We are being told to expect the worst, as coronavirus numbers ramp up here in the U.K. and in many countries around the world. The Hill family are reducing our exposure to the outside world, implementing our social distancing, kissing good-bye to a steady income from our restaurant as it shuts before it has even fully opened, try to home school our 3 boys who appear to be skin grafting themselves to their computers, but please spare a thought for me if you can. Many people will have worse nightmares to handle, but mine at the moment is being potentially “locked-in” with my ageing mother-in-law for month after month after month…….!
These are extremely difficult times for everyone, and the impact on the energy world, and specifically the LPG market, will continue to evolve in the days, weeks and months ahead. Without doubt the pendulum is swinging, and we are only able to see a snapshot of what might or might not be going to happen in the future. Things are materializing that I just haven’t seen before, and fast!
It is being reported that President Trump’s administration is considering intervening in the current oil price war, predominantly between Saudi Arabia and Russia, but very much aimed at U.S. crude oil production and exports. The regulators in Texas are even considering significant cutbacks in crude oil production, as the WTI price is driven lower and lower. Yes, there will be a diplomatic push aimed at the Saudi’s to cut production, and there will be further threats of sanctions against Russia, but to try and bring back order in the oil markets there needs to be a stance by U.S. producers, that any production cuts would not only involve no mirrored production increase in the U.S., but also a level of cuts to show solidarity behind Saudi Arabia (i.e. OPEC) and Russia (i.e. OPEC+). I’m not sure I’ve actually said this, I must be going mad! Let me temper it by saying all companies in the oil sector have different agendas, and whether President Trump will go along with it, let alone try to implement/ negotiate it, is still to be decided. Yes, the market reacted positively on Thursday, but it seems the doubters got the measure of it by Friday night with WTI back down to around $22.50/ Bbl, it’s lowest level for the best part of 20 years.
What it shows is that the golden rules we had assumed were set for the foreseeable future have been blasted out of the water. Not just the economic impact of this worldwide shift in demand, but also the changing leverage of regions, countries, and companies, and the impact that this will have on trying to make any future assumptions. I have no doubt that some sort of U.S. production cut is required, and I believe it will happen, by design or not, it just has to happen, with world demand so devastated in such a short period of time there is no future for a price war that will ultimately harm the whole sector far more than the damage it already faces. This will mean that we are likely to see less LPG produced in the short to medium term.
But my eyes, as always, are on the ARB, and we are seeing a reversal of what we were expecting only a couple of months ago, as the squeeze gathers pace, bringing spreads right down to circa $100/ Mt by the end of the week. We’ve been lower before, but this just seems so dramatic and so fast. I mentioned last week that the narrowing of the Brent/ WTI spread would also have a similar impact on the propane ARB between the U.S. and Asia, but events in the LPG patch are now directly influencing what happens next.
Just a couple of weeks ago we were talking openly about the likelihood of further OPEC cutbacks, and that Saudi Arabia would be taking the brunt of these decreases, resulting in less LPG from the Middle East. We were also talking about the impact coronavirus was having on Chinese demand, the likely spread of the virus in Asia, and the fact that we might see supply and demand find something of an equilibrium, albeit at a lower level. On the back of this we saw owners re-direct their ships to the U.S. Gulf, as ships started to appear open in the Middle East, and rate levels started to succumb to the downward pressure. Don’t forget that the Baltic had been close to $80/ Mt in early February, but had dropped to $53/ Mt just over a week ago.
But major world events started to suddenly flip everything on its head. An expected OPEC (and friends) accord to further cut production, became the oil industry’s equivalent of “pistols at dawn”, as the threat and reality to open the oil taps started the price war, and catapulted prices way down. Swiftly, the LPG market started counting the likely increase in LPG exports, not the expected decreases, as the ramping-up of the Kingdom’s oil production from less than 10 million Bbls/d to something closer to 12 million Bbls/d was likely to result in an additional 4 million Mt/ year of LPG for the export market. The shock factor was further amplified by the statistics that March export numbers were likely to be half of the circa 15 VLGCs, typically counted each month leaving Saudi ports, a result of the impact of sales reduced by the coronavirus related demand drop in Asia and early maintenance at the Yanbu refinery. Now we are hearing that not only have previous cancellations been re-instated, but additional spot cargoes are being pushed into the market, that may well put April liftings above 20 VLGCs. We have also seen spot Qatar and Adgas cargoes in the market. At a time of unprecedented weakening of world demand, including for LPG, this is a significant regional glut of supply in the market.
There has been a bounce back in Chinese demand, as PDH plants that had closed at the peak of the coronavirus outbreak in China come back on-stream. I think this is a knee-jerk reaction and may not be the result of demand for the ultimate products being produced, but what it has done is give a ray of light that there are pockets of demand appearing, albeit still relatively small. The problem for the ARB is that a lot of this demand will be covered by the extra spot volumes appearing out of the Middle East.
A few weeks ago you would have expected to see the U.S. market follow down prices in Asia, maintain an open ARB, and maybe go a little further as export capacity constraints would start to throw extra production into inventory. But forget it, the world has flipped. Not only has the price of crude oil dumped significantly, putting nearly all shale oil and gas producers into the red, but actual production levels have started to ease-off, with refineries already reducing supply as a result of demand in the U.S. significantly falling, especially for premium motor gasoline. Just look at where normal butane sits – below the price of propane – when did that happen last? But there are those that still argue, even with crazily low propane prices, they are still relatively strong, as the market is still in draw mode, despite export reductions and uncertainties. One thing is for certain, a weak Asia and a relatively strong Mont Belvieu can only point to the narrowing of the ARB.
We shouldn’t forget that less production doesn’t immediately result in less exports, the drop in recent weeks has been as much the result of fog issues than anything else. Yes there are a few ships sat, the result of previous redirection before the OPEC fall-out, but the length is spread over April and early May, and it’s largely ship owner controlled. But with the fixing window now mid-month there might be the potential of rates slipping into the $80s/Mt, but again ship owners next move out of Asia will be to head to the Middle East, at least until we see another about-turn.
At the end of the day just do the maths, $100/ Mt minus say $90/ Mt freight leaves $10/Mt, less than a 2 cents/ gallon netback. It really looks like cancellation time is upon us again!