, Suggests Stabilization

Saudi Arabia just reported their end-January foreign exchange reserves. Further improvement towards possible fiscal stabilization continues to unfold with the level falling just $1.9 billion USD vs. December, which is a reversal of the $2 billion USD gain seen the previous month. Evidence of a reduced breakeven in the Saudi economy is broadly evident, as the stabilization of fx reserves that occurred in 4Q09 was associated with a Dubai price of $72-75/Bbl, whereas the most recent stabilization is occurring with Dubai prices near $60/Bbl.

February Weather: U.S. Warm, Europe and Japan Cold

February’s heating degree days came in above the 10-year normal by 4% for the three major OECD markets with a composite net oil-heat demand gain of 137 MB/D. On a 30-year-normal basis, the markets were roughly 3% warmer than normal.

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

The EIA just released its monthly December 2017 (PSM) U.S. oil supply/demand data. December 2017 demand came in at 20.082 MMB/D, which was 114 MB/D higher than S&P Global Platts Analytics had assumed, but revised lower by 478 MB/D from the weeklies. Total product demand growth, year-on-year, grew 98 MB/D, or 0.5%. The demand strength was concentrated in kero-jet, which was higher by 102 MB/D or 6.2%, while “other” product demand also outperformed, higher by 109 MB/D or 2.3% and resid demand grew 83 MB/D. End-December total commercial stocks stood at 1,232.1 MMBbls, which were 2.8 MMBbls lower than S&P Global Platts Analytics had assumed. Compared to the preliminary weeklies, total commercial stocks were revised higher by 8.4 MMBbls, with products raised 10.4 MMBbls, but crude lowered 1.9 MMBbls. Compared to December 2016 PSA data, total commercial stocks are now lower than year-ago by 102.4 MMBbls vs. 99.9 MMBbls seen at end-November. Crude stocks are 63.5 MMBbls below year-ago at end-December, compared to being 38.4 MMBbls lower at end-Nov.

Drop in the Gulf of Mexico Drags Production Lower in December

U.S. crude and condensate actuals for December 2017 came in at 9,968 MB/D, a decline of 104 MB/D month-on-month but still growth of 1,187 MB/D year-on-year. The Gulf of Mexico, California, and North Dakota pulled down production while Texas, New Mexico, and Colorado continued to grow. Our Reference Case outlook forecasts U.S. crude and condensate production growing 1,070 MB/D in 2018 and 670 MB/D in 2019.

Exports Commence from LOOP Terminal

February was a landmark month for crude oil exports from the Gulf of Mexico, with the first fully laden VLCC loading from the LOOP terminal in Louisiana. Platts’ cFlow software showed the Shaden arriving at the terminal on Sunday, February 4, and appears to have begun loading a few days later. After spending 4 to 5 days loading at the terminal, the vessel set sail from the terminal approximately a week after arriving. The Shaden, which is charted by Shell, is currently showing China as its destination.

Aramco Pricing for April: As Expected, Cuts in Europe and Asia

Saudi Arabia just released their pricing for April liftings. The adjustments were in line with market fundamentals for all three key importing regions. Pricing into Northwest Europe was reduced $1.40/Bbl on Arab Light and alignment with the wider discount on Urals vs. Dated Brent. In Asia, pricing on Arab Light was reduced $0.55/Bbl, which is in alignment with the reduced backwardation in Dubai market structure. In the U.S., prices were left unchanged on Arab Medium, which is the pivot crude, which still retains a pricing premium to competing domestic grades.

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.