Author: Brynne Kelly 3/19/2023
TL; DR
The US now habitually exports its excess oil and covers its refined product shortfall with imports. The whole country is, on balance, short cracks; and the DOE/ Admin will likely rely on newfound confidence in its ability to tamp down demand financially while not changing the fundamental calculus to address the shortfall. Surviving Heat season almost guarantees this
Backdrop
California Gov. Newsom announced Thursday the creation of a new independent watchdog within the California Energy Commission “charged with monitoring California’s petroleum market on a daily basis to ensure market participants play by the rules. The division would be able to: access to new information require refiners to give access to new data, give subpoena power to compel production of other data/records investigating potential misconduct (manipulation) and lastly refer violations of law to the Attorney General for prosecution.”
On the surface of things, this is odd since the California Energy Commission not long ago found “no evidence that gasoline retailers fixed prices or engaged in false advertising.”
Dave Noerr countered the implicit accusations saying: “The growing difference between the price of crude oil and the retail cost of gas and diesel as well as the additional cost Californians pay compared to every bordering state and the rest of the U.S. is due to any number of things"
He then went on to list 8 of them:
Sacramento surcharge, cost of California, growing of Government, Low Carbon Fuel Standard, Cap and Trade Program, Vapor recycling requirements, Data collection ,and Air quality mandated equipment replacements
He went on adding:
"So California, the fact of the matter is, you are paying the same or less for the crude oil contained in a gallon of gas or diesel. You are just paying a lot more for government,”
Finally, Noerr sternly pointed out that in1988, "the state of California only imported about 4.5% of all the oil that they consumed in their state, but now they import over 70%
“If you wonder what happens when you give up energy independence, that’s what’s going on.”
We would add things aren't much better on the refined products side. In 1982, California had 43 operational oil refineries and a population of nearly 25 million; today they have only 11 operational oil refineries and a population of nearly 40 million.
In California as in the rest of the USA, demand is up, production is down, and politicians are getting a head start on the seasonal finger pointing They may be a little worried again as well. Given what happened last year and the extreme measures needed to take gas prices down mid-season, maybe they are sweating a little? Short some 3-2-1's maybe? Who knows. But lets check in elsewhere
China Refined Exports Dropping
On the Asian side, a Reuters survey shows that China's diesel exports could fall to an eight-month low in March. Refiners are focusing on their own demand and increasing domestic stockpiles ahead of planned refinery overhauls.
China customs data showed exports of the industrial and transportation fuel are estimated at 400,000 to 770,000 tonnes compared with estimates of about 2 million tonnes in February, according to JLC, Longzhong, Refinitiv, and two China-based trade sources. Diesel exports were last at similar levels in July 2022,
This could bring the combined March exports for all three products - diesel, gasoline and jet fuel - to between 1.5 million and 1.94 million tonnes, at least 50% lower than February's estimate of 3.9 million to 4.15 million tonnes, the survey showed.
Banking Fears
Multiple Bank crises also definitely had significant impact on WTI.
Depending on how you look at it, fears of contagion in the banking sector exacerbated the above, or the above was exacerbated by fears of contagion in the banking sector. Either way, traders on the fence pulled the trigger with the combination of events. We could get increased liquidity into the markets to stave of the crisis and that would support Oil. But, unless it is straight QE, most of that money will stay on the banks' balance sheets in loan form, as opposed to Powell's money printer raining down on everyone. Right now, they are all trying to stop depositor defaults, not prop stocks.
The market appears to be taking this into account as exhibited in cracks. While crude oil prices were getting clobbered last week, refining margins, consistent with the above news items, were on the rise.
Crude Oil takes a hit, Gasoline and Distillate Not as Much
The calendar 2024 - 2027 WTI futures curve retreated on Friday to levels not seen since January 2022. The elusive $67 level came and went, and with it initial hopes that an SPR "put" existed. Way back in October, 2022 the US Department of Energy (DOE) stated:
...the President is announcing the Administration intends to repurchase crude oil for the SPR when prices are at or below about $67-$72 per barrel, adding to global demand when prices are around that range. As part of its commitment to ensure replenishment of the SPR, the DOE is finalizing a rule that will allow it to enter fixed price contracts through a competitive bid process for product delivered at a future date.
But, as of last Friday's close, WTI oil futures are below the bottom-end of the 'repurchase range' regardless of the expiration you choose.
WTI Calendar 2024-27 Curve Back to 2022 Opening Levels, Although Curve is Flatter
Chart Comment: Note the curve has a flatter trajectory with spot essentially at the same $66 area going back to 2022 (red vs yellow). While this is neither bearish nor bullish short term, it does imply the rising cost of production (something touched on before) going out on the curve and/or no drop in demand. This market, for now, is base-lining at higher levels.
SPR Bid: Cancel If Close?
We have three new pieces of information further casting doubt on the administrations intentions on buying oil back
First: We had a real test of the SPR "Put" last week - and no purchasing announcements were forthcoming.
Second: President Biden's administration has actually delayed by roughly a year the return of more than 8mn bl of crude borrowed from the SPR. The delays were approved as recently as last week, when the US DOE revised two "exchange" contracts it negotiated with Shell, delaying the return of 3.6mn bl of crude to the SPR until 2025.
Third: In a note from Rapidan Energy Group we heard the Energy Department is unlikely to begin refilling the Reserve before the end of Q2, even though oil prices have slumped into the range the administration has targeted to purchase oil for the cache.
Further, the Energy Department will be making deliveries from a recent 26 million barrel sale from April though June of this year. Taken together, buy limits seem to be sell stops now with no announced SPR buying (yet) and previously mandated sales reaffirmed.
Here we are again with the market testing the SPR buyback bid and finding none yet. If the level remains penetrated for long, that puts OPEC+ in focus. Far from weak, the last time this happened, they announced cutbacks. Most recently Russia announced them as well. We think a comment from SA and company would be on the face of it necessary in this game of chicken. But, we warn that if China cannot get its economic act in gear, and the US continues to pump, that combination might not test Russia or the Saudis, but the smaller OPEC members. Dissension in the ranks would be the concern there. That has happened before,1999 being the big one.
Taking all of the above in, let's look at crack spreads.
Gas Crack Spreads
While crude oil prices were busy moving lower last week, partly driven by the turmoil in global banking, gasoline futures held relative ground. Longer-dated gasoline crack spreads were on the rise, showing no signs of the sell-off chaos being felt in flat price.
Gasoline vs WTI Crack Spreads Hit Yearly Highs Last Week...
Of course, if you look at gasoline futures in a vacuum, they moved lower in sympathy to the oil price move.
Meanwhile, Gasoline Futures Themselves are only Marginally Higher than 2022 Lows
Yes, gasoline futures are not even close to their highs, and have continued to move lower this year. But, the fact that the associated crack spreads rallied says that the consumer is still on the hook for the lack of infrastructure needed to support an economic recovery. Marginal producers of refined products are keeping their production 'local'. Forgoing exports to supply themselves before the rest of the world. Oil is being affected by macroeconomics. Gasoline, less so.
If you think the reaction to the banking crisis will be to pump money as we head into driving season, and the Gov't does not (last we checked) have a stash of Gasoline, that crack looks dangerous to be short.
Heat Crack Spreads
There was a similar move in distillate cracks and distillate futures to the move in gasoline. Distillate cracks remained relatively strong versus crude oil while outright prices moved lower in sympathy to crude oil. The main difference being that distillate cracks lost more ground to WTI than gasoline cracks did.
Distillate Cracks vs WTI are Trading Inside their Yearly Range
Distillate cracks are much stronger than their RB counter parts compared to the 2022 red line. That could be a comment on the increased and repeated exports to the EU. Maybe the Heat to Gas spread is something to look at here.
Outright Distillate Futures are also Marginally Higher than 2022 Lows....
Product markets are not giving up in the same way the oil markets did. Perhaps this is due at least in part to short-term refinery issues in general and France most recently; Especially on the Distillate side?
Refinery Issues in France Are Not Helping:
France's two biggest refineries are halting operations as protests over the government's pension reform plans continue to escalate, union officials said last week.
The 247,000 b/d Gonfreville refinery in Normandy is set to halt operations, with the first unit closures starting "in a few hours," a CGT union official told to S&P Global Commodity Insights early March 17.
ExxonMobil's Gravenchon refinery in northwestern France has also halted one of its two CDUs due to a lack of crude as port staff at the nearby oil terminal at Le Havre are also on strike, the official said. The second CDU is likely to halt early next week if crude deliveries remain suspended, even though staff at the refinery resumed product dispatches March 8. ExxonMobil was not available to comment.
Staff at Petroineos' Lavera refinery have also decided to start halting units from March 20, another union source said. The CGT union has also called on the staff to stop product dispatches as of March 17. The company declined to comment.
The French government's plans to raise the retirement age from 62 to 64 has sparked more than a month of heated political debate and protest strikes. Unions have vowed to maintain their opposition to the pension changes, with the CGT calling for another nationwide day of protests March 23, extending the action that started Jan. 19.
If these were resolved would be temporarily bearish, but it would not solve the broader problems and may actually be dips to be bought. In any event market behavior upon resolution should be watched.
Gasoline Octane is Bid
U.S. and European refiners are scrambling to get enough octane to make high-quality gasoline. There are several potential reasons for the shortfall, including the fallout of Russia’s war in Ukraine, the impact of US environmental regulations and a lack of refining capacity.
The net effect is that it’s making the fuel even more expensive than usual, when compared to regular unleaded. In the U.S., the price gap is around 75 cents a gallon — about 15% more than during the same period last year — data from automotive group AAA show. In the U.K., the premium has widened by 25% on an annual basis, their most recent monthly data show.
Because of the lost capacity, there aren’t enough reformer units to upgrade low-octane naphtha, to raise its octane levels for use in making premium gasoline. Spreads like this continue to underpin the product shortage narrative.
Refined Product Inventories
As we enter the summer season, combined gasoline and distillate inventory in the US remain low, according to the latest EIA data. With the exception of 2020, we are entering a period of seasonal decline in combined product inventories.
Meanwhile US commercial crude oil inventory levels are well off their lows as we enter a historical period of seasonal stability.
US EIA Gasoline, Distillate Combined Inventory Near Decade Lows Relative to Prior Years...
If you back out "Covid 2020" (teal line above), it's a consistent trend lower. The historical trajectory would have US inventories moving lower from here.
US EIA Commercial Crude Oil Inventory....
Oil inventories are now on a march higher while products inventories are near dangerous lows. Oil prices are lower, the term structure is basing at a higher level. Gas cracks are strong as we head into the season. Heat cracks are stronger likely due to EU risks.
Seasonal Calendar Spreads
Product spreads remained elevated relative to WTI. There is a clear trend in cracks Either it's a trend to surf or it's a trade to fade.
What we know is that looking for contradictions we cannot find any yet. Products remain elevated relative to crude oil, no matter how it is sliced, refinery issues persist and local demand is overriding exports.
If we want to entertain a thesis that cracks are breaking down soon, there was only one other spread worth looking at-- the 'summer versus winter' spread.
WTI April/October 2023 Ends the Week at Lows..
Using April as the front summer leg (even though it's often viewed as a seasonal transition month) and October as a winter month we found was of no help for any bearish ideas we had.
Gasoline April/Oct ("Summer vs Winter") Spread Remains Elevated in 2023, Back to Normal in 2024...
Crude, as you'd expect (see 2 charts up), dropped and took its backwardation down with it No such luck in Gasoline or Distillates. When the markets dropped last week, the Apr/Oct spreads in both RB and HO markets (above and below) rallied while the spread collapsed in oil markets..
Distillate April/Oct ("Summer vs Winter") Spread Remains Elevated in 2023, Slightly Above Normal in 2024
Based on that behavioral pattern it implies that selling was lead by fund or investment based in crude, and consistent with bank-panic selling; but it was most certainly not from a glut of gasoline going into the season. That may come as we get nearer to Labor Day. But not this early.
Bank Throws in the Towel on Oil
Several months ago a couple banks were bullish oil for fundamental reasons. About a month ago one of them, while remaining fundamentally bullish, adjusted their time-frame due to the delay in China reopening and the extent to which the Fed was raising rates.
Saturday March 18th they released a report lowering their targets across the board for oil. Their first line states: "Oil prices have plunged despite the China demand boom given banking stress, recession fears, and an exodus of investor flows" From their report entitled A longer road to higher prices they said:
We ... nudge down our Brent forecasts to $90/bbl in December 2023, $94/bbl for 12 months ahead, and $97/bbl in 2024H2 (vs. $100 previously for all three), accordingly.
They cite "somewhat softer fundamentals" as their reason for the adjustment as well. Here is their grid reflecting those changes
If they are right we should see cracks come in to reflect those fundamentals
Bottom Line: Cracks, OPEC, and FOMC
The US exports its excess oil and covers its shortfall in refined products by importing it. The whole country is, on balance, short cracks.
Cracks have been sticky on the way down. This could be from no-one having the nerve to sell them. And that may be for good reason. We'd be more inclined to lean into them if this were after Memorial day, but admittedly that is a tactical decision. The bull case is we're not making enough of it fundamentally. The bear case is... deep recession is on deck with this bank thing, gasoline ain't distillates, and unless domestic driving picks up, Europe won't likely buy our supply to go driving on the autobahn.
Some outliers are: Liquidity injection to combat banking risks; OPEC cutting production; and a confidence that demand can be tamped down at the financial level.
The semi-obvious trades are many will be buying RB weakness and either selling WTI strength or losing patience and selling it as it softens. The less obvious one is to sell the crack. One thing worth noting. The FOMC is this Wednesday, and after the banking sector bloodbath these past 2 weeks, it really matters how stocks and oil handle whatever the decision is on rates.
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EIA Inventory Recap - Week Ending 3/10/2023
Weekly Changes
The EIA reported a total petroleum inventory DRAW of (3.20) for the week ending March 10, 2023. Conversely, Commercial inventories continued to BUILD by 1.50 on the week while SPR inventories were flat on the week.
YTD Changes
YTD total petroleum EIA inventory changes show a BUILD of 72.80 through the week ending March 10, 2023, well above prior year builds through this date.
Inventory Levels
Only Gasoline inventory levels remain below their 5-year average for this time of year while US Commercial Crude inventories continue to exceed its 5-year average.
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