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A Worrying Sign For Global Oil Demand

Friday June 21, 2019

1. Corn prices surge…so does ethanol

Corn

- Catastrophic flooding in the U.S. Midwest delayed plantings and ravaged corn fields, which is having knock on effects in multiple commodity markets.

- Corn prices have spiked as a result of fears over adequate supplies.

- “If less corn is produced in the US, less ethanol can be produced as a result. Since mid-May, this prospect has pushed up not only the corn price but also the prices of ethanol,” Commerzbank wrote in a note. Ethanol prices are up 18 percent since mid-May, even as oil prices have declined over that timeframe.

- Higher ethanol prices in the U.S. are leading to higher ethanol prices in Brazil. But in Brazil, ethanol is produced from sugar, which means more sugar is being diverted into ethanol production.

2. Canada pushes Trans Mountain Pipeline again

Oil

- The Canadian government gave the greenlight (again) to the Trans Mountain Expansion, a pipeline that it bought from Kinder Morgan (NYSE: KMI) last year. In addition to Enbridge’s (NYSE: ENB) Line 3 replacement, the Trans Mountain Expansion is the best shot that Canada’s oil industry has at bringing midstream capacity online.

- Still, the pipeline will take several years to build, assuming there are not further delays.

- “The expansion will go a long way in alleviating chronic capacity challenges that have plagued the Canadian oil sector as it is expected to boost TMX’s current capacity threefold to 890 kbpd,” Scotiabank wrote in a report. “However, with the earliest completion date only by 2022, Canadian crude will still rely on oil-by-rail to get its product to market in the meantime.

- Mandatory oil production cuts have rescued Western Canada Select prices, but more rail capacity will be needed in order to allow production to grow.

3. Distillate demand weak

Distillate

- Fears of weak oil demand and an economic slowdown have dominated the oil market narrative (that is, when everyone isn’t focused on war in the Middle East).

- Central to those fears are evidence of weak distillate demand, which is an indicator of a slowdown in global industrial activity. “[O]ur analysis shows that distillate fuel demand has weakened materially in recent months across various fuel types and regions,” Bank of America Merrill Lynch wrote in a note. “In short, we are in the midst of the third large industrial downturn since the global financial crisis.”

- The investment bank slashed its oil demand forecast for this year to just 0.93 mb/d, down from 1.2 mb/d previously.

- The cracks in the global economy point to a broad economic slowdown. A lot is riding on the outcome of the Trump-Xi trade talks next week.

4. Commodities get a lift from the Fed

Commodities

- Battered for weeks, commodity markets received a boost in recent days following dovish comments from the U.S. Federal Reserve.

- The central bank took note of the slowdown in manufacturing activity and weak economic indicators across the globe, even as it cited relative strength in the United States. Still, it softened its language and financial markets widely interpreted the statement as a sign that interest rate cuts are just around the corner.

- It’s a remarkable turnaround from last year. “Back in November when we published our 2019 energy outlook, the forward rates market was pricing in one 25bps hike in 2019 and our economists were calling for 4 Fed fund rate increases of a similar magnitude,” Bank of America Merrill Lynch wrote in a report. “Now, the forward rates markets are pointing to 3 cuts over the next 12 months.”

- “If these lower US rates expectations materialize, we believe they could also result in a materially weaker USD and eventually lend some support to Brent crude oil prices,” the bank said.

- The Fed will respond to weakening conditions, so the negative shock from an escalation of the U.S.-China trade war could be somewhat blunted by subsequent cuts to interest rates.

5. Is Copper underpriced?

Copper

- The downside for copper prices might be limited, and a price gain is possible.

- A strike at a copper mine in Chile has stoked some bullish sentiment on supply fears.

- “[E]ven more importantly, the negative news and expectations now appear to be completely priced in,” Commerzbank wrote in a report.

- In fact, speculators appear overstretched on the downside. “After all, sentiment among institutional investors is extremely pessimistic: according to the CFTC, they increased their net short positions in copper on the COMEX to 52,305 contracts as per last Tuesday, putting them at their highest level since records of so-called disaggregated data began exactly 13 years ago,” Commerzbank said.

- “Such extreme pessimism often marks a turning point on the market. The economic stimulus measures expected from the government in China are therefore likely to result in higher prices,” the investment bank concluded.

6. Oil supply outages grow

Cumulative

- OPEC+ production in May was 530,000 bpd below their 44.3 mb/d target, according to the IEA. In other words, the group had a compliance rate with the agreed upon cuts of 145 percent.

- Saudi Arabia cut by more than required, while Russia suffered an outage from its contaminated pipeline.

- Meanwhile, Iran and Venezuela have lost more than 1 mb/d since late last year.

- But the deep cuts also leaves OPEC+ with 3.5 mb/d of spare capacity, which has eased supply concerns. “This is a useful insurance should Iranian and Venezuelan supplies fall further or in case of supply disruptions elsewhere. Output in Nigeria and Libya remains vulnerable due to ongoing civil unrest.”

7. IMO rules to shift demand

IMO

- The new rules on sulfur content for marine fuels set to take effect at the start of 2020 are expected to boost demand for gasoil, a distillate somewhat similar to diesel. Shipowners will swap out high-sulfur fuel oil (HSFO) for gasoil or very low sulfur fuel oil (VLSFO).

- The demand shift may begin in earnest in the fourth quarter of this year.

- Demand for HSFO will fall precipitously in 2020, falling by 300,000 bpd year-on-year in 2019 and then by a staggering 1.6 mb/d next year.

- Complex refineries capable of adjusting to the switch in fuel demand should benefit, but older simpler refineries focused on heavier and higher-sulfur fuels will take a hit.


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