Most people have been back at their desks for a week already since the end of the festive holidays, and what a week it’s been. Crude oil prices, actually settled on Friday, below the levels prior to the assassination of General Soleimani, with Brent around $65/ Bbl. The week seemed to have this macabre stage management feel to it, with missiles launched at U.S. military base targets inside Iraq, but apparently Iraqi authorities were pre-warned, no casualties were reported, and the oil market started to discount the geo-political tensions, assuming that neither party was prepared to escalate the face-off. Across the oil space, most players were concerned about possible attacks on shipping and oil installations, and this looked less likely as the week progressed, especially as focus started to increase on the causes of the crash of the Ukrainian airline just after take-off from Tehran airport.
The tensions in the Middle East are by no means over, but with the more amber coloured light now flashing, it has allowed market players to get back to trying to determine the main supply and demand factors likely to impact the oil and gas markets in 2020. What still seems to be the greatest worry, is the potential for a global oil glut this year, the impact that this will have on oil prices and the knock-on influence on LPG production in the U.S., as well as exports from the U.S. into the international market. I think there will be worries at many stages of 2020 about current drilling programmes and future production forecasts, but all eyes are probably going to be fixed on the start-ups of the new U.S. NGL fractionation units.
The end of 2019 saw the impact of the Oneok 4 and Enterprise 10 fractionators coming on-stream in the U.S. Gulf, as PADD 3 propane/propylene production began 2020 at 1.422 million Bbls/d, up from averaging around 1.25 million Bbls/d, back in the three to four months up to the end of November 2019. I’m expecting up to 7 new fractionators to come on stream across the Texas coastline in Houston and Corpus Christi with capacity for about 700 M Bbls/d, so assuming 40-45% of it will be propane, this could add a further 0.3 million Bbls/d to the EIA weekly production numbers, which calculate refinery and fractionations output. To put it into the perspective of the international players, an increase from 1.3 to say 1.7 million Bbls/d, spread over 2020, is likely to increase production and propane exports by about 8.5 to 9 million Mt, then add in increased normal butane exports, and we could be looking at 10 million mt of exports from the U.S.
The debate though has changed, last year there was more production and not enough infrastructure, this year will be more focused on whether the extra capacity can be filled-up. Despite worrying drilling and production forecasts, coupled with negative Permian gas netback prices and the souring of all things energy on Wall Street, which is already impacting the access to capital markets for funding future E&P/ midstreamer investments, I still think we will hit the upper end of capacity utilization given the pent-up Y-grade issues of 2019 rolling forward into 2020, and the need to improve financial returns as much as possible. What happens beyond the end of 2020 is very much in the air.
But coming back to the present, we entered the new decade on the whirlwind of a dramatic widening of the ARB, between the U.S. and Asia, triggered by OPEC cutbacks, U.S. export capacity constraints and of course the prolonging U.S./ China trade war, and of course that old chestnut, the Iran sanctions. But as with all markets, the ARB had just gone too far, CP had jumped beyond its norm, premiums above February FEI levels are still terrifyingly high, but have at least eased to the mid $50s/ Mt for first half February arrivals. Japan and Korea have taken a back seat, but Chinese demand continues to be strong, mainly as a result of propane demand for the propane dehydrogenation (PDH) plants. Split cargoes into China aren’t attracting much interest at the moment, with most of the increased demand for Chinese New Year pretty much covered. The real problem is that the PDH plants could do with importing more propane, but with the Middle East relatively short of full cargoes the excess propane supply remains out of the U.S., but there’s no way the margins can sustain 30% tariffs, let alone the very high premiums that suppliers are expecting in-order to re-organise their programmes so as to provide non-U.S. origin propane. A split cargo, rumored to be from Kuwait, was sold for a $22/ Mt premium above CP on a FOB basis, so with freight in the mid $60s/ Mt, and an additional premium for propane only, you can see why differentials into North China are likely to be pushing $100/ Mt. By my abacus that’s still short of the $140-150/ Mt in tariff fees, but I bet a few more calculations have been made recently. It will be interesting to see what premiums the Qatari’s are able to get for a late February propane tender, even with the market having somewhat run out of steam. What’s for certain is that it’s forcing the PDH operators to not only reduce their facility running rates and start to bring forward planned maintenance, but they must also begin to evaluate whether a short-term supply issue may well be a prolonged problem, especially as we move out of the winter period, surely not.
At the same time the U.S. market is going through its own reversal, but the theory and the reality don’t seem to match. We would expect that the drop in Asian values on the back of the reduction in Middle East tensions would lead to the ARB narrowing, and this has certainly been the case. At the start of the week the February ARB was standing at $300/ Mt wide, but by Friday it was languishing at $228/ Mt, although the word “languishing” is maybe slight word overkill! When translated into the U.S. Gulf resale market a similar drop was calculated for net-back levels with numbers above 32 cents/ gallon ($165/ Mt+) dropping down to below 24 cents/ gallon by the end of the week. It’s certainly a crash, but with trade thin and hopefully astute hedging by buyers who paid above the 30 cents/ gallon mark, any pain has been reduced. One thing is for certain, when markets take such a drop the life is squeezed out of them until a more realistic equilibrium level has been found.
The other factor influencing the ARB to narrow has been a resurgence in freight interest post holidays. A few trader relets in the market were fixed for the period up to Valentine’s Day! Clearly the romance associated with these high rates is still with us. Rates have been pulled up by owners to just shy of $120/ Mt for late January/ early February voyages, but whether these levels can be sustained, as we are seeing more tonnage appearing in the second half of February, really depends on the weather, namely the impact of any fog. It’s certainly around but so far it’s not causing any significant delays. What still interests me is whether we are going to see the amount of exports we should be expecting given production increases.
What’s been a bit of a surprise is the fact that we have seen a mid-winter build in the weekly EIA stock levels of 700 M Bbls, to keep inventories nearly 20 million Bbls higher than the same time last year. Yes there are some blue patches appearing on the weather maps in the U.S., but will it be enough to drag inventories down in time for the start of the stock-build season, I doubt it. Sorry I’m drifting down the path of logic and I forgot to mention that U.S. prices strengthened against crude oil, when to be honest the dual impact of crude falling, and propane stocks increasing should have caused a further slip in propane values.