PIRA Energy Market Recap for the Week Ending March 13, 2017

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Saudi Aramco Placing More Crude in Out-of-Country Refining Joint Ventures

PIRA Energy Group

Overall commercial oil inventories fell 2.4 million barrels on the week led by a sharp decline in gasoline of 6.6 million barrels

NYC-based PIRA Energy Group reports that Saudi Aramco is placing more crude in out-of-country refining joint ventures. In the U.S., there was a bruising crude stock build but a sharp light product draw. In Japan, product stocks are low, but cracks continue to weaken. Specifically, PIRA’s analysis of the oil market fundamentals has revealed the following:

Bruising U.S. Crude Stock Build, Sharp Light Product Draw

Overall commercial oil inventories fell 2.4 million barrels on the week led by a sharp decline in gasoline of 6.6 million barrels. Crude oil continued its unrelenting stock build, adding 8.2 million barrels to an already bloated system, while Cushing crude stocks built 0.9 million barrels. U.S. product demand (adjusted) remains constructive, up 3.1% or 600 MB/D over the last four weeks.

Shoulder Months Are When Pipeline/LNG Wars Will Be Waged

Two important supply-side factors in the European gas landscape are converging in a way that may make shoulder months among the most interesting going forward and fiercely competitive for suppliers. One, gas supply contracts are becoming more and more spot indexed. Two, shoulder months tend to be when LNG supplies are at their loosest.

UK Spark Spread Supported as Gas Prices Slide

With NBP prices falling off the cliff, the UK dark spread has been narrowing at a point that doesn’t currently justify the baseload operation of coal, with operation during the peak hours also increasingly at risk because of the limited flexibility of many of these plants and the insufficient price margins. The result is that coal output has dropped from 8 GW in February to 3.8 GW month-to-date without major planned unavailabilities. We have observed lower de-rated margins (DRM) in the system during March, which are occurring with fairly high power prices, even with relatively high wind output.

Weaker Oil Market, China Supply Developments Depress Pricing

The sharply weaker oil market proved to be a drag for coal market pricing this week, although there was a modest rally for coal pricing on Friday. Price declines were the most pronounced in the FOB Newcastle market, likely due to the supply side policy developments in China with growing certainty that domestic producers will be given flexibility to operate at high levels if prices are high. With the largest upside risk to prices fading (potential shortage in China) and seasonal demand falling, FOB Newcastle prices will be under considerable downward pressure over the next 90 days, particularly after the wave of safety inspections at Chinese coal mines has concluded.

Market Must Buy California Carbon for CP2; Court Decision Imminent

WCI carbon prices declined after the severely undersubscribed auction, but have recovered. The market still needs to acquire significant volumes of compliance instruments to reconcile CP2 emissions. Next year, the auction offering will primarily consist of V-18s and a price premium could emerge for vintages usable for CP2 compliance. A decision in the auction lawsuit will come by the end of next month and likely sooner. A ruling against the auctions will be appealed for sure, but could send market prices below the floor. CA legislation is being teed up to address a potential legal setback. CARB has agreed to delay finalization of the Scoping Plan/Cap and Trade Amendments until outreach is complete – and a compromise on offsets seems likely.

U.S. Labor Market Conditions Turn Better; ECB Stays Dovish

The U.S. labor market report for February was constructive for two reasons. First, the pace of job growth quickened significantly compared to late 2016. The labor force participation rate also improved, and this has apparently been responsible for keeping wage growth in check. After this positive report, the high likelihood is that the Fed will go ahead with a rate hike at next week’s meeting. The European Central Bank maintained its dovish policy stance, even though European inflation has accelerated significantly in recent periods. China’s 2017 economic targets signaled that the country intends to keep the pace of economic growth roughly stable from last year.

Ethanol Production Flat; Stocks Build

The week ending March 3, U.S. ethanol production was flat, but stocks continued to build. RIN values tumbled amid rumors that the point of biofuels obligation would shift from refiners and importers to blenders at the rack. In the South-Central region of Brazil, 116 mills are expected to start the 2017/2018 season by the end of March. European ethanol values ease from the 14-month high.

Crop Forecasting Comes Full Circle

Ten or so years ago the use of satellite imagery was all the rage in crop forecasting, until one bad year when the leader in that technology spent the fall extensively surveying elevators as the satellites didn’t get the job done. Satellite imagery is still used by many, including NASS, but those numbers are always augmented by some other closer-to-the-ground data points.

Japanese Product Stocks Low, but Cracks Continue to Weaken

Japanese crude runs eased again on the week, while crude imports fell sharply and crude stocks drew 2.8 million barrels. Finished products built modestly with a fall back in aggregate major product demand. Gasoil demand was surprising strong and stocks drew again. Kerosene demand fell back seasonally, but the stock draw rate accelerated. Margins remain very mediocre, of late.

Netbacks Remain Skewed Against Dry Gas

The continuation of the late season rally has lifted NYMEX gas futures prices back to ~$3 this week as production remains anchored well below year-ago levels. For the most part, the market has focused on timing the next leg higher for Appalachian production. Yet, given former outsized contributions wet gas has made to total domestic supply, this segment warrants attention. Although U.S. tight oil and NGL field production growth will turn positive in 2017, for now residual year-on-year losses are also still undermining wet gas, and thus, overall U.S. production. Moreover, a build-up of year-on-year gains in the 2-3 BCF/D area (as realized in the 2012-15 period) will not occur until 2018 at the earliest.

Record Warm Feb Whittles Prices

Record warmth in many East/ERCOT markets led to steep declines in heating loads in February. Gas prices weakened from January but remain up year-on-year due to export gains, production declines, and lower storage. Price projections have been revised down from last month, mainly at the front of the curve. Implied on-peak gas heat rates for Mar-Dec 2017 are down year-on-year on most markets due to higher gas prices, lower cooling demand, and gas-fired capacity additions. The steepest decline are expected in the Mid-Atlantic markets.

Low RGGI Compliance Interest, Specs Engage at Low Prices

The March RGGI allowance auction cleared well below secondary market prices and down significantly from the December auction. The coverage ratio remains relatively strong, but has fallen to its lowest level since September 2013. Winnings by compliance entities fell, suggesting increased speculative buying at these price levels. Market uncertainty continues, with another RGGI program review meeting slated for the “spring.” Tightening the cap, further banking adjustments and the proposed Emissions Containment Reserve could provide supportive pricing signals this year.

Market Awaiting Fed Rate Increase

The S&P 500 backed off its record highs, but financial stresses remain low. Even so, volatility (VIX), high yield debt (HYG), and emerging market debt (EMB) all fell again slightly in price on the week. The market appears to be digesting the almost certain prospects of a rate increase by the Fed, and as such, credit spreads have widened a bit, commodities have weakened, and long-term yields have moved up.

Bearish March WASDE

Soybeans were the star of the show in the March WASDE with Brazil getting almost all the focus, as we had been suggesting in the run-up to the report. This year’s aggressiveness of the soybean group at the World Board came through once again through a sizeable jump in Brazilian bean production, along with a cut in U.S. exports.

U.S. Ethanol Stocks Decline

U.S. ethanol stocks declined for the first time in nine weeks, falling by 235 thousand barrels to 22.9 million barrels during the week ending March 3. PADD II inventories soared to a record high 8.4 million barrels, though total inventories are now 451 thousand barrels lower than they were at this time last year. Domestic ethanol production sunk 12 MB/D to a 14-week low 1,022 MB/D. Ethanol-blended gasoline manufacture dropped to 8,697 MB/D from 8,738 MB/D as total gasoline production decreased.

U.S. Customs Data Point to Very Low Imports

PIRA is now collecting Customs Data on U.S. oil imports. For last Friday through Wednesday, crude imports are just 6.0-6.5 MMB/D. With the Houston Ship Channel closed most of Thursday, crude imports likely stayed very low. Light product imports are also very low with gasoline at just 380 MB/D. The crude import figure taken literally would imply a sizable crude stock draw for the week, but likely reflects oil backing up on the water because of poor weather and logistical constraints.

Japan Reversing Course on LNG?

The winter surge in imports to Japan offers a sharp contrast with the markedly more pessimistic LNG forecast PIRA has been presenting over the course of the past 24 months. The question is whether this resurgence is a mere seasonal phenomena or can we expect to see LNG consumption patterns of recent years in Japan to reverse course?

Will U.S. Shale Oil Resources Last Forever?

U.S. shale resources are massive with approximately 160 billion barrels recoverable oil at $50-80/Bbl, of which roughly half are economic at around $50/Bbl based on today’s well economics, admittedly at the bottom of the cycle. At the current drilling rate of 10,000 horizontal oil wells/year, it would take around 45 years to deplete the resources (22 years for the ones currently economic at $50/Bbl). The well locations economic at above $50/Bbl will get drilled only if oil prices are higher than $50/Bbl or if well productivity improvements offset higher costs expected from service providers.

Global Equities Consolidate Recent Record Strength

U.S. markets eased off record highs. Even so, technology and housing sectors still posted gains. Energy was the weakest performing sector. Internationally, Europe continued to post gains, while other tracking indices were only modestly lower. Most longer-term equity trends remain bullish.

Argentina Will Reduce Incentives for Gas Producers

Argentina will lower the price it guarantees for gas drilled from new wells after 2018 to encourage companies to speed up investment in the vast Vaca Muerta shale play, Energy Minister Juan Jose Aranguren said on Wednesday. In January, President Mauricio Macri announced a plan to stimulate production in Vaca Muerta in which the government would guarantee a minimum price and tax stability, while companies pledged investments and unions agreed to measures to lower notoriously high labor costs.

How Profitable is Argentinian Shale Oil?

Argentina has most of the ingredients to become a major shale oil producer. Its shale resources are significant, with its main accumulation (Vaca Muerta) comparable in size and quality to the Bakken and Eagle Ford plays. It also has mostly favorable conditions for shale production. However, development is still primarily in the appraisal stage, current production is small (< 50 MB/D liquids) and play wide breakeven costs of around $60/Bbl are much higher than comparable U.S. shale plays. Long term growth will depend on continued favorable fiscal terms to attract more foreign investment and favorable resolution of labor issues that have so far slowed down shale development.

Saudi Aramco Placing More Crude in Out-of-Country Refining Joint Ventures

Saudi Aramco is entering into additional out-of-country refining joint-ventures (JV’s) with accompanying term crude supply arrangements. In the last year, agreement was reached with Pertamina on a JV to expand the Cilacap refinery in Indonesia, as well as participation in Petronas’ new RAPID refinery/petrochemical project in Johar, Malaysia. These JV’s are part of Saudi Aramco’s long-term strategy to maintain its market share in competition with other crude suppliers.

U.S. Crude Oil Exports Increase to New Record in January 2017

PIRA has been forecasting high January 2017 exports for several months now. As early as in the December outlook, PIRA noted that reported November and December exports would be low but would increase in January 2017 – which ultimately occurred. Additionally, in PIRA's report on U.S. port-level exports in mid-December PIRA stated that the late-2016 OPEC/non-OPEC output cuts would keep the incentive to export U.S. crude to Europe larger than it otherwise would have been as reduced crude supplies to Europe and Asia would directionally widen crude differentials.

Iraq Oil Monitor, 1Q17

Baghdad is implementing pledged production cuts, with 1Q17 averaging over 200 MB/D below 4Q16. Southern export infrastructure capacity now looks sustainable above 3.4 MMB/D, and work is ongoing to provide another boost. In the north, the KRG and Baghdad agreed to refine 40 MB/D of NOC oil in Kurdistan. But the deal reignited a Kurdish political feud, causing a brief shutdown of 120 MB/D of NOC flows. An ISIS sleeper cell is suspected of recent bombings at the 195 MB/D Bai Hasan field, highlighting risks of insurgent attacks as ISIS is evicted from Mosul.

Low Inventories Support LPG Prices

The EIA reported that propane exports rallied to 1,022 MB/D for the week ending on March 3rd. This high volume resulted in an unusually high stock draw for this time of year of 4.1 MMB, which brought U.S. propane inventories 17.1 MMB below last year’s level. Exports above 1 MMB/D have persisted since the end of December, and fell to an annual low of 755 MB/D for the week ending February 24th. Bullish sentiment from high exports and plummeting inventories caused U.S. LPG prices to buoy from its seasonal downward trend. Mont Belvieu C3 futures rallied 3% (2¢) to 63¢/gal, while butane futures were also up by 3% (2¢) to 72¢. Ethane futures registered a slightly faster rise of 15% (3¢) to 23¢/gal.

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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