With everyone now talking about the record gasoline glut, something which we first predicted in February is the “big threat” to oil prices, oil finally succumbed to the unprecedented imbalance in the market, not only on the crude side of the supply-chain, but more importantly in the past month, on the product side, led by both record gasoline stocks as well as soaring Chinese exports of gasoline, distillates and other refined products.
To underscore this point, earlier today Morgan Stanley’s Adam Longson – a prominent oil bear – released a note saying that “A refinery-driven correction is upon us.” Some of his key points:
Along with supply disruptions, healthy refinery margins and overly bullish sentiment towards global gasoline helped drive abnormally high crude oil demand in late 2015 and early 2016 – well beyond what product markets required. While such appetite for crude oil helped to improve crude oil statistics in some regions, it simply resulted in a market awash in product, namely gasoline. With inventories above 5Y highs in almost every region, product margins have been falling sharply. This product overhang will weigh on crude oil markets as well, just with a lag. As refinery margins continue to fall, refiners will look to cut back on utilization, leading to lower crude oil demand. Ultimately, this should lead to distressed cargoes, deeper contangos, inventory builds, and lower prices.
Just as bad, the widely anticipated gasoline demand surge, which was supposed to open the gasoline inventories and provide the impetus for the next leg higher in crude oil prices, never happened. In fact, gasoline demand, according to Morgan Stanley is decelerating.
Refined product demand is decelerating, especially in key gasoline and diesel markets. Transportation fuels, and particularly gasoline, are the most valuable products in the barrel, but demand growth shows signs of slowing. China has been a large source of gasoline growth in recent years, yet growth has slowed markedly. Gasoline demand fell 1.8% YoY in May (after growing 12-15% for much of 2015), while diesel fell 11%. Many EM countries responsible for growth are also slowing as lower commodity prices and the removal of oil subsidies crimp demand (e.g., Saudi Arabia, Brazil). The US and India have been bright spots, but even here we are seeing signs of deceleration in recent data points. US April gasoline demand was below March, counter to seasonal trends.
Crude oil demand is trending below refined product demand for the first time in 3 years. Refineries are the true consumer of crude oil, and crude oil demand is ultimately more important than aggregate refined product demand for oil balances. Given the oversupply in the refined product markets, fading refinery margins, and economic run cuts, we expect crude oil demand to deteriorate further over the coming months.
The result: after tagging $50 just several weeks ago, WTI is back under $43 and accelerating its drop in a move reminiscent of the price action in the second half of 2015.
However just because the problem has been recognized, that doesn’t mean that anything is being done to address it. To the contrary: according to Reuters, refiners are now shifting to yet another desperate attempt to delay the inevitable market equilibrium point. They are doing so by switching from summer to winter blend several weeks in advance as demand for the former has disappointed. The problem is that by doing so early, stocks of winter blend will fill up that much sooner, and absent some miraculous surge in demand in the winter months – a very improbable event – the moment when the price of oil crashes has just been postponed by a few months, while assuring that the drop – when it comes – will be much more acute.
According to Reuters, the
switchover from summer blends, which are more environmentally friendly and costlier to produce, usually happens in August for sale starting on Sept. 15, the date allowed under U.S. government regulations. Winter blends are more likely to evaporate in the summer heat and cause smog.
“Why produce more summer grade right now when you can produce something at a cheaper cost and then be prepared to bring that into your supply chain right when the government specifications allow,” said Eric Rosenfeldt, refined products trader at PAPCO Inc. What he did not say is why produce more summer grade now when there is just not enough demand for it. What he also did not say is that by shifting early, refiners will simply end up with an even greater glut of product.
Reuters admits as much: “mixing more winter gasoline now threatens to worsen the glut later, a risk willingly taken by an industry left with few other choices.”
As a reminder, one look at crack spreads confirms that U.S. refiners are expected to post another quarter of weak earnings en route to possibly the worst year since the shale boom began in 2011. So what are refiners – many of whom are unable to stop the crude supply train – to do? Why bet it all on the “winter driving season”
Summer grade gasoline is harder to produce than winter grade, which is why pump prices tend to rise with the heat. In the winter, when evaporation is less of a concern, gasoline is made with a higher Reid Vapor Pressure (RVP), a common measure of the volatility of gasoline.
This year, looking to cut costs, refiners and blenders are making an early move to mix cheap butane – a cheaper blending component than most other ingredients – to convert the summer barrels into winter barrels, according to the trading sources.
No matter how one wants to spin it, this is bad news for both margins, and for crude prices. “Some see the shift as a sign of a tougher road ahead. “They made summer grade in winter because winter was crap. Now they will make winter in summer because summer is crap,” said one U.S. East Coast trader.”
Part of the reason for the shift to winter grade is the anomaly in the structure of the market, traders said. Historically, gasoline prices weaken as autumn begins in September and refiners start to switch to winter grade gasoline. But this time, the drop in forward prices is not expected to be as pronounced as in the past six years according to Reuters.
Futures for delivery in September traded at a premium of just 7 cents to those for delivery in October. That is well below the 20-cent gap at this time last year. This, along with the overhang in summer-grade gasoline inventory, has motivated refiners to shift to winter gasoline before August, betting that gasoline in storage would satisfy demand for the rest of the summer.
They are right about this, but for a very bad reason: there was simply not enough demand. And if the summer driving season was poor, winter is going to be a disaster.
This desperate move is unlikely to be more than a short-term fix. With U.S. gasoline stocks last week at 241 million barrels, 10% more than a year ago and well above the five-year average, more run cuts are likely.
“Simply trimming the amount of crude a refinery processes does very little to reduce gasoline supply,” Energy Aspects said in a note on Thursday. “Bigger cuts need to come.”
And they will, likely resulting in the next sharp leg lower in crude oil, because – just as we predicted in February – the collapse in oil prices is as much an excess supply story as it is a lack of demand, something which can not be blamed on OPEC dysfunctionality, and is the result of a very politically charged topic: a weak US economy.
via http://ift.tt/2a97aey Tyler Durden