The attacks on Saudi Arabian energy infrastructure have prompted a rethink across LPG markets. While the initial panic has subsided, the market is struggling to return to business as usual. A limit to the prevalent bearish market sentiment has emerged and further upside risk is on the rise for Q4 19. The real proof of Saudi production recovery will ultimately lie in the November LPG and naphtha lifting programmes. Any delays of cargoes into early December will surely fuel traders’ fears of prolonged supply issues, pushing some of the tightness into November and December swaps.
The attacks have exacerbated existing geopolitical risks in the Gulf region amid US sanctions on Iran and efforts to reduce Iranian exports to zero. On top of this comes more evidence that US shale supply growth is falling short of lofty expectations. Recent US production data has led us to revise our US supply forecasts down to 4.88 mb/d (+0.51 mb/d y/y) in 2019 and 5.32 mb/d in 2020 (+0.44 mb/d y/y), compared to y/y upticks of 0.53 mb/d and 0.51 mb/d in our previous forecast as onshore producers scale back drilling programmes with crude, NGL and natural gas prices still under pressure.
Moreover, rising long positions, particularly in US butane, are now no longer merely anchored on a cold winter. There is now growing bullishness in gasoline amid a possible tightening in short-term PADD 1 balances and as a result of feedstock competition with very-low-sulphur fuel oil for vacuum gasoil as part of IMO 2020 in Q1 20. While this could put a floor under gasoline prices in the new year, the resulting reduction of FCC rates means butane and naphtha—which will be further displaced by Tier 3 gasoline sulphur regulations’ full compliance—face fresh downward pressure.
No doubt butane prices will be closely linked to the vacillations in gasoline prices in winter, when it is the primary blendstock, but we maintain that oversupply will prevail, especially when naphtha is pushed out of the gasoline pool as a result of Tier 3. Should the gasoline pool shrink substantially amid the IMO feedstock fight, both LPG and naphtha will look again to petchem cracking as a primary source of incremental demand, reigniting the ‘race to the bottom’. A further degradation of Brent prices could give naphtha the edge, however, hurting LPG demand, which we expect is likely in Q1 20.
The upshot is Q4 19 now looks a lot more constructive, but much depends on Saudi’s November LPG export programme. The Kingdom has made great efforts to paper over the damage to its supplies, but there have been plenty of delays to October exports already. If this persists into November, the market will sit up and take notice. But the operative phrase here is ‘near term’. The expiry of most US Tier 3 gasoline sulphur credits at year-end means higher sulphur naphtha is going to be displaced from US gasoline blends and LPG will seek to remain competitive in order to maintain its space in the petrochemical cracking pool. But coming to counter that in in H2 20 is a further downside trajectory to US shale output, which somewhat blunts our view of oversupply amid beleaguered demand. Bullish positions in the next few months for LPG and naphtha are increasingly justified; the battleground for LPG and naphtha prices has now shifted to the back half of next year.