SIMON SAYS: Directions of Trade – turn right or turn left?

Submitted by Simon Hill on Tue, 11/12/2019 - 15:34
Directions of Trade – turn right or turn left?

I bet some of you are saying that all I seem to talk about these days is that damn ARB, from Houston to Chiba, but to soothe any sore feelings I’m going to explain a little more about the direction of seaborne trade. Not just the route from the U.S. to Asia, however important it might be. We’ve all seen the world maps with those directional arrows, and in a nutshell that’s pretty much what it is all about. Whatever anybody says you can’t beat a good world map!

The most important influence on the direction of trade is the basic rationale behind the supply and demand of LPG. Well, I would go one step further and say it’s all about supply, as it’s fundamentally a supply push business. As we know, no one has ever woken up in a morning saying they are only going to produce LPG, maybe it’s second or third on the list, after the decision has been made to find and develop crude oil and natural gas reserves, and it still gets called a by-product anyway. Most LPG is extracted from either associated gas if its origin is from crude oil production, or non-associated gas if its origin is from natural gas production. Most of the time LPG is produced in areas where demand is hardly close-by, whether that’s in the hostile waters of the North Sea, the deserts of the Middle East, Russia’s remote Siberian region, north west Australia, or even the jungles of tropical west Africa.

The other source of LPG comes from the refinery sector, where LPG is boiled off and collected during the refinery process. The amounts will depend on whether the crude oil is light or heavy, as well as the percentages of LPG in the particular crude oil specification. LPG is also extracted at the source in order to stabilise the crude oil for shipment, but there will still be a small percentage left in the delivered crude oil barrel, that is again taken out during the refining activity.

In total nearly 310 million Mt of LPG will be produced this year around the world, split roughly 190 million Mt from gas plants and a further 120 million Mt from the refinery sector. Of that production about one third moves by sea between countries and continents, today that’s well over 100 million Mt, and has grown consistently as a proportion of total production, from less than 25% ten years ago. Approximately 70% of the volumes move on Very Large Gas Carriers (VLGCs), with the balance volumes moving on all other sized LPG vessels, down to the smallest of around 1,000 cubic metres (500 Mt lots).

The key factor is how much of the production is consumed domestically and how much is being exported. The major LPG producer in the world is the U.S., at over 85 million Mt per annum, and U.S. exports will grow to just under 40 million Mt by the end of 2019, nearly 45% of production. Most commentators believe this figure will increase as a percentage, as most of the production growth will have to be exported. Asia, including Australia and the Pacific, produce nearly 75 million Mt annually, consuming all of it and also importing another 40 million Mt on top of it.  The Middle East region produces just over 65 million Mt of LPG, with exports close to 40 million Mt, which is well over 60%. In Europe production is more than 40 million Mt of LPG, and exports are about 6 million Mt, while Latin America produces half the total of Europe, just over 20 million Mt, but still needs to net import nearly 10 million Mt per annum. And finally, Africa produces less than 20 million mt, but with north Africa, and Sub Saharan Africa, both being net exporters totaling about 4 million Mt per year, and this is at a time Africa needs LPG!

Those are the key numbers, but the direction of trade is really what counts. From the Middle East nearly 13 million Mt of the 40 million exports go to India, covering pretty close to 100% of India’s supply. Just under 20 million Mt goes to north east China, Japan and Korea, with the balance 7-8 million Mt being sold into South East Asia, including South China, Indonesia, Thailand and Vietnam.

The U.S. has seen the direction of cargoes and their final destination change, as more exports have become available from the growing shale gas production. Pre-shale, the U.S. made small cargoes available for export to the Caribbean, Mexico and Ecuador. The key was pricing, and because these countries accepted the Mont Belvieu pricing system, then the only question was a fair level of premium to cover terminal costs plus freight, and usually the premiums were attractive for this business to be maintained. There are exports to Canada, but I would include this under the North American heading.

As shale gas exports increased, cargoes had to be directed to different destinations. Europe was the natural first choice, but the volumes were limited given the maturity of demand, and the supply strength in the region out of the North Sea, Russia and Algeria. This has pushed the U.S. to find homes further afield, but at the start it was the Asian buyers in Japan, China and Korea coming to the U.S. for contracts. Their belief was that due to the export constraints out of the U.S., and a lack of domestic demand growth, U.S. pricing was going to get cheaper and cheaper against the world price, dominated at the time by the influence of the Saudi CP. But as more volumes infiltrated into the Asian market, CP sellers started to compete, and suddenly the U.S. price was not always the cheapest. Whereas the CP price was acceptable to nearly all Asian importers, and was the backbone of wholesale and domestic retail pricing in those countries. It became clear that having to buy on one price, Mont Belvieu and sell on either an FEI or a CP plus freight basis, something was likely to come unstuck and it did.

The U.S. manages exports and cargo destination by pricing its FOBs in order to clear surpluses. If exports are uncompetitive then cancellations could happen, stock levels go up in the U.S., prices drop, and exports become competitive again. Europe’s pricing mechanisms are geared to the European downstream market, meaning that product generally clears. So, with base export prices matching the same base import prices, the direction of trade tends to remain the same except for logistical and seasonal hiccups, it’s where the prices are different, that the direction of trade can be very short term in nature, or can continue for a lengthy period. Clearly the non-Mont Belvieu priced import markets, Asia, Europe, and also petrochemical buying worldwide, is where the more opportunist trades will take place. Nearly all petrochemical buyers are looking at economics that doesn’t fit any of the main suppliers, whether the price is Mont Belvieu, CP, Sonatrach or North Sea. Therefore, purchases tend to be more spot related, with very few contracts being signed. The one exception has been the PDH plants in China, who appear to be happy to contract on a price basis that is not related to their end product, luckily so far margins have been okay.

I’ve talked about the prices pushing cargoes out of the major export countries/regions, and the demand based on similar or different pricing. This leads to trading decisions being made based on the best margin or netback. But there are other factors to consider. The routes that ships might take, having to go through expensive canals or through poor weather areas, the impact of government regulations, such as the current U.S. / China trade war resulting in more Middle East cargoes heading to China, and U.S. cargoes normally destined for China heading to Japan and Korea. Logistically it makes sense, but other factors have made this a premium business.

I thought that after this more general look at trade direction I will try to delve deeper, and compare where we are today, to the direction ten years ago.