Summary
The USA is so focused on gasoline that in my opinion many have lost sight of the fact that the oil market is being led up by strong diesel demand around the world. Oil prices are up roughly 30% since the beginning of 2008, and although the fundamentals in the long term point to higher prices, there is a possibility of lower prices by the end of the year, one must just specify which commodity. Hurricane season aside, the fundamentals point ahead to a very weak gasoline market, a very strong diesel and heating oil market, and crude oil tucked in between the two.
Analysis
The crude oil supply demand picture is finely balanced these days. The IEA recently reported that world oil production fell 400,000 barrels per day in April. In addition, the IEA statistics showed developed country distillate inventories dropped 6.7% in March 2008 vs March 2007 while total crude and product inventory in the developed world dropped 1.3 million barrels in March 2008.
Production declines in Russia, the North Sea, Venezuela, Mexico, Ecuador, Indonesia, violence in Nigeria, a few Alsakan North Slope outages and a Canadian Oil Sands industry plagued by a multitude of upgrader outages over the last several months don't lend themselves to an improving supply picture going forward. In fact, new windfall profit regimes in Venezuela and Ecuador as well as record tariffs to export crude oil out of Russia (they are approximately $55 per barrel beginning June 1) scare off investment. Even the State of Alaska and the Province of Alberta are seeking increased royalties in one form or another.
Coupled with a continued forecast of increasing oil demand, it is difficult to be anything but bullish. However, there is a plausible scenario in which gasoline prices decline 50 or 60 cents per gallon by the end of the year, and perhaps the 55% of the CEO's in the survey are focused on that. The flip side is that world wide diesel demand is great, and will continue to be so during the balance of 2008 and this is what i expect to keep crude oil prices high.
Gasoline: The latest California Board of Equilization statistics issued end April showed a 4.5% year on year decline in California gasoline sales. For all intents and purposes, California is a leading indicator with high gas prices and over 1 million barrels per day of gasoline demand. The DOE in February showed a nationwide year on year gasoline demand decline of 2%. Now that prices are substantially higher throughout the country, national levels of demand decline are probably approaching California rates. A 4% decline in gasoline consumption is about 360,000 barrels per day.
Then there is ethanol. We are blending about 550,000 barrels per day today into the gasoline pool, representing about 6% of supply. One can calculate this number using DOE statistics. As of May 17, 2008, the RFA had not updated their website for ethanol capacity which shows 8.5 billion gallons per year. I believe today's number is closer to 9.4 billion and will be 11.5 by the end of the year. Thats another 2 billion gallons per year of supply or 130,000 barrels per day or 1.5% added to the gasoline pool (setting aside BTU issues).
European gasoline demand is declining an estimated 1-2% per year (30-60,000 barrels per day) as more diesel autos are sold, Japanese gasoline demand is down as well and exports continue to the USA. Some other Asian fuel subsidies are ending on gasoline which have the potential to reduce demand and increase exports to the USA.
Finally add the production of the Reliance Jamnagar 580,000 barrel per day refinery in India coming on line. the refinery will produce 210,000 barrels per day of gasoline plus another 60,000 barrels per day alkylate when completely on line at the end of the year. However, when the catcracker somes on line in July/August, we expect 100,000 barrels per day of gasoline to head staright for New Yrok Harbor. To put this refinery in perspective, total gasoline demand in Indai today is about 220,000 barrels per day, ther refinery will produce 270,000 of gasoline and blendstocks.
This is very bearish for gasoline and the NYMEX reflects it. Today's gasoline crack, i.e. the spread of gasoline to WTI is about $8.50 per barrel; in December, the gas crack is $1. Bad news for refiners with high gasoline yields. Good news for the SUV owner.
Diesel on the other hand looks very bullish. Shortages abound around the world. China, South America, the Arabian Gulf. The USA exported 10% of its distillate production in February. Distillate inventories in the USA are 12% lower than this time last year. Refiners must produce ultra low sulfur diesel which has effectively cut capacity because there are now moire processing units involved in the manufacture. More processing units equals more unscheduled downtime since one now relies on the hydrotreater, hydrogen units and sulfur recovery units to make on spec product. The drought in South America is reducing hydropower availability and diesel is used to make up the difference. The earthquake in China caused power disruptions and deisel is the fuel for small generators.
Meanwhile demand for diesel in the EU and China is twice that of gasoline, diesel demand in India is 5 time that of gasoline. The petroleum product demand growth is occurring in parts of the world that regulate or subsidize the street price to the consumer. Many of these countries face a day of reckoning--food subsidies or fuel subsidies. I expect a slow phase out of fuel subsidies.
The NYMEX reflects this shortage of distillate. Today, the heating oil crack is $28 per barrel and it rises to over $31 per barrel in December 2008. The crack is even higher in Europe. In fact, the heating oil market is in contango until the end of the year. Bad news for the trucking and airline industry seeking relief.
The big downside on diesel demand is that high prices lead to a wave of bankruptcies from truckers who can not pass on the fuels costs and their equipment is shut down. Railroads and barge companies seem to have been able to do so. Reductions in airline capacity will also add to the heating oil supply (not diesel since jet fuel sulfur is too high to meet todays on road diesel specifications)
What all this means is that diesel margins will carry refiners going forward, gasoline becomes a " byproduct", in fact, gasoline margins can, and probably will go negative. Add to that poor fuel oil margins and the refiner is stuck. If gasoline and fuel oil are so bad, they may cut runs which directly impacts diesel product further driving up diesel prices and perhaps dragging crude with it. However, if refiners process maximum crude, gasoline and fuel oil only looks worse, those product prices fall and drag down crude prices.
What no one wants to fathom is the scenario of rising oil prices to the point of a deep economic contraction not only in the USA, but Europe and Japan as well. This drags the rest of the world down from which it takes years to recover.
For the 55% of the CEO's who think that prices will fall to $100 by the end of the year, this is then a great hedging opportunity--NYMEX futures indicate one can sell close to $120 per barrel through the year 2016.
