Welcome to Hot Commodites Edition 4: Texports and Vanillionaires
Welcome to the fourth edition of Hot Commodities. This bi-weekly newsletter uses the PanXchange team’s experience and knowledge in physical commodities to bring you perspectives on what’s happening in the elusive, opaque domestic and international markets. And, of course, we're going to keep you up to date on blockchain -- what's working, what's practical, and what's downright lunacy.
Texas Becomes a Net Exporter of Crude
With booming U.S. crude oil production and relatively flat product demand year over year particularly for gasoline, Texas has become the outlet for marginal U.S. crude oil production, with exports overtaking imports for the first time in decades. Can export growth continue at this pace?
The first limiting factor would be delivery to the Gulf Coast. Takeaway capacity out of the Permian is all but maxed, with the next pipeline capacity additions coming in 2019.
We’ve seen a few crude-by-rail contracts signed and shipments sent out, but the volume potential is relatively low. WTI Cushing vs. Midland prices reflect this constraint, with basis differentials above $10, and even seeing $16, translating to a flat price in the low $50s in the Permian basin.
Completions (making a drilled well ready for production) in the Permian have flat-lined and frac sand prices have dropped in tandem (see below). When takeaway constraints ease, this gives operators more room for higher crew costs, which are the other major costs on the completion side and have been rising with the tight employment market.
The second factor is the export facilities. LOOP (Louisiana Offshore Oil Port) is currently the only major Gulf export facility able to handle full loading of VLCCs – the largest crude carriers – for export. Corpus Christi is developing the Harbor Island Port, which is scheduled for 2020 completion, and currently partially loads VLCCs at OXY Ingleside Energy Center (OIEC) export terminal with the remainder loaded from smaller transport vessels for offshore.
Another major factor is the type of crude. The marginal crude oil production has been light, tight shale oil with high average API gravity. U.S. Gulf Coast refining capacity is not set up to take the amount of light oil the U.S. is producing, with Europe and China absorbing the excess. How much of that light oil is displacing other grades of light oil, and how much more can the world absorb? Those are the billion-dollar questions.
Frac Sand Update
Frac sand markets are experiencing the pain of the takeaway capacity constraints from the Permian, as noted above. As an input to a boom-and-bust market, proppant not only has its own growing pains, but is particularly sensitive to the output markets. In the last update, we explained how high prices spurred huge investment in new sand mines, backed by offtake supply agreements. Since the deluge of supply, much of it in-basin Permian, hit the market, buyers have been facing a tough decision about how to act on the offtake agreements.
Here’s a snippet from our weekly market update:
"We believe that current pricing is sparking internal debates as end users decide how they wish to proceed. Term contracts have essentially become a call option for end users with the premium being the take-or-pay penalty acting as the option premium. At a certain point, it will make sense to pay the penalty on term contracts, buy on the spot market, and recover a few dollars per ton."
As many global ag markets struggle with bumper crops hitting the markets, traders found a new shining star in the global route. The price of natural vanilla traded above silver at times over the past year after a tropical cyclone slammed the island of Madagascar in March 2017, destroying a large amount of the crop in two major producing regions, with new flowers taking three to five years to start producing vanilla beans.
The boom in prices and high market share in Madagascar (see production figures to the right) has created a class of “vanillionaires” on the island. These vanillionaires are mostly traders and middlemen who aggregate production from smallholder farmers and sell in export markets.
Numerous initiatives started over the years aiming to give smallholder farmers in the supply chain more of the revenue from international sales, but disintermediating the traders and brokers in the middle of transactions is a tough endeavor.
Brazil basis soybean prices dropped significantly the past week after Chinese traders…well, pretty much bought them all. Demand dropped after Chinese buyers purchased as much as they could of the record crop as 25% retaliatory tariffs from the Chinese government on US soybeans hit.
So, what’s next for U.S. beans? We’ve heard reports of U.S. soybeans landing on Chinese soil, but who exactly paid the tariff is not clear. The bulk of the U.S. harvest begins soon and could be a stressful time for U.S. farmers as they wait and see how long Chinese buyers can hold out. It will be particularly tough, as the USDA WASDE earlier this month expects 51.6 bushel per acre average, leading to a record carryout. The USDA also announced the structure of the farm payouts with estimates of a total of $4.7 billion with the bulk going to soybean producers. Payment rates and estimated payments from below.
With the next Brazilian harvest due in February, it will be a long haul, and if there is no alleviation of the trade war, there will be a time and a price that makes sense.
A note from CEO Julie Lerner:
Since penning this article for the Futures Industry Association's MarketVoice, I've had several opportunities to speak with fellow industry leaders about all the blockchain hype and where the true potential for physical markets lies.
Reactions to the article and my tweets and commentary have been extremely consistent from the trade. First, we can ignore the hype over blockchain and accept that nothing is going to happen overnight - BCG a few weeks back published A Reality Check for Blockchain in Commodity Trading. Second, those most enthusiastic about blockchain are technologists, not those with deep industry knowledge of the problems and opportunities in physical commodity supply chains. Proof of concepts don’t necessarily translate to mass adoption. We need to focus on ONE ASPECT first, such as the highest point of pain in the post-trade transaction. Bills of lading, perhaps?
Finally, the best way to build a roadmap for a successful blockchain implementation is to focus on those who will be using it. Thus, I am exploring the appetite to launch a global physical commodity blockchain alliance. PanXchange is perfectly positioned as a neutral and global market structure solutions provider.
Should we proceed, the alliance would invite the strategy and operations executives from leading international trade houses to an open discussion. We would identify the priority of problems that could be solved with blockchain and decide which to address first. Only then would we begin discussions with vendors to see which systems are most adaptable to the industry's needs.
If you are interested in participating in this group, please contact email@example.com
Another Blockchain-based exchange was announced this past week, this time allowing anyone in the world to trade esoteric products, namely “tokenized” warehouse receipts, in the bastion of ethical business practices, Nigeria! How does it work, you ask?
“When a farmer or depositor brings a commodity into a warehouse, a warehouse receipt is issued and converted into a token which can then be traded on the blockchain platform. This is what Binkabi calls the ‘tokenisation of commodities.’
“It makes the commodity tradable instantly, and you can also use the token as collateral to borrow money from a bank,” Le says. “More people can engage in it, and really make the market very liquid.”
While a blockchain might be immutable in certain ideal world cases, tying any token to a physical commodity asset in some warehouse in the middle of Nigeria immediately removes all ideas of credibility. I think the Birch Model blockchain decision tree below explains this one well.