Oil prices continued to slide Wednesday off the market’s belief that a global glut in gasoline has displaced the oversupply of crude, which had depressed oil prices since July 2014. The day's trading was also affected by announcements from the Federal Reserve that hinted at the possibility of a rate rise in the near future, strengthening the dollar and pressuring oil prices. The front-month WTI contract settled down 2.3 percent at $41.91/bbl Wednesday, while the Brent front-month contract settled down about 3 percent on the ICE to $43.47/bbl.
With refineries taking advantage of lower input prices, utilization rates have been at historically high rates, which has led many to believe we are in the throes of a negative feedback loop where an oversupply of product pushes down refiner margins, which then pressures crude demand, and results in dragging down oil prices.
The integrated oil business model, traditionally, in times of low commodity prices, was able to partially offset falling revenues in its E&P business with gains made in its downstream business. This natural hedge, however, has proved to not be as effective during this price downturn. On Tuesday, BP, the first of the major integrated oil companies to report second quarter 2016 earnings, announced reduced earnings in its refining business both versus the previous quarter and in comparison to the same time last year – with results the lowest since 2010, when Brent averaged $80/bbl (versus an average of $46/bbl in the second quarter of 2016).
Seemingly, market conditions are not adverse for refiners – with advantaged crude prices and relatively strong product demand, especially in the United States. On Wednesday, the Energy Information Agency’s (EIA) closely watched Weekly Petroleum Status Report released data that backs up that assertion. The report showed that for the week ending July 22, U.S. demand for products, which includes gasoline, diesel and jet fuel, was up almost one percent versus the same period last year, and that gasoline demand was up 2.6 percent during the last four weeks versus the same period in 2015.
The EIA data also showed a surprise increase to crude inventories (+1.7 million barrels versus expectations for a draw of 1.6 million barrels). Oil stored at Cushing, OK, the delivery point for the WTI contract (and located in PADD 2), showed an increase of 1.1 million barrels. The front-month contract for both WTI and Brent traded down, over two percent, off the newsflow.
Given the oversupply of crude in the region, it is not surprising that Midwest refiners (PADD 2) were operating at the highest clip at 94.8 percent versus other regions (the U.S. average utilization rate for the week ending July 22 was 92.4 percent). U.S. gasoline inventories also rose 500,000 barrels (versus expectations of an increase of 600,000), and distillate stocks decreased 800,000 barrels. According to the EIA data, U.S. gasoline stocks, which stood at 241.5 million barrels for the week ending July 22, were almost 12% higher than during the same period in 2015. With about five weeks left in the summer driving season (normally the period for the greatest gas consumption), and diminishing returns on demand growth being seen from lower pump prices, it does not appear that extra product supply will be adequately absorbed by the time fall refinery maintenance season arrives.
Over the past few months, oil was able to broach the $50 level largely based off the combination of one-off supply disruptions, including wildfires in Canada that affected oil sands production and attacks on production platforms by the militant group, the Niger Delta Avengers.
Absent these events, the fundamentals still point to an oversupplied crude market – in the IEA’s latest monthly report, global supply outstripped demand by 1 million b/d. OPEC countries in the Gulf continue to produce at a record pace, and don’t look to be slowing down - as competition intensifies within the cartel for market share. Recently, Iraq surpassed Saudi Arabia as India’s top crude supplier; while Iran has re-gained ground lost during the period when international sanctions were imposed.
Delia Morris has worked in the international upstream oil & gas industry for over 12 years, and is currently Director, Global Energy Sector at Stratfor, a geopolitical intelligence firm that provides strategic analysis and forecasting services. Please contact Delia at email@example.com.
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