Commodities Update

Oil is flat and looking at a weak short term trend sliding between $105-110/bbl Brent.

The short term palliative of a deal in Washington to temporarily address the debt ceiling and budget overcame the potential longer-term implications of reports of constructive dialogue between Iran and the global powers in Geneva which has the potential, given the US’ positive reaction, to see sanctions eased. Clearly there is a long way to go to get to something substantive and Iranian exports will not recover quickly but fall in Iranian’s exports has compensated for poor demand growth and strong US production growth.

I still see the discount of WTI to Brent ($10/bbl currently) widening as supply in the US and inventories increase while tightness in Brent market remains, with Libya disruptions continuing. Libya’s oil production is stable at around 600kbpd, where it has been for about a month.

The Eagle Ford shale of South Texas has nosed ahead of the rival Bakken play of North Dakota in the race to produce 1 million barrels per day of oil, according to the US Energy Information Administration. The EIA’s new monthly Drilling Productivity Report says total production from the Eagle Ford hit the 1 million-bpd milestone in August and expects output to rise to 1.07 million bpd in October, and to 1.09 million bpd in November, Reuters reported.

Regarding US production of shale oil and gas, an EIA study was published that covers the Bakken, Eagle Ford, Niobrara, Permian, Marcellus and Haynesville tight oil/shale plays which it says covers over 90% of US tight oil/shale production and nearly all gas production (~3.7m b/d of oil and ~34,000 mcf/d). States new well production per rig (b/d) has increased yoy in all 6 regions for both oil and gas, with the exception of gas production in the Niobrara which is down and in the Permian which is flat. Most notable were the increases yoy in Bakken oil and Marcellus gas production/rig.  Conversely production from older wells is falling faster than it did a year ago for oil, though little change in the trends for gas, on average. Net net, the EIA estimates that oil production in November will rise (vs Oct) in all 6 regions, by ~60k b/d (+1.6%), primarily from the Bakken and Eagle Ford. The picture for gas is more mixed with the IEA predicting rises from the Marcellus, Eagle Ford and Bakken but falls from the Haynesville and Niobrara (Permian flat), leading to an overall rise of just over 1% m/m.

US crude inventories have been building on strong domestic supply and the onset of refinery maintenance season.. This week EIA Crude stocks were +5.25 mboe vs. +4 mboe expected. Gasoline stocks -1.81 mboe vs. -2.57 mboe expected. Demand 18.269 Mboepd, yoy -4.5% . Crude oil production up +1,286 kboepd yoy.
US Gas also likely to keep the $3.80-4/mmbtu level. Inventories are now 3,577bcf, widening the surplus versus the 5-yr average to 57bcf. Since May, weather has been 1% cooler than the 5-yr average.
Over the last month, the weather-adjusted Supply/Demand balance has been 0.7bcf/d oversupplied vs the 5-yr average.
US natural gas producer hedging activity has slowed in the past quarter, but with $4/mmbtu, a greater portion of next year’s gas output is hedged than in the past three years.
CO2 is in no man’s land and likely to be rangebound for a while despite German Chancellor Angela Merkel support for EU plans to prop up carbon prices by temporarily removing some of the surplus allowances. “We need a degree of back-loading of CO2 emissions so that the certificate price can reach a reasonable level again,” Merkel said. She said a rise in certificate prices would help modern, flexible gas-fired power stations which were now struggling to compete with coal-fired plants, which emit many more carbon emissions, because carbon permit prices were now so low.

Coal has enjoyed a short term rally driven by stronger thermal coal demand in Japan (+24% ytd) but oversupply, high inventories and weakening India and China consumption are likely to keep it rangebound.

Latest port data shows that India imported 9.1mt of thermal coal in September –the lowest since last year. This is an 11.6% mom decline and 33.5% down YTD. Met coal imports rose 8% to 25.1mt. The outlook short term remains poor and traders comment that the rupee’s weakness curbs Indian buying and an open arbitrage remains the key to China’s appetite for seaborne coal, meaning neither is likely to bid thermal prices higherOn the positive side, Japanese thermal coal demand remains strong +24% YTD as nuclear output still not improving. Despite Japanese data, inventories and oversupply still weigh in on price.

Australian coal exports continue at a strong pace. At just under 8.2mt, they are up from the 7.6mt YTD average, with both met and thermal coal shipments up WoW.  The World Steel Association released global steel and pig iron production data for September earlier this week. Global production reached an annualised rate of 1,613mtpa, up 7% YoY, but the real story was the return to growth of ex-China steel production for the first time since May 2012.
Morgan Stanley mentioning safety regulation in China could put a floor on coal despite oversupply. Both Central and Shanxi local governments issued new policy papers on enhancing mine safety standards.

a) State Council aims to shut down at least 2,000 mines by the end of 2015, targeting coal mines of  less than 90 thousand mt

b) The government will stop approvals for new coal mines with annual capacity of less than 300 thousand mt

c) Shanxi government is ordering a halt to all new mine construction projects and plans to conduct safety checks. The halt came after a mine accident at Shanxi Coking Group on Sept 28. MS estimate this will reduce Shanxi’s new capacity additions by 40-80mt from the initial expectation of 100mt for this year.

UK Gas looks to remain strong and trading above the resistance of 69p/therm as volumes from Norway pick up. No unplanned LNG cargoes diverted to UK this week as demand from Asia continues to absorb most supply of LNG. . Inventories fall further below the 5 year average but companies maintain there is still enough to supply the winter demand. With storage levels in the UK trending near five-year lows (4,539 mcm), the likelihood of a spike is quite relevant as we enter maintenance season in Norway.

Power prices in Europe will probably remain weak, with German power down as thermal output continues to disappoint with wind and solar taking up to 39% of all generation and capacity cuts mentioned by RWE more a long-term fix than a reality that could help prices.

German power demand in August declined -1.9% y/y on working day adjusted basis (-2.6% unadjusted) according to BDEW data, despite August industrial production being up 0.3% y/y. Demand is also down for the first 8 months 2013, by -1.2% y/y.

Brokers mentioning the possibility of stabilizing the German power market through capacity closures. The industry has so far announced 7 GW or 5% of thermal capacity closures over the next 5 years. UBS estimate that this would need to increase 7x to 50 GW to stabilise profits at the 2012 level.

Nordpool is sliding back to parity with German power prices, with demand weaker, weather improving and hydro generation picking up, it’s likely to continue to slide unless winter kicks in colder than expected.

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

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