SIMON SAYS: Change Afoot!

Submitted by Simon Hill on Sun, 02/16/2020 - 17:00
Change Afoot!

It’s been somewhat of a topsy turvy week in the energy sector, as market players try to wriggle out on the other side of the bed each morning, especially on Valentine’s Day! As always, once we’ve had a few weeks of bad news, driven by a worsening but not yet catastrophic coronavirus epidemic, we know that around the corner there will be change, whether it’s tomorrow, next week or next year. So, can we say there’s been any change yet?

The market has apparently “shaken-off” the panic surrounding the spread of coronavirus, it’s not that energy traders are somehow more knowledgeable than senior representatives of the World Health Organisation, it’s just that they need to take a view of potential change occurring. After five consecutive weekly drops in the price of crude oil, that’s seen Brent fall from nearly $69/ Bbl at the start of the year to just under $54/ Bbl ten days ago, we’ve now had a week of gains, closing up above $57/ Bbl. We have all built into our mental, or arithmetical models, the potential abrupt slowdown in the Chinese economy and the knock-on effects worldwide, but now there’s hope for a Chinese stimulus package to revive growth numbers. In addition the fact that the “Elliot wave” pattern has done its three down waves and two up, normally associated with the patterns of a bear market, means that a new independent move can now take place. I’m not an Elliot wave purist myself but why not ride with it!

So, despite all this “bad” news circulating the market, the price of crude oil, the main driver of change in the LPG market, has gone up. Even on the day OPEC dramatically revised downwards its outlook for global demand growth in 2020, by a staggering 0.23 million Bbls/d to 0.99 million Bbls/d, the price of crude oil actually went up. Traders have now moved on, with their focus redirected to March 5th, when OPEC get together for their next regular meeting. One of their advisory technical committees has reportedly recommended a 600 M Bbls/d decrease in oil production, but so far Russia has yet to make-up its mind as to whether it is prepared to sign-up.  Russia clearly don’t want to reduce their own production levels, and Energy Minister Alex Novak believes that more time should be taken to evaluate the impact of the coronavirus, while retaining the belief that global demand might only see a 200 M Bbls/d global decline, but the market is starting to believe Russia will end-up coming to the table, and OPEC cuts will be enforced. That’s sweet news to the more bullish players in the market, and it all fed through to the LPG space this week as well.

The main area of interest in the LPG world has been centered on the March Saudi Aramco CP, with paper CP propane levels having surged to around $400/ Mt, with butane currently maintaining a $35/ Mt premium. We have again reached the position where the FOB price at the source is higher than the delivered price at the point of consumption, i.e. basis FEI. I’ve struggled in the past to explain this, but even with CP and FEI prices both applicable for the same month, one is set a day or so before the month begins, and the other is an average of 20+ quotes throughout the month, it still doesn’t explain the full story. In addition, because CP pricing discussions tend to be more focused on a narrow number of days, there is more than a tendency to try and drive up the likely CP posting against holding a long CP paper position, and it tends to work more often than not. With a certain level of expectation currently surrounding future OPEC cuts, the feeling is that supply might not even be strong enough to cover a reduced level of demand in the market. Whatever is your view on the impact of the coronavirus on both Chinese and worldwide LPG demand, international supply is looking a little sketchy to say the least, not only in the Middle East but also U.S. exports.

There are also those commentators in the market who believe that a potential slowdown in Chinese refinery running rates will reduce the availability of domestic mixed LPG supplies, forcing Chinese buyers to persist in seeking international split propane and butane cargoes. The impact on economic demand of the coronavirus is likely to thwart recent attempts to move the U.S./ China trade tariff discussions  forward, especially in light of likely difficulties for China in meeting proposed purchase obligations, therefore the premiums being paid for Middle East supplies are likely to continue. Then add in the demand for propane into the Propane Dehydrogenation (PDH) sector, albeit slightly reduced as running rates are lowered, and it’s easy to see why the market has become upbeat, despite the coronavirus cloud of doom hanging over it. The Asian “window” rallied from slight negative levels at the beginning of the week, to low double digits by the end.

In the meantime, the big news out of the U.S., was not South Korea’s historic capturing of the two main awards at this year’s Oscar ceremony in Los Angeles, but the dramatic 6.2 million Bbl draw in propane inventories, as reported by the EIA, some 4 to 5 times greater than had been expected. With crude stronger, it meant that Mont Belvieu prices nearly kissed 40 cents/gallon on Friday. But, don’t get too excited, propane exports, although showing signs of weekly consistency, are still not pushing through the barriers commentators like me feel will be required, to stop U.S. propane price ratios to WTI crude oil falling below 30% levels. And there’s a sting in the tail to come! Although normal butane rebounded on the jump in crude oil prices this week, the gasoline blending season is running out of steam, with the switch-over to lower vapour pressure levels not much more than a couple of months away. While crude oil prices slipped 20% over the last month, normal butane has slipped by more than 30%. At 60 cents/ gallon plus 9 cents/gallon spot terminal fees, we get a FOB level of $312.50/ Mt. Then add on freight of $115ish and we arrive in Japan below $430/ Mt. Now if you believe that the butane CP will come out $35/ Mt above propane, and the propane CP is being traded at around $400/ Mt, then it doesn’t require the Einstein amongst us to work out that it’s better loading butane in the U.S., swapping out Middle East contract supplies to China and India, and taking U.S. cargo to Japan and Korea as well as meeting monthly Indonesian spot demand requirements. Now there is greater butane loading capability in the U.S. Gulf, but the capacity overall still remains relatively constrained. My money’s going on a sudden surge in U.S. normal butane exports, especially as we enter the second quarter, while propane exports, dare I say they might end-up falling to under 1,200 M Bbls/d, when the U.S. market could do with propane exports exceeding 1,500 M Bbls/d.

U.S. propane inventory levels are currently over 30% higher than at this time last year, while U.S. NGL production is still expected to grow (even the BakerHughes rig count has stopped falling). Then add-in the recent Rystad Energy report that says the Permian is getting “gassier”, meaning that more will have to be produced to meet the same forecasted crude oil production levels, and that’s more natgas and more NGLs, the way my simple mind works. You somehow get the feeling that without propane exports surging it’s going to be a sticky time ahead for U.S. domestic propane prices. If the previously announced expansions in U.S. export capacity were now in place, I would expect freight rates for the Houston to Chiba run to be nearer $200/ Mt, but they’re not. In fact they have dropped from $130/ Mt to barely above $115/ Mt, it’s a sure sign to me that supply is limited, whatever the demand scenario in Asia might suggest.

Maybe I’ve also changed my mind in a week on that dreaded word “cancellation”, I don’t how I could have even suggested them. Instead I think we could well see full cargo propane premiums being bid-up, while the U.S. export market transitions to split propane and butane loadings, therefore reducing the number of propane cargoes available for export given the limited slot availability. As John F Kennedy once said, “change is the law of life and those who look only to the past or present are certain to miss the future”. It certainly looks like change is afoot to me.