We had all packed our factor 50 Ambre Solaire sun cream, the latest Ray Ban sunglasses and the essential white floppy hat, ready for a couple of weeks in the sun. The LPG market was in its usual summer doldrums, so when we get back, batteries re-charged, we will be well prepared for the start of the pre-winter buying to commence. Well, all the holiday gear is packed, but the market is showing signs that it’s about to move in a different direction. Guess it’s time to check that the cut-price villa, miles away from anywhere, really does have the internet my kids demand from a holiday, and I so desperately wanted to avoid!
We’ve all been absorbed with forecast after forecast showing the pace of U.S. shale production continuing to be maintained despite all its consequences, such as; takeaway issues, ethane rejection, lack of fractionation space, pipeline delays, export capacity constraints, the list goes on. As each restriction is removed, or will be removed in the next twelve months, we keep asking the question where on earth, literally, will all this LPG end up finding a home. For the summer so far, the limitations have been in place and we have been expecting to see stock levels in the U.S. jump, way above recent years and cutting through the 100 million Bbl level before the end of October. Back in the Mar/Apr time frame it looked like maybe it will, now, probably it won’t!
I looked at whether Asia was losing its Mojo in SIMON SAYS 07/15/19, but with the ARB appearing to be under pressure I’ve re-focused my attention to the U.S. market, and the messages coming out are pointing to stronger propane prices. It also appears to be both demand and supply factors influencing where the market might be heading over the next few weeks.
The start of the summer saw early robust injections vs previous years, see Figure 1 below, so we were all predicting the big builds would continue, and propane prices were certainly acting as if this would be the case, being continuously pressured lower; the Propane to Oil Price ratio nearly tested 30%. But after a small draw in the week ending May 24th, stock builds have been more erratic, yes, it’s still building but at rates less than market expectations, and even another draw occurring for the week ending July 5th.
I was chatting to a good friend in Houston last week in charge of an U.S. based oil services company, and he was going fishing or was it hunting, anyway they do a lot of it in the U.S., especially in the oil services sector. He started talking about DUCs, and being a little jet lagged at the time, I got the wrong impression that he was talking about the feathered variety and somehow, he was going to be shooting them on the weekend in Canada. Turns out he was going fishing, but that’s another story, so it got me thinking what a DUC is. Now most readers outside of the U.S. will be like me, needing the term explained.
Apparently DUCs are “drilled but uncompleted” wells, and as the name infers, the wells are drilled but final completion, which nowadays almost certainly includes fracturing the well, is withheld to a later date. There are many reasons why such decisions are made and hence DUCs exist. It could be the vertical part of the horizontal well maybe drilled to set pilot hole casing, or they are just drilled as a requirement to maintain the terms of a leasehold. Or like now, where the takeaway is not available so a producer must wait until they can actually move the product to the fractionator/market. Other drilling specific infrastructure issues also occur, i.e. water or power shortages, or it could be that operators are waiting for the financial climate to improve (oil or gas price increases, but also technology). Other circumstances could be an operator is drilling to prove reserves in order to maintain borrowing facilities, maximizing the use of available capital resources at any given time as these funds may well disappear if not used, or simply that the producer is waiting on another operator to do his “thing”. Obviously, there’s numerous reasons, the point here is that DUCs exist and the current inventory is quite plentiful.
During 2018, the DUC count was pretty much in line with the rate of new drilling, but it was starting to cause some concern, simply because of the sheer magnitude of uncompleted wells. The obvious reason was takeaway limitations, but with financial pressures on the smaller operators, most impacted by the lack of pipeline / fractionation capacity, something was likely to give, and it appears it has. In order to minimize extra drilling costs given the time lag in capturing revenues, producers went ahead and started to complete their DUCs inventory.
Since fractionation capacity constraints still exist, as these DUCs are completed and production starts to flow, the Y-grade being produced fills up any spare pipeline space and heads to storage, to wait for fractionation space to open up. This keeps production growing, whilst providing potentially discounted Y-grade for those fractionation companies looking to build up their stocks prior to the new 2020 capacity coming on stream. With such low prices why not build inventory? The problem is that rig counts have been declining for a while now, meaning fewer new wells are being drilled and this will become a problem very quickly as winter is approaching, export capacity is increasing and propane in Y-grade is not consumable; i.e. it can’t be burned for heating, loaded on a vessel for export, or used as a feedstock for petrochemicals. And all of this is probably taking shape right now!
In fact, my buddy feels that the incremental cost of new wells is becoming so high for what is a relatively short-term financial fracking play, that a number of companies are now reverting back to looking at opportunities in the U.S. Gulf of Mexico, where the production profiles are both more stable and longer-term.
So, while supply looks a little like it could start to underperform expectations, there have also been positive developments on the demand side. The combination of the two is starting to raise more and more questions about where the stock build will end, above or below 100 million Bbls. We will answer more of this tomorrow but let’s look at we believe is the change happening on the demand side. In early May we started to see propane cracking margins look better than ethane off and on, and by mid-May the gap started to grow between the two in favour of propane. This is still the case today and clearly those who can switch are moving away from ethane.
As Figure 2 below shows, normal butane is the most favored feedstock in olefin steam crackers, but once approximately 150,000 Bbls/day is reached, it’s difficult to run more normal butane as clearing the by-product outputs becomes a constraint. Herein lies the opportunity for propane as it doesn’t face the same limitations on by-product evacuation. The 25-30% of steam crackers that can switch from ethane, we believe, will have done so by now. It’s interesting to look at the stock graph again and pinpoint when the dip occurred in the stock levels and notice this was the same timing as the switch in ethane / propane margins. Therefore, propane demand for the petrochemicals is in vogue but what sorts of magnitudes are involved. If history is a guide, there’s ample room for propane petchem feedstock consumption to increase; maybe reaching upwards of 400,000 Bbls/day.
Ethane feedstock has been the axiom for both current plant operations, if you have flexibility, and investment decision-making to build ethane-only steam crackers. It’s far cheaper to build an ethane only cracker! But ethane produces 80% ethylene, 2% propylene, 13% hydrogen and methane, while propane produces only 45% ethylene but 15% propylene, 28% hydrogen and methane and nearly 10% C5+. So, the product yield olefin prices are key. Ethylene prices have been weak as there’s just too much of it around, and now with ethane only plants, either built or on the way, it’s looking more precarious. In addition, ethylene export potential is currently quite low, though Enterprise is expanding their Morgan’s Point terminal to eventually handle ethylene exports, sometime in 2020. Also, downstream ethylene consumption facilities are still playing catchup to all the new ethylene crackers recently built, so this ethylene demand is still on the horizon.
Tomorrow we will delve deeper on the demand side and explain more about the trade we are looking at in our virtual trading room, grab the Ray Bans as it might make your eyes water!