The Fuse

Gasoline Market Sends Mixed Signals as Inventory Overhang Persists

by Nick Cunningham | February 08, 2017

Although gasoline stocks in the U.S. declined, albeit slightly, last week, the market for the largest consumer in the world is still well supplied.

OPEC seemed to have put an end to the oil market downturn when it agreed to cut production last November, but recent data suggests that the market is not balancing as quickly as once thought, with bearish data in U.S. gasoline having to potential to weigh heavily on global crude markets. The sharp increase in gasoline inventories since the end of last year has already raised some concerns, deflating the overwhelming sense of optimism from traders that has permeated the oil market over the past two months. But it’s too soon to count out bullish scenarios—gasoline’s weakness could be a temporary anomaly due to seasonal factors, while OPEC’s actions will start to bite during the second half of the year.

Gasoline inventories up sharply

Although gasoline stocks in the U.S. declined, albeit slightly, last week, the market for the largest consumer in the world is still well supplied. After skyrocketing to record heights a year ago, inventories managed to finally come back within the running five-year average at the end of 2016. Since then, however, they have managed to shoot back up close to all-time highs. Against this backdrop, the price for the March NYMEX RBOB gasoline contract is now selling for about $1.55 per gallon, down 17 cents per gallon versus the beginning of the year. The market rallied sharply on Wednesday on news of the stock draw, but the 900,000 barrel decline was hardly a bullish sign, particularly given how high stock levels are.

There are several possible explanations for these current trends in gasoline fundamentals. At first glance, it appears that gasoline consumption has suddenly slowed down. At the end of January, gasoline demand averaged over four weeks plunged to 8.2 mbd, the lowest level in nearly five years. A halt of U.S. gasoline demand would amount to major red flag for the health of a fragile recovery in the oil market.

“Prompt (U.S. East Coast) gasoline cracks continue to sell off and the contango in U.S. gasoline futures is deepening, reflecting the likelihood that the overhang will be carried into the summer months,” Energy Aspects said in a research note.

Storage a short-term problem?

Gasoline demand may not be the main problem, however. Higher-than-average refining runs could also be the culprit for strong gains in inventories. Refining margins improved at the end of 2016, leading some refineries to put off maintenance and take advantage of the brief window of opportunity. According to Goldman Sachs, refining maintenance was 160,000 barrels per day (b/d) lower than the average, which in turn pushed gasoline production to a five-year seasonal high. In other words, high gasoline storage levels are due to refineries churning out exceptional volumes of gasoline, not only because demand is disproportionately weak.

Refining margins improved at the end of 2016, leading some refineries to put off maintenance and take advantage of the brief window of opportunity.

Although the latest stock decline hardly shifted fundamentals in the gasoline market, it could portend tighter conditions ahead. Weekly EIA figures from the beginning of February, for instance, show a strong uptick in demand. Traders latched on to this data as a positive sign, evidence that gasoline demand, in fact, was not as soft as was thought at the end of January. The markets overlooked the massive build in crude stocks, fixating on the stronger gasoline demand. Crude oil prices jumped and gasoline crack spreads surged by 20 percent on February 8, a sign that the markets are still bullish on demand.

“There’s been a lot of concern about plunging gasoline demand and with this report it’s returned to normal levels,” John Kilduff, a partner at Again Capital LLC, told Bloomberg in an interview, referring to the EIA’s weekly petroleum data. “Healthy gasoline demand eventually translates into higher refinery runs and increasing crude demand.”

OPEC’s actions in the coming months and for the rest of the year will be crucial in price direction, but given that U.S. gasoline consumption makes up almost 10 percent of the global oil market, fundamentals in this key area will be key to watch too.

In fact, the astounding 13.8 million barrel increase in crude oil inventories for the week ending on February 3, one of the largest weekly increases on record, may not be as bearish as originally though. Oil analysts argue that the increase is an abnormality, and they chalk it up to elevated OPEC production at the end of 2016 just ahead of implementation of the deal. As Saudi Arabia, Iraq, and other cartel members rushed to lift production before they were required to cut in 2017, the additional barrels made their way onto the market. Those barrels are now showing up in the data in the United States a few weeks after the fact. Indeed, U.S. oil imports shot up by 1.1 mbd in the first week of February from the week before, helping explain the inventory increase. Moreover, the sudden influx of imports came at a time of rising U.S. oil production. Extra oil from abroad combined with rising domestic output led to a jump in inventory levels. In other words, the exceptionally bearish data from the EIA for the first few weeks of 2017 could dissipate in time.

“We were probably seeing the last surge of OPEC output and now inventories will start decline, at least they better for the bulls’ sake,” Kyle Cooper, director of research with IAF Advisors, said in a Bloomberg interview.

OPEC’s actions in the coming months and for the rest of the year will be crucial in price direction, but given that U.S. gasoline consumption makes up almost 10 percent of the global oil market, fundamentals in this key area will be key to watch too.

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