Summary
There is good news and bad news. As floating crude oil inventory cleans up, the crude oil market perceives increased demand and consequently higher crude oil prices ahead. Good for oil producers. On the other hand, releasing VLCC's from storage along with continued delivery of new builds depresses the tanker market. Bad for shipowners. The oil markets recently have bid up refining margins and utilization is rising. Good news for refiners. Unfortunately they are increasing the supply of distillate which is running out of land based storage. In the last week, traders took 3 more VLCC's for distillate storage. Bad for the heat crack, some good for tanker owners.
Analysis
Expectations that the recession is easing and the economy is stabilizing is leading to the perception that oil demand will increase over the next several months. Seasonally that is exactly what will happen as the world exits the poor demand second quarter.
Members of OPEC cite increasing Asian demand for crude oil as one reason for optimism. Considerring the start up of Asian refineries such as Reliance Jamnagar (580 MBD), Petrovietnam (140 MBD), CNOOC Daya Bay (240 MBD), PetroChina Qinzhou (200 MBD), and the Sinopec Fujian Expansion (160 MBD), it is no wonder that demand is up in parts of Asia.
Meanwhile, Japanese refineries are under pressure operating at 70% capacity while Korean refiners are cutting runs as well. The contango is coming out of the crude market. Brent contango is only 60 cents per barrel per month, hardly enough to cover a VLCC rate at $35K per day plus the time value of money. The contango in WTI is a bit better at 90 cents per barrel per month, making it economic to store Light Sweet crude at Cushing.
Unfortunately a 9.4% unemployment rate in the USA is not going to help demand, in fact, demand will remain under pressure for the next several months. Although total petroleum product demand in the USA is off close to 7% year on year, the differences in diesel and jet fuel are more stark: Demand off approximately 10% for both. Gasoline demand is off perhaps 1 to 2%.
This means at a refinery utilization rate in the USA of over 85%, the USA must export over 700 MBD distillate just to keep inventory from rising. (Ten year comparisons of USA refinery utilization are poor-- refiners have added about 2 million barrels per day of capacity since 1997). Todays distillate inventory of 150 million barrels is nearly 40% higher than this time last year and will continue to rise. Some exports will go to South America and Europe; but much of the excess production will go into storage.
And why not: the contango for heating oil is 3.5 cents per gallon per month, roughly $1.50 per barrel per month through January 2010. The same market structure can be said for ICE gasoil. It makes perfect sense for a trader to take a VLCC for distillate storage. Three more VLCC's have been taken in the last week: Front Queen, Ghazal and Caesar. It is estimated that 20 to 30 million barrels of jet fuel and distillate are now in floating storage.
Come the winter, this material will come out of floating storage. On shore distillate inventories will not fall as rapidly as one might expect and the heating oil crack will come under pressure.
So while the recent run up in crude oil prices are a result of several factors, oil producers may breathe a temporary sigh of relief while tanker owners and refiners continue to see margins remain under pressure.
