Stephen Schork of the Schork Report sums up the energy demand picture in the US succinctly on Thursday:
So there you go, refiners did not make a lot of product last week because demand is in the toilet.
That assessment comes after an unexpected build in US crude inventories – the first in a month — saw oil prices do this on Wednesday:
It’s no surprise, really, given that the weekly build in crude stocks came in at 2.9m barrels versus a market consensus for a drawdown of some 1.4m barrels. This was largely down to a large jump in crude oil imports for the first time in a month.
The real issue though is the ongoing build we’re seeing in distillate stocks. These just keep on building, and worryingly, almost regularly at a higher-than-expected rate. On Wednesday, the build came in at 1.6m barrels while the market had been expecting a 1m barrel rise. The following chart from BNP Paribas neatly sums up the state of affairs:
The distillate picture is important because it gives a good indication of the state of industrial energy demand in the US, industry being one of the main consumers of distillate product.
On the flip side, gasoline demand appears to remain robust with drawdowns nearly always coming in at a larger than expected rate. This week 200,000 barrels were drawn, versus market consensus for a build of 500,000 barrels.
This imbalance tells us a lot about the wider health of the US economy as it implies a relative constant picture for gasoline on a historical basis versus a massive drop in demand for distillates (relative to the overall volume of product being refined). As one barrel of oil will always produce both, refineries have for years tried to balance the proportional output of each product according to demand. Gasoline tended traditionally to be the product maximised.
But that dynamic began to change over the last few years leading to some expensive refinery adjustments for the purpose of producing more distillates.
Which brings us to today. Refineries have no doubt been switching back to their old gasoline-max settings, and yet there appears to be no slowdown in distillate overproduction. This is troubling because the greatest danger for the price of oil is the appearance of a massive mismatch in the distillate/gasoline demand picture. It skews the overall price scenario for crude. While a lot of the excess distillate can be exported out, a global industrial slowdown creates the risk that exports might not be a sustainable solution for long. What’s more, onshore storage facilities may soon run tight.
The above certainly might explain why some energy trading firms are resorting to storing distillates in floating storage, a highly unusual and expensive way to go about storage due to certain spec and maintenance-related costs. As Platts reported on Wednesday (H/T Morgan Downey, author of Oil 101):
JP Morgan and Gunvor have fixed newbuild VLCCs to store gasoil, according to shipping reports, alleviating some of the gloom for VLCC owners by taking some tonnage out of an oversupplied market, shipping sources said Wednesday. JP Morgan has taken the newly built VLCC Front Queen for possible gasoil storage in the UK Continent for 270 days at a rate of $35,000/day, according to shipping reports.
It goes on to explain:
Storing gasoil on VLCCs is unusual and can only be done on vessels that have not yet carried crude as the cost of cleaning so that clean products can be stored is prohibitive.
Trading house Trafigura set the ball rolling for gasoil to be stored on VLCCs last December, fixing the Desh Viraat for gasoil storage duty from end-December 2008 and more recently the Desh Viraal. However it was not clear whether the Desh Viraal would be replacing the Desh Viraat or if it would be in addition to it.But as Schork points out there may even be aberrations in the current gasoline demand picture:
Per last week’s report gasoline demand topped 9.5 MMbbl/d for the first time since August 2007. Then for last week, which includes the U.S. Memorial Day holiday, demand plunged 5.4% to 9.02 MMbbl/d!
He goes on:
In fact, demand for petroleum products in the aggregate fell off of the proverbial cliff. The net amount of products supplied to the market fell below 18 MMbbl/d for the first time since the week following 9/11 and fell to the lowest level, 17.7 MMbbl/d, since May 1999. (see today’s Chart of the Day).
To sum up, the general point is that overall product supply is down, a massive distillate overhang exists but what gasoline is being produced is still undershooting demand.
To provide an analogy for what is wrong with that picture (please bear with us); it’s comparable to the availability of a massive number of 600 sqft two-bedroom, two-bathroom flats on the market going for an average of £200,000, but demand is actually greater for two-bedroom, one-bathroom flats (people preferring to have living space over a bathroom).
In this (unlikely we know) scenario there just aren’t enough of the latter. The costs of converting a bathroom to a traditional room are c. £10,000-20,000, yet near identical flats with one less bathroom are going at £250,000.
So despite there being a glut of two-bedroom flats on the market, the huge demand for two-bedroom, one-bathroom flats stops the price of two-bedroom, two-bathroom flats falling off a cliff. You can always convert them into the former, with a delay.
But to assess where prices might be going for two-bedroom flats (crude) generally there’s no point in looking at the overall demand/supply picture for these sorts of dwellings; you need to look at demand for two-bedroom, one-bathroom flats (gasoline) versus demand for two-bedroom, two-bathroom flats (distillates), keeping in mind the former will in this scenario drive the latter.
The point is if suddenly those dynamics change, and people didn’t mind how many bathrooms they have — the price could very easily collapse to reflect the overall glut. But until they do the premium for two bedroom, one-bathroom flats (aka gasoline) is likely to only keep pushing up the price.
Related links:
Distillate hangover – FT Alphaville
Oil, the great inflation hedge – FT Alphaville