SIMON SAYS: Did we really think U.S. NGL production was going to go down the plug-hole?

Submitted by Simon Hill on Sun, 06/28/2020 - 17:00
Did we really think U.S. NGL production was going to go down the plug-hole?

For a lot of internationally based LPG players the U.S. market is a somewhat intimidating place, pipelines are running here, there and everywhere, dominating the logistical landscape, there are no ships to spot moving LPG around the vast U.S. coastline sending out a clue or two about what is happening, and to top it all, it’s called  NGL, then throw in this stuff called ethane, which is pronounced somewhat differently this side of the pond, and there’s natural gasoline to boot. Oh yes, they even split mixed butanes up between normal and iso. I could go on, but the complexity tends to lead us international sorts to simplify the picture as much as we can. So we end-up talking about stocks every Wednesday,  and we love to follow the Baker Hughes rig count late on a Friday, or as an early Saturday morning treat. This simple approach probably tells us more than we might think, and if we throw in a couple of other factors, it’s showing us that we are probably seeing a change starting to happen, not that the market appears to be championing it yet. But give them time and they will.

The Friday night rig count reported the number of oil and gas rigs operating in the U.S. had fallen yet again, but only by 1, to a total 265, suggesting there could be at least a slowing, if not bottoming in the decline. But, to put it all into perspective, at the same time last year there were nearly 800 active rigs versus less than 200 today. Of course the EIA’s longer term projections show the resultant decline in future production levels compared to last year, but this week saw the first increase in crude oil output in eleven weeks, as production rebounded to 11 MM Bbls/d, still 2.1 MM Bbls/d off the peak of recent years, but it’s 500 M Bbls/d up on the previous week, as supply reacts to improving U.S. demand given the easing of lockdown, for the time being anyway. Some are even saying records continue to be broken, as producers are able to expand volumes from the significantly reduced rigs operating, by concentrating not only on field sweet spots, but also by the use of enhanced horizontal drilling techniques.

Of course it’s difficult to swim against the tide of depressed oil and gas prices, but there’s one thing that always stands out to me about the U.S., it’s the ability to get to grips with problems, looking forward not backwards, and with a little help from the crude oil price, things start to happen. Who would have thought that U.S. propane production would have been as resilient as it’s been in recent weeks, especially given all the adverse news on demand destruction, economic slowdown and the rest? Yes, we’re not at the levels of early January this year, when the EIA published a weekly number of 2.464 MM Bbls/d, but I certainly expected production levels to have dropped below 1.8 MM Bbls/d or even further. So when May’s numbers started to roll in at sub 1.9 MM Bbls/d the writing appeared to be on the wall, but last week we saw another increase from 2.142 to 2.154 M Bbls/d.

Now natgas production is also bearing up reasonably well under the strain of recent months, yes it’s down on last year, but production has not capitulated in line with the demand destruction impact of the coronavirus outbreak. The lower 48 states of the U.S. have seen production levels drop in the last month by an average of almost 10 BCF/ d from its peak of nearly 95 BCF/ d, but with storages starting to fill faster than normal in the traditional natgas injection period, it’s a sign that production levels could or should be lower. Henry Hub prices have reacted in a downwards direction, with the market closing on Friday below the 1.50/ MMBtu level, the lowest June price ever recorded and a drop of 18% in just over two weeks. The drop in LNG exports, and a cooler than anticipated Summer, are the major factors impacting storage levels, but production could be much lower, but it isn’t.

The equilibrium equation appears to point to oil and gas related demand falling faster than production over recent weeks and months, therefore transferring excess supplies to inventory, but the pendulum could be swinging back in favour of demand. We are all worried about a secondary surge in coronavirus cases in Europe and in the U.S, with the World Health Organisation arguing that the number of instances of the disease worldwide is still on an upward trajectory, and there are signs in Europe that localised jumps in infections could spread wider as people are unleashed back into the so-called “new normal”. But demand is starting to improve, return, pick-up if not surge, and this can only start to encourage shale producers in the U.S. to turn-up their output controls. U.S. Inventory numbers now appear to be matching the growth levels we were seeing this time last year, after extended draws in late March and April, normally the start of the injection season. If this trend continues then downward pressure will again be reasserted on propane prices in Mont Belvieu. Of course the market is marching to a totally different tune this year than last, but the players are still influenced by the degree of build in the summer propane stocks, especially with petrochemical and Asian winter demand still uncertain.

So it’s maybe time to try and look a little further down the time curve, and expect a relative increase in U.S. propane production, probably above most people’s expectations for 2020, starting to erode the price of Mont Belvieu relative to its Asian counterpart FEI. I’m also not expecting any immediate surge in OPEC crude oil production, and therefore Middle East LPG export supplies, there’s normally a time-lag anyway. So FEI levels, although feeling the impact of the weakened demand, are unlikely to accelerate downwards, and with winter around the corner Asian demand will start to slowly react. In my mind this should hasten a widening of the ARB in the forward months beyond the levels we are seeing today.

Also be aware of the shipping market. Generally commodity prices tend to move slightly earlier than freight levels, and the methods ship owners use to withdraw spot supply, slow steaming, re-routing around the Cape, dry-docking or just sitting, are only just rolling out, and once employed they will delay any sudden return of spot freight supply. Just take last week, we started it with levels of $45/ Mt for the Houston to Chiba voyage via Panama, but with open ships disappearing, given a spurt of fixtures mid-week, it didn’t take long for rates to ascend to nearly $60/ Mt. If production in the U.S. was spiraling down at previously predicted rates, I would be promoting the call for more cancellations, instead I think the ones we are seeing, coupled with inventory increases, may well force the ARB wider, especially with a little nudge from ship-owners keen to see rates recover.