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PIRA Energy Market Recap May 7, 2018

Downstream Market Tension as Global Crude Balances Tighten

PIRA copyGlobal oil demand growth continues to be very strong. Although that is partly covered by growing NGLs into petrochemicals, refinery runs growth will also increase substantially and that will be particularly evident as seasonal refinery maintenance finishes up. Crude stocks will be pulled lower over the next several months driving Brent prices higher. Crude tightness will compete with product tightness to set refinery margins and runs. For the Atlantic Basin, poor performance in Latin American refining will keep pressure on gasoline and diesel markets although there are some signs of modest improvement in Mexican refining. European distillates will remain tight, with strong global prices and steep backwardation challenging arbitrage opportunities into the region. Gasoline will have a reasonably healthy summer season, but it will likely underperform last year.

What Can Trip Up U.S. Economic Growth?

The most reliable signals on U.S. economic performance come from labor market statistics, and the data release for April showed that all is well with the economy. The unemployment rate fell, but wage data were benign. U.S. oil expenditures are projected to record a large increase during 2018, but the U.S. is expected to be able to withstand this challenge without too much difficulty. The latest growth and inflation data from the euro area were disappointing, but the sluggishness is expected to be temporary.

Propane Prices Retreat

Non-LST propane prices lost ground week-on-week and closed the week 5.7% lower. Propane stocks built 1.8% to 36.4 million barrels for the week ending April 27th according to the EIA. Propane demand increased 14% to 1.0 million b/d. Propane exports were down 19% from the previous week’s high and are expected to remain in the 850 thousand barrel neighborhood for the week ending May 4. Steam cracker feedstock margins recorded solid gains last week but are still bearish territory with only ethane and butane being in positive territory.

U.S. Ethanol Prices Fell Last Week after Rising Most of April

U.S. ethanol prices climbed during most of April as the market tightened. The EPA has granted about 25 small refinery hardship waivers from the RFS for 2017, with more applications pending. These waivers have increased the supply of RINs, which has lowered RIN prices. Ethanol production in Brazil’s South-Central region in the first half of April was up 44.7% year-on-year. Brazil had imported a record 86.0 million gallons of ethanol in March. Higher mandates in 2018 in some EU countries contributed to an increase in biodiesel imports and a decline in exports.

platts logo copyBrazilian Dryness Worsens

In Chicago they say “if you don’t like the weather, wait a few hours”. In South America it’s a bit of a longer wait, but the sentiment is the same. Over the past month the shift from a dry to wet Argentina along with a wet to dry southern Brazil has been dramatic. While Argentina to the south has received plenty of what is now unhelpful rain, the second-season Brazilian corn crop has remained extremely dry, and in distress, with no help coming in the foreseeable future. To this point Platts Analytics has been slowly walking down the Brazilian production estimate. After starting at 95M MT, we have been in the 88-90M MT range most recently as the World Board’s 92M MT April forecast gets more far-fetched by the day given the lack of moisture over the past 3-4 weeks. With no foreseeable rain, and a forecast for continuing dry conditions, a larger cut in production is warranted in our opinion.

Iran Nuclear Deal: The U.S. Looks Likely to Reinstate Oil Export Sanctions by May 12

The Iran nuclear deal (JCPOA) faces a binary event on May 12, the fourth 120-day deadline for U.S. President Trump to waive oil export sanctions on Iran. The EU will continue its extensive efforts to save the deal for the next 10 days, but the fundamental issue will remain unchanged: the EU is unlikely to meet Trump’s demands in full by May 12. Therefore, we put the odds at 60/40 that the U.S. will pull out of the JCPOA, which would snap back sanctions on Iranian crude exports. This would technically require third countries to “significantly” reduce Iranian crude purchases every 180 days (thought to be 18-20% under President Obama). But an adjustment period of up to 180 days for crude buyers is possible (pushing back implementation until November), as are temporary exemptions for some countries. Moreover, unilateral U.S. sanctions would be more difficult to enforce than the multilateral measures implemented in 2012, while the term “significant” within the sanctions legislation leaves some wiggle room for the administration to avoid trade disputes. But some buyers would likely comply, placing around 200 MB/D of Iranian crude exports at risk by the first half of 2019. This would almost certainly cause a downward revision to our Reference Case, which forecasts 80 MB/D of crude production growth between 4Q18 and 4Q19.

Permian Differentials Widen on Takeaway Constraint Concerns

The WCS discount narrowed considerably during April, as seasonal maintenance at production facilities alleviated constraints out of the region. In contrast, Midland differentials weakened sharply as concerns around takeaway constraints increased on the back of higher production in the region offsetting the return of refineries from maintenance and pipeline capacity additions. Inventories at Cushing rose slightly during April to 35.8 million barrels. Draws are expected to commence in May, with inventories at Cushing reaching very low levels during the summer months. Tight inventories at Cushing will support a stronger WTI price during that timeframe.

US Gas Weekly Report

Following last Thursday’s higher than expected 62 Bcf injection, the NYMEX June contract dropped below key support at ~$2.75/MMBtu. The first injection of the season rattled market bulls as US balances appeared to loosen more than expected. Even so, the NYMEX nearby remains range bound between $2.60/MMBtu and $2.85/MMBtu for now. The balance of the summer (Jun-Oct) NYMEX strip settled at ~$2.75/MMBtu yesterday, which if realized would come in 6% below 2017. Clearly, expectations for production growth momentum remain the dominant factor behind price formation.

A Change in Flows in the Pyrenees Brings Increasing France/Spain Interconnection into Question

Iberia has been a key demand center for a number of years, but with 90% of its supply coming from Algeria and LNG (in roughly equal measure last year), it is often more closely associated with other global demand centers than the European market. However, Iberia is moving closer to Europe, and will continue in this direction regardless of whether pipeline capacity is increased.

One clear movement towards European markets will come via a change in French gas flows to the north, with the integration of the two French hubs. France is set to increase their internal pipeline capacity and fully integrate their gas market in Q4 this year, as PEG Nord is expected to merge with TRS to become the PEG (Point d’échange de Gaz) hub. We saw TRS disconnect from its Northern counterpart just last month and on a number of other occasions over the past two years, normally driving (or partly driven by) a subsequent disconnection of the Iberian hub, as gas is constrained from flowing south and west. In essence, bringing southern France into Northwest Europe also brings Spain a step closer to the most liquid NWE gas markets.

Thirsty for Storage Injections, Growth in Asia is Making Europe Pay Up for More Supplies

For similar spread levels versus Asia, Northwest Europe is receiving less and less LNG, making this winter ever more precarious given incredibly low storage stock levels. Winter JKM pricing has been getting ever more expensive versus both Northwest European pricing and even oil. This pricing divergence is not because Europe is flush with gas, but it is creating the scope for some strong price increases if complacency in Europe begins to break. In addition, it is increasingly making it more and more profitable for Europe to reload come peak winter time – potentially further weakening net LNG demand in the region.

Summer Nuclear Output Curbed by Extended Outages this Year, but License Renewal of French Reactors Main Driver in 2019

Maintenance extensions at a number of reactors across Western Europe are expected to lead to another summer of poor nuclear output. The aging of the plants appears to be the primary reason behind these extensions, and comes on top of the ASN review across the French fleet this year and the license renewal for 8.6 GW of capacity in 2019.

Pacific Coal Pricing Remains Strong, China to Drag Market Lower

The bumpy transition from a tight coal market to a looser one was on full display last week, with CIF ARA forwards slipping slightly week-over-week while the front of the FOB Richards Bay and FOB Newcastle forward curves surged by $2.50/mt or more. While there were undoubtedly some market distortions due to holiday observations in Europe and Asia last week, it was clear that the market continued to have misgivings that supply/demand balances were loosening from prevailing tightness, particularly in the Pacific Basin. With global crude oil prices close to $75/Bbl and LNG prices nearly $8.00/MMBtu, it should not be surprising that the market is hesitant to let coal prices slide. However, Platts Analytics continues to assert that global import demand will fade notably in the coming months, led by weaker demand in China.

U.S. Commercial Stocks Build

Overall commercial oil inventories built 5.4 million barrels last week with crude stocks increasing 6.2 million barrels. Gasoline demand had another soft week, causing inventories to increase for the second consecutive week (+1.1 million barrels). Distillate demand rebounded sharply last week, helped by farm demand and a robust economy, pulling inventories 3.9 million barrels lower for the eleventh inventory decline in the last twelve weeks and setting the stage for continued relatively strong distillate markets with inventories quite low relative to history. Crude stocks had a large counter-seasonal build last week as imports bulged to 8.55 MMB/D, but with imports declining sharply this week and runs picking up, crude inventories show a 1.7 million barrel decline. Distillate stocks will substantially decline again this week while gasoline inventories will slightly decline as imports remain high. Cushing crude inventories increased 0.4 million barrels last week but with flows pointing to tighter Cushing balances, a flat stock profile is forecast for this week.

Financial Stresses Remain Well Contained

What looked like another week of consolidation and reassessment, reversed on Friday with a solid performance, which improved the overall tone. Equity volatility (VIX) eased and the S&P 500 ended the week on a strong note, but was still down about 0.25% for the week. Despite further strengthening in the U.S. dollar and growing turmoil in certain emerging markets, commodities had a positive week. Industrial metals led the pack, higher by 1.8%, while energy gained 0.5%. The St. Louis financial stress indicator moved modestly higher on the week, but overall stress levels remain low.

U.S. Ethanol Scorecard and Supply Report

U.S. ethanol production jumped 47 MB/D last week to 1,032 MB/D as many plants came back on line following spring maintenance. Output had been at a six-month low prior to last week’s spike. Ethanol stocks built for the second consecutive week, increasing by 441 thousand barrels to 22.1 million barrels. Ethanol-blended gasoline output rose by 110 MB/D to 9,146 MB/D as overall gasoline production increased.

Lower Downtime in China Will Lead to New High Refinery Runs in 2018

Chinese refining capacity has been growing rather significantly, adding about 20% to crude distillation capability or around 3 MMB/D over the five years since the beginning of 2013. With around 17.3 MMB/D of crude unit capacity, Chinese capacity is approaching that of the U.S. But overall, China has a somewhat less complex refining system.

Global Equity Markets Ease Modestly

Global equities fell 0.5% on the week, while the U.S. was down by only half of that. Among the domestic tracking indices, technology had a solid week, higher by 2.7%, while energy was unchanged. Consumer staples fell 2.1% and was the weakest performer. Internationally, China gained, while Latin America was lower by 5.5% with weakness all the key Latam markets, led by Argentina.

Strong Regional Refiners Combine

Last week’s announced acquisition of Andeavor’s assets by Marathon Petroleum will combine two regionally quite strong refining operations into the largest domestic U.S. refining company with a combined capacity of over 3 MMB/D or around 16% of total U.S. refining capability.

February U.S. Production Reaches New High Following Winter Interruptions

U.S. crude and condensate actuals for February 2018 came in at 10,288 MB/D, 264 MB/D above January and 1,216 MB/D higher year-on-year. Volumes were up in Texas and New Mexico where freeze-offs had curbed production in December and January. The Gulf of Mexico also recovered strongly after earlier outages at the Tahiti, Enchilada, and other platforms. Our Reference Case outlook forecasts U.S. crude and condensate production growing by 1,100 MB/D in 2018 and 675 MB/D in 2019.

April Weather: U.S. Cold; Europe and Japan Warm

April weather was warmer than normal by 9% in the three major OECD markets, bringing the month’s oil-heat demand below normal by 168 MB/D. The three-region composite was almost 18% warmer on a 30-year-normal basis.

Aramco Pricing for June: Barrels Priced Higher than Market Drivers

Saudi Arabia released their pricing for June liftings last week. For the second month, pricing to Asia was made less generous than the market expected or customers were looking for. The adjustments continue to discourage liftings at the margin while Asian refiner demand will be on the upswing over the summer and the ready availability of Iranian barrels remains problematic if economic sanctions are reinstated. This all points to reinforcement for sizeable summer crude stock draws. Price adjustments to Europe were not cut as a deeply as the increased discount on Urals vs. Dated Brent would have suggested. So here too, pricing was less accommodative at the margin. U.S. pricing was cut slightly for the lightest grade, raised slightly on Arab light, with no changes to medium or heavy grades. Saudi barrels into the U.S. remain priced at a premium to competing domestic grades by $1.30-1.50/Bbl. Lastly, the Kingdom’s domestic demand for crude burn in power gen rises into summer with less export barrels becoming available, although this year it will replace some crude with fuel oil. Basically, with rising summer refiner demand, supply uncertainty from Iran, and less avails due to higher domestic consumption, Saudi could afford to be less generous.

INE Chinese Crude Oil Futures: A Promising Start with Challenges Ahead

Chinese crude oil futures exchange exhibited fine liquidity and stable price movement in the first four weeks after its debut. Foreign participation might be limited in the early stages given INE’s high margin and trading cost. Unique bonded warehouse delivery likely poses basis risk and weakens efficiency of hedging.

China’s Product Export Quotas are Likely to be Higher This Year

China controls refined product exports through quotas to refiners after assessing domestic needs. China issued some 43 million MT of export quotas for gasoline, kero/jet and gasoil in 2017, and refiners used up ~95% of these quotas. The MOFCOM issued recently a second batch of 19.42 million MT product export quotas under the normal trade route, taking the total of the first two rounds of this year to 39.42 million MT, which is about 92% of the total for the whole of last year. Overall, S&P Global Platts Analytics expects there will be an increase of ~0.6 MMB/D in refinery runs in 2018, with apparent oil demand growth at ~0.47 MMB/D, and key product exports could rise by some 20% this year. China exported ~41 million MT of oil products in 2017. The 20% increase implies that ~49.2 million MT of quotas would be needed. Assuming 95% of quotas will be used this year, total quotas allocation would have to be ~52 million MT for 2018.

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.

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