PIRA Energy Market Recap for the Week Ending January 19, 2016

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Oil Sands Production to Remain Resilient Despite Low Prices

NYC-based PIRA Energy Group believes that oil sands production will remain resilient despite low prices. In the U.S., a large commercial stock build matched last year. In Japan, crude runs and imports rose and stocks built. Specifically, PIRA’s analysis of the oil market fundamentals has revealed the following:

Large U.S. Commercial Stock Build Matches Last Year

This past week commercial oil inventories increased 10.0 million barrels, leaving the stock surplus to last year at 163 million barrels. Most of the build was in the key refined light products and these builds were even stronger than last year’s. Hence, the stock surplus for distillate widened and the stock deficit for gasoline virtually disappeared.

Demand Improves but Supplies Remain Overbearing

Going into a New Year, fear remains largely focused on additional price weakness, which is also reflected in the PIRA price forecast. Demand is definitely stronger, but still not strong enough to alleviate the pressure building behind burgeoning global gas supplies. The supply pressure is much more apparent in Asia spot prices, where LNG supplies are building and demand remains weak, but it will be coming to Europe in the weeks and months ahead.

Energy Markets Melt Down

The German and French year ahead contracts have plummeted to an all-time low, mirroring a large downward move in the energy pricing complex. While this move is reminiscent of the collapses seen in January 2009, the current market dynamics appear so far to be very different from the great recession of 2008-9, as the current price plunge appears to be driven by a major mismatch in oil supply/demand. Collapsing oil prices have ramifications all over the energy space, but they are also spooking the financial markets, as a financial upheaval is a possibility either in China or in other emerging markets. The trends in real-time electricity demand are an important signpost in the current market turmoil. While data is generally mixed across markets, demand is, so far, not falling as severely as it did back in 2008/2009. If the macroeconomic framework holds up, as it appears, then we should continue to expect relatively steady margins for power generators. The spark spreads could potentially benefit, considering that global oil and LNG balances are now extremely long. However, this length in the fuel markets implies that German power may nevertheless touch new lows.

Bearish Wave Pushes Coal Prices Even Lower

Notable declines in most equity and commodity markets caused coal prices to also move south last week. 1Q16 API#2 (Northwest Europe) prices lost more than $2.00/mt, and pushed below the $45/mt to finish the week at $43.85/mt. Both prompt FOB Newcastle (Australia) and API#4 (South Africa) prices are now below $50.00/mt, and the backwardation in these markets have Cal-17 prices at or below $40/mt. There is not much by way of support for pricing that would prevent further deterioration over the next 90 days.

California Carbon: Gas/Diesel Demand Up, Crude Production Emissions Down

CP1 reconciliation indicates a large allowance surplus with another expected for 2015. For 2016, with weak oil prices, potential lower emissions from shut-in of high-cost oil wells will be more than offset by stronger gasoline, diesel demand. El Nino rain will help CA hydro, though NW hydro may be adversely impacted. Pricing dynamics in early 2016 contrast to one year ago, when hedging from broad scope entities drove prices. Interest in futures will provide an indication of the likelihood of fully-subscribed V-19 auctions.

NGL Prices Dragged Lower by Weak Crude

LPG prices plunged with crude oil with Mt Belvieu propane losing 12% week-on-week. Butane and natural gasoline fared worse at the market center, despite motor gasoline’s slight outperformance on the week. February butane futures at the Texas market center fell 15% to 42.8¢/gal while C5s weakened to 67¢.

Implementation Day for the Iran Nuclear Deal: What it Really Means for Sanctions

The landmark nuclear deal between Iran and the P5+1 was officially implemented. With the IAEA verification that Iran has met its nuclear obligations, EU and U.S. nuclear-related sanctions are lifted. We summarize the major sanctions that will remain in place as the nuclear deal runs its course, and those that are now lifted.

Global Equities Again Broadly Lower

Global equity markets extended their losses in the New Year. All of our tracking indices moved lower, other than the domestic utility index, which moved higher by 0.8%. Banking, housing, and materials were again the worst performers. Internationally, all the indices lost 2.6-5.3% for the week. Even the strongest performer, Europe, still only performed in line with the U.S. S&P 500 tracking index, down 2.6%.

Japanese Runs and Imports Rose and Crude Stocks Built

Crude runs continued to rise and imports picked up sufficiently to build stocks. Except for kerosene, finished product stocks also built. Gasoil demand rebounded, but balances still produced a stock build. Gasoline demand eased despite a holiday. Refining margins remain very strong with higher gasoline, naphtha, and fuel oil cracks offsetting softer middle distillate cracks.

Tighter January Balances But Still Bearish February Risks

Thursday’s unexpectedly modest 168 BCF reported stock draw further tempered the upward HH price momentum, which already had been arrested earlier this week. Last week’s Gas Flash: Part II (1/8) discussed how colder weather and weaker production had sparked the former HH rally. While January gas balances now appear slightly less supportive, a more resilient backdrop remains, notwithstanding the latest weekly storage report.

Eastern Grid/ERCOT Market Forecast

December 2015 was the warmest and wettest December in the continental U.S. in the 121 year period of record. Eastern Interconnect (U.S.) loads fell by 5.8% (~19 aGW) from the prior year. On-peak energy prices declined in almost every market in December with the exceptions being NY-J, NY-G and the MN hub. Despite the weak prices, implied gas heat rates remained firm with CCGT units in the money everywhere except Ontario. This allowed the power market to absorb incremental volumes of gas that were not required by space heating customers.

Arch Coal Bankruptcy and Market Implications

To no great surprise, Arch Coal (ACI) filed for Chapter 11 bankruptcy in order to facilitate a restructuring of its financial debt load. ACI has entered into a restructuring support agreement with a group of lenders that currently hold more than 50% of the company’s first lien debt. While the typical assumption of a corporate bankruptcy in the commodity sector might seem to be bullish on first glance, this is not necessarily the case in the short-run in a cost-competitive region such as the PRB, and ACI may look to gain market share due to the cost relief. However, it may give ACI some flexibility to temporarily idle Coal Creek, the type of action PIRA believes is necessary (by ACI or another PRB producer) to balance supply and demand.

European Carbon Pushed Down As Gas Replaces Coal

The recent EUA price drop has brought into greater focus many of the existing downside risks: greater supply, weakening demand, and few new policy developments. Low gas prices raise the prospect of increased coal to gas fuel switching and greater uncertainty regarding forward EUA demand – in a market with a shorter appetite for hedging. However, EUA prices may be weather-supported for the remainder of January, following a record-warm December.

Significant Build in Financial Stresses

Financial stresses are building while markets broadly deteriorate. In addition to a decline in equities, the other key indicators such as VIX, high yield debt (HYG) and emerging market debt (EMB) also performed poorly on the week. Total commodities continue to decline. Energy, palladium, aluminum and copper all extended their losses. The U.S. dollar continues to generally strengthen.

Oil Sands Production to Remain Resilient Despite Low Prices

PIRA expects there to be no material shut-ins in Canadian oil sands despite oil prices below cash operating cost. High fixed cost, shut down/restart costs, and risk of reservoir damage make the potential for shut-ins unlikely. Rather, operators are likely to increase utilization rates to further drive down per barrel cost. PIRA expects oil sands production to grow 250 MB/D in 2016 in spite of low prices.

Is 3 MMB/D Of Oil Production At Risk At Current Low Prices?

PIRA estimates that 3 MMB/D of high cost (Canadian oil sands and U.S. stripper wells) oil supplies are potentially at risk at current crude prices below $40/Bbl. However, in reality significantly less volumes (<0.1 MMB/D) are likely to be lost. Canadian oil sand production (2.4 MMB/D) is very unlikely to be shut in mainly due to the potential damage to reservoir from stopping steam injections at thermal operations, and the very high costs to shut down and later restart at integrated mining and upgrading operations. U.S. stripper well production (0.7 MMB/D) is also unlikely to lose significant volumes due to the measures being taken to reduce operating costs and the risk of losing leases and facing abandonment obligations.

U.S. Set to Upend Atlantic Basic LNG Markets

The somnambulant nature of the Atlantic Basin LNG market is all about to change with a first cargo from the first of five 6.2-bcm/yr. trains at the Sabine Pass project. In contrast with the ongoing surge in Asian LNG volumes over the past 18 months, which so far have added some 15-bcm of new supplies since this time in 2014, Atlantic Basin LNG volumes have been in a years-long state of atrophy, with new liquefaction trains (Algeria, Angola) adding nothing to incremental regional supply; in the extreme case of Egypt, which added three “new” trains in 2005, the market had to quickly react to the sudden loss of 17-bcm of volumes over the course of seven months in 2013-14.

Some Latin American Refineries Might Benefit from U.S. Crude Oil

With the lifting of the U.S. crude export ban, Latin America would seem to be a logical destination for U.S. light sweet crude. However, besides Mexico, there are not many suitable refining candidates because only a few refineries currently process light sweet crude. Outside of Mexico, PIRA estimates that maximum penetration of U.S. crude exports into Latin America might be 50-75 MB/D. Mexico could take an additional 75-100 MB/D of light U.S. crude freeing up Mexican heavy crude for export. Beyond these volumes, European refiners are a larger potential market for U.S. crude as they already import substantial volumes of competing West African grades.

WA State Regs Propose Creation of Another Carbon Market

WA released its proposed Clean Air Rule, capping GHG emissions. Compliance will take place over 3-year compliance periods, starting in 2017-19 relying on domestic reductions, RGGI allowances, CCAs, offsets as well as RECs from the Pacific Northwest. This smaller market would draw on lowest-cost supply first - with more limited impacts on the allowance markets. Lower value supply could be some WA-specific reductions, RECs and offset types not eligible in the CA carbon market.

Asian Demand Update: Growth Slowing, but Still Robust

PIRA's latest update of Asian product demand shows continued slowing. PIRA's December update had shown growth of 1.1 MMB/D, which has now slowed to 0.74 MMB/D, with the four major products showing growth of about 0.5 MMB/D. Accounting for the slower growth was China, throttling back from 513 MB/D to 255 MB/D, Japan slowing from 29 MB/D to -98 MB/D, and India easing from growth of 444 MB/D to 396 MB/D. Looking at individual products, the overwhelming change in Asian demand growth has been in middle distillates, both gasoil and jet-kero.

Algerians Raise Gas Prices to Counter Effect of Currency Falls

CREG, the Algerian energy regulator, has increased electricity and gas tariffs for high-voltage electricity and high pressure gas (industry) by 20% and 35% respectively. Retro-active from 1 January 2016, increases in electricity prices cover nearly 76% of consumers while the gas price increase affect 57% of consumers, according to data released by the CREG. The 35% rise reverses prices in USD to Aug 2014 when the Algerian Dinar was 35% stronger than it is currently.

Latest Economic Data Have Downbeat Tone, but There Are No Imminent Signs of Danger

An onslaught of financial risk appetite continued for the second consecutive week, as major equity indices registered further declines. Market conditions have reflected broad-based nervousness about fragilities in the macro backdrop. Key economic data releases have been resilient recently, however, and there are no indications that global growth has weakened notably.

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.

Click here for additional information on PIRA’s global energy commodity market research services.

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PIRA Energy Group
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New York, NY 10016
212-686-6808
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