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Oil's Summer Holiday Is Over

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The oil price war has reached the gates — specifically, the refinery gates. Expect casualties.

Wednesday’s release of U.S. oil inventory and demand numbers was noted chiefly for the jump of eight million barrels in crude stocks last week, more than double the Bloomberg analyst consensus forecast. The more insidious threat, though, was in the demand data.

Gasoline makes up about half of U.S. oil consumption. Luckily for an otherwise suffering industry, it tends to respond well to low prices. This summer, gasoline consumption hit its highest level since those far-off, pre-crisis days of 2007, based on the four-week moving average. 


And that did wonders for gasoline prices. The price of the main unfinished gasoline blending component — which goes by the ungainly name of reformulated blendstock for oxygenate blending, or RBOB — had gained 50 percent by the middle of June, at the height of driving season. As the chart below shows, that helped pump some life back into crude oil prices, too. 

Click to enlarge

Now summer is over. As the first chart shows, on a four-week average basis, gasoline consumption is down by about 440,000 barrels a day since the end of August. Americans are still burning 3.1 percent more gasoline than they were a year ago, lending support to the market. But the rate of change is dropping: Back in July and August, those year-over-year change percentages began with a 4, 5, or 6.

That slowdown can also be seen in the second chart: Since the end of August, the RBOB price is down 30 percent, while crude oil is off by just a few percentage points.

And this is where it gets bad for the outlook for crude oil prices. Refiners operate complex equipment, but lead relatively simple lives. They aim to buy cheap barrels of crude oil and then turn them into barrels of stuff like gasoline to sell at a higher price, hoping to profit from the difference. Now look at what has happened to indicative refining margins (the one below measures the spread between a barrel of RBOB and a barrel of West Texas Intermediate crude oil).

Click to enlarge

To fix that, refiners need the price of their products to go up, or the price of crude to go down (preferably both, obviously). On the product side, though, it is hard to see what would move prices up a lot, unless we see a marked pick-up in the U.S. economy. Stocks of gasoline and distillate remain high or about average, respectively, providing a cushion to absorb unexpected increases.

Without that, refiners will hope crude oil prices fall to take the strain on margins.

And right now, it is a buyer’s market out there in global oil, as behemoths like Saudi Arabia and Russia fight for market share. Earlier this month, the chief executive of Kremlin-controlled oil major Rosneft said Saudi Arabia was “actively dumping” oil on the market. Polish refiner PKN Orlen is considering higher imports of oil from the Persian Gulf to take advantage of lower prices, threatening Rosneft’s traditional backyard.

The rebalancing of the oil market will require producers to feel pain to a degree that actually forces them to curb output. Signs of this remain nascent, suggesting the squeeze hasn’t been hard enough yet. Expect refiners defending their own profits to ratchet up the pressure in coming months.