SIMON SAYS: Go West: Part II

Submitted by Simon Hill on Sun, 07/14/2019 - 16:00
Go West

In Friday’s SIMON SAYS I talked about the move in Asia, away from the relative rigidity of the Saudi Aramco Contract Price (CP), and more towards greater spot pricing, especially as supplies are increasingly related to both Mont Belvieu and Far East Index (FEI) price indices. We know that the majority of cargoes will head to Asia, but what drives cargoes at the margin to seek a buyer in North West Europe, especially when originating from the U.S.? And, even more unexpectedly, why do shipments move to Asia from Europe, especially when Europe needs to net import. We’re talking about the East/West spread again today and our view as to where we think cargoes will be heading.

I just need to explain something first, over here in Houston occasionally some things can look a little confusing. For instance, when I say East/West, I mean Asia/North West Europe, whilst here in the Houston office I was asked, doesn’t the ship go east to Europe and west to Asia. I hope I’ve cleared up the befuddlement. Sorry, Befud…..means..

I thought it was time to try and bring to life a little bit more the events and changes that I see having an impact on the near-term LPG market. I’ll try and blend it with a few background facts and how I see it from a trader’s perspective, albeit one with a few too many gray hairs.

What I was building up to in Friday’s blog, was a view that the price differential between Asia and North West Europe (NWE), as measured by the East/West (E/W) trade, was getting a little toppy, therefore throwing up a trade opportunity.

Typically, the E/W spread looks to narrow after the northern hemisphere winter comes to an end (Please see figure 1 below). Asia appears to show greater price elasticity during the winter months than is found in NWE, due to the size of underlying imports into the region, a larger stock building programme pre-winter, and the impact of any unexpected patch of cold weather. These factors tend to influence Asian prices relatively more than they do in the smaller, more mature North West Europe. In addition, after the post winter price drop, NWE levels tend to find a floor, and also recover slightly earlier than in Asia. This is mainly the result of Europe’s petrochemical buyers re-entering the market, whereas Asia’s total olefin cracker demand, especially for propane, is much smaller, therefore making less of an impression.

The same scenario happened again this year, although slightly earlier, where the winter E/W spread, ranging between $40/Mt and $50/Mt, narrowed to sub $30/Mt levels by the beginning of March. However, Asia was much stronger than the market had anticipated, and the spread quickly widened, rising steeply to levels as high as $70/Mt+ by the end of June. What made this happen?

For one, Saudi Arabia’s LPG exports were feeling the impact of both crude oil production cuts and their Indian customers overbuying in the run-up to the April General election in India, please see my blog, “Who said reading the markets was Easy. Another factor being the U.S. / China trade tariff war was still fueling higher premiums in the Middle East, especially in relation to the levels of Saudi Aramco’s Contract Price (CP), with buyers being forced to cover Chinese demand from the region. Furthermore, the U.S. / Iran sanctions added heat to the Middle East market translating to the stronger prices being paid in Asia. While Asia was strong, NWE was anticipating the start-up of Mariner East 2, please see my blog “Marcus Hook Terminal Fee Warning, and the doubling of exports from Marcus Hook, which would be more than enough to cover any NWE supply shortfalls. In fact, NWE could have weakened further if it wasn’t for cargoes also moving out of the region to the Mediterranean and to the buoyant Asian market.

It’s therefore not such a big surprise that the E/W spread widened so much. Today it is still hanging-in around $65/Mt+ for August, but for how much longer, and what’s likely to move it the other way? Let me delve further!

The trade we ended up putting on last week, in our virtual trading office, was the E/W propane spread for September 2019 where we sold 8,000 Mt of FEI propane and bought 8,000 Mt of ARA propane. ARA being the generic term used for large cargo deals in NWE, and stands for Amsterdam, Rotterdam, Antwerp. The spread was fixed at $59.5/Mt. So, what do I think will change?

First off let me explain why we picked September. It was simply to give us more time, but it’s also close enough to the front of the curve for it to be impacted by current events. The big change for me has been the weakness of prompt propane in Asia, shown by the FEI market moving into contango, shown in figure 2 below. A contango pricing structure usually signifies to the trader that there’s more cargoes for sale than there are buyers. So, if you ask me as a buyer to purchase your cargo, based on a monthly price, you better give me a discount. This weakness is the opposite of what we’ve seen for most of the summer so far, where the difference between the current market price minus next month’s price has been positive, suggesting buyers are prepared to bid higher than they would for the following month.

So far, the weakness in Asia has not closed the ARB, as we might have expected it to, so U.S. Mount Belvieu numbers are still showing similar fragility to Asia, keeping the differential between Belvieu and Asia reasonably static. With freight levels for Houston to Chiba, Japan falling from around $125/Mt to $115/Mt, it’s unlikely we are going to see the ARB close, and with Enterprise having further capacity coming on stream, there doesn’t appear to be any future let-up in cargoes bound for Asia. There will be an element of stock-building in Asia, but this is unlikely to happen in significant quantities before September, and only if prices are low enough. This suggests to me that the contango has to get steeper to bring buyers to the market.

Now, if NWE mirrors Asia, the E/W spread will hold, but propane demand in the summer is a little more stable as it’s linked a lot more to petrochemical demand than is the case in Asia. We can argue that imported ethane is having an impact, but with current U.S. economics for ethane versus propane, even this is becoming marginal. Summer months are always periods for maintenance in the North Sea while exports from the Russian Ust Lugar terminal are likely to start to drop off as ZapSib-2 petrochemical complex starts-up, please see my blog, “Europe: From Russia with Love.

But I know you are thinking that the additional Marcus Hook cargoes should counter-balance this. However we are looking at relative market movements, and I don’t believe that additional Marcus Hook cargoes will be pushed into Europe, as the pipeline capacity constraints put on Mariner East 2, due to using older pipelines of smaller diameter to loop to Marcus Hook, is putting a limit on exports to 6/7 cargoes as against the 8/9 cargoes per month originally planned.

I’m going to see where we head on the East/West spread over the next couple of weeks, and I’m looking to see it start to drop to the low $50s as an exit point for the trade. However, the size of the NWE  market can mean it gets distorted by individual events, therefore it is a trade I will certainly be keeping an eye on.