Bye-Bye Heating Oil, Hello Gasoline.
Winter has been elusive this year, and with 10 days left in January, the market decided to give up on winter heating oil and look towards summer gasoline season.
We saw both the summer and winter heating oil (ULSD) crack spread futures (basis WTI) take a big hit last week, with both strips seen lower by almost $3.00 per barrel. Not only did ULSD lose ground against crude oil, it also sold off relative to it's High-Sulphur counterpart. The Low-Sulphur/High-Sulphur spread that rallied so significantly in 4Q last year is now down almost $8.00 per barrel since the start of the year, with about half of that decline seen just last week last week.
Conversely, while winter gasoline cracks saw some weakness, the summer cracks (basis WTI) managed to end the week basically where they began at just above $18.50 per barrel. For now, this tempers the weakness in ULSD markets, as it may simply be a sign of market rotation towards the new summer driving season.
Summer gasoline demand season typically hits its peak between June and August. The U.S. Environmental Protection Agency (EPA) defines April to June as the “transition season” for fuel production. Refineries lead this transition and switch over to summer-blend production in March and April. As we all know, gasoline blends used in the summer months are different than the blends used in the winter. Refiners briefly produce a transition-grade fuel during the spring but usually shift to summer-grade gasoline by late March ahead of the required May 1 date.
The general difference between the summer and winter blends is the amount of less expensive components that can be blended into the the finished product (the EPA requires gasoline produced for warmer months to carry a lower Reid Vapor Pressure (RVP). This cheaper component is generally butane. In the summer a gasoline blend might only contain 2 percent butane. In the fall, that gasoline blend might contain 10 or 12 percent butane.
As a result, the March/April spread in RB typically reflects this cost difference (or in the case of the next few charts, April over March for simplicity sake). This cost difference is expressed below via 10% of the Natural Gasoline vs Normal Butane futures spread (black line).
This spread is shown in US $/gal along with the current and prior 3 years April/March futures spread. With the exception of 2018, the spread in RB futures tends to converge with the actual cost difference (represented by 10% of the N. Gasoline/Butane spread to approximate the 10% loss of the cheaper butane component in summer blends). We appear to be entering the window where these 2 spreads could be highly correlated. Keep that in mind as you look to interpret any movements in March/April RB.
We can also see how closely linked the spread between March and April RB/WTI cracks (or the 'box') are to the RB March/April spread itself. This is expressed below in US $/bbl for comparison. As the winter to summer blending changeover gets closer, these spreads become more tightly linked. We present this as a reminder that while the rotation out of ULSD makes the market 'feel' bearish, a widening gasoline spread in March/April is not necessarily a bearish signal, rather a reflection of underlying fundamental prices.
An NGL Perspective
As a refresher, light naphtha comes from distillation of crude oil or from separation of NGL's in an NGL fractionation plant. Light naphtha from NGL fractionation is often called natural gasoline or pentanes plus. The growth in US production of natural gas from shale formations has led to a growth in cheap sources of NGL's that are now upsetting the traditional refining model.
In a refinery, light naphtha is often blended directly into gasoline. However, its low octane and relatively high vapor pressure typically limit it to 5% or less of the gasoline pool. To boost its octane, it is often sent to the isomerization unit before gasoline blending.
As a petrochemical feed stock, light naphtha is used in steam crackers to make ethylene and ultimately make plastics. In this use, it competes with propane and ethane as a feed-stock.
The propane-naphtha gap, known as the pro-nap, is a measure of propane’s competitiveness against crude-derived naphtha as an alternative feed-stock for petrochemical buyers. While earlier we used the naphtha (or N. Gasoline) spread to butane to assess the cost difference between the two, below we present the premium that Natural Gasoline currently has over another NGL, propane.
The NGL's produced from shale drillers are creating severe market dislocations. The winners are those that have access to the export market and are in demand. With a mild winter-to-date, propane, much like ULSD and natural gas, are under pressure. The same goes for propane. However, propane has a petrochemical end-user that could be motivated to opt for lower cost propane if the above spread were to continue to rise.
We highlight this to bring market price relationships to the forefront. While the Natural Gasoline to Butane spread is widening and driving relationships in the oil markets, the 'pro-nap' spread also drives decisions.
One only has to look at examples of global headlines to see that there is a link:
"Singapore — Asian petrochemical makers' growing use of LPG over naphtha as a feed-stock, along with ample LPG supply from the US, will pressure Asia's naphtha cracks over the coming months, market participants said."
Bottom line, these are very efficient markets. Technology has enabled quicker recognition of physical 'arbs' between markets. The only barrier left is logistical.
The EIA inventory report for week ending January 10, 2020 reported total inventory BUILD of 12.30 million barrels with Crude oil posting a net DRAW of 2.50 million barrels. Overall, the crude and product changes are in line with previous years for this same week.
To get a relative sense of where we are, the next chart compares the relationship between WTI month-one futures and weekly inventories of Crude+Gasoline+Distillate.
The product builds have spooked the market, yet as we noted in our weekly inventory change table, these are fairly typical this time of year. However, in the next chart we drill down and compare weekly Cushing inventory levels to Month-1 WTI prices. A traditionalist would be inclined to take note of relative Cushing inventory levels.
Lee Taylor - Technical Levels
Resistance: 67.65 / 68.48
March Brent Crude is trying to continue a weekly uptrend since early October, which this week comes in at 63.69. Resistance is above at 67.65 then 68.48 on the daily charts. April/May Brent has support near .65 then .52 with resistance between .82 to .88.
Resistance: 59.68 / 63.73
Support: 57.73 / 55.62
The major weekly support level is now basis March WTI and comes in at 57.73 this week with resistance above at 59.68. If the market can sustain any type of rally this week and settle above resistance then 63.73 is our next objective above; however, a fail of the trend-line and 55.62 is waiting underneath. On the daily charts, 57.78 is support (very close to the weekly support) so keep close attention to this level is we approach it. Our object on March/April WTI still signals a return to a contango market. Resistance above is fierce at 12-14 and support near .02-.03.
March RBOB, just like the rest of the energy complex, has struggled to have a sustained rally lately. 1.6747 is still acting as resistance with 1.6324 as support. RBOB needs to settle above the prior mentioned resistance level to have any chance of nearing the 50% retracement of 1.7440. Late last week, RBOB spreads failed dramatically after nearing resistance objectives of -100 in GH, -1760 in HJ and flat in JK. This week, it seems as though the outlook is how low can they go? Our prediction is -175 in GH, -1978 in HJ and -81 in JK.
Resistance: 1.8250 / 1.9520
Support: 1.8472 / 1.8250
March Heating struggled mightily last week even after an impressive rally Friday morning, only to close out the week on a sour note. Support is found at last week’s low of 1.8472 with resistance at 1.8925. We find some major support underneath at 1.8250 with no real major