Crude oil: Rock and range

July 30, 2018 08:07 AM
Daily Energy Market Analysis

Crude oil prices are stuck between a rock and a range with seasonal weakness, as well as the promise of more oil production, which is alleviating fears of a tightening global marketplace. On Friday, the market was looking for a reason to rally or break. It got the reason to break on a report by The Wall Street Journal that Russia’s Energy Minister Alexander Novak, who said he “did not rule out… an increase in oil production in excess of 1 million barrels a day may be discussed.”

The comments were taken as big news on a quiet day, yet when you analyze what he said it is not really anything different than they have been saying all along. Then you must wonder if Russia does indeed raise output, how much spare oil production capacity will that leave them? The market also moved lower on the fact that Baker Hughes reported that U.S. drillers added three oil rigs in the week of July 27, the first time in the past three weeks that drillers have added rigs. Gas rigs fell -1 to 186.  

We are behind the curve and you should use market weakness to put on long-term bullish strategies and make sure you are hedged on gasoline and diesel. Even though oil is acting weak, the reality is that this is the calm before the storm. As we start heading into the last quarter of the year supply tightness will start rearing its ugly head.

U.S. refiners are producing a lot of gasoline and that is a good thing. Platts is reporting that growing gasoline demand in West Africa is pulling more supply from Northwest Europe, curtailing exports to the New York Harbor and shifting the focus of traders there to securing August supply. Sources on both sides of the Atlantic said this week that exports from NWE to the U.S. Atlantic Coast trading hub will fall in August as the arbitrage becomes less profitable and netbacks to other regions grow. So, look for U.S. gasoline prices to stay strong. Buy RBOB Options as well as diesel options.

The Energy Information Administration put out a report on the tightening supply on diesel. The EIA points out that inventories of distillate fuel, a category that includes both diesel and home heating oil, were 117.7 million barrels at the end of June, the lowest end-of-June level since 2004. Distillate inventories have generally been lower than the previous five-year (2013–2017) average throughout 2018. Relatively low inventory levels reflect growth in distillate consumption during 2018 that has not been fully offset by increased domestic refinery production or by lower net exports of distillate. 

EIA estimates that U.S. consumption of distillate fuel averaged 4.12 million barrels per day (b/d) during the first half of 2018, which was 190,000 b/d (5%) higher than in the same period of 2017. This increase is largely attributable to an increase in trucking activity-- the leading use of diesel fuel. Demand for trucking services tends to be closely correlated to economic growth and industrial activity, both of which have been higher in the first half of 2018 compared with the first half of 2017. 

Cold January temperatures in the Northeast also led to more heating oil consumption. In January 2018, temperatures in the Middle Atlantic and New England—regions with relatively high shares of homes using heating oil—were 25% and 21% colder, respectively, than in January 2017.

On the supply side, EIA estimates that refinery production of distillate fuel in the United States averaged 5.0 million b/d in first six months of 2018, which was 30,000 b/d higher (1%) than in the same period of 2017. Net exports (gross exports minus gross imports) of distillate fuel averaged 1.1 million b/d in the first half of the year--80,000 b/d (7%) lower than in the first half of last year. The lower net exports largely reflected an increase in imports during the first quarter of the year to meet increased demand for home heating oil. 

The increase in domestic distillate consumption relative to supply has contributed to diesel prices rising more than crude oil prices (the main input cost in distillate production) during the past year. The spot price of Brent crude oil averaged $71 per barrel (b) in the first half of 2018, an increase of $19/b, or 46 cents/gallon from the first half of 2018. The retail price of diesel averaged $3.11/gallon from January through June 2018, up 55 cents/gallon from January through June 2017.

My take is that this undersupply of distillate is going to get worse. Light shale does not produce enough heavy fuels leaving the market short. This is a bullish risk factor going forward. Nat gas is being supported on hot weather. Baker Hughes reported that U.S. gas rigs fell by 1 rig to 186. 

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.