By Mark Rossano [ihc-hide-content ihc_mb_type="show" ihc_mb_who="10,13,14,16,18,19" ihc_mb_template="1"] SUMMARY • U.S. Completions Update • The Global Power Crisis • OPEC+ Meeting • Brief Update on Evergrande (More next week) • U.S. and Global NGL Deep Dive U.S. Completions Update U.S. completions had the surge we have been discussing as activity ramped into Oct starting off on a very strong footing. Our view was a mid Sept bump to about 254 spreads, which was achieved about a week later than we initial thought, but now sets up well for a final push in Oct. Natural gas/ liquid regions will attract the most near-term investment as pricing stays conducive for a ramp. There is a lot of staying power in pricing given the global shortfalls on natural gas supporting U.S. LNG flows, and the expansion of petchem assets driving liquids adoption. The Permian is approaching a steady state of activity with maybe another 2-3 spreads but unlikely to get much past 137 over the next few weeks. We expect a bit more activity out of the Williston, Western Gulf, TX-LA-SALT, Anadarko, and Other as we go through Q4. The “Other” covers a lot of dry gas in OK that will find additional capital given the underlying economics. Now we have Cheniere commissioning train 6 that will increase the amount of natural gas moving into the region. Even at elevated pricing, companies will continue to “take” and not “pay” for product as global storage remains very tight. Natural gas storage will see a bump the next two weeks (above seasonal norms), but the swing will be when does “winter weather” start to kick in. I know this is always a major moving target, but we are kicking off storage at the low end in the U.S. with a record amount of LNG exports and local consumption driven by residential, industrial, and power generation assets. The supply response will be measured keeping prices elevated as demand remains strong. The exports of natural gas liquids will remain supported as China increases their consumption of NGLs. The recent petchem facilities that have come online and will come online over the next few years will be ethane and LPG based. This will increase the NGL basket more than the naphtha side, especially because ethane cracks have to be at least 87% ethane to function properly. In total, it will support the flow of NGLs into the Chinese markets and support global pricing. As US demand stays strong, the underlying Mt. B basket will keep liquids activity humming along in the U.S. Some clarifications have started to come out on what Premier Li Keqiang meant by his statement of “procure energy at all costs.” It appears he was describing: 1) regardless of political uncertainty (U.S. and Australia) 2) regardless of the risk of life. There have been coal mines that were shut down due to safety risks, and he was saying that the issues must be addressed quickly and brought back online. Coal stockpiles have been dwindling around the world, and India is no different with a huge drop in India as well. The slowing global economy (especially on a manufacturing level) will accelerate over the coming months as costs continue to move higher and trend well out of control. China’s holiday kicks off Oct 1st and will go for one week (golden week), which helped support some of September’s numbers as companies try to increase production ahead of the prolonged holiday. This will put pressure on October figures, but also help alleviate at least some of the front-end pressure on power capacity. The underlying Chinese economy is teetering at this point with more contagion to come as the real estate sector comes under more scrutiny. Where there is smoke… there is fire, and as we have said from the beginning that Evergrande isn’t the “Lehman Event” but rather more akin to the Bear Sterns/ Country Wide failure. We are still at the very beginning of what things will look like in China, and the fact this is happening in the biggest oil demand growth engine over the last decade should provide a measure of caution when evaluating crude demand. The Global Power Crisis So here we are- poor policy leading us down a path that was completely and utterly avoidable. I am not against adopting green technology and integrating it into our grid, but to do so blindly with forced closures and conversions leaves us in our current predicament. On a global level, we have restricted the build out of pipelines and shuttered coal facilities and other baseload capacity while increasing demand. China has now issued the follow: “Orders top energy firms to secure supplies at all costs.” “In a sign of how worried Chinese officials are, Premier Li Keqiang has vowed that every effort will be taken to maintain economic growth. China will ensure the needs of basic livelihoods are met and will keep industrial and supply chains stable, Li was cited as saying by China National radio during a meeting with foreign diplomats Thursday.” We discussed the clarification above- but it will create a reaction regardless as more heavy disty is consumed in EMs. But, there is a decent amount of refined product available to fill any new demand. It will be very bullish for the next leg of coal and natural gas (LNG) given where prices currently sit. It will also pull in additional fuel oil but remember the Teapot refiners (Shandong) are sitting on a near record amount of fuel oil. There isn’t a shortage on the Shandong side as run rates have been going lower and not higher following electricity issues as well as sluggish demand. Floating storage is also heading higher again as the storms have passed, and the issues on the port level limiting “normal” processing. We will see floating storage go higher again as China pulls a big card with the recent announcement. There should be no confusing on timing as they make this declaration right before the OPEC+ meeting on Oct 4th. It also comes on the back of KSA testing the words with “rumors” of a Nov OSP cut “Saudi Aramco may reduce the official selling price of its Arab Light crude by 40 cents a barrel month-on-month for November sales to Asia, according to the median estimate in a Bloomberg survey of five traders and refiners. The Arab Light OSP differential is seen at a premium of $1.30 to the Oman-Dubai benchmark for November, compared with $1.70 for October.” China has been non-existent in the WAF market outside of normal Angola allotments, which is the same in the Middle East. They have cut a lot of spare purchases from the region based on the recent Iraq announcement: Iraq is on track to boost oil exports by 5% in September, reaching the highest level in over a year and a half, as global energy prices surge amid shortages in key markets. • Exports are on track to rise to 3.58m b/d in September, up 170k b/d from a revised 3.41m b/d in August, according to tanker-tracking and port-agent data compiled by Bloomberg • Sales to China and India, Iraq’s largest customers, were little changed from August; shipments to the U.S. plummeted to 33k b/d so far in September from 193k b/d in August • Those numbers may change as tankers carrying the equivalent of about 389k b/d of crude are still to designate a port for delivery; several of them appear headed via the Red Sea to the Mediterranean region and could head on to the U.S. On the other side, we have additional cargoes sitting in the North Sea as the slowdown of demand expands. Almost All North Sea Forties Crude for Sept. Is Floating at Sea, which is a much bigger problem because we are now entering October. The floating storage levels keep piling up as cargoes are slow to move around the world given the sluggish demand. The other issue is obviously price with Brent and WTI still holding well above Dubai and slowing underlying demand. • More than 90% of the 7.2m bbl of North Sea Forties crude that has been loaded so far this month is now floating off European shores, according to ship-tracking data compiled by Bloomberg. • It is rare to see so many cargoes fail to find buyers, suggesting weak demand from Asia, the main buyer of the grade The issue remains a large amount of crude in the global market struggling to clear. We have had OSPs slashed across the globe with Nigeria making some of the deepest cuts to try to move some cargoes. It has started to work with additional shipments heading into the U.S. and European markets. I know we keep harping on this aspect (and the data supports us), but the futures market has shaken off all of the underlying issues. Outside of just the physical sluggishness, the rising prices internally is hitting demand directly with India being the latest to announce price increases. Some refiners are pivoting to reduce their diesel production and increase gasoline given the lack of demand for one vs the other. Diesel has always been a great bellwether for the Indian economy, so the difficulty getting that even close to pre-COVID levels has much broader implications. India also raised their natural gas prices by 62% starting Oct 1st, and that is still reduced given the lagging component of the metric used. “India’s pricing formula is on a lag, and doesn’t capture the most immediate price increases. The gains in prices over the last few months will be reflected when India’s gas rates are revised from April.” This will provide a tailwind to inflationary pressures, which were already expected to rise even before the “mark to market” of natural gas. And to make matters worse for the supply chain: “Retailers could also raise prices of compressed natural gas by as much as 53% by October 2022 to pass on the rising cost and maintain margins, ICICI Securities said.” India’s diesel exports are set to reach a four-month high in September as refiners maintain high operating rates despite weak domestic demand, Serena Huang, an analyst at Vortexa in Singapore, said by email. • Exports have climbed to 650k b/d this month, according to preliminary data from Vortexa, the highest level since May o That’s a 9% gain m/m; 12% increase y/y • India’s diesel demand has struggled to recover over the past months, with the monsoon further curtailing consumption by the transport and agriculture sectors in recent weeks, said Huang • “Despite the growing diesel surplus, refiners are still keeping runs high to meet the country’s soaring gasoline demand,” she said The diesel glut in the country is the biggest driver for the shift to focus more on the gasoline part of the stack, but it will keep exports elevated into a market that has seen demand pick-up following additional gas to oil (diesel/fuel oil) switching. The key areas to watch regarding additional demand will be Singapore and Fujairah- both of which have recorded some nice drops in storage. The increase in exports from India and China will help replenish some of those shortfalls, but with the Chinese comments- that could cause refiners to adjust their exports in November. China had a big drop in exports in Aug, but there was a big rebound in Sept- which will make Oct an interesting month. Residual fuel and middle distillate will be the key focus on the amount of product that is being pulled into the market on the gas to oil switch. It will pull in more high sulfur fuel oil and other heavy products that will be cost competitive for the region. Fujairah has been showing some strong demand in the emerging markets- especially on the middle and heavy distillate side. There have been some bids coming through Pakistan and Bangladesh pulling in some additional cargoes. The electricity crisis is expanding with prices skyrocketing again in Europe and China. Europe has seen prices reach record levels resulting in either cutbacks or outright shutdowns of industrial facilities. Even with some of the adjustments in activity, prices continue to sore across the continent resulting in additional closures- now expanding to greenhouses which helps to make the food crisis even worse! We have been talking about food forever, and the fact prices are now at 60-year highs is not surprising in the slightest. Europe remains tight on the gasoil side, but well supplied in fuel oil with a normal amount of gasoline in storage tanks. The U.S. will be hard pressed to export additional distillate into the market even as prices spike given the amount of volume heading into the Atlantic Basin. The low storage in the U.S. also keeps barrels fairly trapped in the region and competing to get into PADD 1- especially as we prepare for winter. The cost of fuel is always going to be the biggest driver but also the ABILITY to produce using the available fuels. For example, just because coal is the “cheapest” in the U.S. doesn’t mean we have the facilities to capitalize on the available fuels. We have torn down many of the available capacity or mothballed them making us beholden to natural gas and renewables. When we turn to Asia, we can say the same for fuel oil/ gas oil in some areas- but most importantly China. China spent the last 7 years converting many coal and diesel facilities into natural gas power generation. There is some backup generation that uses fuel oil, but there has been a big focus on adopting more natural gas across the grid. The EU faces a bit of a different challenge as they still have coal and fuel oil power generation, but the cost of carbon has EXPLODED. So even with the massive spike in electricity prices, a company still can’t make money generating power from coal because it isn’t enough to cover carbon costs. At some point, Europe will have to issue a carbon waiver especially as we head into the winter with natural gas storage so low and Russia not able to meet the rising demand. The adoption of renewables has increased the pressure on “peakers” because in order to deem a solar or wind farm as “baseload” there needs to be backup power generation. This job falls on natural gas peakers that are used to provide power when the sun isn’t shining, or the wind isn’t blowing. So as we head into a period of near record low storage, any hiccup in the weather will result in another surge in pricing in order to attract product. The problem is… WE ARE IN SHOULDER SEASON?!?!?!?!?! All of this is happening AFTER air conditioning and BEFORE any real heating requirements. The shift will keep prices elevated and LNG flowing from the U.S. into Europe as China increases their purchases of energy needs. China is a little bit different as they have been facing a heat wave in some regions as well as droughts restricting hydro-electric capacity. They also implemented “green initiatives” as the beginning of the year capping the amount of electricity by region. Over the past few days, provinces nationwide have been grappling with sudden power shortages. On Friday, Zhejiang ordered industrial production halts. • Regulators said the move was necessitated by upcoming end-of-year energy targets. Some context: Under the 14th Five-Year Plan, by 2025, China is supposed to decrease energy consumption per unit of GDP by 13.5% and carbon emissions per unit of GDP by 18% (compared to 2020 levels). On Saturday, Guangdong called for power curbs across the industrial, commercial, and residential sectors. • The curbs were driven by thermal coal and natural gas shortages, with demand exacerbated by the ongoing heatwave. • Notably, Guangdong’s electricity consumption from January through August rose over 17% y/y. On Sunday, Liaoning energy authorities held a provincial power guarantee work conference following sudden power supply gaps. • Liaoning’s shortages – reaching 10-20% at peak – were exacerbated by an unexpected drop in wind generation. More context: Additional provinces remain on the verge of instituting strict curbs amid ongoing tight coal supply and unusual weather patterns. • On Wednesday, for example, Hunan’s provincial grid operator recommended curtailment of non-essential power use, such as billboards, in an attempt to avoid industrial power rationing. Get smart: The current power crunch reflects the ongoing risk of China’s dependence on coal. • However, shifting weather patters likewise threaten renewable energy’s reliability – as seen in Liaoning. Get smarter: The end result? A need for increased energy diversification – in which coal plays an ongoing, if diminished, role. • The natural stopgap? Natural gas. The bottom line: None of these power supply issues can be addressed quickly. So for the next few months, at least, expect rolling power shortages to be the order of the day. The reduction in power consumption is happening in some of the largest provinces in the country and biggest drivers of Chinese GDP. The below puts into perspective the GDP output of many of these regions that are facing broad slow downs in activity due to electricity generation shortfalls. In recent days, several local governments have resorted to power rationing to limit and manage electricity demand. They include: • Hunan • Guangdong • Hebei • Anhui • Shandong • Tianjin • Liaoning Hardest hit are Hunan, Anhui, and Guangdong (Caixin): • If left unaddressed, Hunan’s power supply shortage could exceed 10 million KW within a week. • Anhui suffered a 2.5 million KW power shortage on Wednesday. • On Thursday, Guangdong’s Shenzhen ran short by 2.8 million KW. Local authorities rushed into action: • The Hunan power grid pledged to prioritize electricity dispatch for public use, while limiting industrial use. • Guangdong’s energy regulator ordered coal-fired power plants to reserve coal supply for at least seven days. Get this: Guangdong is even considering increasing subsidies for thermal power plants to keep them running despite the high costs of power generation due to high commodity prices. Get smart: It’s no secret how China’s power shortages have got this bad. • Summer weather, cooling needs, and economic recovery from COVID have increased demand. • Power supply was hit by expensive fuel costs and insufficient fuel supplies. • That dynamic forced some generators to produce at a net loss, so some plants stopped work by switching to facility maintenance and repairs. Get smarter: Power shortages are bad for everybody. They affect people’s daily lives, and also limit industrial activity, and economic growth. It is a mixture of bad policy, but also provides an “excuse” for the party to miss the prevailing GDP growth forecasts. Some power providers have sent notices to heavy users to either halt production during peak power periods that can run from 7 a.m. and 11 p.m., or shut operations entirely for two to three days a week. Others have been told to shut until further notice or a particular date, including soybean processing plants in Tianjin in eastern China which have been shut since Sept. 22. The broad crackdown spans many industries as well, which typically see an acceleration at this period of time. Instead, the provinces are creating broad restrictions to cap electricity consumption. The total power consumption in China has outpaced recent years, which is a bigger problem as the shift in generation to more renewables created some shortfalls. But, they also remain in a political battle with Australia that has only worsened as Australia entered into a nuclear submarine deal with the U.S. and U.K. China has already started to reconsider some of the broader restrictions against Australia as their coal stockpiles have been depleted and they look for ways to replenish them ahead of winter. Oct and Nov will see some reductions, which will allow for some rebuilding of stockpiles- especially with the new directive from the Chinese government to purchase energy. The key word in there is “energy” as it doesn’t specify crude but rather all forms of energy to bridge the shortfalls. It is likely that Saudi Arabia will play ball and cut OSPs into Asia opening up additional flow from the Middle East into Asia. Prices still remain advantageous from the Middle East into Asia- especially given the pricing premiums vs WTI and Brent have expanded to over $4. This will limit the number of exports from the US and Europe given some of these growing headwinds to underlying flows. OPEC+ Meeting At the OPEC+ meeting on Oct 4th, we expect to see a continuation of the deal bringing another 400k barrels of production back online. The issues are expanding for 2022 and U.S. storage, but the fact Ida removed 30+ million barrels for the market allows them to increase output. There is also a fine balance they need to walk when it comes to elevated prices as inflation has hit many consumers hard. I expect to see OPEC+ stay the course of 400k barrels a day increase but see KSA cut their OSPs into Asia to help alleviate some pricing pressure. The problem is- the physical market remains very lose vs the LNG or LPG market. There are more than enough cargoes available for buyers looking to purchase, and the cut in Angola/ Nigeria loadings also help improve the underlying “compliance” while others (Russia) produce above their allotted quotas. Plus exports have increased from the Middle East as local power burns diminish and more crude is slated for the water. Russia has increased their exports for Oct already with Angola following suit, but it is likely some of that slips into Nov as Nigeria tries to increase loading schedules for Nov. The North Sea struggles to sell with 90% of Forties still available for sale- putting about 7.2M barrels on the water. The question comes back to- what is OPEC spare capacity? There is always a lot of debate around what are the right levels, and the below charts are just two examples of the capacity. One chart has it at 8.5M while the Bloomberg one at about 7.5M barrels a day. The problem is National Oil Companies (NOCs) don’t have to announce anything to public, and we know that KSA, Kuwait, Iraq, and the UAE have been actively investing in their oil fields. They may try to portray a green initiative, but they have been quietly or not so quietly increasing their capacity both onshore and offshore. Angola and Nigeria on the other hand need significant investment over the next few years to even get close to the stated levels on that Bloomberg chart. Nigeria could probably get to about 1.7M and Angola could likely achieve the 1.45M barrels a day- but anything above that will require a step up in investments. Libya has started trying to attract new oil investment from U.S. partners as well as Russian. Libya still has a lot of low hanging fruit in terms of conventional plays that can be increased, but companies would have to get comfortable with the direction of the politics and underlying tribes. There is a key election in Dec (General Haftar is running for president) that will help allay some fears if things go smoothly and bring in some capital. On a generational dynamics level, Libya is ripe for an “awakening” period that should allow for some cohesion among the local populace. There is a lot of potential to get back to 2M barrels a day of production, but that would take over 18 months of investment- so that isn’t a quick turnaround. They are in a position to hold the line at about 1.3M that would put about 1.17-1.2M barrels into the export market. Libya offers opportunities both onshore and offshore with the water offering a certain amount of “insulation” from the problems onshore, but the larger expansion of production is weighted to the onshore segment. The backdrop will be one of steady supply growth with a shift on the OSP side to help promote additional purchases. We had a nice spike in crude exports for Sept, which we have been highlighting and calling for as it will bring more product into the U.S. markets. “Crude exports globally are on course for a big boost in September, due in large part to increased flows from West Africa, Iraq and the UAE.” A lot of this crude is going to show up in PADD 3, Europe, and China. “UAE, OPEC’s third-largest producer, shipped the most oil since April 2020.” A large part of the shipments to the U.S. are “en-route” and will be more an Oct event vs a Sept one. As Ida hit, companies went out to purchase the replacement barrels but they take time to show up. Saudi Exports Edge Higher Amid Output Hike (10:02 a.m.) • Observed crude exports from Saudi Arabia crept higher to 6.32m b/d in September, as stronger flows to countries including India and South Korea outweighed a drop in shipments to China. o Compares with revised 6.28m b/d for August o Flows to India rose to the highest since January; exports to Egypt, both a storage hub and transit point for shipments west, also increased We will provide a broader OPEC+ update post the meeting taking place on Oct 4th! Brief Update on Evergrande (More next week) Evergrande remains in the headlines with more interest payments skipped and pressure growing internally to contain the fall out. The company has failed to sell assets but was able to liquidate about 10B yuan of bank holdings allowing them to continue some construction projects. There is a concern that confidence will be lost across the industry, which is magnitudes bigger than the U.S. at the peak of the housing bubble. “The detail is eye-popping. In all, around 27% of Chinese bank loans come from the real estate sector. Real estate is the main form of collateral for loan securitization. In 2017, almost 18% of the urban labor force was employed in real estate and related industries. In 2018, the sale of land by local governments accounted for as much as 35% of their revenues. Much as happened in Japan in the housing bubble of the late 1980s, the market value of China’s housing stock is now more than double that of the U.S. and triple that of Europe. This means that housing wealth forms a significantly larger share of overall assets in China (78%) than it does in the U.S. (35%). Rogoff and Yang conclude that Chinese households’ consumption is therefore “significantly more sensitive to a decline in housing prices” than that of their American and Japanese counterparts. A “20% fall in real estate activity could lead to a 5-10% fall in GDP, even without amplification from a banking crisis, or accounting for the importance of real estate as collateral.” To put it simply, China’s growth has been boosted for many years by the construction of an excess supply of housing units. This has been financed by an unsustainable mountain of debt. As the Beijing-based economist Michael Pettis noted last week, “China’s official debt-to-GDP ratio has soared by nearly 45 percentage points in the past five years, leaving it with among the highest debt ratios for any developing country in history.” Relative to the size of the economy, nonfinancial corporate debt in China is now even bigger than it was in Japan in the late 1980s. And both tower blocks and debts have been going up at a time when the Chinese workforce has begun to come down. With the birthrate falling, the total population is forecast by the United Nations to shrink by around 25% by the end of the century — conceivably even by 50%.” There is a lot of potential contagion as you look at the Chinese property market and how it compares globally. It also gets much worse as you look at the weightings of household assets vs the rest of the world. Many people like to highlight- “most of the Chinese debt is local” but so was the USSR and that had a reverberating factor. China and the U.S are integrally linked and a fall in one (especially the 2nd largest economy in the world) would spread through the system at incredible speed. It would hit the local populace at an even greater level vs the U.S. and that was devasting for many in ’07. The PBoC has been maintained their liquidity limitations with a small increase ahead of month/quarter end and golden week- but remains well below “normal” liquidity injections given the timing. The lending will keep tightening as banks limit lending and increase underlying rates: Chinese banks have tightened mortgage lending. Rates between 5.2-6.4% in major cities for mortgages on first properties, 6.4-6.5% for second. 70% of cities raised rates in H2.” Here is the interest payment schedule that will be important to watch. Next week- we will provide a broad update on the Chinese economy now that our PMI calls have been proven correct and how much Evergrande can impact growth. U.S. and Global NGL Deep Dive US SLOWDOWN TIGHTENS BALANCE, NGL BARREL SOARS OVER $40 Natural gas liquids (NGL) prices continue to move higher over concerns that slower U.S. production growth will struggle to meet the needs of a rising global LPG demand environment that has held strong through the pandemic. U.S. NGL production, which accounts for about 40% of global supply, surpassed 5.4 million barrels a day in 2Q, but growth continues to flatten after having to overcome some production disruptions from the Texas storms in February. Exports remain strong at over 2.3 million barrels a day, in particular for propane with an uptick in ethane, though future growth could be constrained by a lack of incremental NGL production as U.S. shale slows. NGL prices have nearly doubled to over $44 per barrel since year-end 2020 in anticipation of these tightening markets, outpacing gains in WTI and now reflecting over 60% of the value of a barrel of crude oil. This is a far cry from an average of under $18 a barrel in 2020 and lows below $13 in March 2020. The bullish setup has driven NGL prices 112% above 4Q20 averages, versus a 76% rise in crude oil prices during that same span. Skyrocketing prices may provide a backdrop for stronger production growth forecasts for U.S. shale in 2022, in particular the Permian Basin, which would ease some supply concerns and inflationary pressure on prices. A significant rise in naphtha prices in Asia has pushed for a switch to more ethane cracking at petrochemical plants at home and abroad, giving life to ethane prices that trailed the other components of the NGL barrel. Input economics for ethane, the largest component of the NGL barrel, are becoming more attractive, and though supply remains high, a boost in ethane demand as new domestic ethylene crackers come online could cut down further on ethane rejection levels and give longer-term support to the recent rise in the NGL barrel. Ethane exports of 400,000 barrels a day in 2Q compare to an average of about 280,000 a day last year and would rise with several new ethylene crackers coming online in China and growing export capabilities in the U.S. With a visible new growth platform, midstream companies spent most of the last 5 years building out infrastructure and laying out huge sums of capital for the NGL boom that we are seeing today. However, the industry has stopped putting capital towards new growth, capex has been cut to bare bone levels and balance sheet management is the focus after many players were forced to slash dividends to avoid unmanageable leverage ratios. U.S. infrastructure bottlenecks have been mostly cleared up with a newly built pipeline system leaving significant excess capacity to carry supplies from producing basins throughout the U.S. to the Gulf Coast and Mont Belvieu, Texas, the top global NGL hub and home to significant processing and export facilities. A major expansion in fractionation capacity is coming to an end, though more processing would be welcome in that regard and several companies are likely to add new fractionation projects or complete those stalled by the pandemic. Export capabilities appear suffice though midstream companies were clamoring to add more dock capacity prior to the slowdown in U.S. shale and several projects remain in development. SUPPLY FEARS CREEP IN, PROP PRICES WITH GLOBAL EXPORT MARKET HOT A recovery in crude, NGL exports and global ethylene and petrochemical demand drove NGL prices to more-than double so far in 2021. The most recent spike to over $44 a barrel is being driven by worsening supply fears as U.S. crude production struggles to rebound. While crude output in the U.S. fell 8% in 2020 and struggles to make gains in part due to storm disruptions, U.S. NGL production is just starting to flatten out at under 5.5 million barrels a day. Less ethane rejection due to rising natural gas prices and a higher gas content in new shale wells have kept output from dropping, but upside is limited from here without new crude production. Seasonality and this winter’s cold weather aside, propane prices were bound to improve as exports and the global demand picture remained strong over the last two years and projected U.S. supply growth rates proved unsustainable. NGL Exports Up 10%, New Production Must Fuel Growth from Here Other than a disruption due to storms on the Gulf Coast this winter, global demand and domestic NGL exports remain strong this year and the outlook for 2022 is bullish as well. The rise in NGL production should support exports in the near-term, but visibility is limited going forward as crude production wanes. The U.S. is exporting an average of 2.3 million barrels a day in 2021, up over 10% from last year’s average of 2 million a day. This amounts to about 45% of the NGL produced in the U.S. being sent abroad. The fear that a lack of additional global NGL supply will be unable to satiate demand have sent prices soaring and caused them to de-link somewhat from crude oil as the NGL market develops. Demand from top importers Japan, Mexico, South Korea and China is rising and the U.S. infrastructure system is now more adept to handle its own supply, limiting pipeline and processing bottlenecks and gaining greater access to global markets a pricing. China’s imports are not back to previous levels, though the easing of tariffs has sparked higher volumes and the planned addition of several new ethylene crackers should support higher exports from the U.S. over coming years. As Japan continues to diversify its energy portfolio, demand for U.S. NGL’s will remain strong. PROPANE FINALLY GETS SOME LOVE; PRICES TRIPLE Propane Spike Elongated by Supply Fears, Texas Storms, Harsh Winter Propane prices continue to spike this year, surging passed a 5-year high of 110 cents a gallon in the aftermath of the storms in Texas to over 132 cents a gallon recently. As production took some hits earlier in the year with the Texas storm disruptions, propane prices have tripled the 2020 average of 46 cents as harsh winter conditions plagued the U.S., international demand rebounds and fuels domestic exports, and inventory stocks return to more normal levels. Propane represents about 32% of the average U.S. NGL barrel and is highly seasonal, with peak consumption in the winter. Propane stocks have fallen off significantly since nearing a 5-year high in September 2020, likely indicative of higher demand, falling shale production post-Covid 19 and a resumption in export growth. The storms in Texas drove propane even higher though near-term shortage concerns mostly impacted the ability to conduct export shipments. Prices are surging with fears that U.S. production will be unable to meet global needs as exports rebound after a drop to below 800,000 barrels a day the week of February 26th. Exports were back above 1.1 million barrels a day the following week and appear poised to return to levels above 1.5 million barrels a day in 2021. Propane Prices Skyrocket (Cents per Gallon), Drive Overall NGLs Higher Propane Markets Tight With Exports in Need, Supply Growth Elusive Exports continue to eat incremental propane barrels from the U.S. as domestic consumption levels flatten at over 1.7 million barrels a day, but a slowdown in production growth is causing concerns of a global supply shortfall. With global demand remaining strong and production struggling to recover from U.S. shale, propane prices continue to surge. Average propane exports of over 1.3 million barrels a day have surpassed average domestic demand that we peg at just under 900,000 barrels a day, and exports are likely to see a significant bump. Stocks have been at 5-year highs for some time, but the average days of supply has been declining of late to close to 22 days. The five-year low is 17.5 days of supply. U.S. propane production (including refinery production) has surpassed 2 million barrels a day and imports from Canada average about 130,000 barrels a day. Domestic propane demand spikes to over 1.2 million barrels a day during peak winter conditions. While exports are rising at a significant rate, global demand growth will likely need more production to satiate future needs. PROPANE PRODUCTION (MBD) RISES WITH NEW SHALE WELLS Propane Exports Ready for 2H Spike Propane exports have recovered from cold winter weather, peak demand season and infrastructure hang-ups related to recent storms in Texas, with volumes surpassing 1.5 million barrels a day at times this year. Exports are averaging over 1.3 million barrels a day in 2021, up 3%, but seem to be primed to rise further in 2H after the disruptions as cheap U.S. propane gains global market share, demand strengthens and fractionation and export capabilities on the Gulf Coast improve. Higher crude oil prices support U.S. shale production in the near-term, though we remain skeptical on the competitive landscape and the U.S. ability to compete should higher prices lead Saudi Arabia or Russia to flood markets with supply. PROPANE EXPORTS (MBD) Continue to Hit New Records NAPHTHA RISE, NEW CRACKERS IN CHINA AND APAC BOOST LAGGING ETHANE PRICES New steam cracker capacity in China and the restart of existing plants in Asia has provided a bullish background for naphtha in 2021 that has driven prices higher since November and to near 3-year highs. Naphtha prices in Asia should drive higher U.S. ethane demand as it becomes a cheaper feedstock for petrochemical plants. With Asian markets generally short naphtha, U.S. shipments are counted on to meet demand, as seen through rising ethane exports that recently peaked at over 400,000 barrels a day. While higher naphtha exports from the U.S. are already occurring, a switch to ethane could drive NGL demand higher while helping to ward off flaring and rejection. Asia Spot Naphtha Prices ($ per Metric Tonne) China’s Demand Lends Hope for Future Home to US Ethane Supply The exports of natural gas liquids will remain supported as China increases their consumption of NGLs. The recent petchem facilities that have come online and will come online over the next few years will be ethane and LPG based. This will increase the NGL basket more than the naphtha side, especially because ethane cracks have to be at least 87% ethane to function properly. In total, it will support the flow of NGLs into the Chinese markets and support global pricing. As US demand stays strong, the underlying Mt. B basket will keep liquids activity humming along in the U.S. Ethane Prices Gets Boost with NGL Barrel, Naphtha Spike Though propane and other LPG’s have risen sharply, a rise in ethane prices has been more moderate until recently. Ethane recently reached 40 cents a gallon, up from an average of 19 cents for all of 2020. Prices are trending similar to naphtha, though there tends to be a lag, which to us indicates potential upside in ethane prices that could prove to come rapidly with naphtha prices more than tripling and approaching $700 per tonne. This is further supported by a tendency for petrochemical plants to switch over to ethane cracking once naphtha prices hit a certain level. As ethane and propane prices improve, NGL fractionation spreads have widened as well. An indicator on NGL processing margins, higher frac spreads are providing for a better environment for natural gas gathering and processing companies. Separately, the abundance of NGL production and new pipeline capacity that all leads to Mt. Belvieu on the Gulf Coast of Texas, has increased the need for new fractionation plants. The buildout for these facilities is one of the last to remain viable in the midstream sector, and while some projects were put on the shelf after the Covid related slowdown, new capacity is likely to be added through 2022. We view the need for new frac plants as a major priority for the midstream sector in order to alleviate remaining gluts throughout the three-stream system. Mt. Belvieu Ethane Prices (Cents per Gallon) Look for Jolt SUPPLY DISPOSITION: BREAKDOWN OF NGL PURITY PRODUCTS NGL fractionation plants can process raw y-grade NGL’s into ethane, propane, butane, iso-butane and natural gasoline. Propane and ethane are the primary drivers for NGL prices, combined composing about 70% of the price of an NGL barrel. Fractionation plants in the US have combined capacity to process over 5 million barrels a day, with most barrels flowing to Mt. Belvieu, TX, and to a lesser extents, Conway, KS. The economics for each product is crucial to the price of the full NGL barrel, which is likely to further disconnect from its relationship with crude oil prices as markets form for each purity product. Exports are crucial to economics, as US demand won’t keep up with supply and natural gas production. But the coronavirus has put in a major roadblock to future growth plans and potential price inflation as many products are being shipped to badly inflicted nations. ETHANE (C2H6): U.S. natural gas production with a high ethane content has grown so fast that ethane supply will continue to outstrip demand for the foreseeable future. This will result in continued ethane rejection by gas processors and sustained pressure on prices as inventories sit well above 3-year and 5-year averages. Ethane prices had erased most gains since 2016 as domestic demand and exports could not soak up incremental barrels, keeping ethane rejection and gas flaring prominent. However, ethane prices have risen 47% on average in 2021, but currently stand at 42 cents per gallon and more-than double last year’s average of just under 19 cents a gallon. With global demand remaining strong and competing products receiving higher prices, ethane has gotten a lift this year on NGL supply fears and increased U.S. ethane export capacity. However, the U.S. can raise production very easily by reducing rejection/flaring and a shortage in ethane is not in the cards as it could be for other LPG’s. Ethane is the most prominent portion of the NGL barrel, representing about 37% for representative purposes, though the mix in y-grade NGL’s will vary greatly by basin. It is used as a petrochemical feedstock to produce ethylene, which is used to produce mostly plastics, but also for anti-freeze and detergents in the industrial sector. As new petrochemical plants come online globally, in particular China, ethane demand will increase due to its lower cost relative to other feedstocks like propane and naptha. The timing on demand growth remains murky with the petrochemical buildout having been much slower than promised and further delayed with the impact of Covid-19. Ethane production was up about 10% in 2020, to 1.8 million barrels a day, following 28% growth in 2017-19 combined and double-digit gains since 2015. Prices took a dive in 2019 as demand growth expectations continued to be pushed further into the future, and ethane rejection remained prominent with US shale driving associated gas production significantly higher. Ethane storage continues to rise as ethane prices do and rejection falls. Exports, which hit a high of over 400,000 barrels in 2Q and continue to rise on added capacity, have lifted total US ethane demand since first flowing by pipeline to Canada in 2014. This still remains only about 15-20% of total domestic production that is up over 60% since 2015 despite rampant rejection. Seaborne exports of ethane to Europe began in early 2016, out of the Energy Transfer Marcus Hook terminal in Philadelphia. Since then, exports rose to average 280,000 a day in 2019, with the addition of Enterprise Products’ Morgan’s Point, TX, terminal coming online and exporting product to India (89,000 b/d), Europe (81,000 b/d), and to a lesser extent China (9,000 b/d) and Mexico (7,000 b/d). Exports to Canada via pipeline averaged about 91,000 b/d, or 32% of overall ethane exports. PROPANE (C3H8): Much of the positive outlook for propane prices had been driven by continued growth in exports, which have exceeded most forecasts. The other component, slower production growth, has not come to fruition with 20% growth over the last two years. Exports are the lone hope to eat incremental barrels as domestic consumption levels at least seem to be flattening, given some volatility for harsher winter weather on an annual basis. Propane represents about 32% of the NGL barrel and is used as a fuel for industrial and residential heating, cooking and drying, primarily were access to natural gas is scarce or unavailable. Propane demand is highly seasonal, with peak consumption in the winter. It is also used as a petrochemical feedstock to produce propylene and as fuel for transportation. Propane production averaged about 1.7 million barrels a day in 2020, up 20% since 2018 while domestic demand growth stagnates. Exports continue to grow, averaging nearly 1.3 million barrels a day so far this year after the February disruptions. At times exports have spiked to over 1.7 million a day, and have held up well during the pandemic. Since 2015, propane exports have more than doubled, spurred by low costs, international demand and new trade patterns. Growth will be driven by petrochemical demand in Asia and, to a lesser extent, Europe. In 2019, of the 1.1 million b/d in average propane exports, 67% were sent to Japan (374,000 b/d), Mexico (137,000 b/d), South Korea (87,000 b/d), Netherlands (51,000 b/d), Brazil (43,000 b/d) and Indonesia (37,000 b/d). BUTANE (C4H10): Normal butane exports have skyrocketed since 2018, averaging about 420,000 barrels a day this year, indicating the industry has been able to export most incremental barrels since then. That is over 280,000 a day higher than the US exported in 2017 and coincides with a 52% rise in production. Of the 350,000 barrels a day exported in 2020, about 50% were sent to Japan, Morocco, South Korea and Indonesia. The remainder is shipped to various regions throughout the globe. Still production continues to rise rapidly and average storage levels continue to trend higher overall, though as of June are below normal levels due to production disruptions and the rapid rise in export demand. Draws at peak demand times have increased as well with rising demand abroad and new export capacity on the Gulf Coast. Butane prices are up over 100% this year, averaging 106 cents per gallon compared to 5-year averages closer to 68 cents. Normal butane is a liquefied petroleum gas (LPG) and comprises about 11% of the overall NGL barrel after production. About 50% of butane produced from fractionation facilities is exported, while the remainder is split between the petchem sector to produce butadiene for synthetic rubbers and by refineries in motor gasoline blending. ISO-BUTANE (HC(CH3)3): Alongside all NGL’s, iso-butane production is on the rise, 3% in 2020 and 8% in 2019, to 430,000 b/d. Inventories are now below five-year averages after the production disruptions from storms in Texas earlier this year, but output is now above last year’s level. Growing use in the US has helped partly to digest incremental production as exports tend to volatile and only represent a small portion of supply. Iso-butane is a liquefied petroleum gas (LPG) and comprises about 6% of the overall NGL barrel after production. It is used to increase octane in gasoline and as a feedstock to manufacture lubricants, rubber products and light fuel additives. Only about 3,000 barrels a day of iso-butane are currently being exported from the US, with all of it being shipped to Mexico. NATURAL GASOLINE (C5+): Natural gasoline production continues to rise, up 5% last year and 10% in 2019. Volumes are down a notch this year on production disruptions, averaging 546,000 b/d, but have now rebounded and reached a record of over 607,000 barrels a day in June. While domestic demand is rising, faster production growth and a decline in exports to Canada’s oil sands had led to historically high inventory last year. Rebounding exports to the oil sands and the production disruptions in 1Q have drawn storage levels lower so far in 2021. Natural gasoline is an NGL with a vapor pressure between gas condensate and liquefied petroleum gas (LPG) and comprises about 14% of the overall NGL barrel after production. It is used mostly as a denaturant for fuel ethanol, but also as diluent to help heavy crude flow via pipeline. The US exported about 216,000 barrels a day of natural gasoline in 1H21, compared to 192,000 barrels a day in all of 2020. Natural gasoline exports fell in 2015-19 as Canada’s own NGL supply expanded in the Montney Basin, but new markets are being accessed and Canada’s gas production is expected to drop again, renewing the need for it to import as oil sands production is mostly steady. Natural gasoline is used as diluent to move heavy crude and bitumen out of the oil sands. [/ihc-hide-content]