High Light Product Stocks Weigh on Refining MarginsAlthough the lows are already past, oil prices are stuck in a $40-50/Bbl range for now. The market is not yet worried about creating supply with the current large stock surplus, but that surplus will drop in 2H16 and 2017. Ultimately this will drive prices over $60/Bbl to create supply to cover global oil demand growth. Softer refinery margins may prompt some trimming of discretionary runs this autumn as refiners are walking a delicate balance between gasoline vs. distillate yields and runs levels. European gasoline yields will likely trend lower than last year, while distillate yields will trend higher. Gasoline, diesel, and jet stocks are at/above historical range, but they will trend lower. Product markets will shift from gasoline toward distillate. HFO supply is lower with reduced Russian production helping to support cracks.
Since the start of August, the natural gas market has endured a rapid bout of speculative selling, driving the prompt month NYMEX contract down by more than ~8% to ~$2.60/MMBtu. Moreover, entering Friday, the market had registered an impressive streak of six consecutive negative sessions, the first such occasion since 2014. Certainly, recent trading has begun to take on a rather bearish hue, as prices effortlessly (with volume) sliced through key moving averages this week, while breaching ~$2.60/MMBtu, near the low end of the trading range in place since June.
Warmer-than-normal weather led to solid gains in On-peak prices in nearly all markets in July as loads increased by 2.5% (9.6 aGW) from the prior year in the East and 3.3% (1.7 aGW) in ERCOT. The return of more normal winter heating demand coupled with challenges for growing supply pose upside price risks for natural gas and coal. Prices will move higher in CY 2017 and 2018 as gas and coal prices rebound but implied gas heat rates are mostly weaker. Weakness in 2017 reflects loss of market share to coal and renewables and incremental gas-fired capacity.
Volatility in coal pricing was on full display this week, with daily swings of more than $1.00/mt occurring for the three major forward curves. The market moved decidedly higher this week, with gains on the order of $4.00 - $6.00/mt, offsetting the declines observed in the previous week. Stronger oil prices, constructive data in China, and some modest disruptions in the supply chain (weather- and labor-related) all served to drive prices higher this week. A flurry of data from China were released this week which was on balance considerably bullish for the market. This was led by a 4.4% year-on-year increase in thermal generation which was a confirmation of PIRA's Spotlight last week. The Spotlight noted that hot weather would likely push loads up enough to offset the strength in hydro generation.
CCA prices continued the upward trend, pushing above the Auction Reserve Price. This is not being driven by robust market activity, as weak volumes and a first-time-ever year-on-year loss in open interest suggests players are staying on the sidelines. The re-offering of unsold consigned allowances raises the auction quantity in August and will require a higher bidding volume to clear. PIRA again expects the auction to be undersubscribed – though a strong undersubscription could prove bullish for longer term balances. It will also take strong undersubscription of the November auction for market supply for CP2 compliance to be impacted. California power generator data through 2Q are showing emissions strongly down year-on-year, in line with expectations. All eyes are on the legislative front this month, with SB 32 facing hard negotiations for passage.
In July, year-on-year growth in Chinese industrial production decelerated slightly from June. The manufacturing sector stayed resilient, but the mining sector recorded a large year-on-year drop in output. There were both positive and negative signals about the industrial sector outlook in the latest data. Encouraging developments included recent sequential movements in the producer price index and a moderate depreciation in the country’s currency. On the negative side, business investment is apparently losing steam rapidly. PIRA’s overall assessment is that Chinese manufacturing activity will prove resilient and support global economic growth.
Output increased to 1,029 MB/D the week ending August 5, the second highest on record. Stocks drew by 143 thousand barrels to 2.46 million barrels, cancelling most of the build that occurred during the previous week.
Rainfall amounts of 1.5 to 8 inches late last week, mostly in the western Belt, have proven to be a God-send for some but a headache for others. At this point the rains will have a minimal effect on corn, although some late-planted acres will benefit with better kernel fill. However, the effect on soybeans can be dramatic as August through mid-September is a critical time.
Asian LPG markets were the worst performers among the three key regions last week. The physical market remains largely oversupplied, with cargoes arriving from both the East and West routes from the US Gulf Coast on top of the steady flow of Arab Gulf originated cargoes which are increasingly focused almost entirely upon Asia as an outlet. Cash propane cargoes arriving in the Far East in September were called $4 lower near $280/MT while the corresponding physical butane stems were unchanged near $295.
This past week’s EIA data showed U.S. commercial stocks increasing 2.5 million barrels, roughly split 50/50 between crude and products. Expected crude stock declines have not materialized as crude imports have stayed exceptionally high, and even Cushing crude inventories increased 1.2 million barrels last week. Product demand has continued to be strong, led by gasoline. For next week’s EIA data, PIRA sees lower crude imports and finally a sizable crude stock draw of 480 MB/D with Cushing crude stocks declining 110 MB/D. Gasoline stocks continue to decline, helped by stronger exports (+170 MB/D) and lower imports (-260 MB/D), while distillate stocks build modestly.
Estimating the price of supply contracts is always a moving target, especially now, as a growing number of these contracts are shifting their indexing from oil to gas. Traditional contract gas deals are generally a series of lagged rolling oil prices, and the data is further lagged, but we are seeing new opportunities to access more information. In particular, gas supply contracts are becoming more exposed to spot gas, while oil moves into more a broader role. Is greater spot price exposure in gas supply contract coming with longer or shorter lags?
The number of days in each month with positive spark spreads – both at peak and base – has been increasing in Germany. The rebound in API#2 coal prices, hovering at a two year high, is also leading to this outcome, but the reduction in nuclear generation in France has contributed as well. Higher gas storage levels in several European markets create further downside risks for gas prices at a time when power needs to move up for seasonal reasons (solar starts moving lower, while demand starts recovering).
The Massachusetts Solar renewable credit markets, SREC I and SREC II, are managed to limit the extent of any oversupply. The annual Solar Clearinghouse Auction serves as a price support point, while the Alternative Compliance Payment level (ACP) serves as an upper bound. Tightness in the SREC I market for 2015 and 2016 has pushed pricing to ACP levels, while SREC II prices are currently tied to the auction price level. However, increasing compliance obligations going forward will work to eliminate the SREC II surplus, with deficits possible beginning in 2018. Recent emergency regulations are allowing new solar build to continue beyond the original cap/target. Also, new legislation raised MA net metering caps and calls for development of a successor solar program.
Global equities were higher on the week, with strength coming from the various international indices that are tracked. All such indices bested performance in the U.S. where energy led all the tracking indices, higher by 1.7%. Retail also outperformed. Banking was the laggard and moved lower.
Ethanol prices bottom the week ending August 5. It’s just a pause before the decline continues. RIN prices were sharply lower.
It’s impossible to argue with the advanced state of this year’s corn crop when compared to historical averages. What can be argued is the effect of a hot June on some of the corn crop, which was not reflected in the August WASDE as no husks were harmed in the compilation of said report. The effect of August heat on kernel fill also has yet to be determined and will be a big deal given the record weight expected.
Global oil supply disruptions currently stand at 5 MMB/D, and how quickly these outages return is critical to oil markets at this juncture. In our view, the potential for the return of disrupted oil is limited. Production gains are possible out of Nigeria, Libya, and Yemen in the very near future. But we do not expect increases from any of these countries to exceed 100 or 200 MB/D, and security risks will remain high. Meanwhile, political and security situations in Iraq, Neutral Zone, Venezuela, Syria, and South Sudan show no signs of improvement. Also, a recent uptick in violence in Nigeria and northern Iraq/Kurdistan suggests growing risk of more disruptions. PIRA’s end-July Reference Case may be understating global oil supply disruptions by 200-300 MB/D in 4Q16.
Crude runs continued their rise following the winding down of maintenance. Crude imports dropped sufficiently for crude stocks to draw 2.5 MMBbls. Finished product stocks built 1.4 MMBbls, largely due to higher naphtha stocks and a seasonal kero build. Gasoline demand was helped by the Mountain Day holiday impact. Refining margins have been poor and have been getting worse.
Japan’s announcement of an inquiry into the legality of destination restriction clauses and its possible agreement on all its contracted volumes would pave the way for Japanese buyers to play a much more active role in the global LNG traded market, much as we have seen with key European buyers following the easement of destination restrictions in 2004. It is likely to help other regional buyers of LNG as well. This could deliver a fatal blow to the integrated value chain as we know it.
EUA prices are rising in August as ongoing auction volumes are seasonally cut. The cancellation of several Common auctions late in the month and French nuclear outages also support prices. Bearish signals may soon return, including higher auction supply, and a lack of policy developments. However, the correlation between EUAs and both Brent oil and NBP gas, which kept prices above €5 after this year’s first dramatic but short-lived price drop (in January) is rising again. With prices for both oil and gas still expected to rise in the balance of 2016, this correlation may serve to support higher EUA prices following the second major drop of the year.
The S&P 500 extended its move into record territory on Thursday and then eased slightly on Friday. Volatility moved lower, while high yield debt and emerging market debt indices generally moved higher. The dollar was slightly weaker, but it strengthened against the British pound. The total commodity index was fractionally changed on the week, while energy gained.
Saudi Arabia's still has a financial cushion to weather the current price environment, though that cushion is diminishing and its sustainability is not endless. Perhaps this is behind the recent price supportive statement from the Saudi Oil Minister given earlier price weakness. The decline in Saudi foreign exchange reserves continues, now down $176 billion from its peak or almost 24%. At today's prices, further declines are occurring, probably about $8-16 billion per month. Saudi's vulnerability to prices at today's level or lower has increased significantly since the last time reserves were drawn down during the financial crisis.
The sharp decline in the price of domestic natural gas in the first half of the current fiscal year is likely to lead to a saving in the Indian government’s subsidy outgo on urea by up to Rs.9,000 crore ($1.34-billion) in 2016-17. According to official estimates, the 20% price cut on domestically produced gas for the April-September period and the renegotiated price of imported LNG from Qatar’s RasGas Co. Ltd has reduced the price of pooled gas available to fertilizer factories by nearly a third from a year ago. However, should the price of domestic fertilizer be lowered, the subsidy could reverse track.
Last winter was extremely mild because of a record breaking El Niño. U.S. and Europe lost a combined 270 MB/D of middle distillate heating fuel demand. This upcoming winter will be influenced by the dramatic shift from El Niño to La Niña, which should lead to a substantial increase in heating fuel demand compared to last winter.
The condensate market East of Suez was generally balanced to long from 2014 through mid-2016, but with new condensate splitters starting up in 2016/17, the market looks poised to be short of condensate supplies. Furthermore, with U.S. condensate production flat to down for now, incremental condensate from the U.S. will not be available to help balance East of Suez markets unless it were displaced from current uses. While condensate prices are well correlated with naphtha cracks and naphtha cracks are affected by a number of factors (e.g., petrochemical margins, alternative steam cracker feed economics), the tightening of the East of Suez condensate market should give support to higher condensate prices and should directionally help naphtha cracks (all else being equal).
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.
Record levels of drilling and production – particularly in the US – were fundamental factors in the downturn that swept across the oil and gas industry over the last 18 months. Much of the crude oversupply has been sent into storage – either at refining bases, storage hubs, strategic reserves or moored in crude carriers.
Such is the scale of the crude flows that oil prices routinely track movements in inventories at the world’s largest storage and trading hubs. EIA data shows US crude oil stocks hit peak levels of 543 million barrels (excluding the strategic petroleum reserve) in late April, which has since contracted to 523 mmbbls (week ending 29th July).
US storage draws since April have resulted in an uptick in refinery utilization, rising from 89.7% to over ~93% by the end of July. Much of this spike in utilization is due to the summer driving season – typically resulting in a marked increase in gasoline consumption. This has been a feature of the US downstream sector for a number of years, however, current utilization at US refineries is markedly lower than the peak seen in 2015 (96.1% in late July-early August).
It may be surprising that US refinery utilization is down on the same point last year – given the sheer volume of cheap feedstock available – yet, it is not altogether unexpected.
Refining margins which were routinely reaching levels not seen since 2012, are now back to $3-4/bbl due to a saturated products market. Consequently, incentives to delay routine maintenance and sustain high utilization have evaporated.
Early indications from DW’s soon to be released World Downstream Maintenance Market Forecast suggest that this may provide opportunities for those involved in MMO activities. However, consumers at the pumps are not likely to see further falls in prices without large scale storage draws. Fundamentally, operators of refineries must balance the allure of cheap feedstock with the risks of an over-saturated products market.
Matt Adams, Douglas-Westwood London
North American Crude Prices Fall as Canadian Production ReturnsCrude prices fell in July, as Western Canadian oil sands production recovered from recent wildfires. Stocks rebuilt in Canada, weakening differentials for Bakken and Rockies, as well as Canadian grades. Cushing stocks were unchanged in July, but a small draw is likely for August, as overall U.S. crude stocks decline sharply.
Attempts to support spot price will be on two fronts: lower production ramp ups and finding new non-European pockets of demand (i.e. India), even if it means lower netbacks. Among the larger producers and portfolio marketers, the logic goes that it's better to make less money off a few cargoes than demonstrably damage the benchmark for all cargoes. As such, PIRA adjusted the LNG volumes we’ve projected would land on European shores.
The U.K. supply picture for the upcoming winter remains very fluid, with Eggborough Power Ltd announcing this week that its unit 4 coal plant (495 MW) will be available again in the wholesale market over the winter 2016/17, starting from September 16. This announcement comes a few months after the signature of a Supplemental Balancing Reserve (SBR) contract with National Grid for the provision of 681 MW of de-rated capacity from units 1 and 2 during the coming winter. The additional capacity that we potentially see coming back for winter 2016/17 is only the remaining unit at Eggborough. As for the other coal plants currently closed, we see the decision to come back online technically much more difficult to implement.
The coal market lost significant ground this week, with the three major forward curves shedding between $4.00/mt-$6.00/mt along the curve. The headline development of the week was the announcement that Turkey will be adding a $15/mt tax on imported thermal coal for power generation. Before this announcement, Turkey's imports had been one of the sole remaining sources of potential growth on the demand side in the Atlantic. The process of rebalancing for the coal market will continue, particularly as the outlook for Chinese import demand remains bullish. However, limitations on import demand such as what was announced in Turkey this week limit the upside for pricing, although our bullish expectations on oil pricing will drag the market higher as production costs escalate.
Mt. Belvieu LPG prices followed broader energy markets by changing little. September propane at the market center eased by 0.1% despite a very weak inventory build, which pushed stocks back into deficit vs. the year prior. Meanwhile, butane futures gained 1.3% to the settle above 61¢/gal as markets anticipate higher blending demand next season. Prompt August ethane prices plunged as the EIA reported another huge increase in production in June and a substantial inventory increase.
Manufacturing margins also declined. RIN prices decreased after soaring 30% since May.
The August WASDE could very well put in the high for corn yields as the euphoria around the 2016 crop peaks due to crop conditions. The December 2016/December 2017 corn spread traded down to -40 Thursday suggesting the market may even be looking at a 172 yield come next Friday, while PIRA is looking for a 170-171 number for the report.
This week’s U.S. July activity data (such as nonfarm payrolls and the ISM manufacturing index) suggested that the pace of economic growth will pick up in the second half of 2016. While wage growth has accelerated, it is not expected to impact the Fed policy outlook. The Bank of England delivered an easing package that went far beyond market expectations. Japan delivered a one-two punch of fiscal and monetary easing, but the Bank of Japan muddled its message about the upcoming policy action. A directional correlation between China’s manufacturing confidence and Brazil’s industrial production has continued to hold.
Overall stocks built 2.1 million barrels this past week with crude inventories building 1.4 million barrels but gasoline stocks declining 3.3 million barrels. This should be the last of the crude stock builds with offshore floating inventories relatively depleted thereby resulting in lower imports and a forecast 3.6 million-barrel stock decline in next week’s data. Cushing crude stocks fell 1.1 million barrels this past week and should decline another 0.5 million barrels in next week’s EIA report. Another gasoline stock decline is forecast for next week, albeit more moderate than this past week, while distillate stocks build just slightly.
Thursday’s 6 BCF U.S. storage pull was extremely rare — the last such cooling season event occurred a decade ago — driven by record-breaking gas power burn. Yet, barring a few transient spikes, NYMEX Henry Hub (HH) futures trading was relatively ambivalent. Part of this trepidation stems from looming shoulder season fundamentals that will weigh on gas burn for electric generation (EG). However, renewed production resiliency — until recently masked by transitory disruptions — may be even more influential in threatening balances in the weeks ahead.
The S&P 500 moved to another record high, though the Russell 2000 remained well short of its record high. Volatility moved lower, while high yield debt and emerging market debt indices generally moved higher in price. The UK long bond yield moved lower as the Bank of England lowered their overnight policy rate 25 basis points.
Inventories built to 20.6 million barrels the week ending July 29. About 10.6 million gallons of ethanol were imported. The production of ethanol blended gasoline increased to 9,439 MB/D the third highest on record.
Heading into the August WASDE this week there seems to be an inordinate amount of discussion around setting the lows “earlier than normal” this year. A lot of the discussion seems to center on reports from scouting farmers that this year’s corn crop is “good, but not great” and that it’s not as good as it looks from the road. More and more crop tours seemed to confirm these concerns last week, but the markets are “stuck” as the methodology employed by NASS for their August yield estimate solely counts stalks, which should not be an issue in any area with the exception of southern Minnesota and possibly far northern Iowa due to frost.
Crude runs rose 146 MB/D on the week, reflecting the restart of capacity previously in maintenance. Crude imports stayed sufficiently high to build crude stocks 0.77 MMBbls. Finished product stocks drew 0.57 MMBbls. Refining margins are poor and getting worse, which will prompt further discretionary run cuts that will ultimately tighten the market.
It’s probably safe to say that there really isn’t anything else left to delay this year with the exception of Australia Pacific LNG train 2, which PIRA has in its short term balance for October. The question then becomes should we should expect a similar number of delays in start-ups among the 12-odd trains on the books for 2017? The answer at this point is a firm maybe, as we have some evidence to suggest that this year’s flawed timing will be duplicated. One area where delays are mounting are on future projects. The rate of announcements delaying FIDs for the next generation of liquefaction is gathering force, as it becomes abundantly clear to even the most optimistic of project backers that lower oil prices are set to be a longer term feature of the market.
Global equities were broadly higher on the week. In the U.S., the growth indicator outperformed the defensive indicator as many of the growth sensitive sectors posted good gains. Banking and technology led the way higher, while utilities declined and underperformed. The international sectors performed even better than the U.S., and were led by Latin America, China, and emerging Asia. Europe fell back.
Over 70% of the gains in the rig count since May lows has been driven by private operators. Of these private rig additions, nearly 90% has come from operators that had been recently inactive. Many operators dropped to 0 rigs in the first quarter as WTI prices averaged $33/Bbl. As prices recovered, these operators have returned from 0 to 1 rig programs and they have been the primary driver of higher rigs. Now that a significant number of private operators have returned, PIRA thinks it is likely that gains in the rig count will slow.
The federal government has decided against raising the tariffs of petroleum related products despite Oil and Gas Regulatory Authority’s (OGRA) recommendation to raise prices, Finance Minister Ishaq Dar has said. Speaking to reporters in Islamabad, Finance Minister Ishaq Dar said that OGRA's summary was rejected after Prime Minister Nawaz Sharif directed not to raise the prices. He said that the current petroleum prices would remain unchanged until at least August 31, 2016.
EIA recently released their May oil balances. Domestic crude supply, which is domestic crude production plus the balancing item, was unchanged month-on-month and the year-on-year decline rate slowed from about 900 MB/D to 550 MB/D. Looking to June, based on PIRA's adjusted weekly data through July 22nd, domestic crude supply for June is estimated to have declined by 155 MB/D, month-on-month and the year-on-year decline rate has reaccelerated back to 735 MB/D.
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.
There is a general consensus amongst industry analysts that the oil oversupply creating the current market downturn will narrow by the end of 2016. Douglas-Westwood (DW) data support this view, with our World Drilling & Production Market Forecast showing the first oil production decline in 2016 since 2009 – when OPEC strategically cut output in order to support prices. This is largely due to considerable reductions in oil production from the US shale plays as well as widespread outages in Nigeria as a result of militant attacks in the Niger Delta. Therefore, the oversupply will be eroded from the supply side with the demand side stuttering as a result of slowing Chinese economic growth and uncertainty surrounding the future of European markets.
DW’s 2017 view is less positive for the oversupply. The implementation of a host of offshore developments sanctioned before the oil price crash will lead to a 1.8 million barrels per day (mmbbl/d) increase in offshore oil output and a 2.1 mmbbl/d increase overall. Such projects include the ill-fated Kashagan project in the Kazakh Caspian. Kashagan alone is expected to contribute nearly 300 thousand barrels per day (kbbl/d) in 2017. Significant additions are also expected from the Middle East in the form of condensate output from the 24-phase South Pars development and around 300 kbbl/d Khafji field – previously shut-in due to environmental infringements and disagreements between joint operators Kuwait and Saudi Arabia. This pattern is expected to be seen globally, even mature plays in the North Sea and south-east Asia seeing increased output in 2017 as a result of the lag effect of offshore developments (the time between project sanctioning and first oil can be many years).
Demand outlooks from BP, EIA and IEA suggest 2017 demand growth around 1.2 mmbbl/d to 1.5 mmbbl/d, therefore it is highly likely the oversupply will increase once again next year. Whilst this is not certain to push oil prices down once more, it is likely to dampen the recovery until later this decade when a lack of project sanctioning in the last two years leads to a significant drop in offshore oil output additions towards to the end of the decade. This will cause offshore oil production to peak at 29.1 mmbbl/d in 2019 before declining slowly into the 2020s. Onshore oil production is unlikely to sufficiently offset this trend to keep pace with demand growth later this decade, therefore, this may be the point the market reaches equilibrium.
Matt Cook, Douglas-Westwood London
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