Petchem strength points to a cyclical recovery in oil demand

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Link to full report including important disclosures: http:// research1.ml.com/C?q=Fb/MbIkAkUIUBQv367VMnA==&s=edwato

Both crude oil and distillate prices have fallen recently...We recently argued that the upside for oil prices was capped near- term due to a number of factors, including the end of winter. Since we released our note, faster-than-anticipated monetary policy tightening in China, a surge in Greece sovereign risk, and increased regulatory uncertainty in the US financial sector have reduced risk appetite and fuelled a rally in the USD. Crude oil prices have fallen across all regions and middle distillate cracks have eased. And yet, despite this price drop, we still see physical demand for petroleum products continuing to improve.

...but increased petrochemical runs suggest a recovery aheadA surge in petchem demand and a steeply backwardated naphtha market suggest that, in absence of major external shocks, a cyclical recovery for the broader economy is around the corner. Historically, demand for naphtha, a key input into petchem processes, has led demand for other petroleum products. It should be no different this time. With more demand and low refinery capacity utilization, global naphtha stocks are drawing quickly. Currently at $2.10/bbl, front- month NWE naphtha cracks are above the seasonal norm, and backwardation in naphtha and other petchem feeds such as propane or butane could continue in the near-term.

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Tight now, liquid gas supply is increasing in 2H10In addition, we project an 8.6 million tons/year increase in ethylene cracking capacity this year, suggesting that the market will be craving for incremental feedstock. However, a potential increase in OPEC NGL supply of 600 thousand b/d this year should temper propane prices, limiting the upside on naphtha as these new barrels enter the petrochemical stream. Thus, with the end of winter reducing demand for liquid gas and petrochemical units going into maintenance in early March, the strength in the very light ends could start to fade as other parts of the barrel like gasoline and middle distillates start to pick up some steam.

Please see full report for further details...

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