The Fuse

With Crude Oil So Weak, Why Aren’t Drivers Seeing More Relief at the Pump?

by Matt Piotrowski | August 27, 2015

The fundamentals of the current oil market are well known—gigantic global oversupply and bloated commercial inventories have caused prices to crash. But, even though the situation is beginning to loosen, U.S. gasoline markets have been unusually tight, meaning consumers aren’t fully experiencing the benefits of the oil price fall.

U.S. gasoline markets have been unusually tight, meaning consumers aren’t fully experiencing the benefits of the oil price fall.

The outlook is changing quickly as summer winds down and gasoline market fundamentals become sloppier. The NYMEX RBOB futures contract for September has lost significant ground as of late, falling by more than 40 cents per gallon, or 25 percent, since August 13 before rebounding to current levels around $1.42/gallon, with the retail average at $2.73/gallon. RBOB futures for October, which will be the prompt-month contract starting next week, is trading some 10 percent lower, a sign that the market expects any immediate tightness to alleviate even further, giving motorists some relief.

Three main factors are behind the fact that gasoline prices are so strong when compared to crude oil. One is mostly short term, while the others are structural issues. Refining problems, particularly the outage at BP’s large Whiting plant, constricted supply in the Midwest and drove a regional price surge. But more critically, U.S. consumption is on the rise because, on a relative scale, gasoline is the cheapest it’s been in six years. Moreover, refiners are not only meeting demand for U.S. consumers, but they are also sending large volumes to other markets: Cheap crude oil is good for the refining business, and refineries are running at record highs of around 95 percent utilization. These dynamics have kept gasoline inventories at normal levels. Commercial stocks, at 214 million barrels, are only slightly above year-ago levels and the five-year average. By contrast, crude inventories are up by some 25 percent versus last year at this time and the five-year average, a reflection of how the two markets are dealing with differing fundamentals.

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The wide RBOB-West Texas Intermediate (WTI) crack spread—the price differential between crude and refined products—is another sign of the disconnect between the two markets, and has provided stellar margins for refiners. The front-month crack spread soared above $30 per barrel in July, and recently averaged around $15-$20 before falling to more normal levels of around $13. It should continue to narrow. For instance, the January 2016 RBOB crack spread is now trading around $8, a sign that traders expect less divergence from the two markets going forward.

Peak demand?

Consumption has taken off, rising back to average roughly 9.5 million barrels per day throughout the summer—an increase of about .53 mbd, or 6 percent, year-on-year, as miles traveled in the U.S. have risen by 52 billion versus the same period in 2014. This reflects the third largest jump in U.S. liquid fuel demand since 1970. This sharp increase in driving is partly the result of lower pump prices, but it is also the result of steady economic growth. Despite the turbulence seen lately in stock markets, GDP has performed well in the U.S., with growth coming in at a healthy 3.7 percent in the second quarter, above consensus expectations and original estimates, another sign that the economy has fully recovered from the 2008 financial crisis.

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These developments in both demand and prices call into question whether the days of growing U.S. gasoline demand are truly behind us. The conventional wisdom is that U.S. gasoline demand peaked at 9.23 mbd in 2007—right before the financial crisis occurred, prices rebounded to around $4 per gallon for about three years, and stricter fuel economy standards kicked in.

An extended period of lower prices, along with savings from vehicles becoming more efficient and continued economic growth, could prompt motorists to consume even more and break previous records for demand.

The Energy Information Administration (EIA) forecasts gasoline demand to average 9.13 mbd this year, and slightly higher in 2016, based on retail prices remaining at similar levels. The expected averages for 2015-6 are roughly .1 mbd higher than 2014, and up some .45 mbd from the trough in 2012. The EIA, however, could be too conservative in its demand estimates. An extended period of lower prices, along with savings from vehicles becoming more efficient and continued economic growth, could prompt motorists to consume even more and break previous records for demand.

Exports

The demand for gasoline outside U.S. borders has kept the price for the refined fuel elevated.

The demand for gasoline outside U.S. borders has kept the price for the refined fuel elevated. Unlike crude oil, there are no restrictions on exports for refined petroleum products. Thus, refiners are motivated to keep gasoline output high and ship volumes outside the U.S. This is helping keep prices high here in the U.S.

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Mexico is the main export outlet for U.S. refiners, but Panama, Ecuador, Colombia, Canada, and even Venezuela are key buyers of gasoline from the U.S. Exports provided new markets for refiners when U.S. demand contracted after 2007, but they have held onto market share beyond U.S. borders even as domestic demand has rebounded. The trend of higher exports has been a boon for U.S. refiners, which struggled in the aftermath of the 2008 recession due to weaker domestic demand and elevated crude prices. It’s unclear if U.S. refiners will continue to see exports grow at such a rapid pace, given that new refining capacity is coming online, in Latin America and elsewhere. The competitive global downstream environment could eventually bring about a downturn in exports, causing the U.S. refining industry to lose some of its profits.

But for now, against the backdrop of high demand in the U.S. and elsewhere, refiners are running at very high rates and capturing strong margins. U.S. refining utilization has hovered around a very high 95 percent throughout the entire summer, with gasoline production averaging 10 mbd over the past month, almost .5 mbd above domestic demand.

Correction underway

The U.S. gasoline market typically undergoes a correction during the autumn months as gasoline demand dips seasonally, and this year should be no different. This is likely to help bring gasoline prices more in-line with low crude oil prices. However, as stock levels for the refined product are at just average levels, refinery maintenance is long overdue, and domestic demand is on the upswing (year-over-year), gasoline ought to remain the tighter market for some time.

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