The Magic of Refiner Inputs
$34 oil seems like quite an accomplishment after momentarily staring down at the barrel of negative prices and living to talk about it. Comforted by the relative price 'stability' since then followed by two weekly draws in Cushing inventories, market participants are eager to place new bets. Today we explore evidence that might underpin the recent recovery in prices.
To do this, we focus on gasoline, as higher US gasoline prices are reviving interest in refinery unit restarts. As the chief executive of PBF Energy said in it's quarterly earnings call on May 15, 2020: "One of the things we should really learn from what we have seen here, and I am not sure we will, is that crude has no value unless it can find its way inside a refinery".
He goes on to say "Our competitors, in their calls, have recognized and acknowledge that they are not going to swallow the bait (of higher gasoline prices), they are going to be very tempered in making sure that any recovery in demand is going to be sustainable before they increase runs".
So much has happened over the last 2 months. The severe drop in demand associated with the coronavirus has led to oil production cuts across the globe, as well as a swift drop in refiner through-put. Has this been enough to balance the market?
According to a Reuters article, Russia’s energy ministry sees global oil demand and supply balancing in the next two months. The article states that "the ministry expects global oil demand to improve this month and says supply has already dropped by 14 million to 15 million barrels per day (bpd).....adding that Moscow estimates the current global surplus at between 7 million and 12 million barrels per day (bpd)."
So, where does that leave us? A sustainable price recovery relies on a balance of the following:
Inventory (aka, demand)
Crude oil input to refiners has been a fairly benign statistic in the past. Seasonality and maintenance outages have generally been balanced via inventory and therefore not materially impacted prices. This changed dramatically when refiners became the first-responders to a collapse in demand. As shown below, refiner inputs of crude oil dropped over 2 million barrels per day in the US since the start of the year (orange line). Oil prices followed suit (black line).
It's no surprise that a chart of monthly inventory changes (blue line) is almost a mirror opposite to refiner inputs (less production, less net imports - black line). Inventory is what operationally balances the system from week to week, month to month.
The biggest hit to demand for oil products during this pandemic is to gasoline and jet fuel. To understand how refiners have optimized output while reducing inputs, we review a simple diagram of the refining process (red circles denote areas of reduction in processes and the green circle denotes areas of continued operations).
To reduce gasoline output, refiners have either shut down their FCC and isomerization units or pulled forward maintenance on them originally scheduled for this fall (FCC's convert vacuum gas oil [VGO] into gasoline and gasoline blending components). Distilled crude oil has been routed towards the production of diesel to support the cross-country deliveries of goods during the pandemic via semi-truck.
BUT, as gasoline demand begins to tick higher as driving mobility increases, VGO supplies have tightened. Low refining margins would mean refiners are likely to continue capping crude runs, while adjusting secondary units to shift more toward gasoline production and minimize diesel. Feedstocks like VGO will likely remain in short supply as a result.
Again referencing the PBF energy conference call, a fluid catalytic cracking (FCC) unit idled for weeks beginning in March at PBF's 170,000 b/d refinery in Toledo, Ohio, would soon restart to produce gasoline, PBF said. "But cracking diesel into gasoline and other unusual, inventory-controlling methods would only increase crude through-puts there by 2,000-3,000 b/d", Nimbley said.
The way we see this expressed in futures markets is via the Gasoline (RB) vs Heating Oil (HO) spread.
The RB/HO spread has completely recovered since it's initial decline in March. This suggests that refiners have found equilibrium in output. Equilibrium in the relationship between gasoline and distillate prices does not, however, translate into outright price recovery as seen in gasoline futures (below). It's crucial though for this spread to maintain strength in order for outright prices to recover.
It's no surprise that the largest increases in gasoline inventories are on the East coast and Gulf coast. (the east coast consumes the gasoline, the Gulf coast produces the gasoline).
Taken in total (below), at a time when US gasoline inventories are normally entering a seasonal period of decline, they have increased.
But, as mentioned above, refiners responded quickly with reductions in gasoline output (EIA gasoline product supplied, below). In fact, US gasoline output reached it's lowest level in recent history.
By contrast, US output of distillate products has stayed within it's historical range.
Refiner inputs are the 'magic' that will provide clarity going forward.As refiners begin to optimize their output to meet demand, their needs will be expressed in the market. Increasing output of gasoline prematurely will overload already bloated gasoline inventories. By contrast, a cautious response to demand will cause inventories to draw down too quickly. Gasoline, gasoline inventories and gasoline blending components will be the key to watch going forward. Remember, we have over 15 million barrels of oil production cuts across the world waiting in the wings to respond.
US inventory levels by PADD vs total storage capacity by PADD:
The EIA reported a total inventory BUILD of 3.50 million barrels for the week ending May 15, 2020. Over half of this build went in to the US Strategic Petroleum Reserve while Cushing saw a draw.
Year-to-date, this bring us to a Total Inventory BUILD of a record 125.90 million barrels. This surpasses all previous year to date builds in total, however the crude oil build alone (ex SPR) is still less than the 2015 ytd build by almost 5 million barrels.
Inventory levels are shown below, compared to prior year levels for the same week ending as well as against total storage capacity. Cushing inventory levels are the only outlier here as the only one below previous-year highs (likely due to re-direction to the SPR).
Lee Taylor - Technical Levels
Resistance: 36.98 / 37.80 / 39.70
Support: 33.20 / 30.70 / 28.19
July Brent was able to get above the last retracement level prior to its climb towards the enormous gaps left back in March of 2020. Although the gap does not begin until we reach 41.25 basis July Brent, the oil markets cannot be thought of as making a substantial recovery until these gaps are penetrated and filled. July/Aug Brent did fill the gap last week but retraced back to support of -.66. If flat price in Brent retraces, look for July/Aug to fall -.66 and head back another .90 cents.
Resistance: 35.18 / 36.35 / 37.64
Support: 33.10/ 31.04 / 29.82
After a well needed break because of the holiday weekend, traders will look to see if July WTI can maintain its climb back toward the gap. The bottom of the gap is 36.35 basis on the weekly and continuation charts, but 37.64 basis the July WTI chart. Either of those levels will surely put up a good hurdle for the market to get over. For the gap to be filled, the market will need to reach 41.05 and 41.88, respectively. Speaking of gaps, there is still a gap in July/August wti between -.36 to -.31.
Resistance: 1.0819 / 1.0999 / 1.1124
Support: 1.0262 / .9881 / .9275
July RBOB seems to be overdone to the upside technically, however, if it can hold 1.0262 early in the week it may be able to stabilize and drift higher. Many of the RBOB spreads seem over-priced as well. Look for July/Sep to retest -237 and Sep/Oct to test -800.
Resistance: 1.0611 / 1.1159 / 1.1384
Support: .9878 / .9708 / .9368
July Heating Oil is lagging the rest of the complex from a technical standpoint. It still needs to break above some key technical levels prior to making a run at the gaps left in March. Keep an eye at 1.0611 as key resistance in heat and it will need to finally break that level after three failed attempts last week. Look for July/August to hold -345 to make a move towards the bottom of the gap, however, if it fails, a move back to the -400 level is a sure bet.