Energy Market Recap for the Week Ending August 22, 2016

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East of Suez Competition Increases and the Mideast Is Contributing to the Products Glut

PIRA Energy Group

Global oil market rebalancing is under way, but the process will vary quarter-to-quarter, with less progress expected in 3Q16 but more in 4Q16.

NYC-based PIRA Energy Group reports that East of Suez competition increases and the Middle East is contributing to the products glut. In the U.S., stocks showed a smaller increase. Specifically, PIRA’s analysis of the oil market fundamentals has revealed the following:

East of Suez Competition Increases Mideast Contributing to Products Glut

Global oil market rebalancing is under way, but the process will vary quarter-to-quarter, with less progress expected in 3Q16 but more in 4Q16. Product balances point to some recovery of both gasoline and gasoil/diesel cracks in 4Q16. As a result of refinery capacity additions since 2013-14 and slower demand growth in the Middle East, the region has become a rising net exporter of diesel and its net imports of gasoline are dwindling. Competition is increasing East of Suez, and the Middle East is contributing to the regional glut of products. Asian refining margins are likely to remain modest as summer driving season winds down and some refiners may trim back on discretionary runs at times.

August Balances — Burning Off Congestion Risk

Last week we pondered whether the seasonal sell-off had already run its course. Certainly, the month-to-date trend in prices would suggest that the market has already taken into account the forthcoming fundamental weakness — as evidenced by the fact that the prompt NYMEX contract is now trading back in line with early June levels. Yet, the inability to sustain short-term gains, despite a string of lower-than-anticipated inventory releases, hints at a willingness to plumb even lower depths as stockpiling begins to reaccelerate. Nevertheless, the critical additional rebalancing that has taken place so far this month might avert further material price declines. At a minimum, the relative tightness in supply/demand balances suggests a higher theoretical floor.

Higher Load Factors Aside, Outlook for French Gas Capacity Remains Uncertain

With oil plants closing (Aramon is offline and the others will follow in 2017-18) and coal further undermined by the likely introduction of a carbon floor and poor market conditions, the French system is set to rely more on gas, together with pumped hydro and interconnectors, to balance the intermittency of renewables and weather-related changes in demand. Despite improving market conditions for gas-fired generators, our analysis shows that French forward power prices are still not high enough to allow a number of French gas plants to fully recover their costs, especially the units located in the TRS (formerly PEG SUD).

Markets Begin to Respond

U.S. coal power demand continues to recover seasonally, aided by more favorable coal-to-gas differentials. This has drawn stocks lower, notably so in light of prior coal production cuts. However, we are seeing growing signs of stronger coal production in the western U.S. (PRB), suggesting markets are responding to the resurgence in demand for this lower cost coal.

Optimism about India on the Rise

In India, industrial production slumped in the first half of 2016, but physical activity indicators such as car sales and air travel (and demand for gasoline and jet fuel) performed strongly. The country’s overall economic growth is continuing at a fast pace in all likelihood. Based on news reports, the long-awaited goods and services tax (which will replace a myriad of local sales taxes with one single, nationwide tax code) will become a reality soon, and that is expected to provide a large boost to India’s economic productivity. In the U.S., Fed chair Yellen’s speech next week is expected to clarify the central bank’s thinking.

Natural Gasoline Prices Strengthen, as LPG Futures Remain Weak

U.S. LPG price underperformance continues. A large build in U.S. propane stocks and waning export demand helped keep Mt Belvieu C3 prices contained, despite surging broader energy market prices. September propane futures at the market center eased by just 0.3% and settled just below 48¢/gal. Butane did marginally better, adding 2% to 64.3¢ as blender demand awakens for the upcoming higher RVP gasoline season. Prompt (August) natural gasoline continues to attract lots of attention as cash prices surge. Reasons for the rapid increase are mixed, but seem to be in part agenda driven and also due to the surge in crude and gasoline prices. Gasoline merchants that are preparing September blends will have a natural incentive to bid up relatively inexpensive August C5s when September prices rally as they have in recent weeks.

U.S. Prices and Manufacturing Margins Stable the Week Ending August 12

RIN prices bottomed, with 2016-D6s dropping to 75 cents inter-day, before rebounding to 85 cents Friday. California Low Carbon Fuel Credit values increase.

Regional Supply Constraints Continue to Boost Gasoline Imports into Latin America

Gasoline and distillate demand in Latin America is forecast to be softer year-on-year. PIRA projects 3Q16 regional gasoline and distillate demand to be lower than 3Q15. In 3Q16 PIRA expects gasoline imports to be higher than 3Q15 as refinery issues continue to restrain regional supply. Imports of diesel into Latin America are projected to be lower year-on-year in 3Q16 due to demand weakness. PIRA projects crude runs in Latin America to drop relative to 3Q15. Gasoline cracks are expected to ease in the next few weeks: high stocks on both sides of the Atlantic, the switch to winter spec, and softening demand are bearish signals. Current weak distillate cracks should gain strength going into the autumn, but high inventories in all major trading hubs will restrain upward swings.

Withdrawals Will Be Stronger this 4Q, But Will Compete with Pipelines for Burn

Three of the last five 4Qs have been warmer than normal from a gas demand perspective. Can we expect the pattern to finally break? While pinning hopes on a shift from El Nino to La Nina will lead to a colder European winter, historical data do not strongly support this conclusion. Interestingly though, looking at the last 10 years of European storage data, temperature is not necessarily the strongest indicator for the amount of injections or withdrawals.

Coal Market Shifts Lower on Weaker Chinese Fundamentals

The coal market was decidedly bearish this past week, largely on fading strength stemming from the Chinese market. Over the previous three to five weeks, strong weather-related increases in electricity demand (and the related strength in coal-fired generation), coupled with reduced production (from strategic capacity curtailments and wet weather), bolstered import demand. While reduction in domestic coal production capacity will continue, weather-related losses to production have leveled off, and the lack of this bullish pressure caused a sell-off. Forward prices lost between $3.00 - $5.00/mt, with deferred prices losing slightly more ground than the prompt. While the end of the exceptional bullish momentum that stemmed from weather-related impacts on Chinese demand and supply was inevitable, PIRA believes the market may have overreacted.

U.S. Stocks Show Smaller Increase

U.S. commercial stocks showed the smallest weekly increase of the past several weeks at about 1.3 million barrels according to the latest EIA data. Crude stocks declined by 2.5 million barrels as crude imports fell by 210 MB/D on the week and crude runs gained by 270 MB/D. Products inventory built by 3.8 million barrels largely of distillate and NGLs, although gasoline drew by 2.7 million barrels, for the third consecutive weekly decline. Product demand remains relatively firm especially for gasoline and kerojet. For the next week’s EIA data PIRA sees a further crude stock draw of 430 MB/D. Gasoline inventory is expected to decline once again by 280 MB/D.

LNG Business Thinks Bigger by Building Smaller

The LNG market is stuck between the reality of bearishness in short-term thinking that is grinding traditional investment patterns to a halt and the optimism for bullishness in long-term planning that will lead to the next generation of new LNG supply. It is a safe assumption to project the need for additional LNG supply in the future; it is much more difficult to foresee how and where it will emerge. With power markets in a major state of flux — will LNG be used as a peak or off-peak fuel? — the outlook for gas use offers a wide range of outcomes that make the long-term more unpredictable than in any recent time. While the next five years are correctly assumed to be long, the next generation of LNG projects and trade are starting to see some creative thinking on all fronts.

U.S. Dollar Continues to Weaken

The S&P 500 was fractionally lower Friday-to-Friday, but it set another new record on Monday. High yield debt and emerging market debt indices performed strongly on the week. The dollar has generally been weakening. It has moved lower versus the euro, pound, yen, many of the Asian currencies (except the Korean Won and Chinese yuan), the ruble, and many of the Eastern European currencies. The total commodity index was higher.

Production Reaches an All-Time High 1,029 MB/D the Week Ending August 12

Inventories drawn by 35 thousand barrels to 20.4 million barrels. Production of ethanol blended- gasoline decreased by 76 MB/D to 9,356 MB/D, but it was still 270 MB/D higher than at this time last year.

Inflection Point in Sight

Operators reported production declines in the Bakken and Eagle Ford, but persistent growth in the Permian. Still, 2Q16 will likely show the sharpest quarterly declines in U.S. shale production. Permian operators are increasing drilling and completion activity, and in the Eagle Ford completions on uncompleted wells are picking up. Operators raised full-year production guidance to a 4.4% decline in response to productivity improvements and increased activity, up 3.3% points from guidance issued in 4Q15. Looking to 2017, Permian and Eagle Ford operators are increasingly pointing to growth. Bakken operators have indicated a recovery is dependent on higher prices.

Gas Price Rise Rolled Back in Argentina

Argentina’s Supreme Court annulled a move by President Mauricio Macri to raise residential natural gas prices, saying the government must first hold a series of public comment sessions before raising related utility rates. The unanimous court decision is a significant but temporary setback for the Macri administration, which is scrambling to reduce a gaping fiscal hole that economists say fueled double-digit inflation over the past decade. Argentina’s government has been spending billions of dollars every year to subsidize the cost of a wide range of utility rates, including natural gas, electricity, water and transportation. The court ruling effectively sends residential gas prices back to what they were in March, before the government raised rates and slashed subsidies that had kept home heating bills here among the lowest in the world.

Is Shale Oil Really Profitable at Current Prices?

Shale oil operators have made remarkable achievements in the past 18 months to reduce well costs and improve well productivity. Many of them now report outstanding well economics with internal rates of return (IRR) after tax greater than 30% at current oil prices. If these economics are real at current prices, why is there no more drilling activity besides the modest increase seen in the past couple of months? The reasons for this include unwillingness from banks to lend more money in the current price environment, some of the reported economics reflecting the best wells versus the average in the play and, more important, the exclusion of sunk costs in the analysis.

Global Equities Modestly Changed

While the global equity market was modestly changed on the week, some sectors put in very strong performances. For the second straight week, energy was the strongest performing sector in the U.S, while banking and materials were also strongly higher. The “growth” indicator well surpassed the defensive indicator. Internationally, China and BRICs put in a strong showing, while Japan fell back on the week and was the weakest performer.

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.

PIRA Energy Group
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New York, NY 10016

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