Primary Vision Insights – March 17th, 2021

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By Mark Rossano

SUMMARY

US Completion Activity Physical Crude Market Update - India Economic Backdrop Global Inflation Pressure OPEC+ Update NGL Update

The next report will have a section looking at “what comes next” as the reopening/vaccine roll out accelerates.

US Completion Activity

Activity in the U.S. has mostly bounced back from the Texas blackout with only a 3%-5% residual of downtime left in the market. Prior to weather restrictions, we were at 175 spreads nationally and the gap will be closed this week with completion activity back to a growth profile. The Permian will be over 100 spreads within the next 2 weeks as the whole region attracts growth- especially in the Delaware. Naphtha exports have increased from the U.S. into Europe- with the flow remaining elevated as the arbitrage has opened. The strength in liquids pricing provides support for activity across the Anadarko as well, which has seen some new spreads start work again. The Anadarko has enough work to get back to about 10 spreads over the next 2 weeks, which will be a near term pause. Based on the current liquids and NGL prices, there will be longer term support for a steady increase to get closer to 15-17- but the rolling 4-week average in 2020 of 29 will be difficult to achieve based on available horsepower in that region. The Permian will move closer to 115 as we head into the head of March/ beginning of April as activity will be centered around the main growth regions. There is also the “largest” DUC (drilled but uncompleted) well inventory in the region that will provide running room for activity. Some of the other regions (Bakken and Eagle Ford) have seen their DUCs decline over the last 18 months and will need to see a rise in rig activity to see a sustained rise in frac activity. We will see at least another 20 spreads added to the national spread count over the next 2-3 weeks as activity maintains a steady increase across Texas.

There will be additional activity in the TX-LA-SALT and Western Gulf over the next 2 weeks as activity crosses back above pre-Texas blackout impacts. The Williston will also start to see some activity come back as normally things accelerate from mid-March and peak around early July. As we said last week: “DUC inventory has been drawn down since 2020 with completion crews out pacing rig activity drawing on inventory. The Permian still has more than enough running room to support a ramp in activity, but we will need to see a pickup in drilling across the Eagle Ford and Bakken over the next 6 months to replenish inventories. We need to see frac spreads increasing activity in the Williston (currently at 7) to around 15-20 to see production start to stabilize. Based on the seasonality chart below, we will see some increases throughout March with another 7-10 activations over the month. The biggest headwind to accelerating activity will be the DAPL pipeline decision because if the pipe is decommissioned differentials will blow out and limit new capacity. A shutdown of the pipeline would result in spreads widening by another $5-$7 in order to cover the cost of additional rail and competition for other pipe capacity. Until this is clarified, the pace of completions will remain subdued, but companies will at least look to stem declines in the near term. This will put completion crew activity at 12 quickly, but the remaining 7 or so will take a bit more time and clarity on DAPL.”

The DAPL component will be important to overcome in order to see the acceleration of activity in the near term. There is enough support in pricing to see some activity come back into the Bakken, but it will still be limited across the board. The growth drivers over the next 2 weeks remain: Permian, Western Gulf, and TX-LA-SALT with everything else holding close to current run rates last week. We will start to get some one offs in the smaller basins as operates start to get back to work as spring rolls around. This will attract some additional activity in the near term, and as pricing across the complex supports new spreads. We have also started to get new approvals on some permitted wells: “The US Interior Department's Bureau of Land Management (BLM) has approved 200 drilling permits over the past two weeks, compared to the just 16 drilling permits approved during the first full month of the new administration. The surge in activity brings the number of approved drilling permits to 229 since Biden took office, of which more than 70pc went to operators in Wyoming and 24pc went to operators in North Dakota.” We are still well off the normal pace, but as approvals started again some pressure has been removed on the administration. “US independent Continental Resources last month filed a lawsuit that accused the Biden administration of unlawfully delaying 50 drilling permits in North Dakota, which the company said could jeopardize its ability to build well pads before a 10 June deadline needed to avoid disturbing endangered species. But the company voluntarily withdrew the lawsuit this week after the permits were approved from 25 February and 9 March. [1] ” So far, the administration is just stating that the pause is due to creating a more rigorous review process and less about stopping activity all together.

The general pricing structure being so deep in backwardation will be enough to support near term activity especially with the curve well above $55 offering up viable hedging opportunities. The curve is currently trading above $55 through April 2023, but it is important to appreciate that since the beginning of the year- we started to see prices above key levels opening up hedging capacity. This will help protect activity in the U.S. even if we get a pull back in front month pricing.

WTI Crude Curve

Brent vs LLS has widened a bit to $1.72 and Brent vs MEH to $2.62 as the spreads widened to try to pull more U.S. crude into the market. Pricing into Europe has gotten more competitive as physical crude diffs have weakened across the board and OSPs (Official Selling Prices) were cut heading into the European markets. There is also a structural shift in the ICE market as a big short appears to be stopping out as longs remain near the highs from March 2020.

ICE Brent Crude Longs

Physical Crude Market Update- India Economic Backdrop

Based on recent data from Europe and Asia, U.S. crude exports will remain hindered by slowing demand in two of our key markets. Europe is experiencing a rise in COVID19 cases in Germany, Italy, and France resulting in a delay in restrictions being lifted and slowing refined product demand, The slow down of Chinese purchases of North Sea crude is also leaving more crude in the region as we can see with narrowing differentials. China imports based on ship tracking data is showing that March so far will fall below 10M barrels a day: “Ship-tracking data show a m/m fall in tankers heading to China since January 2021 to ~8-9m b/d in March, although official import figures could be higher with the addition of floating storage getting discharged.” India is also facing an increase in COVID19 cases in some provinces causing some regions to increase restrictions on movement. They are also faced with record high pricing on diesel and gasoline, which is hindering near term demand levels. The slow down into Asia has also kept the physical market a bit soft, and setup India to accelerate their diversification of imports.

Socar sold 650k bbl of Azeri Light for April 1-5 delivery at 70c/bbl more than Dated Brent, CIF Augusta: last traded at +80c on Mar 9 Litasco offered 100k tons of Urals for March 24-28 delivery at Dated -$2.05/bbl, CIF Rotterdam: Compares with -$1.85 last trade Mar 9 Also sold Brent to Vitol for March 29- pril 2 delivery at +$1.10/bbl, CIF Rotterdam

Vitol bid Forties at +25c for April 3-10, FOB Mercuria bid Forties at +20c for April 7-9, FOB Totsa bid Brent at +20c for April 1-3, FOB Mercuria bid Brent at parity to Dated for March 22-26, FOB

India is also facing a rise in COVID19 cases that is caused an increase in lockdowns and restricting movements in the country. It is weighted towards specific regions, and isn’t a sweeping increase across the country- but it is causing a drop in general refined product demand. India: oil consumption fell by 4.9% y/y to 17.212m tons in February, but last year also had an extra day in it- so the numbers are still down just not as extreme. On refined products: Diesel -5.3% Gasoline +0.4% LPG +11.5% petcoke +4.1% naphtha +3.9% Total -1.5%. The pressure that remains in diesel is concerning given its main usage as a economic bellwether.

India has started to rely more on Non-Opec nations in order to fill the need for their growing demand. Russia, U.S., and Brazil have become a bigger staple in to their refiners with more diversification coming over the next few years. It will be difficult to replace everything, but they could reduce another 3%-5% over the next 12 months coming from OPEC nations- but more importantly Saudi Arabia. The UAE is also looking to take more market share in Asia, and the current backdrop with KSA could provide a solid opening. Inflation in the country is also pushing gasoline and diesel prices to all time highs and putting additional pressure on the economy. While prices internally shift higher, the yield curve has also responded- which is becoming more of a problem as Modi’s government looks to stimulate the economy with a much bigger deficit expected in 2021 and 2022. “The RBI is using three means to deliver accommodation to try to keep yields in check: bond purchases, forward guidance and suppressing market yields by paying higher underwriting fees on government debt issuance to primary dealers. It has managed to flatten the sovereign yield curve. But it has had little success in preventing an upward shift in the curve, which has been driven by increased government borrowing, rising fuel prices and a global bond sell-off.” Inflation and yields are still within a reasonable level and it won’t cause the RBI to change course, but it will be watched closely with targeted rates as the means to address the changes.

Inflation bounced again in February as prices increased across the board, which is putting more pressure on the overall economy. Diesel and gasoline prices are reaching all time highs even at reduced demand cycles, which is putting pressure on the physical market. India is still holding steady at around 4.5%, and if their 10-year yield is able to hold in this position- another rate cut is possible to give another boost to the economy. I think the continued rise of the US 10 year will put pressure on India, and they will end up not being able to cut rates and instead will hold the course of the current rate cycle allowing for fiscal stimulus to push through the system. The problem is the mixed signals on the inflation front that have hit consumers in the region. It will be difficult to get a cut if gasoline/diesel prices consistently move to all-time highs. We are coming out of one of the largest pandemics in our history, and the rise in underlying prices while unemployment remains elevated and wage compression increases will keep the recovery muted.

Global Inflation Pressure

Inflation is an issue that is hitting most emerging markets and will limit the monetary and fiscal policies. This will limit the inherent money that can be used as stimulus, and makes any borrowing all the more expensive.

The below PMIs across the Emerging markets arena have been weak over the last 3 years, so we were already entering 2020 on a weaker footing. Now on the other side of the pandemic- the goal is to stimulate a global economy that was already inundated with debt and liquidity. The rise in the US yields and the “rate” of change will make this much worse in the near to medium term. The cost of stimulus becomes a much bigger factor as we head into another round of deficits, which will create more stress on the internal balance sheets. The hope is for a strong rebound in GDP that would offset the level of stimulus or at least interest expense, but with new export orders softening, imports dropping, producer prices rising, and inflation perking up… there will be some choppy roads ahead.

Another issue facing Asia is the rapid buildup of commodities within the Chinese market. I have described over the last few weeks how China now has over 100 days in crude storage, refined product storage is approaching 60%, while other materials: copper/ rebar/ iron ore/ steel push to at or above all-time highs. A jump in OPEC+ exports -- by 665k b/d in Feb. -- despite the group’s pledge to limit output has contributed to softer fundamentals, which is keeping the physical market well supplied. This is also coming as China increases their refinery maintenance and floating storage shifts higher.

OPEC+ Update

OPEC put out their monthly report, and reduced demand over the course of Q1 and Q2 as restrictions remain elevated on activity. This has shifted the demand metrics in OPEC’s opinion to the second half of the year. India, France, Germany, Italy, and Brazil have experienced some varying levels of new COVID19 cases that have limited activity recovery in some key areas. This will just prolong the return to normalcy, but we are always looking at high frequency data points to identify pivots in the market. Middle and light distillate levels remain elevated in the market with more heading into storage across Asia. We are seeing a bit more movement into Europe after storage accelerated to the downside following large amount of exports to U.S. markets.

European imports of clean products from the Middle East, mostly middle distillates, are poised to gain m/m in March, aided by a surge in exports from the UAE. 8 tankers hauling total 537k tons have arrived in Europe from the Middle East so far in March, according to ship-tracking data compiled by Bloomberg Europe’s diesel margin dropped to its lowest since late November, with U.S. refiners ramping up operations again after last month’s big freeze. The ICE gasoil crack, a measure of the profit refiners make from turning crude oil into diesel, fell to $4.32 a barrel on Thursday, the lowest since Nov. 25. Covid-19 lockdowns have curtailed Europe’s demand for diesel and the margin has languished well below seasonal norms since late April. Now U.S. demand for imports, which has been giving some support to Europe’s struggling market, looks set to weaken.

The middle distillat market is a key metric to gauge the underlying global economy, so it will be important to track over the next few weeks. It will help uncover how much economic growth is being generated as the vaccine roll out continues in different markets. Europe remains slow on their roll out, while the U.S. is accelerating activity. The biggest unknown is China and general Asian activity as activity remains fairly muted. “Shipments of gasoline into the U.S. East and Gulf coasts jumped last week and are set to climb again this week, said Ioannis Papadimitriou, a freight analyst at Vortexa. Global imports of gasoline/blending components into the so-called PADD 1 and PADD 3 regions more than doubled to 572k b/d in the week ended March 7.

“Higher volumes are expected for this week, at 802k b/d”

At the end of the week finishing March 7, there were 30 Medium Range tankers carrying gasoline/blending components from Europe toward PADD 1 and PADD 3, according to data from the tanker analytics firm

This is the “highest number of tankers seen for this flow since May 2018”: Papadimitriou

The amount of gasoline heading into the U.S. is at record levels as gasoline builds continue in Europe and Singapore.

Production remains fairly muted, but we always stress the importance of separating out exports vs production. “A jump in OPEC+ exports -- by 665k b/d in Feb. -- despite the group’s pledge to limit output has contributed to softer fundamentals. In Russia, production rose to 10.174 million barrels a day on March 1-11, which we need to see how much makes it into the export market. Novak has said that the increase in production is important for the operation of local refiners. March 11, according to data from the Energy Ministry’s CDU-TEK unit seen by Bloomberg. That equates to daily production of 10.174 million barrels and is about 79,000 above February level, according to Bloomberg calculations based on 7.33 barrels-per-ton conversion rate. Angola (West Africa in general) still has a significant amount of crude left to sell, while May loading schedule is set for next week. They should be much further along in their process at this point as China resells or limits the amount of cargoes they are taking.

Libya has achieved production levels at about 1.28M barrels a day, which is supporting exports around 1.2M. They expect to reach 1.45M by year end, which would bring another 150k -175k additional barrels into the export markets over the next 2 quarters. It will also depend on the unity government, and if any disagreements remain in the conference room and not the battle field. It appears (so far) that the peace is holding as more structure is implemented to repair and expand oil assets.

At the current strip, U.S. production will grow slightly and likely hit about 11.3M barrels a day- achieving growth of about 300k barrels a day. This will require more activity in the market and putting frac spreads over 200- and much closer to around 230. The interesting side of the equation so far… OPEC cut 647k barrels a day in production, but saw exports increase by 655k barrels a day. The biggest component of the next few months will be production vs exports.

NGL Update

BARREL OF NGL SOARS 51%; HOLDS STEADY ON CRUDE POST-TEXAS FAILURE

Natural gas liquids (NGL) prices have held onto most of their recent gains as a minor pullback in propane and a setback in ethane over the last two weeks were met with higher prices for butane, iso-butane and natural gasoline. While NGL production has surged in the U.S., surpassing 5.3 million barrels a day in late 2020, some signs of flattening volumes and a recent recovery in crude oil prices has pushed the NGL barrel close to $32, a far cry from an average of under $18 a barrel in 2020 and lows below $13 in March 2020. NGL prices have risen 51% from 4Q20 averages, versus a 35% rise in crude oil prices during that same span. Though we continue to see the U.S. NGL market as oversupplied with some processing limitations and bottlenecks at the main hub in Mt. Belvieu, Texas, the near-term rise in prices is not only attributable to the spike in crude, but also due to year-end stock draws, rising exports and recovering international demand. A significant rise in naphtha prices in Asia bodes well for a switch to more ethane cracking at petrochemical plants at home and abroad, a positive given ethane prices continue to wallow versus the other components of the NGL barrel. Input economics for ethane are becoming more attractive, and though supply remains high, a boost in ethane demand could help provide a spark to stagnant prices and further support the recent rise in the NGL barrel. The storms in Texas that drove the collapse of an unprepared power grid have pressured short-term shale production and propane exports that remained on the rise after a spike in 2H20.

LINK TO CRUDE STICKS, BUT US SUPPLY, GLOBAL EXPORT MARKET DEVELOPING RAPIDLY

Lower crude prices and an ongoing supply glut kept NGLs below $18 a barrel for most of 2020 and hopes of a recovery in crude, NGL exports and global ethylene and petrochemical demand drive hopes of a higher price environment that is materializing this year. Propane prices were bound to improve as exports recovered and the winter went into full swing, even though the recent price inflation is beyond what we expected. The drop in NGL prices in 2020 was more pronounced than a jump in supply would have suggested as bottlenecks became more noticeable at the processing level. Raw, Y-grade, mixed-NGL output had been rising faster than Mt. Belvieu can handle, spurring intermittent ethane rejection, natural gas flaring and higher product storage. The incremental barrel still needs to be exported internationally and market access improved to support a prolonged improved pricing environment that can complete globally. A significant portion of NGL production in Mid-continent basins are being shipped to Mt. Belvieu, bypassing traditional processing centers and placing more pressure on fractionation infrastructure on the Gulf Coast.

NGL Prices (Cents per Gallon) Rise on LPG Demand, Export Recovery and Texas Storms

Is Steam Running-Out of US NGL Production Ramp

There are signs of slowing U.S. NGL production through above average inventory draws over the last several months. Winter usually results in higher demand, but draws in stocks have been greater than normal, even in the harsh weather we’ve seen recently, and could prove to be a result of flattening or even declining NGL production at U.S. shale plays that are lending less supply. NGL prices will remain linked to crude, though the ongoing development of the U.S. NGL market, including a revamped pipeline network and growing fractionation and export capabilities, should combine with ongoing demand growth globally to increasingly detach the two commodities going forward.

NGL Exports Rebound, Trajectory Still Points Higher

Despite a recent disruption due to storms on the Gulf Coast, we expect global demand and domestic NGL exports to remain a strength in 2021. NGL supply remains high and places a cap on prices at these levels, with ethane the likely outlier. With weather remaining a factor, propane prices should remain seasonally firm and a switch to ethane use in the petrochemical sector, due to rising Naphtha prices in Asia, could provide support to the NGL barrel in the near term. Supply continues to remain the biggest question mark as the crude barrel continues to contain more NGL’s, meaning incremental barrels increasingly need a home overseas to keep markets balanced and prices from weakening.

DOUBLING IN PROPANE DRIVES NGL PRICE HIKE; TEXAS STORM PROVIDES FRESH BOOST

Propane Spike Elongated by Texas Storms, Harsh Winter

Propane prices continued to spike this year, inching close to a 5-year high of 110 cents a gallon in the aftermath of the storms in Texas. Despite a continued rise in production, propane prices have more-than doubled the 2020 average of 46 cents as harsh winter conditions continue to plague the U.S., international demand rebounds fueling 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, 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 impact the ability to conduct export shipments. Prices have pulled-back to pre-storm levels, with exports beginning to rebound after a drop to below 800,000 barrels a day the week of February 26 th . Exports were back above 1.1 million barrels a day the following week and appear poised to surpass highs of 1.7 million barrels a day in 2021.

Propane Prices Skyrocket (Cents per Gallon), Drive Overall NGLs Higher

Propane Markets Tighter Than They Appear With Exports in Need

The cold weather this winter is certainly a factor in a recovery in propane prices, and exports peaking at the same time have provided an added boost. Average propane exports of over 1.3 million barrels a day, prior to recent disruptions, have surpassed average domestic demand that we peg at just under 900,000 barrels a day. Stocks have been at 5-year highs for some time, but the average days of supply has been declining of late to close to 26 days. The five-year low is 17.5 days of supply. Exports are the lone hope to eat incremental propane barrels as domestic consumption levels seem to be flattening, given some volatility for harsher winter weather on an annual basis. U.S. propane production (including refinery production) surpassed 2 million barrels a day in late 2020 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.

PROPANE PRODUCTION (MBD) RISES WITH NEW SHALE WELLS

After Spike in 2020, Propane Exports Look to Surpass 1.5 Mbd

Cold winter weather, peak demand season and infrastructure hang-ups related to recent storms in Texas have eaten into propane and LPG export shipments in recent weeks. However, propane exports have surpassed 1.5 million barrels a day on several occasions since late December and appear primed to break records in the spring. Exports averaged over 1.25 million barrels a day in 2020, up 15% over 2019, and seem to be headed toward similar growth rates this year as cheap U.S. propane gains global market share, fractionation and export capabilities on the Gulf Coast improve and shale production delivers an increasing percentage of NGL output per barrel. 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 COULD PROVIDE BOOST TO LAGGING ETHANE PRICES

New steam cracker capacity and the restart of existing plants in Asia has provided a bullish background for naphtha in 2021 that has driven prices higher since November. Naphtha prices in Asia have returned to pre-2020 levels and a further jump could 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. While higher naphtha exports from the U.S. are already occurring, a switch to ethane could drive NGL demand higher and provide a destination for rising U.S. production, while helping to ward off flaring and rejection.

Asia Spot Naphtha Prices ($ per Metric Tonne)

Lackadaisical Ethane Prices Could See Boost as Naphtha Spikes

Though propane and other LPG’s have risen sharply, a rise in ethane prices has been more moderate. Ethane recently reached 27 cents a gallon this week, up from an average of 21.5 cents in 4Q and 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. 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 being added. Still, 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.