The slow decline in the oil/natural gas ratio that has persisted through the year continues – this time oil is falling faster than natural gas as both are reacting to slower demand or expectations of slower demand. We are unconvinced that the price declines will continue, but it is much less clear which direction the ratio will move. OPEC+ has far more chance of keeping cash flows high by trimming volume to balance the oil market and the overwhelming strategic logic of such a move means that it is a likely path – there is no 10-20% boost to demand to be found by lowering prices. US natural gas is still on a medium-term demand march higher in our view and more limited E&P spending should keep the market balance quite tight. There are no near-term large increments of new LNG capacity on the horizon and consequently, inventory and pricing will likely bounce around on weather changes for a while. See more in today's daily report.
The methanol supply constraint in the US will add to the price momentum that we are seeing today, in part helped by the higher natural gas price. Despite the higher US natural gas price and the much weaker Asia price, there is still enough margin in US exports to Asia to justify the trade, although US producers would see meaningfully lower margins from these sales. However, to keep the US market balanced, pushing any surpluses offshore makes more sense than pushing into the domestic market and risking price declines. Much as in the polymer markets, US domestic sellers have quite a bit of pricing protection because of the high costs of getting any competing material into the US. See more on Methanol in today's daily report.
If this commodity cycle has the same drivers as prior cycles, producers like LyondellBasell and others will make comments like “stronger of longer” until prices turn, and if history is any guide, that turn will catch everyone by surprise, and even if it does not, there is no upside for any producer in predicting its end. As with all commodities, markets are tight until they are not, and markets are long until they are not. If you look at the ethylene and propylene price movements in the exhibit below you can see the speed of change that is possible and while the slope may be less severe for polymers in both directions, it can still be abrupt. The worst-case for the US industry would be a step down in demand coincident with the rising natural gas trend. There is no evidence of demand weakness today, but there will not be until it is happening. The extraordinary incremental freight rates shown in Exhibit 1 of today's daily report, make it increasingly unlikely that anyone sitting on surplus polyethylene or polypropylene in Asia can exploit the regional price difference. When demand and sentiment around supply chains turn, we would expect this spot shipping rate to collapse also – but there is no sign of that today.
Methanol prices in the US remain very robust and quite profitable for producers, despite weakness in China. The higher natural gas price in the US (see today's daily report) provides some support for methanol pricing, but ultimately coal-based methanol in China will win out if US costs keep rising and this may curtail demand for US methanol at the margin. As with all other chemical and polymer markets today, freight costs are making it difficult to play off some of these apparent regional arbitrages and the US methanol producers would have to be somewhat reckless to upset the balance domestically and give up the margins that they have today. Domestic demand for methanol derivatives is high and the LyondellBasell accident may provide more pricing strength through the acetic acid chain. While the incident will decrease the demand for methanol, LyondellBasell should be able to manage this, and higher pricing in the acetic chain would mean that consumers would have no issue paying current prices. Higher MMA production in the US – implied in the headline below - should keep methanol demand high.
The Halliburton forecast of an upcycle for oil services likely needs to be put into context, as while activity should rise in the sector with higher oil and gas prices, it is unlikely that we will see a major boom. The uncertainty in the energy market, coupled with ESG pressure and borrowing constraints means that the oil industry will likely focus on its lowest hanging fruit first and may hold off on secondary opportunities completely. The oil service guys will benefit because the more productive shale wells can require longer laterals, deeper wells, and more fracking pressure, but it will likely be quality over volume when it comes to drilling activity, in keeping with what we have seen year to date.
The commentary on oil reflects the opposing views that OPEC+ capacity is looming and that every piece of incremental negative demand news is frightening, versus that OPEC+ is disciplined and wants higher prices, resulting in every incremental positive being welcomed. We are firmly on the side of higher oil prices as we cannot see any stakeholder in oil wanting anything except opportunity profits for as long as it may last from here.