LPG Markets Under Middle East Conflict Pressure

Peter: Hello, and welcome to the latest "Global LPG Conversations" podcast from Argus Media. Peter Wilton here, editor of Argus's international LPG publication, our daily pricing service we put out for the global market. And I'm joined today by Jack Greenwood who heads up our LPG consulting business here. Hello, Jack.

Jack: Hello, Peter.

Peter: And also by Waldemar Jaszczyk, deputy editor on our European pricing team here in London. Hi, Jaszczyk.

Waldemar: Hey, Peter.

Peter: And today on the pod, the three of us are going to discuss the most recent market and pricing developments following the memorandum of understanding between the U.S. and Iran that has given some genuine hope that we may be at the sort of beginning of the end of war in the Middle East and the resultant supply shock that's really been top of minds for all those exposed to LPG prices in recent months. First, I'll be turning to Jaszczyk where we'll be looking to sort of cover a backwards view of how global trade and prices responded in the build up to and the subsequent announcement of this peace deal. We'll be taking a real broad approach here really.

There's no corner of global pricing that was untouched by this crisis. We'll check in on China, Europe, as a continent-wide view on Europe, and also, northwest Europe, the main sort of pricing hub in the region, we'll look at India, and of course, the U.S. With that covered I'll move on to a discussion with Jack where I'll be looking to tease out his forward-looking view of what this means for supply demand and pricing over the coming months. Just, you know, how a potential return to, you know, "normal" Strait of Hormuz transit will impact things, and how quick can we even expect supply to recover if this really is the beginning of the end of hostilities?

But first, as I said, I'll turn to Waldemar. I think we should probably start in Asia. It's of course, this region that, you know, is the globe's most massive net short region. And so, it really sort of provides price direction for all other regions. Quite often other areas of the globe pricing there sort of falls out the back of what's going on in Asia. So, Waldemar, in the build up to the MOU, how were things in these eastern markets?

Waldemar: Well, for Asia, but also globally, you could really distinguish two phases of this conflict. And the first one that we covered at length was the bullish run in the first weeks, a scramble for alternative supply with the closure of the strait. But the supply shock and resulting price surge has taken a heavy toll on Asia Pacific consumption. India, which is the most affected, country worth reminding that a 90% of the country's imports came through strait of Hormuz last year, their imports almost halved in April to an eight-year low of around 1 million tons. And of course, sellers were forced to hike retail prices in response to this tight supply. And demand was not unaffected. Indian consumption declined about 20% on the year in May to a 5 year low.

But we also had a lot of mitigation measures that kind of help the market to deal with the drop in imports. Refineries under instruction from the government raised LPG production by almost 50% mainly through redirecting an LPG supply that was going to petrochemicals. Flows also after the initial shock started to rebounding a bit. So, from 1 million tons in April, we went to around 1.3 million tons in June with record volumes coming from the United States. And there was some modest uptick in Middle East Gulf flows, but I mean, nothing compared to pre-war, mostly coming from ship-to-ship transfer offshore Oman. So, the combination of the declining demand because of the price shocks, higher refinery production, and just more optimists, I suppose, has calmed the market, and actually, allowed the government to restore LPG supplies to commercial and industrial consumers recently to pre-war levels compared to, obviously, quite a bit of a cut that they had to take when the first supply shock happened.

Moving on a bit east to Southeast Asia, here's scramble for new imports from the likes of Indonesia or Philippines combined with the same factors on the demand side. So, waning use because of the price shock and limited initial supply actually flooded the country's inventories. So, this demand erosion, high inventories began to limit spot buying even in the lead up to the deal, and that hasn't changed a whole lot since. Another country, China, big buyer on Middle East and LPG, saw a bit more of a recovery leading to a deal. And that's because of improved PDH economics supporting consumption. PDH margins reached five-year high by mid-June driven by significant propylene and polypropylene production cuts, refineries, and steam crackers. But all other sectors, demand-wise, remain quite depressed.

Peter: Okay, and Chinese demand is, of course, massively influential in Asia Pacific pricing benchmark the Argus Far East Index. These prices naturally soared in the initial reaction to the war, of course. Everybody was scrambling for supply, massive competition for cargos, those prices really, really flew. But what impact has this sort of demand destruction you mentioned had as time went on?

Waldemar: The impact of the demand destruction was massive. It pushed our benchmark propane Argus Far East Index for propane down by around 40% from their peak. And the peak was a 12-year high reached in March of around $1,131 per ton. So, we're down 40% even before the deal was announced. And then another hit from the bearish hit from the deal put the prices down by 17%. Obviously those prices then began to kind of recover as we had the violations of the peace agreement including recent days. Another important thing to notice is that the supply glutes that I mentioned, basically, raised butanes premium to its propane equivalent, which had reached around $156 in April, an all-time high. Of course, the war as we mentioned, many times hit butane supply globally much harder than propane given the even split nature of Mid-East Gulf cargos.

Peter: Yeah, totally. That's been a big factor we've been mentioning a lot. And any sort of analysis that has been looking at this as an LPG supply issue is really sort of selling you short really as a client because, of course, it affected butane so much more than it did propane for factors, you know, covered at length in prior podcasts. So, just back to the prices, a real climb down indeed, you talk of there, not so much completely back to normal, but down massively from the extreme levels you mentioned. That covered, I'd just like to switch geographies if we can please, Waldemar. We'll move from Asia to the other big net short region and real key global pricing hub, Northwest Europe. How have things looked there over a sort of similar timeframe that you've just covered for Asia?

Waldemar: Yes, of course, always keen to talk about Northwest Europe more over my forte with the pricing side. And the impacts of the Asian supply squeeze as a result of the war was much more limited than initially expected. Of course, the region doesn't take any product from Middle East, but it does compete with Asian buyers for U.S. production. And there was an initial squeeze especially in March when everyone was scrambling for U.S. terminal tons. And there was limited additional capacity for spot cargos that could be added.

But then we were kind of shielded by it, at least partially, by Panama Canal congestion, rising freight rates, and lengthening freight routes, which kept some U.S. cargos within the Atlantic basin despite much stronger eastern netbacks. The flows did weaken a bit, but that was offset by higher supply locally. So, we're talking about North Sea supply, but also robust refinery production with operators increasing run rates to capture steep product margins. Also, worth mentioning is that record imports of lighter U.S. crude replacing lost Iraqi barrels also boosted LPG yield from the refinery.

On the demand side, we did see heating consumption, basically, collapse due to higher prices, but also, warmer weather as we came out of winter. And that really reduced the draw from the inland heating markets on product from Arab break bulking terminals. Which in turn reinforced importers hand-to-mouth buying strategy which they had adopted ever since the conflict erupted.

On the petrochemical side, the demand did not rise substantially despite propane reaching record discounts to the competing feedstock naphtha, because the use of the lighter grade in the region's flexible steam crackers was already pretty much maxed out. We will see probably a bit of an uptick in consumption because of the restart of the Dow's Torneos and Cracker, which we covered also at large. But for now, we haven't seen much of a shift in the market because of a pet cam usage.

And because of all these bearish factors or managing factors, propane large cargo CIF ARA or benchmark for the region collapsed to pre-war levels in the days following the deal. Basically, halving from the peak also reached in March of just under $1,000 per ton, which was the highest level since 2022. On the butane side of things, we also saw the premium to propane, which also initially skyrocketed narrow quite significantly. Propane is still at the premium to propane, but importers from the petrochemical sector basically switched from buying expensive U.S. butane cargos to smaller, but much cheaper barges and coasters coming from local refineries and North Sea.

Peter: Yeah, no, that totally was a massive factor on the butane side here in North West Europe. Those sort of switching from the big cargos to the small really took a substantial amount of buying away from that bigger market. So, just to sum up, I guess, it's quite simple in a way. The very, very firm market had been in place in both of these two big global shorts, North West Europe and Asia Pacific is now sort of largely behind us to the extent that the peace deal holds. I'm conscious, however, that we've been focused almost primarily, or actually, exclusively on the demand side so far. There's of course two sides to every trade. So, how have the sellers... You know, the net longs fed of late in LPG, there's only really two big regional sources of excess supply, the Mideast Gulf, of course, and the U.S. That the pair between them actually account for just over 70% of all global seaborne exports annually. So, we'll move to the U.S. here, if we may. How has U.S. selling sort of been affected of late?

Waldemar: Well, as I said, the war was really a boon for U.S. LPG export as the only really replacement for loss of Middle Eastern tons. And LPG exports from the Gulf Coast and its coast reached a record high of just over 7 million tons in May as Asian buyers look to fill the gaps. But as I mentioned, because of this demand destruction and higher internal outputs, even before the deal potential cargo cancellations had been discussed, and the peace agreement only intensified that by shutting the U.S. propane arbitrage into Asia in the days following the deal potentially being to as many as 12 cargo cancellations or deferrals for July. Which goes without saying, quite significant. But overall, looking a bit short, medium term, more medium term to long term, this war has exposed fragility of the Mideast Gulf supply. We have, obviously, violations happening throughout since the since the deal was announced and throughout the ceasefire as well that preceded it. So, I imagine that Asian buyers will still look to the U.S. for alternatives and hedging their supply.

Peter: Yeah, absolutely, and that's because this story doesn't feel over, not by a long stretch, in fact. We actually sit here recording on the morning of the 8th of July, and the breaking news just this morning was U.S. President Donald Trump suggesting that the MOU could well be over following the return of air strikes between parties overnight. And, well, the outlook, frankly, even before that most recent development this morning was murky. But it's to this outlook that we will now turn and bring in Jack. So, Jack, supply wise how are things looking? I mean, Strait transits have ticked up, although AIS data is not showing a great deal given, you know, widespread turning off of transponders as they transit. But there is a lot going through dark as it were, as we understand it.

Jack: Yes, thank you. So, yeah, let's start with just briefly discussing the terms of the MOU. And the key parts here to discuss is really the fact that in the agreements there is free shipping through the Strait of Hormuz that traffic should return to pre-war levels, but also, that there will be removal of sanctions on the Iranian regime and particularly on Iranian exports. So, on the face of this, that looks like it should not only restore trade flows, but actually, even increase them as Iranian exports are fully unleashed. But in practice this has not really happened. A lot of ship owners remain cautious about transiting the strait for multiple reasons, and as well, the actual governments within Iran, those within the Gulf itself, are not necessarily going to rush to head to restart.

That being said, there is has been some bullish factors here. The UAE, for example, will restart in their production quite even before the MOU was announced. And for that reason, actually, it does look like we are looking a bit more optimistic than we were maybe a month or so ago. But even so, it's the restarting of production is likely to take several months. On top of that, there's also issues with the facilities and potential damage that has gone there due to the drone strikes that Iran launched against its Gulf neighbours.

And on top of that with the crews of these NOCs often acting to repair existing assets, they're unlikely to be able to bring forward announced expansions that they were previously working towards such as Jafurah, which will now likely be coming online slower than previously anticipated. Which in turn means that the production growth that we were previously expecting will not become online, and this loss of supply may extend forward several years due to this knockback effect on the market.

Peter: Yeah, absolutely going to be some slippage in previously expected dates for preplanned works that were going to take place in the region, of course. We have so much more restorative work to do on export sites there. So, that's the supply side, I guess, laid out as clearly as possible given the overarching murk that I had mentioned in regards to our outlook at present. How about the demand side? More clarity there?

Jack: Yeah, so what we could say with the demand is that the fastest demand to return of the demand that's been destroyed is going to be the petrochemical sector, and in fact, it has responded even faster than the supply side did with, for example, Chinese PDH run rates rebounding from below 50% utilisation to almost 70% in recent weeks. Now, that being said, that's still significantly below where they were on the pre-war level, but there's definitely optimism going on there. We expect utilisation to average around that same level of just below 70% for the rest of the year, and on the same time, also going to see upticks in the steam cracker sector as well. And they will probably be heavily using LPG due to lingering tightness in the naphtha market, which has also suffered over this same period.

On the other hand, energy demand is going to be slower to return back into the market. The residential sector has taken a pretty big hit, which is unusual, but it goes to show just how tight the market has been over the Strait of Hormuz closure. India was, by far, the biggest hit in this sector, and the fact, that the Indian market now has lifted the restrictions that we were previously talking about where refiners were heavily incentivised to produce more LPG into the market. So, that means India should be importing more LPG going forward.

One thing to keep in mind as well though is that residential demand usually doesn't rebound as strongly as something like petrochemicals do. The reason for this is that when petrochemical demand is destroyed, this is simply facilities turning themselves off and not running, and when the demand comes back again, they can simply turn back on again. With residential demand though, it's usually a case of people switching away, you know, you still need to cook, you still need to heat your home, etc.

A similar comparison this was in Europe in 2022 when natural gas prices surged. And to this day, we have still not seen demand fully returning in Europe as a result of this price surge. But we think it's going to be less likely that we see a similar result happening in South and Southeast Asia. In Europe, much of the demand was lost to electrification or other forms of energy. Whereas in South and Southeast Asia, a lot of the switching occurred back to firewood, which is, obviously, not an ideal solution in the world right now. And so, we expect people to move back to LPG rather than be permanently lost. Although there will be some level of loss going on here that is pretty certain particularly in China where a lot of people switched over to electrification.

But if we move forward a bit and look at really what's going to be the key determinant right now, which is the geopolitical situation and how that unfolds going forward. So, if you look at the market right now, current prices, futures markets, etc., essentially every commodity right now is assuming that there's going to be a very swift normalisation of Hormuz flows, and at least at time of recording, this is probably a bit optimistic. There's obviously the escalation that we spoke about, that Pete spoke about earlier in the call. And so, we are generally expecting that this sort of disruption will likely continue over the remaining few months. Although, we also do expect that ultimately, the MOU will hold and there will eventually form a lasting peace at the end of this process. It just will probably be a rocky road and maybe take several months for that to eventually arrive.

Peter: Yeah, absolutely, I mean this whole crisis has been unpredictable in the extreme. I remember back in early March, just in the sort of foothills of this really that the consensus view of most I was speaking to in the market was real certainty that we'd be measuring the supply disruption in days, at worst, weeks, but certainly not months. Yet here we are well over three months since those first U.S. Israeli strikes on Iran at the very end of February.

Just to change tack somewhat I'd like to zoom in now and just pick your brains on how inventory stand globally. Now, stocks are absolutely vital in understanding any market at all. You just got to understand how much product you have globally in storage if you want to understand anything to do with, you know, prices either now or in the future. And LPG stocks follow a seasonal pattern, you know. That they naturally draw down in northern hemisphere winter, build in spring, and post their biggest builds in summer. But this natural order has, of course, naturally been affected by the millions of tons effectively lost from the Strait of Hormuz. So, Jack, where do we stand here? How are stocks looking?

Jack: Yeah, no, I mean, you're right. Inventories are really the key factor to be looking at here. Because even if we get Strait flows back, if it comes too late in the year, we might not have enough LPG to last throughout the winter heating season, which is, obviously, so important. Because even at maximum production, the market is unable to keep up with that winter heating demand and stocks must be drawn down.

So, in an optimistic scenario, let's say that the current situation manages to resolve itself quickly and we get a very smooth return to flows in the sector was, basically, a best case scenario type situation. Even then, the loss of production we have had so far this year will mean that inventories likely end down about 2.7 million tons lower than they were at the start of the year, which is a perfectly manageable amount. That's a normal amount of inventory drawdown to expect in a particularly high-demand year.

In a base case though if we're looking at a bit more of a more difficult return, we're looking at more like 4.3 million tons, which would be a very, very large drawdown. In a normal year, that would put inventories in pretty dire condition by the end of the year. But fortunately, the LPG industry started the year with record high inventories due to persistent oversupply over the past couple of years. And so, in that in that situation, the market should still be fine, although we should expect higher prices due to the removal of this oversupply that we have previously seen.

However, in a worst case scenario, the MOU fails, we get back into open conflict, and then we need to rebuild the peace process again. We're looking at the Strait process, reopening process not starting for another two three four months, potentially. We're looking at well above 6 million tons of stock draw this year, which would put inventories scarily close to tank bottoms. And if that persisted, it would go it could go even higher than that, and we would end up with very severe price rises in this tail risk scenario because the market would need to preserve whatever inventories it had at the end of the day. And obviously, it's worth finding out as well, in this scenario as well, it wouldn't just be LPG inventories that would be very tight, we'd also be looking at markets like crude and natural gas that would be really struggling at the same time, which would put even more pressure on LPG to absorb what burden it can take.

Peter: I mean, that really would be a sort of challenge like none of what we've seen in the LPG market even after a few years now of really choppy environments. So, we're going to be closely watching all of this in coming weeks, of course, but we're so much down to geopolitics. I have to say, Jack, I really don't envy your role as Forecaster in Chief at Argus LPG Consulting right now. And before we just close out this chat, I'll just come back to you once more. I wonder if maybe you could sort of just bring it together. I've covered quite a lot here. But even with this sort of inherent uncertainty clouding all outlooks at present, what is your view now, and what factors are you watching that might change this?

Jack: Yeah, so I think the big thing to point out is that prices have come down a lot in the past couple of weeks since the MOU announcement. But we expect this to be sort of the bottom that they come to and there's likely to be a rebound in coming months even in the situation where we have a good situation Strait of Hormuz. And the reason for this is, obviously, we need that contango to build up inventories ahead of the winter heating season, and also, this rapid return of petrochemical demand which is putting a lot of pressure on the existing supplies.

New VLGCs are coming forward into the market that's a very, very large order book over next year or two. And what that's going to do is it's going to bring down the cost of freight and enable a lot more U.S. LPG to enter the market, which will help compensate for lower Middle Eastern exports as they struggle to bring back all of their supply. But because of this longer route we're seeing out of the U.S. market, that's going to mean that even with this extra shipping capacity, there's going to be very strong freight markets expected ahead as ton-mile demand will remain high. Looking at the broader energy market is also another key factor to go ahead, and a lot of the risk premium that we expect to see in these markets as well as inventory rebuilding in things like crude oil is definitely something that could be difficult for the market and promote high prices.

So, the best way to analyze this we really think is with case analysis. And in a bearish case smooth, Strait of Hormuz returns, we probably get a pre-war pricing to walk by the winter heating season of around like low $600 per tons for the AFEI. In our base case, we are probably going to see around $100 per ton premium to pre-war pricing. But there is this very substantial tail risk with the bullish scenario as we outlined, where if inventories do start to approach that tank bottoms, then we are looking at very, very high prices going forward because the market is going to need to protect those inventories. Assuming we don't have this worst case scenario, we can expect that LPG to probably return to normal pricing by the middle of 2027 onwards, though at least relative to the broader energy market. But it will probably be slightly higher than pre-war forecasts due to this ongoing risk premium and need to slowly rebuild crude inventories and strategic reserves over that period.

Peter: Right, sure. I think that's about as clear as one can be right now. You know, this is how we see it, but this is what could move it soon enough. And all that leaves me to say, actually, is to thank you both very much for joining me today. It really was a comprehensive overview of how things have looked and how things may look going forward. And yet as mentioned, you know, once or twice now, especially so in light of recent comments from the U.S. side of the equation, things really are moving quickly. And for that reason, we will of course be back on the podcast in coming weeks, I'm sure, to cover the next developments. But until that time, this has been "Global LPG Conversations".