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Last Updated: March 1, 2017
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Last week in the world oil:

Prices

-       Persistently high US crude stockpiles continue to put pressure on global oil prices, overshadowing a high compliance rate within OPEC in meeting the organisation’s agreed cuts. Resurgence in American shale production has kept inventories high as demand flags, raising the possibility that OPEC may have to extend its supply freeze to have any impact.

Upstream & Midstream

-       ConocoPhillips has reduced its Canadian oil sand reserves by over a billion barrels, as low global crude prices are forcing it to write down resources previously flagged as recoverable. From 2.4 billion barrels of developed and undeveloped bitumen reserves in Alberta at the end of 2015, the number was revised down to 1.2 billion barrels in the company’s annual financial filings for 2016.

-       The active US rig count inched up again by 3 last week, as five additional oil rigs offset a loss of two gas rigs. All gains were on land or in inland waters, with the additions being in the Permian and Eagle Ford basin.

Downstream

-       The UAE’s Adnoc has secured a deal with trader Vitol to supply 528,000 tons of LPG per year over the next 10 years. Beginning January 2017 and lasting through December 2026, it is an attempt to pioneer long-term LPG contracts to deal with an oversupplied market, the additional volumes will likely head to Asia where LPG is fast becoming a new petrochemical feedstock due to the sharp rise in NGL supplies from the US Gulf.

Natural Gas and LNG

-       Shell, now the world’s largest LNG trader following its acquisition of the BG Group, has set out its vision for the future of LNG contracts. Instead of multi-decade, mass volume contracts common from the 1980s and 1990s, clients will instead begin to demand shorter, smaller contracts to give themselves flexibility in a competitive market that now favours buyers. Shell also predicts that the bulk of new LNG growth will come from countries aiming to replace declining domestic gas production, like Egypt, Thailand and Pakistan, or where demand is growing strongly, like China.

-        The Interconnector Greece-Bulgaria (IGB) natural gas pipeline will begin construction at the beginning of 2018, eventually delivering a billion cubic metres of Azeri gas from the Shah Deniz 2 field to Bulgaria. The project is part of a wider EU vision of a Southern Gas Corridor that will bring gas from the Middle East and Caspian region to reduce dependency on Russia natural gas.

Corporate

-       Under its new CEO, Darren Woods, ExxonMobil looks to continue the supermajor’s stance of promoting energy efficiency and discouraging polluting fossil fuels. Succeeding Rex Tillerson, who led the same stance as CEO before he joined the Trump administration as Secretary of State, Woods has called for a carbon tax to incentivise low-carbon energy solutions for the future. This would put ExxonMobil at odds with the White House, which views a resurgence in fossil fuel exploitation as central to its plan to boost the American economy.

 

Last week in Asian oil:

Upstream & Midstream

-       Iran may be getting in on the shale oil revolution, reporting that it has struck a two billion barrel find in the western province of Lorestan. The area is thought to hold major reserves of shale oil and gas, and the Ghali Koh field discovery confirms it. Iran has rapidly ramped up its crude production levels to pre-sanction levels, and the find signals that it still has room to grow, as it competes with rival Saudi Arabia.

Downstream & Shipping

-       After reportedly close to pulling out of the Petronas RAPID refinery project in January, Saudi Aramco is now back on the project. Announced by Malaysian Prime Minister Najib Razak, Aramco will now partner with Petronas on the project as originally planned, investing up to US$7 billion and securing the refinery’s vital crude supply.

-       After years of delays, Vietnam’s second refinery – Nghi Son – is finally ready to begin production. First crude oil deliveries are expected at the 200 kb/d site in May, the second of three planned refineries that will serve Vietnam’s south, central and north regions. Nghi Son is designed to process Kuwaiti crude, with Kuwait Petroleum international and Japan’s Idemitsu Kosan being major stakeholders with 35.1%. PetroVietnam, which operates the country’s first refinery Dung Quat, has 25.1%, while Mitsui Chemicals has 4.7% of the integrated refining project.

-       Taiwan’s Formosa Plastics Group, hampered at home at its attempts to grow, has applied to the US state of Louisiana to invest up to US$9.4 billion to build petrochemical plants. With the amount of natural gas liquids coming out of the shale revolution, petrochemical feedstock in the US are plentiful (and cheap) at the moment, with Formosa aiming to move production over to the US instead of bringing the NGLs over to Taiwan.

Natural Gas & LNG

-       China’s LNG imports rose by nearly 40% in January to 3.44 million tons, providing an opportunity in an oversupplied market. It is the second-highest figure on record behind December 2016, as China imports the fuel for winter heating, and providing hope that continued Chinese demand may lift the slump in LNG prices triggered by fears of a supply overhang.

-       Bangladesh will be raising the state-controlled price for natural gas for the second time in under two years. Gas prices will be raised by some 23% in two phases over the year, in March and in June. It is an attempt to reduce the government’s burden over subsidised gas prices. Domestic natural gas is currently sold at half the imported price, and the hike raises fears of inflation across Bangladesh’s critical garment industry, as most of the gas used in the country goes to the power industry.

Corporate

-       Rumours that the Indian government was planning to merge all or most of the state oil firms into an energy titan may have gotten some credence with the announcement that upstream-focused ONGC may be acquiring downstream player HPCL. The deal apparently calls for the Indian government to transfer its majority 51.11% stake in HPCL to ONGC, and the purchase of an additional 26% from shareholders by ONGC, worth US$6.6 billion in total.

 

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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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