Macro Crude: Understanding Finance and The Global Economy (Oil, Stocks, Commodities, Currencies)

Q2 21: Support from LNG Supply outages in the Pacific Basin and nuclear outages in Japan and Korea

·South Korea had to shut its HanulNo.1 and 2 nuclear reactors (1.9 GW) this week after an influx of sea salps(marine organisms) clogged water systems used to cool the nuclear reactors. This is the second time in less than three weeks these units have had to be shut down and could lead to incremental demand for 1-2 spot LNG cargoes.

·Japan’s nuclear regulator has temporarily banned TEPCO from operating its nuclear plant in Niigata – due to safety concerns. TEPCO had originally planned to restart its two nuclear reactors (2.6 GW) over the May-June period and the latest ruling pushes out the chances of TEPCO operating the plant until at least H2 2022. Japanese LNG imports are expected to be up by 0.45 Mt y/y in Q2 21.

·Prelude and Sakhalin are back to full operation after undergoing maintenance in March, the next planned works will likely happen at Gorgon.

·Gorgon T3 will go offline for large-scale maintenance later this month—starting from 26 April according to Chevron’s schedule. If Chevron finds similar issues to those found at its first two trains last year – the total works could last ~14 weeks until early August (based on T1 work timeline).

·Large-scale maintenance works scheduled at Ichthys, GLNG and North West Shelf in May.

Planned maintenance at PNG LNG will reduce exports from Papua New Guinea in May, although the exact timing of these works has not been officially announced

Q3 21 gas balances to weaken relative to Q2 21 – on higher pipeline supplies

Bearish factors

·Strong pipeline imports from Russia and central Asia will limit Chinese LNG demand growth y/y to 1.0 Mt over the same period.

·Nuclear availability is set to improve in Japan - translating to a drop of 1.1 Mt y/y between July–September.

·11.4 Mt y/y growth of global LNG supply in Q3 21—primarily from the US and Egypt—will far outpace the call from Asia-Pacific markets.

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Constructive factors

•European gas inventories replenished.

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•Argentina expected to import 3 Mt (60-65 cargoes) this sumer of which only 1.7 Mt thus far tendered. They will have to secure another ~1.3 Mt of LNG (June-September). Through the Escobar terminal and Bahia Blanca FSRU terminal.

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•India and Pakistan. ~ 1 Mtpa incremental of imports due to FSRU (HoeghGiant) and ExcelerateSequoia)

This episode helps you understand the basics of California's carbon cap and trade programme. Its a primer that goes through the basic of the program, some history, the sectors included and some of the defining mechanisms of the programme like the maximum holding limit, minimum auction price.

The premium of Asian LNG spot prices (JKM) over the US Henry Hub benchmark has widened to the highest level in nearly two years (spread >US$5/mmbtu). This is partly a function of Pacific basin supply outages coinciding with congestion at the Panama Canal. As a result JKM contracts are pricing in the cost of securing US cargoes through longer transit routes around the Cape of Good Hope (costing an extra US$2.4/mmbtu at current freight rates). Wait times outside the Panama canal have been around nine days recently (Chart of the day), adding almost $0.40/mmbtu to using the route to Northeast Asia without waiting. 

Panama Canal congestion is causing delays to LNG deliveries from the US to Asia, driving up freight rates

• Higher than average arrivals, seasonal fog and      COVID-19 linked staffing reductions is causing congestion at the Panama      Canal.
• Waiting time for vessels with unbooked slots      is as long as 10-15 days and some US cargoes are now transiting through      the Cape of Good Hope.
• The extra shipping cost associated with a      97-day round trip for a US cargo to Northeast Asia via the COGH relative      to delivering to Europe is $2.40/mmbtu at prevailing freight rates and      boil-off costs.
• The Panama route costs $1.16/mmbtu extra at      current rates. The less time vessels spend holding position, the more      tonnage can be freed up and made available to the spot market, in turn      reducing spot freight rates.

Below factors could help ease strength in the JKM Feb-21 contract to reflect the cost of securing the marginal cargo through the Panama route, rather than pricing on more longer routes at present:

• A sequential increase in Pacific basin supply      equivalent to around 8-14 cargoes per month compared to today will help      cut Northeast Asia’s call on US cargoes.
• 3.6 Mtpa Prelude is expected to return by year-end,      followed by the return of Gorgon’s 15.6 Mtpa capacity at the end of Jan-21      (assuming no weld faults are found in trains one and three). The restart      of production at Qatargas’ 7.8 Mtpa train four at Ras Laffan next week      will also boost supply, as will the ramp-up of Egyptian      output—particularly from Idku, with some potentially from Damietta.
• Sequential declines in Northeast Asian demand      for LNG over the rest of winter is also likely. Japan and Korea are      expected to see improving availability in nuclear, and both countries will      be drawing down LNG terminal stocks. China will also be partly relying on      drawing down their undergrounds gas inventories – which have been boosted      y/y by heavy injections.

Per the below LHS chart, the JKM-TTF spread is incentivising transit through the Cape of Good Hope (green line). Costs of using the Panama canal have risen. With higher transit times through the Panama Canal – ships are using the route through the Cape

As rig counts continue to fall. Producers are high grading ie. Shifting to tight oil areas with higher well productivity.  High grading is more pronounced thus far in the current price downturn compared to 15/16.

• This has largely resulted in shale companies reporting higher efficiencies (charts below). Lower activity, concentrated on best assets with service cost reductions helping companies to guide for more efficiency gains.
• As of Friday’s data active oil rig counts are now at the lowest levels since before the shale revolution started, implying despite the efficiency gains being reported below – depletion rates will catch up.

As a result of high grading, well cost reductions expected in both Delaware and Midland Basins, more moderate reductions expected elsewhere.

• Producers across the Permian have realized or anticipate achieving ~20% reductions in normalized well costs relative to 2019 levels.
• While sharply lower activity levels and concomitant service price reductions are surely at play, durable process oriented drivers and “creative destruction” from an unprecedented (and virus-driven) downturn also appear to be contributing to this improvement.
• Above improvements partly linked with cyclical service cost reductions and impact from high grading.
• Beyond expected drivers of efficiency gains associated with downturns and through-cycle learning curve effects, more meaningful operational changes also appear to be occurring, with simultaneous hydraulic fracturing (Simul-Fracs) and increased automation/remote operations recently in focus.
• With respect to the former, multiple Midland basin producers have reported utilizing Simul-Fracs, which may be helping that side of the basin keep pace with the relatively less mature Delaware side this year.

Energy demand is 4% lower than it would have been without efficiency gains. Between 2015-2018 energy efficiency improvements helped reduce 3.5 Gt of Co2 – roughly equivalent to the energy-related emissions of Japan over the same period. 

Why has energy efficiency fallen:

• Consumers      preferring larger cars – vehicle occupancy rates have fallen
• Residential      buildings – increased device ownership and use, growth in per capita      residential floor area in all economies.
• China      and the US increased their share of industrial production - pushing up demand for primary energy      fuels
• Coal      power generation increased in 2017 (3%) and 2018 (2.5%)

But with COVID-19 oil intensity is likely to go higher - although overall consumption faces a cyclical headwind due to the economy. The per user oil intensity is likely to be higher. Especially with demand for PPE , Face Masks and more protection for packaging food.

Oil Market Outlook. Oil (Brent crude) has managed to stay above US$40/bbl over the second week of July, despite a choppy macro environment and looming risks. We explore the key reasons for this and highlight some of the key risks.

Japan may need as much as 13 Mt of additional LNG by 2030 to help fill the gap left by the closure of the ~100 less-efficient coal-fired power plants 

• Japan’s METI released a formal update to its energy policy. Of note is that although they are focusing on decarbonising energy within Japan with the old coal plant shutdowns, outside Japan – they have yielded to their high-tech and bank lobby groups. Ie. Japanese banks can continue funding coal projects abroad. Japanese companies can keep exporting their advanced coal tech as well.
• This is a setback for Japan’s environment minister Koizumi who has been a critic of Japan’s support for coal power abroad (more details below chart).

A few nuances to Japan’s coal support abroad:

• Japan will only supply coal plants to countries that have no other choice than to build these plants
• METI also said that they would make it a requirement for countries to have plans to decarbonize (But they also added an “in principle” after that point, which gives them a bit of wiggle room for exemptions)
• Japan will only provide support for coal plants that use USC tech with an efficiency of 43% or above, lGCC tech, or plants that use tech to drastically cut emissions (Japan only export plants that are this efficient)

The impact of US export turndowns this summer is one of the main reasons why spot freight rates have held so low over the past couple of months.

• Spot freight rates      averaged US$31,000/d in May–June, which was down from US$52,000/d in the      period a year earlier and US$57,000/d in the period in 2018.
• Freight rates have      managed to stay low despite vessels being tied up as floating storage (FS)      or slow-sailed to destinations in recent months, increasing tonnage      demand.
• Per satellite tracking      there are 20 floating storage vessels as of this week, climbing from a low      in recent weeks of 13 on 30 June, while there were no floating storage.      vessels at this point last year. The floating storage vessels likely      constitute a split between vessels struggling to unload because of      terminal congestion, distressed cargoes and some because of firms having      hedged intra-summer spreads.

US export facilities    have an outsized impact on global shipping demand owing to their long      distances from the main global demand centres of Europe and Northeast Asia

• The average sailing time      for a return voyage—assuming a ballast journey at the same speed as the      outward leg and a cargo unloading time of 1.5 days—from US export plants      in 2019 was 47 days. The average for non-US facilities was 30 days.
• The speed of the global fleet has already dropped below the lowest point last year in recent months, with the Q2 20 average of 13 knots for outbound journeys compared to 13.6 knots over the whole of 2019. A drop in the sailing speed from last year’s average meant that global average cargo deliveries needed an extra 1.2 sailing days to complete a round trip voyage in Q2 20. This in turn would have required an additional 16 vessels (403 in total) to provide enough shipping capacity for the 29.6 Mt/m of global exports in Q2 20. This helped offset some of the impact of low US LNG shipping demand.

Impact of slow sailing on freight markets.

The speed of the global fleet has already dropped below the lowest point last year in recent months, with the Q2 20 average of 13 knots for outbound journeys compared to 13.6 knots over the whole of 2019. A drop in the sailing speed from last year’s average meant that global average cargo deliveries needed an extra 1.2 sailing days to complete a round trip voyage in Q2 20. This in turn would have required an additional 16 vessels (403 in total) to provide enough shipping capacity for the 29.6 Mt/m of global exports in Q2 20. This helped offset some of the impact of low US LNG shipping demand.

Charts on twitter.com/macrocrude 8th of July 2020

In this podcast, we help you understand the carbon math we face as humanity trying to keep temperatures from rising below 1.5 degrees.

• Globally our remaining cumulative      carbon budget available is less than 500 Giga Tonnes by 2050 if we      need to maintain temperatures below 1.5 degrees.
• Annual carbon emissions      are around 41 billion tonnes – and unchecked green house gas emissions      could rise annually by 50 - 60 billion tonnes/year to 2050.      Contributing to a cumulative ~1700 Giga tonnes – putting us to a path      of 5 degrees per current climate models. As the carbon goes above      certain thresholds, it triggers climate feedback loops through glacier      melts etc.
• Ongoing efficiency      improvements and growth of renewable power could help lower emissions to      ~35 billion tonnes/year. Still giving us a total of 1300 Giga Tonnes by      2050 – and raising the temperature by well over 3 degrees.
• To really meet Paris,      transportation sector will have to reduce emissions by 32%, industry by      41% and the power sector by 73%. By 2050, ideally we need negative 5 giga      tonnes.

As a result of COVID, daily wage earners, labourers in megacities in Asia, South America, Middle East have been impacted.  As their daily stream of income came to a halt, their remittances to their families back home in their villages and small towns were cut. With no wages to support their own living expenses (food, rent) they were forced to flee as well, at a time when there was no public transportation (no rail, no buses) which meant they had to trek 500 to 900 kilometres by foot carrying their belongings and families with them.

Many migrants are unlikely to return given the semi-state of lockdowns that exist. Given the experience they had to go through while returning, and also balancing out the low probability of finding a job given the slow easing of restrictions and also the health dangers - they may choose to remain in their homelands. Politically there is motivation in their local areas to make them stay by getting government funds.

This changes the demographics in mega cities, it changes economics for small businesses and for construction industries emerging after the lockdown. For central banks in emerging markets - inflation may be a concern.

At the moment, the skew of investor and activist pressure on decarbonisation is highly towards energy producers (oil and gas). You rarely see climate protests in front of residential developers, airlines, agricultural companies. In this context, European airlines – some of the European Union’s biggest polluters – have sought an unprecedented €32.9 billion in government bailouts since the beginning of the Covid-19 crisis, without binding environmental conditions. 

There needs to be more pressure on consumers of energy (airlines, building operators, real estate agents, company's travel policies and operational aspects).

We go through the key drivers behind the Brent Crude oil price falling below US$40/bbl. A shift in sentiment from just days ago when prices were about to test US$45/bbl. The Dallas Fed Survey results we tweeted are of importance here too, as it gives guidance on how US shale producers are responding to the current price and demand environment. 

· The six major US LNG terminals reported a utilisation rate of 40% in late June as the marginal LNG supply source adjusts to lower gas prices. Since April, when the market impact from the virus began to take shape, ~130 cargoes have been cancelled for loading in the US.

· US LNG cargo cancellations for August currently estimated at 40-45 (similar to July levels). More than half of the cancelled US cargo loadings for August are tied to Cheniere's Sabine Pass terminal in Louisiana (16 – 23 cargoes) and Corpus Christi terminal in Texas. The Gulf Coast Marker (GCM) to Henry Hub spread has been negative since the end of March and has reached differentials as wide as negative US$0.7/MMBtu, implying very negative export economics.

· Gas prices in the US are likely to come under further pressure this summer as US natural gas production has recovered this month – partly to do with the resilience of dry gas plays and reflecting reversal of US oil field shut-ins at wet gas plays. Production is recovering at a time of weak domestic demand, limited export availability to exports as well as lower feedgas deliveries to US LNG export facilities (down 38% compared to May levels).

· In Europe, gas storage capacity has reached 77% by late-June compared with the five-year average of 53% for the same period. Storage is expected to be full by August and is likely to place further pressure on gas prices over the next few months until demand picks up.

Shocked by BP's $13 - $17 billion charge? Well, Deloitte expects  the shale industry to impair/write-down the value of their assets by as much as $300 billion—with significant impairments expected in Q2 2020. One may argue against reading too much into this “noncash” impairment figure of companies. Yes, it is just an accounting adjustment. But it translates into writing off the invested shareholder’s equity and carrying a debt that may have been taken to develop or acquire the impaired asset. The result: an immediate increase in the industry’s #Leverage ratio from 40 to 54 % which can trigger many negative sequences of events, including bankruptcy bankruptcy. 

The Australian economy is recovering at full steam. Solid retail sales show the resilience of the Australian consumer. And the GDP estimates are a lot better despite the twin shocks of the bush fire and COVID. This episode goes through some of the positives for the Australian economy as well as some of the headwinds it still faces. Ending with a view on the Australian dollar.