The sharp oil price rally since February came to an abrupt halt at $50 per barrel in June. WTI and Brent have since retraced some of those gains, falling back to $45 per barrel. Bullish oil traders had hoped that recent losses were merely a correction after a considerable price rally, but the global glut of refined products may force the market into another down cycle in the third quarter. While that is bad news for the industry, consumers are reaping the benefits with pump prices in the U.S. expected to be roughly 40 center per gallon, or 15 percent, lower than last summer.
Bullish oil traders had hoped that recent losses were merely a correction after a considerable price rally, but the global glut of refined products may force the market into another down cycle in the third quarter.
The International Energy Agency (IEA) said in its July Oil Market Report that the global surplus in crude oil production is almost over, but just as one threat passes, another looms. Refiners around the world moved aggressively to ramp up production this year in order to take advantage of cheap crude and strong consumer demand. In doing so, they may have overshot the market.
Even as crude oil inventories have only fallen slightly in recent months, the world is now also awash in refined product supplies. The elevated levels of gasoline and diesel sitting in storage, the IEA warns, could put a lid on oil prices this quarter.
Demand slower than expected
Gasoline consumption continues to rise as motorists fill up on cheap fuel, but demand is softer than previously expected. Earlier this month, the Energy Information Administration (EIA) revealed that U.S. gasoline demand dipped to 9.2 million barrels per day in April, the latest month for which revised data is available. The adjusted data flew in the face of the weekly estimates put out by the EIA, which are typically less reliable numbers but ones that traders and analyst eye closely. The more accurate retrospective numbers for April amounted to a downward revision of U.S. gasoline demand for April of about 260,000 barrels per day. In other words, American motorists were not driving as much as once thought.
In isolation, the U.S. data point is not enough to set off alarm bells. However, at the same time, demand looks weaker than expected in other parts of the globe. In May, for example, year-on-year demand growth in China was just 130,000 b/d, which the IEA says is “part of a recent trend of smaller increases.” The culprit is a slowing Chinese economy, a development that is expected to continue.
Moreover, China is hitting the markets with a surprise uptick in refined product exports. According to newly released data, China’s exports of refined fuels in June exceeded 1 million barrels per day, a 38 percent increase from a year earlier. China’s demand for diesel “continues to disappoint, mainly as a result of slower industrial output compared to the same period in 2015,” OPEC wrote in its Monthly Oil Market Report. Weak demand at home means China is dumping surplus fuel onto the global market.
Against the backdrop of a more pessimistic sentiment among oil traders, hedge funds and other money managers have reduced their bets on rising oil prices to their lowest level in four months.
Refiners working overtime
To be sure, demand is still strong and rising—although it’s not as robust as last year’s global growth of 1.8 mbd. One big bearish issue is that refiners ramped up output in anticipation of more impressive growth. The rate of growth in refinery production was 60 percent higher than the growth in demand for refined products, the IEA says. With refiners furiously turning crude oil into gasoline, diesel and other products, inventories have climbed and stayed at elevated levels.
The OECD added 19.7 million barrels of refined product into storage in May, with the largest portion of that coming in the Americas. Other OECD regions saw inventories rise in May, too. The OECD now has 33.0 days of supply, which is 3.3 days above the five-year average.
The downstream sector has been oversupplied in the U.S. for some time. When U.S. gasoline stocks peaked at 258 million barrels in February, it coincided with the low point for crude oil prices at $26 per barrel. In the ensuing weeks, gasoline stocks began to draw down, suggesting that the worst of the glut was over. But after posting six weeks of strong drawdowns, U.S. gasoline stock levels stopped falling, and have stagnated since.
On July 13, the EIA further stoked fears of a protracted refined product glut when it reported a 1.2 million barrel increase in gasoline stocks for the week ending on July 8, bringing gasoline storage levels back above 240 million barrels, leaving inventories largely unchanged from their March levels. After the release of the data on July 13, WTI and Brent fell more than 4 percent on the news.
Inventories may not build too much further, but there is a long way to go before they are worked off. Too much gasoline and diesel sitting in storage is causing some trouble for the product trade. As the IEA noted in its report, “stocks are so high that market participants have been forced to turn to floating storage in the New York Harbor area.”
Floating storage and contango
Floating storage is rising once again, a symptom of too much supply. In June, short-term floating storage increased by 1 million barrels to 95 million barrels, the IEA says, the highest level since 2009. Another typical sign of an oversupplied market is a price contango in which front-month contracts for crude are traded at a discount to deliveries further off into the future. The widening contango has begun to resurface as a problem for crude oil markets. The one-year market contango hit $5.64 per barrel on July 11, twice as high as last month and the highest level since March.
The higher volumes of floating storage have more to do with “logistical and marketing issues” than they do with traders looking to profit from time spreads.
Although the market is oversupplied, the contango is not wide enough to justify the costs of floating storage. As the IEA notes, the higher volumes of floating storage have more to do with “logistical and marketing issues” than they do with traders looking to profit from time spreads. In other words, floating storage does not make sense for traders looking to make a profit—it is occurring because the markets are oversupplied in some regions and tankers are having trouble unloading deliveries at backed up ports.
Still moving toward balance
The extremely high levels of refined products sitting in storage, similar to high crude stocks, will continue to weigh on oil prices. Downstream operators may be forced to cut back on refining runs as inventories rise, which would help draw down stocks. At the same time, that situation would likely lead to weaker crude oil demand as refiners purchase fewer barrels for processing, another development that would put downward pressure on oil prices.
The recent fall in oil prices combined with weak demand and the extraordinary levels of crude oil and refined products sitting in storage “is a reminder that the road ahead is far from smooth.”
Nevertheless, the movement toward market balance “remains on track,” the IEA said. Crude oil demand continues to rise and supplies are falling. What’s more, amid all its bearish news about oil prices for the short run, the agency issued a medium-term warning that the oil industry is underinvesting in new sources of supply, possibly creating the conditions for an oil supply shortage and a price spike in the years ahead.
But in the meantime, the recent fall in oil prices combined with weak demand and the extraordinary levels of crude oil and refined products sitting in storage “is a reminder that the road ahead is far from smooth,” the IEA concluded.