Oil markets proving a study in supply and demand

Waiting for Ben Again

But this "shortage" has as much to do with the positions in futures markets that are currently open. Massive short positions underlie the huge open interest in WTI contracts and support the speculative length that has helped drive the price of WTI sky-high. As futures positioning adjusts and fewer Cushing-area refiners opt to process costly WTI-type crude, this shortage will correct itself.  Much of the same issue is currently playing out in the gasoline market. U.S. gasoline stocks are healthy, well above year ago levels and, in places like the Gulf Coast, seemingly in excess. Yet the price of RBOB futures has soared and the forward curve has become even more heavily backwardated. Why?

Some of this has to do with the rally in crude. But a closer look at the market suggests here too is a basis risk situation. Take East Coast (PADD 1) gasoline stocks. At 62.6 million barrels, the supply on hand is more than 9 million barrels over inventories a year ago. Much of this surplus is concentrated in and about the New York Harbor, the delivery point for RBOB futures. Gasoline stocks in PADD 1B, the part of the east coast nearest the Harbor, are nearly 31 million barrels, more than 7 million barrels over year-ago levels. With the peak demand season already upon us this surplus ought to be comfortable.

But is it? Perhaps gasoline as a whole is healthy but the supply situation for RBOB, the type of gasoline blendstock that must be delivered against the NYMEX futures contract, is less so. RBOB stocks stood at 19.7 million barrels in PADD 1, seemingly comfortable at over 5 million barrels above year ago levels.

The cash market is sending a different signal. Barges of RBOB in the New York Harbor are now trading at a substantial premium to RBOB futures, indicating a scramble for supply at the delivery point. Prompt physical RBOB now fetches more 5.5 cents/USG over the futures price, having moved up suddenly in recent days after weeks of languishing near parity or at a discount to the futures price.

This is probably due to operational problems at the Irving Oil refinery in St John, New Brunswick in Canada, a major supplier of gasoline to the northeastern United States, as well as the lingering effects of run cuts by European refiners.

RBOB production in the Northeast is also on the decline due to refinery closures. The shutdown of Hess' HES.N Port Reading facility, a 70,000 barrels per day fluid catalytic cracker located in the New York Harbor itself, is the most recent example.  So it is possible that we see a similar phenomenon play out in RBOB to that seen in WTI already. Physical tightness of the grade that can be delivered against the futures contract masked by broader oversupply leading to a short-covering rally.

Of course in both cases, if the futures markets are ultimately being driven by highly local supply and demand factors, the broader markets will adjust. Non-deliverable grades will fall in price relative to those that can be delivered against the futures contract, encouraging end-users to switch where possible as well as stimulating higher production.  The real risk here is borne by futures investors and those using these futures products to hedge exposures to the broader market. A refiner with plenty of gasoline on hand may have sold a lot of RBOB short only to be hit because RBOB deliverables are tight. A similar situation can be imagined for WTI. The unwinding of these short exposures may add a further, temporary bid to the market. But ultimately the lesson may be that hedgers, and speculators, must be more aware of the basis risks underlying these products than they have been.” Interesting take by Robert Campbell.

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