Think back, if you will, to late 2013 and then 2014.
Crude oil prices traded between $93/bbl – $108/bbl. Crude traded north of $100/bbl more often than not in 2014 up until the last days of July and then remained above $90/bbl for August and September. American Shale production was hitting its stride and the world was awash with crude oil.
That’s when OPEC met in Vienna and decided to pump as much oil as they wanted into the world’s supply and demand matrix. They said they hoped that over the course of the coming year, the markets would achieve some stability.
Crude oil prices (WTI) stood at $91.16 at market close on 9/30/14.
This was also the beginning of an enormous ramp up in propane production, a byproduct of the natural gas and crude oil shale extraction process. Propane inventories rose 53.5M/bbls from the low point in 2014 through the high point in the fall, which remains the record seasonal build number.
It was at this time when the supply and demand pendulum swung back the other direction; on January 20th, 2015, 477 days later, WTI crude closed below $27/bbl.
Some American shale operations were closing their doors. Rig counts fell off the face of the earth. Boomtown areas in the Dakota’s were busting. Propane inventories hit all time highs of 104M in the 4Q of 2015 as production that summer added 49.9M/bbls to end of winter stocks that were not low, given the 104M/bbls we had going into the winter of 2014-2015.
Crude prices were in the tank, and so were propane prices. United States based propane production dropped off considerably, in the face of such a supply glut. To that end, increased export capacity had come online.
A lot of us felt some pain during these times, and you can include OPEC among the lot. Their strategy, in my opinion, backfired. They cut off their noses to spite their collective faces. They felt, and continue to feel, a great deal of pain from these moves.
John Kemp of Rueters wrote a fine opinion piece on Wednesday, titled ‘Is Aramco Share Sale Distorting OPEC Policy?’.
The lede paragraph reads “By restraining production, OPEC and its allies have succeeded in eliminating excess oil stocks and accelerating the recovery in prices, but they are paying an increasingly high price in terms of market share.”
This next part is what caught my attention and sent me digging through recent history to look for any analogs in order to get a handle on where we could be headed:
U.S. producers will capture all the growth in global oil consumption this year, according to forecasts from the U.S. Energy Information Administration. The agency predicts total crude and liquids production will rise by 2.0 million barrels per day (bpd) in 2018. Over the same period, global consumption is expected to rise by just 1.7 million bpd, ensuring the United States captures all of the demand increase this year.
Surging U.S. shale production is starting to resemble the last boom, when production rose by 1.0 million bpd in 2012, then 1.2 million bpd in 2013, and another 1.8 million bpd in 2014. During the last boom, U.S. producers captured most of the increase in global demand, pushing the market towards surplus and creating conditions for the subsequent slump in prices. Something similar could happen again. The parallels between the last shale boom and the current surge are uncomfortably close.”
Two weeks ago, I wrote a bit about the fundamental supply and demand picture we have experienced this winter and what may be on the horizon for this coming year (linked here).
Here is a portion of what I wrote on February 22nd, from the article I linked just above:
Thus far on this demand season, which I view as beginning on October 1st, we have drawn down roughly 36M/bbls of propane. Compare this to 54M/bbls worth of drawdown during the same period one year ago. This is roughly 18M/bbls of difference in year over year inventory.
Where is that difference coming from? This winter was a lot colder than last winter, right?
Let’s examine things from the first EIA reporting week in October through this present week, which is a 20 week period, for both 2016-2017 and 2017-2018.
EXPORTS: 8.4M/bbls LESS product exported this year than last year
PRODUCTION: 21.8M/bbls additional propane production this year than last year
DEMAND: 11.3M/bbls additional demand this year than last year
Add the export total and production totals together, as they represent additional product on the market this year vs last year, then subtract the demand line as that is additional takeaway from last year, and you get 18.9M/bbls of additional product on the market this year than last, which lines up near perfectly to the year over year inventory draw down difference of 18M/bbls I outlined above.
The production levels are likely coming from the Permian Basin, and Bakken crude production right now sits at record levels.
Propane production was roughly 10% higher this home heating season than last, and a trader told me last week that estimates are for propane production to push even higher this spring and summer. This belief dovetails with the commentary from John Kemp; United States producers have all the incentive in the world to produce at high levels, while Saudi Arabia has incentives to not get into another market share fight with American Shale producers the way they did a few years back, because they know where that leads.
Saudi Arabia and other OPEC nations power their economies with petrodollar stipends and benefits. They need crude oil prices to be at a certain level in order to balance their annual budgets and not dip into cash reserves. Here is a rough estimate on crude oil price levels needed to balance the budgets of various OPEC nations, as of last summer:
Brent crude is trading around $65/bbl right now, which is below the $84/bbl threshold for the Saudi’s, the largest of OPEC’s producing nations.
The Saudi’s also want to launch the IPO of their state owned company Aramco, which will help move them away from being an economy solely at the mercy of commodities pricing. As such, if OPEC wanted to get into a market share fight with American Shale companies as they did a few years ago, thereby increasing their production levels, crude oil prices would likely go in the tank once again, which would make the valuation of an Aramco IPO much less, due to the value of crude being much less. The Saudi’s are hoping for a TWO TRILLION DOLLAR windfall from the sale of a small portion of Aramco in an IPO setting.
This is at the heart of what Kemp wrote about:
“At the moment, however, the current price-led strategy is still paying short-term dividends for the organisation’s (OPEC) members, including Saudi Arabia. Higher prices are more than offsetting the loss of sales volumes. So there is no pressure to switch course. More importantly, the kingdom seems to want a high and rising oil price to provide a favorable backdrop and maximize the valuation for the sale of shares in Aramco later this year or in 2019.”
This is an important factor when considering the direction propane prices will take, as propane prices will be influenced by the direction of crude oil prices.
The Saudi’s have an incentive to see crude oil prices remain firm through the launch of their Aramco IPO. As such, it seems unlikely that they would get into another market share fight with American Shale. As such, American producers are going to collect a nice windfall, as they ramp up production to meet the market share needs of the world (the gap between supply and demand).
This should lead to the anticipated increase in propane production this spring and summer and likely through the year, barring unforeseen changes. This would also seem to limit upside price risks in propane, at least at the Mt Belvieu trading hub, in the near term and until we get a handle on the trajectory of propane inventory builds this spring and summer.
However, the American propane industry is in a different position than it was even three years ago pursuant to its export takeaway capacity. While an increase in propane production (if that materializes) should create softer propane prices, we could see American propane exports rise in a softer price environment as the international trading arb for American sourced propane would likely become quite favorable.
When you think about it, there is an organic beauty to the ebbs and flow of supply and demand, but these new and powerful factors make predicting the future more challenging in some supply seasons.
I spoke a great deal more about these general ideas in a 25 minute video, last week. It was my first big-picture look at the coming supply year, and that video is embedded at the bottom of this piece. Yes, I know that it’s too long…but this is a topic that deserves at least one deep dive because it’s so crucial to the retail propane sector..
I strongly urge you to watch the video if you have yet to do so, and I strongly urge you to read Kemp’s article linked above. As always, thanks for taking the time to read The Propane Buzz and I hope that you find value in what it contains.