Crude Spreads are Unstoppable
Author: Brynne Kelly 6/06/2022
Over the weekend, Bloomberg reported: "Western Canadian Select’s discount to benchmark West Texas Intermediate grew US$1.70 to US$20.80 a barrel in Alberta on Friday, the widest in almost seven months, data compiled by Bloomberg show."
The report goes on to say:
"Soaring energy costs prompted the Biden administration to tap US strategic petroleum reserves, nearly all of which are similar in grade to oil sands crude. As many as 39 million of these sour barrels will be released this summer, just as oil sands sites come out of maintenance."
It's important to note that despite the repeated release of heavier/sour barrels to the market, this has had little impact on it's lighter/sweeter relative, WTI. In normal market environments, an emergency release of SPR reserves would have a residual impact on WTI prices. This does not appear to be the case so far with the current release of strategic reserves.
What does appear to be the case is that to date, no matter how much 'spare' oil we throw at this market, refined products continue to move relatively more to the upside (WTI cracks, below). Sour oil isn't the same as sweet oil, and sweet oil isn't the same as gasoline or distillate. The equilibrium is off.
This is happening during a time when higher demand is being met with, what seem like tank bottoms. A time when the US is furiously pulling barrels out of the Strategic Petroleum Reserve in an effort to keep a lid on prices.
At this point, it's important to go back and read some of the specifics related to US SPR activity for context. The US had, in fact years ago already embarked on a journey of monetizing it's strategic reserves to pay the bills.
According to government documents, in 2015 Congress passed legislation which mandated the sale of SPR oil to fund a variety of government activities. For some, a question exists as to how much oil might be withdrawn from the Reserve while still maintaining an adequate oil “safety net.” Others question whether the evolving world oil market requires the United States to maintain any government-owned reserve holdings at all. Enacted legislation to date prior to the war had already mandated the sale of over 250 million barrels of oil from the SPR. This situation alone brings up another policy issue. If there is less oil in the SPR, what might be done with the “excess capacity” inevitably created? The government may be able to reduce the operating costs of the SPR by leasing reserve capacity freed by mandated sales (hmmmm....interesting to note the mindset).
Due to that 2015 legislation the debate over whether the SPR storage balance was too large given the evolving nature of U.S. oil production, consumption, and net imports resulted in Congress mandating the sale of SPR oil. The real revenue accrued through SPR sales was allocated to a variety of uses; however, energy policy, or security, was not among them.
The legislation mandating SPR oil sales included: the Bipartisan Budget Act of 2015 (P.L. 114-74), the FAST Act of 2015 (P.L. 114-94), the 21st Century Cures Act of 2016 (114-255), the 2017 Tax Revision (P.L. 115-97), the Bipartisan Budget Act of 2018 (P.L. 115-123), the Consolidated Appropriations Act of 2018 (P.L. 115-141) and the America’s Water Infrastructure Act of 2018(P.L. 115-270). Broadly considered, this legislation requires oil to be sold from the reserve over the period FY2017 through FY2027.
So, here is a look at both Commercial crude oil inventories (below, left) and SPR inventories (below, right) since the above legislation has been passed.
This is not a pretty picture in the short-term. For starters, it remains to be seen if US production will respond as significantly as it did to the price signals leading up to the last big production surge. Along with that, we also know that the US is currently releasing 1 million barrels per day over the period of six months which began in May. At least a portion of those sales will need to be replaced in the future.
It does seem a fairly risky proposition to be draining your own reserves in today's geopolitical climate, hoping they will be easily replaceable in the future. We have a government that has budgeted for SPR drawdowns based, in some part, on the anticipation (or extrapolation) of shale production that is not as easily obtained as it has been.
On top of that, it's actually a bit nerve-wracking when you read what that same government document had to say about gasoline inventory:
"Gasoline is less amenable to long-term storage than crude oil. While crude oil may be stored with little observed deterioration for periods in excess of five years, the storage life of gasoline is shorter. Typical gasoline blended with 10% ethanol may have a shelf life in storage of approximately three months. The short shelf life of gasoline requires active supply management of the NGSR."
It's not like this is necessarily any new revelation, however it does highlight how important our refining complex is when it comes to product supply. Which leaves us vulnerable to unforeseen events. The healthier the refining assets are, the more reliable our supply of refined products. One could also argue that there are some big issues facing our refining complex including environmental regulations and the overall age of many of the assets.
The daily refinery hiccups are relentless. Here are three recent examples:
Valero during the last 24 hours was forced to halt operation of its 19,500 barrels per day (bpd) alkylation unit due to a mechanical failure which also forced a cut back in operation of its 75,000 bpd cat cracker (FCC), ENT learned. Initial repair estimates call for 3-5 days. Production losses are currently estimated at 100,000 barrels of high octane gasoline components.
Pemex advised Texas its Deer Park refinery Sunday had an seven-hour emission event involving the cat cracker, alkylation unit and distilling. "High level in C-36201 Knockout pot tripped the CPU compressor and the stream was vented to the flares. Operations took action reduce the flow to the flares," Pemex reported to state regulators
ExxonMobil's 503,000-bpd Baton Rouge, La., refinery resumed planned rates after completing a plantwide restart early-last week, ENT learned. A steam disruption May 21 by an outside provider forced the plant out of service. A 230,000-bpd crude unit was the exception, operating at half capacity since May 4 due to extended planned maintenance. The crude unit last week returned to normal operation along with the rest of the facility. ExxonMobil was not immediately available for comment.
Combined, some traders barely know which end is up in longer-dated markets which is why calendar spreads that involve the front versus the deferred continue to be "unstoppable".
With gasoline prices reaching record highs of nearly $5 a gallon, the US has been repeatedly pressuring the Saudi government and the UAE authorities to: turn on the taps, disregard the assigned quotas, and ramp up production. Diesel is also moving at a pace more bullish than that of the petroleum market as a whole.
These pressures have been to no avail thus far, as OPEC+ has stood staunchly behind the deal.
The difference in seasonality between the gasoline and distillate products shows itself via the calendar spreads. There is a normal cadence to the seasonality of gasoline in the summer and distillate for heating in the winter.
But, what we are witnessing today are extreme reactions of the market beyond traditional seasonal patterns. In comparison to the same spreads last year, you can see the exaggeration of normal seasonality.
Winter heating oil seasonality:
Summer gasoline seasonality:
Given the wildcard that is the 'back' of the curve, note how much ground WTI lost to Brent over the last two weeks. The chronic aspect of the war seems to be reinforcing the narrative that Brent markets are tighter than WTI markets.
Asian refining margins for 10 ppm gasoil surged to a fresh record high on Friday, lifted by weaker feedstock crude prices, low inventories and expectations for firmer Chinese demand in the near term due to easing COVID restrictions.
Singapore’s middle distillate inventories have dropped to a four-week low this week, staying about 39% lower compared with the corresponding week a year ago, while the inventories in UAE’s Fujairah Oil Industry Zone were about 34% lower compared with a year earlier.
Mike Wirth, the CEO of oil giant Chevron appeared on Bloomberg TV discussing what the country can do to ease record prices at the pump. He stated that he doesn't believe there will ever be another new oil refinery built in the U.S.
Even if oil producers increased their production, there's not enough refining capacity to meet the demand for petroleum products like gasoline, jet fuel, and diesel. That means prices will remain elevated even if oil companies pump more crude oil.
Looking at the curve shift of gasoline cracks since the beginning of 2021, it's evident that the refining complex is maxed out.
Are we at the beginning of something that is going to get way worse? New refining capacity generally springs up regionally where growing demand is, as opposed to flat growth areas. When you combine that with the environmental concerns, you can see why many would add refineries in the East versus the West. There are just so many mounting difficulties with opening a refinery in West.
Taken together, these factors are a recipe for future uncertainty, and hence, a spread dynamic that seems unstoppable. Until recently spreads were a lower-risk proxy for market direction. But now, due to refinery uncertainties, SPR math, and geopolitical uncertainties, in their own right may be an increasingly risky proposition.
EIA Inventory Recap - Week Ending 5/27/2022
The EIA reported an astonishing total petroleum inventory DRAW of 11.70 for the week ending May 27, 2022.
YTD total petroleum EIA inventory changes show a DRAW of 104.40 through the week ending May 27, 2022.
Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to surprisingly below historical levels and should continue to draw as long as backwardation in the market persists.