Mind the Crack Between Gas and Crude Prices

May 18, 2020 09:42 AM
Retail gasoline prices rose for a second consecutive week
$12.24 a barrel gap between gasoline and crude prices
Gas will also outperform diesel until airplanes return to the skies
The Energy Report



The Phil Flynn Energy Report 

Unlocking the Economy

Pent up demand, stimulus, and a historic production cutback is unleashing economic optimism and real oil demand. Oil prices are soaring as there are more signs that demand is rising more quickly than many had anticipated and hopes that an economic rebound boom is it is right around the corner. Not only do we see car and air traffic rise, but there are also reports that Chinese oil and gasoline demand are already back to pre-coronavirus levels. China is not only going back to work but also back to play and going out to restaurants and other normal activities. This is a sign that the U.S. and other parts of the world will be on track for a big oil demand recovery. 

This snap-back in oil demand comes as OPEC# is ahead of the curve in implementing production cuts, and U.S. oil producers cut back production in the most significant reduction in history. U.S. oil production has fallen close to 2 million barrels a day (BPD), and U.S. drillers cut oil rigs by 35 rigs to a record low 339 rigs, according to Baker Hughes. Add to that the sense that Fed Chairman Jerome Powell will do whatever it takes on the stimulus front and says that we will get to "an even better place" in the economy before the coronavirus hit and that it "won't take that long." The oil market is taking those words to heart. 

Saudi oil exports reportedly have fallen to 8.19 million BPD. Kuwait and Saudi Arabia have also agreed to halt production from their joint Khafji oil field. This comes as OPEC's second-biggest producer Iraq said it plans to halt output from Al-Ahdab oilfield due to protests that are hampering operations, according to Reuters.

Reports are that the Saudi sovereign wealth fund bought a significant stake of Boeing. It seems like they are betting on a rebound as well.

The U.S. is facing a very tight gasoline market. Gasoline prices are already on the rise, and refiners are dragging their feet as U.S. demand starts to make a come back. I’m not the only one saying that. According to the Wall Street Journal, "Some fund managers think it is safer and will prove more lucrative, to invest in refined-oil products or Brent, a blend of crudes produced in the North Sea. The hottest trade right now: gasoline. A month ago, daily requests for driving directions on Apple Inc.'s Maps app had dropped almost 50% from mid-January, according to data from the technology company. As of May 8, that shortfall had narrowed to 24% with more drivers hitting the road. That has helped push wholesale U.S. gasoline futures 38% higher over the past month to 97 cents a gallon ($40.74 a barrel) Friday.” 

Retail gasoline prices rose for a second consecutive week to a national average of $1.83 a gallon on May 11, according to GasBuddy. Refiners aren't earning much money from making gasoline even at these higher prices. That’s in part because sweeping production cuts, a pickup in road transport, and the re-opening of Asian economies have helped U.S. crude-oil prices rally after their historic crash last month. Futures contracts for the delivery of WTI in June have recovered to $29.71 a barrel, almost triple their closing low on April 21. That came a day after contracts for delivery in May slid beneath $0, the first time WTI futures turned negative.

The gap between gasoline and crude prices stood at $12.24 a barrel Friday, 45% lower than a year before. That difference, known as the crack spread, roughly equates to a refiner's profit margin for "cracking" crude into gasoline. Weak margins will stop refiners from swamping the market with gasoline as demand swells, said Doug King, chief executive of London-based RCMA Capital LLP. Rising consumption, coupled with steady production, has already started to eat into the 250 million-plus barrels of gasoline stored in the U.S. — one reason Mr. King expects gasoline prices will rise faster than crude.

Gasoline prices will also outperform diesel until airplanes return to the skies in significant numbers, according to Mr. King. Diesel is in abundant supply because refiners diverted production away from jet fuel, and toward diesel when planes were grounded because of the coronavirus pandemic. Adding to the pressure, journeys made using diesel are likely to fall as U.S. energy companies cut crude output. Oil producers are a significant user of diesel-fueled trucks. "Gasoline will perform pretty well over the next 2 months. Diesel will continue to struggle," said Mr. King.

Based on what we see in oil, the recession will be much shorter than people think. Barring a second wave of the coronavirus, we will see an economic boom as global economies reopen against a backdrop of the historic stimulus.

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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.