I’ve eluded to how the Asian market had lost its mojo in recent blogs, not unexpected at this time of year, but it’s thrown up a lot of questions as to what happens next. In yesterday’s blog we concentrated on the East/West spread, but today I need to answer where the U.S. / Asian ARB is heading. In our virtual trading room, we decided on Monday to exit our December ARB position (selling Mont Belvieu LST Propane and buying Far East Index Propane), and I’ll explain why we did it, what we were seeing and whether this opens up another trade opportunity.
One report I saw at the end of last week suggested that Asian demand had “evaporated”, I think they’ve hit the nail on the proverbial head. We are well and truly in the summer market, albeit a little later than normal. There was a Formosa purchase tender for the second half of August, but that was snapped up pretty quickly based on a naphtha price relationship, along with some buying interest in Indonesia and Vietnam. Other buyers though are proving very difficult to find, and with Japanese and Korean inventories more than adequate, sellers better buckle in tightly, it could be a challenging couple of months.
We explained yesterday that the market weakening has meant the front of the swaps curve has flipped into contango (i.e., near term prices are lower than future prices). How far this will go is anyone’s guess, but current discounts are certainly at $5/Mt and maybe as high as double digits. We used to measure how far south a contango market could move by applying what we call, the “cost of Carriage”. This I’ll define as being the cost of sitting a ship loaded with product, for say one or more months, and then selling the product at the higher monthly price in the future.
With contango currently between $5 - $10/Mt, however, this just doesn’t make any sense whatsoever today. VLGCs are earning $60,000+ per day, and with the incremental daily costs of the vessel adding another $10,000, that’s roughly $2.1 million per month. We then divide that by 47,000 Mt (the vessel capacity) to get a per unit cost of $45/ Mt. This is obviously much larger than today’s contango ($5-10/Mt), meaning contango has a very long way to go!
So, the pricing structure suggests there are more sellers than buyers, but are there signs of excess cargoes around? If demand has taken a turn downwards, the supply still looks as if it’s coming. In fact, in Abu Dhabi, Asian customers nominated dates at the end of August hoping cargoes would arrive as late as possible at the end of September, but Abu Dhabi National Oil Company (ADNOC) advanced three of their customer’s dates and gave others the earlier dates they wanted, that doesn’t suggest supply cutbacks to me. Let’s see what happens with the Saudi Aramco nomination acceptances expected in the next week.
There is certainly evidence of spot sellers in the Middle East, such as Kuwait Petroleum Corporation, who have sold three cargoes in late July, late August and mid-September, in addition to finding another cargo to sell in the mid part of August. QPC have had a tender as well, whilst Socar, Reliance and BASF have been looking to resell their August Middle East cargoes. Not all have been sold and discounts on the Saudi Aramco Contract Price CP have been comfortably in double digits, again, suggesting ample supply. There are also at least two, some say four, west African cargoes available, one in early August from Nigeria LNG (NLNG) and a mid-month lifting from Sonangol in Angola.
There also appears to be plentiful pure propane cargoes available from the U.S., both CFR and FOB, especially given that the ARB has been open, so far, for most of the year. With record exports this summer, and more to come with Enterprise’s export expansion starting up in September, you wouldn’t expect to suddenly see any shortages. Even Australia has joined the party, exporting their first LPG cargo from the Prelude field and let’s not forget, Iranian exports are still happening whatever Mr Trump seems to say or do.
It’s fine to pile all the focus onto the Asian market, and we are seeing it weaken, but the ARB is a “it takes two to tango” spread, which means we also have to look at what is happening in the U.S. market. If the ARB narrows, or widens, it’s not just because one regional price is moving in the opposite direction of the other, it could also be that both regional prices are dropping or increasing together, but at different rates of change.
While the Asian market has been weakening, the Mont Belvieu market, as measured by the LST (TET) price index, has pretty much kept pace with the weakness happening nearly 10,000 miles away in Asia. Market players who are focused on the U.S., seem to be absorbed with two issues playing heavily on their minds. They have consistently heard reports of higher U.S. production numbers, as released by EIA on a weekly basis, and backed-up by EIA’s more accurate monthly numbers, while also seeing relatively high stock levels currently, and even higher projected numbers by the end of the stock building season, typically in October. With all this in mind there’s a subconscious thought process going on that says the ARB needs to stay open to evacuate US propane supply, whatever the Asian market is doing, let alone where the U.S. to Chiba, Japan freight levels and terminal fees are heading.
Now while the Asian market was strong, even in the early summer, so too were the Houston to Chiba, Japan freight levels and the U.S. terminal fees, which were pressuring U.S. prices. This has been shown well by the way the propane to crude ratio has taken a beating. This pressure, however, is far greater when the Asian structure weakens and flips into contango. If this weakness in Asia continues, the U.S. producers are going to have a tough time ahead of them, though there’s maybe a glint of light suggesting U.S. price weakness may be starting to slow down and this is going to begin to have an impact the ARB, for sure!
EIA numbers have suggested that, over recent weeks, the rate of production growth has been slower, while exports, although difficult to accurately measure on a weekly basis, have gradually grown, with the odd upward leap, such as when Mariner East 2 finally got started in April this year. In fact, we expect another skip up with the Enterprise expansion in September. Although residential and commercial demand is fairly constant, and low, during the summer months, petrochemical feedstock slates are certainly looking at, if not in the process of, increasing their propane usage, as propane cracking margins have become slightly more attractive than ethane. If these factors suggest lower end of season stocks, than had been predicted in recent months, then we might also see relief for the pounded U.S. propane price.
The other secondary, but still very important factors impacting the direction of the ARB, are freight levels and terminal fees. Houston to Chiba, Japan freight levels have been coming under pressure in the last couple of weeks, with rates easing from $125/Mt down to $115/Mt, reducing the pressure on the ARB to widen. The lower freight costs are due, in part, to
- the grouping of ships, that tends to happen naturally once or twice a year due to voyage routes and timing bringing ships closer in timing and geography to each other, this time the U.S. Gulf in the first half of August,
- the war risk premiums in the Arab Gulf (AG) shifting ships West to avoid the region and the payment of insurance risk premiums, and
- a few more new builds (NBs) marginally increasing the supply of vessels
Terminal fees, however, are still relatively strong, as capacity has been limited, and spare tonnes are there but need to be encouraged out as exports. That is going to change, though, with the expansion of the Enterprise export terminal, starting in September, and hopefully helping to ease the current buoyancy in terminal fees.
I believe we are going to see the ARB narrow; this is my call on the market this week, and this is likely to happen at the front of the curve, the summer part if I can call it that. Although closing the door on the December ARB virtual position is the right strategy to take, it does open up another door, another trading opportunity. We’ll use the same logic to close one position and open another. We closed December by buying the ARB and now we will buy more of the ARB, but this time in September. This will take us from being short the ARB in December to being long the ARB in September.