Strange as it may sound, gasoline is toxic to the oil market.
West Texas Intermediate Crude fell below $ 60 a barrel on Friday morning for the first time since early April. The crucial reason is that the sanctions against Iran were a wet Squib (for now at least). But there is also a more prosaic problem: the ground is made of gasoline. Nymex gasoline has dropped by a quarter since the end of August, a steeper decline than in autumn 2014, the beginning of the oil crash.
Worse, what has happened to improving margins. Chief Chefs on recent earnings announcements for PBF Energy Inc., Phillips 66 and Valero Energy Corp. noted that the "gasoline jumps" (a simple proxy proxy that deducts crude oil costs from the price of the refined product) are weakening. You can see why:
The problem is a weak demand that comes with a strangely growing supply. Gasoline consumption in the US – the biggest demand for oil everywhere – has decreased again. Take, as I wrote here, only one state, Texas, out of the equation, and demand would virtually shrink.
Nevertheless, gasoline production has increased by almost 2 percent compared to the previous year. As a result, inventories are high and net imports have become even more negative:
However, gasoline is not the only product you get when you refine a barrel of crude oil. Another important output is middle distillates, which include diesel. Unlike gasoline, the demand for distillate is still growing and inventories are low. Therefore, getting is good for refineries who throw it out. In fact, the low-margin diesel low-sulfur margin over West Texas Intermediate crude is now over $ 32 a barrel, nearly $ 25 higher than gasoline:
With such diesel margins, American refineries can endure a certain weakness of the gasoline. And that's a problem: So far this year, every barrel of US refinery distillates has produced two barrels of gasoline.
That's the puzzle: the world demands more distillate, but producing means also bringing more gasoline to the market.
Refiners can optimize their production to some extent to maximize margins, and US facilities are well prepared for that. That does not seem to happen though:
The apparent perseverance of gasoline in the US refining yield and an increasing share of even lighter products indicate that the shale boom is playing a role.
Oil produced in formations like the permian is classified as light. Conventionally, this is considered premium crude oil because it supplies products that usually have a higher value, such as gasoline. At the moment, however, a growing share of gasoline looks less like a premium product than a by-product of diesel production. Shale's lighter crude is simply geared towards higher gasoline breakdown compared to other heavier grades.
Light oil in the US is expected to provide much of the new oil supply outside OPEC over the next five years. However, it is unclear how easily the global refining system can accommodate it. While diesel accounts for only about one-fifth of US oil demand, it is closer to 30 percent for the rest of the world, and international refineries are focused on processing medium and heavier crude oil grades.
Something must be given here, and there are signs that some refineries on the East Coast and the Midwest have been slowing down lately. However, about half of the country's capacity is on the Gulf Coast, and these facilities are actually hotter.
The resilience of these Gulf Coast refineries, as well as these robust frackers further inland, are penetrating the global oil market. With the increase in US gasoline exports, they are competing with other refineries, especially those in Europe, who traditionally exported their surplus states. As the Energy Information Administration noted in its recent short-term outlook, gasoline jumps in north-western Europe are already negative, and Singapore's has fallen to its lowest level in years.
More refineries, especially in peripheral areas in Europe and on the east coast of North America, will take offense and further restrict activities. And because refineries, instead of you or me, are buying crude oil, that means demand and price, as crude oil will suffer as well. As the economist Phil publisher likes to say, crude oil usually follows the price when it comes to prices.
The result is that, in addition to the widely visible placards of Iran, Venezuela and the OPEC policy, lower flows are driving oil prices. The fuel gluteal acts as a pulling force on it. Refining refineries are also hampering diesel supply, strengthening those margins and pulling oil prices in the opposite direction, especially for medium-sized ones. High diesel prices are already a problem for key sectors of the global economy, such as truck traffic, and new regulations on ship emissions in 2020 could peak in the near future (see above).
The net duration of hedge funds in the main futures contracts for crude oil and refined products has halved since January as open interest continued to decline. Obviously there are fewer bulls. With everything in play in 2019, it's possible the smart money just feels confused.
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Liam Denning is a columnist for Bloomberg Opinion on energy, mining and commodities. Previously, he was editor of the Wall Street Journal column Heard on the Street and wrote for the Lex column of the Financial Times. He was also an investment banker.
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