NYC-based PIRA Energy Group believes that fundamentals at weakest point; forward look Is supportive. In the U.S., there was a modest stock increase. In Japan, crude runs were marginally higher, imports rose and stocks still drew. Specifically, PIRA’s analysis of the oil market fundamentals has revealed the following:
Fundamentals at Weakest Point; Forward Look Is Supportive
Physical crude markets are currently at their maximum period of weakness because of refinery maintenance. Overall global oil supplies increase much less in 2016 than demand growth which will surprise to the upside. The huge difference between supply and demand should force global surplus stocks down in second half 2016 and, in turn, drive oil prices substantially higher. Oil supply disruptions surged in March amidst heightened political risks, and these risks look likely to continue. Margins and refinery runs will strengthen through the summer before weakening.
Supply Challenges Remain
With the 2015-2016 “heating season” officially complete, the market’s focus on weather has clearly slackened. Moreover, it appears spring is already stoking more bullish price expectations despite massive storage surpluses, not to mention the early arrival of injections in some regions, most notably in the South Central (SC). The inherent limits on injections in that region in particular is more than capable of limiting any sustained Henry Hub price strength given the needed increased reliance on demand gains in the electric generation sector. Moreover, the heightened risk of SC storage congestion in 2Q16 stands to distort regional basis relationships, especially in the Midwest (MW). Downstream prices in the MW appear to have already begun to decouple with HH amid the heightened supply competition. Excess SC supply will likely migrate into the MW region, despite the high risk of incremental supply from the WCSB, Rockies, Midcontinent and/or Appalachia.
Wet March Boosts WECC Hydro Prospects
Above-normal precipitation in the Columbia River Basin above The Dalles boosted March hydro generation and lifted April to September runoff projections to above-normal status. With California precipitation also above normal, hydro output forecasts have been revised up WECC-wide. Gas prices averaged below February levels at all Western hubs, with declines ranging from 11% at the PG&E Citygate to 18% at Sumas. However, despite the huge storage overhang, gas spot prices have rallied since early March as markets factored in negative supply impacts from this winter’s price rout. March on-peak energy prices fell from February levels at all hubs with declines ranging from $2/MWh at Palo Verde to $5 at SP15. Given the turnaround in gas markets and warmer-than-normal spring/summer weather forecasts, Southwest power prices should begin to move higher, but strong hydro and rising solar output will pressure gas unit margins for the balance of 2016.
Global Equities Mostly Positive
Global equities posted an aggregated gain of 0.6%, week-on-week. In the U.S, all the tracking indices, other than energy, moved higher. The best performers were housing, technology, consumer staples and consumer discretionary. Internationally, all the tracking indices gained, other than Japan. BRICs, emerging Asia, and China performed the best.
Ethanol Stocks Build
U.S. ethanol production declined for the second straight week as several plants have started to undergo annual maintenance. Inventories built by 503 thousand barrels to 23.0 million barrels, with PADD I stocks increasing to a four-year high.
Funds Selling Corn Again
For the two weeks ending March 29th, Non-Commercials covered 85+K corn shorts, something they probably wished they hadn’t done. While the net short was 142K contracts as of last Tuesday, volume and open interest statistics lead us to believe that the Fund net short is back over the 200K contracts entering a new week of trading. The net soybean short from two weeks ago had turned into 40K contract net long as of last Tuesday, a result of 47K contracts in net buys over the two-week period, and it is currently estimated around 42K contracts.
Coal Market Remains Weak, but Signs of Life for 2017
Forward prices moved decidedly higher in March, particularly for late-2016 and Cal-17. This brings forward prices more in line with PIRA’s outlook from February. While prices are expected to soften over the next two months, we remain generally bullish for 2017 pricing, on the expectation of higher oil prices and slowly realigning fundamentals. There is measurably less upside for CIF ARA pricing due to further weakening in demand.
Russia Confirms Removal of Discount on Ukraine Gas
The discount on the gas price for Ukraine that was valid in the first quarter of the year expired, and from April 1 the price of gas will be in compliance with the current contract, Russia’s Energy Minister Alexander Novak said. The discount was agreed within the framework of the so-called "winter package" by Russia, Ukraine and the European Union. From April 1 of this year, the price of gas for Ukraine will fully comply with the current contract between Gazprom and Naftogaz of Ukraine, the minister said.
Modest U.S. Stock Increase
U.S. commercial oil inventories increased this past week, about half last year’s build for the same week. Crude and distillate narrowed their surplus to last year, while gasoline and the rest of the barrel modestly increased it. Overall stocks remain a huge 150 million barrels (12%) above last year. Higher crude runs and higher product demand have resulted in the first crude stock draw in eight weeks and modest product stock declines.
LNG Looms as We Look Forward to Injection Season
After four straight months of significant demand destruction, March was relatively normal with only 416 MMCM lost due to warmer-than-normal weather. Still, this winter marked the third winter in a row of above-normal temperatures that led to a deterioration in spot prices. This year’s deterioration has been the largest of the last three winters in both absolute (11p/th) and percentage terms (28%). This price loss also confirms our assumption that the relationship between temperature deviations and price is actually growing in significance due to the demise of gas use in the power sector (until recently).
Financial Stress Lower
For the seventh straight week, the S&P 500 rose on a weekly average basis. It also posted a solid gain of about 1.8% week-on-week. Of note was a weakening in the high yield debt tracking index (HYG), though other indicators retained a constructive bias. There continues to be a decline in the yield of BAA rated corporate bonds, which suggests financial stresses have lessened.
Stocks Remain Elevated
U.S. coal stocks remain at elevated levels, as massive supply cuts have been neutralized by extreme demand weakness due to very low natural gas prices and a mild winter. The production constraint does set the stage for material stock declines in the future as natural gas prices rise.
U.S. Ethanol Prices Follow Corn Cost Lower
U.S ethanol prices declined March 31 after corn prices plunged following a bearish report.
Farm Economy Concerns Intensify
As if on cue, the Kansas City Federal Reserve sent out a report titled “Mounting Pressure in the U.S. Farm Sector” Thursday morning before the annual Prospective Plantings and Quarterly Stocks reports were released. Once the numbers were disseminated to the markets, the picture went from worrisome to bleak.
Japanese Crude Runs Marginally Higher; Imports Rose and Stocks Still Drew
Crude runs were marginally higher and crude imports rose, though crude stocks still drew. Finished product stocks also drew slightly. Gasoline demand eased post-holiday, but higher yield was offset by higher exports and stocks drew slightly. Gasoil stocks built on lower demand and much higher yield. Kerosene demand was little changed and stocks continued to post an end-of-season draw. Margins remain good. Cracks were higher week-on-week due to strength in gasoline and naphtha.
Second-Half Price Rebound Ahead
PIRA’s bullish price outlook has been tempered by the collapse of gas-weighted heating degree days (GWHDDs) and the related inflation of end-March storage. During 2Q, the ~1 TCF year-on-year storage surplus should ultimately limit recovery. An end-March exit of ~2.5 TCF will mandate ~40% less year-on-year net injections. Unlike 2012, when EG gains from coal to gas curbed injections, the 2016 remedy will be more back-loaded, tied to declining production and stronger non-EG demand. Indeed, PIRA has maintained a bullish post-2Q HH price posture from expected structurally corrective factors gradually taking firmer control of the market.
Spreads Unsustainably Squeezed
German forward prices have been stabilizing, thanks to higher API 2 coal and carbon prices, but spreads are barely allowing existing coal units to cover their fixed costs. Hedging strategies are in part to blame, as power generators continue to sell, while demand is limited. French prices are too low relative to the forward curve, especially during the winter, considering that the French conventional fleet has narrowed considerably. Even in the U.K. market, where reserve capacity margins are razor thin, prices and spark spreads remain fairly weak. Cash-out prices on March 10 spiked to a multi-year high, suggesting market tightness is already happening during days with lower plant availability.
March Weather: U.S. and Japan Warm, Europe Cold
March weather for the three major OECD markets turned out 6% warmer than the 10-year normal, bringing the month’s oil-heat demand in these markets to a negative 97 MB/D versus normal. They were warmer than the 30-year normal by 13%.
Interplay of Nigerian and Qatari LNG Spot Sales Tell an Important Tale
PIRA sees the flow of Nigerian LNG to Asia and Qatari LNG to Europe as central drivers in spot price formation in the emerging LNG spot trade. These two producing countries alone accounted for 50% of all spot deals in 2015 (and the previous two years) and a vast majority of all LNG moving to markets outside their own region. PIRA sees the role of Nigerian LNG shifting significantly in the years to come, as the opportunity to place spot volumes in Asia will become harder to justify on a netback basis.
Mixed Data on U.S. Economic Growth, but Positive Surprises on Global Manufacturing
There were three main takeaways from this week’s U.S. data releases: key indicators of economic momentum showed strength; data used as inputs for computing GDP, in contrast, pointed to sluggish growth; and inflation has begun to firm. So the question was: how do these developments impact the U.S. growth and monetary policy outlooks? Globally, key confidence indicators on manufacturing revealed surprising strength during March.
LPG Freight Rates Keep Falling
Spot VLGC freight rates continue to plumb new lows. The benchmark Ras Tanura to Chiba, Japan, rate fell another 12% last week to just $28/MT – 82% below the 2015 high. Freight rates are currently at their lowest levels since 2010. There seems to be little relief in sight as new-build tanker deliveries will continue to flood into the fleet throughout 2016 and with, as PIRA predicts, lower exports out of the U.S. in the second half of this year.
Slow Start to the Injection Season Motivates Buyers
Thursday’s 25 BCF storage draw could be the year’s final week-on-week net reduction, despite a shift to colder-than-normal weather in early April. That said, U.S. balances this month should provide greater clarity on the difficulty ahead of adequately curbing year-on-year storage injections given an end-March carryout of ~2.48 TCF. Moreover, while PIRA’s April balances appear constructive, bearish risks exist on both sides of the ledger.
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.
