NrgEdge Staff

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Last Updated: February 8, 2017
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Last week in world oil:

Prices

- Oil prices started the week on a stronger note, as new tensions between the US and Iran raised fears that crude supplies could be affected. The spat has escalated recently with the US re-imposing sanctions in response to Iranian ballistic missile tests. This will colour crude prices over the rest of the quarter, with Brent currently at US$56/b and WTI at US$54/b.

Upstream & Midstream

- Defying protest attempts, Energy Transfer Partners Dakota Access crude oil pipeline linking Bakken shale oil to terminals in Illinois will begin pumping crude as early as June 2017, barring any new legal obstacles. None are anticipated, with President Trump already signalling his support, moving the US$3.8 billion pipeline ahead after it was stalled last September by the Obama administration for environmental review.

- The US oil and gas rig count has exceeded 700 for the first time since December 2015, as strength in oil prices prompted 17 new oil rigs to start up, bringing the total to 729. All but one of the rigs were onshore, with shale plays in Oklahoma, Texas and New Mexico comprising the bulk of the additions.

Downstream

- Perhaps a little too late, Algeria is attempting to ape its OPEC allies in the Middle East by expanding into petrochemicals. It has launched tenders to build four large petrochemical plants linked to state firm Sonatrachs four existing refineries in Tiaret, Hassi Messaoud and Skikda. The investment plans, valued at up to US$6 billion, includes a fuel oil cracking plant and a naphtha processing plant, with a planned petrochemical capacity exceeding 10 million tons per year.

Natural Gas and LNG

- Despite wariness over Russias ambitions, the town of Karlshamn in southern Sweden has agreed to let Russias Gazprom use its port for the construction of the Nord Stream 2 gas pipeline. The decision is supported by the Swedish government after the island of Gotland rejected hosting the pipeline last year, despite lingering national security concerns. The Nord Stream 2 pipeline is Russias latest way of feeding Western Europes appetite for natural gas, running from Russia through the Baltic Sea. Some resistance has been mounted over Russian dependence, and Ukraine has also objected over the possible loss of transit revenues from existing pipelines that run through the country.

- Germanys Uniper is selling its stake in the OLT offshore LNG Toscana terminal in Italy, divesting its 48.24% share in a deal that could value the entire business at 1 billion. The other stakeholders in OLT are Italian utility group Iren (49.07%) and US shipping group Golar LNG (2.69%).

Corporate

- After disappointing results from Chevron and ExxonMobil, Anglo-Dutch supermajor Shell reported its results for 2016, with full year profits down by 37% to US$7.185 billion, but 2H16 profits exceeded ExxonMobils, a rare occurrence. Its debt-to-equity ratio fell from 29.2% to 28%, as it makes progress in its post-BG Group acquisition debt reduction program, with assets sales of some US$3 billion in 4Q16.

Last week in Asian oil:

Upstream & Midstream

- One of the drawbacks of a free market is that it can undermine efforts to influence prices. OPECs supply cut has lifted prices over the past two months, but its power is muted as suppliers from the rest of the world rush to fill the gap left by OPEC members in Asia. Crude from the North Sea and the US Gulf Coast is making their way to Asia already, and some 2.19 million barrels of West African crude is scheduled for delivery to Asia in February, the highest level since August 2011. Meanwhile, Saudi Arabia has raised prices for March crude shipments across the board, including Asia, as it follows through on supply cuts to boost crude prices. It had previously refrained from raising prices to Asian buyers in January and February, limiting its price hikes to Europe and North America.

Downstream & Shipping

- After the departure of Saudi Aramco, Indonesias Pertamina has decided to proceed on its own to upgrade the Balongan refinery. The company, however, warned that the investment will be less than initially planned, with Pertamina lacking the financial muscle to juggle the project along with its wider goals of boosting upstream production. The Balongan upgrade was originally meant to double capacity to 240 kb/d, and expand the refinerys crude diet to include medium sour grades.

Natural Gas & LNG

- Iraq is aiming to up its capacity to process gas by-products from its oil sites in the southern fields, recovering natural gas liquids that would otherwise be flared. State player South Gas Co already runs one gas processing ventures in Basra with Basrah Gas Co (a joint venture between Shell and Mitsubishi), which began in 2013. That venture recovers some 700 cubic feet of gas per day, and competition rules requires that South Gas Co find new partners for the second gas processing venture, which would help reduce the current estimated flared amount of 600 million cubic feet per day. This would increase Iraqs exports of LPG and condensates, but current tensions with the US over President Trumps Muslim ban could see US players frozen out of the venture.

- Italys Eni has struck gas in Indonesia, moving a step closer to developing its Merakes discovery. Successful drills and tested at the Merakes-2 well indicate the excellent gas deliverability of the Merakes reservoir, discovered in October 2014 with estimated recoverable reservers of 2 Tcf of natural gas. Merakes is also just up the street from the another Eni-operated field, the Jangkrik field that began production in Q216, potentially maximising production synergies between the two fields through shared infrastructure. The Merakes field is in the prolific offshore Kutei Basin, led by Eni under the East Sepinggan Production Sharing Contract (PSC).

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High Oil Prices and Indonesia’s Ban on Oil Palm Exports

Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.  

A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.

Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.

Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.

And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.

That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.

Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.

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Market Outlook:

  • Crude price trading range: Brent – US$110-1113/b, WTI – US$105-110/b
  • As the war in Ukraine becomes increasingly entrenched, the pressure on global crude prices as Russian energy exports remain curtailed; OPEC+ is offering little hope to consumers of displaced Russian crude, with no indication that it is ready to drastically increase supply beyond its current gentle approach
  • In the US, the so-called NOPEC bill is moving ahead, paving the way for the US to sue the OPEC+ group under antitrust rules for market manipulation, setting up a tense next few months as international geopolitics and trade relations are re-evaluated

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