Poor fundamentals for crude and petroleum products and climbing refining capacity globally will ultimately cause some companies to close refineries or file for bankruptcy, Andy Lipow of Lipow Oil Associates LLC said in a presentation made at Telvent DTN’s annual Refined Fuels Summit in Omaha last week.
“The only question is who will shut down, and where,” he said.
Lipow pointed to new refining capacity coming online in Asia that will add to the world’s coffer of gasoline and diesel fuel supply. He referenced new oil refineries either in service or being built in India, China and Vietnam. In highlighting the 580,000 bpd Reliance export refinery in Jamnagar, India that was brought into service in December 2008, he said that supply will either come to U.S. shores or displace supply elsewhere that will show up as imports to the United States.
In reviewing current domestic supply, the most recent build in crude stockpiles was reported by the Energy Information Administration at 5.1 million bbl for the week-ended July 24. At 347.8 million bbl, crude supply is 9.23 percent higher than the five-year average of 318.4 million bbl for July 24.
While supply has surged, demand has waned. The report also showed an 84,000 bpd drop in implied demand for gasoline.
Declining gasoline demand coupled with the mandated increase in renewable fuels will lead to additional spare oil refining capacity in the U.S., Lipow said.
He predicts that less demand will eventually lead to less supply as refiners dial back on production. In the meantime however, margins will be pressured, and some refiners will be unable to bounce back in time for an improvement in fundamentals.
“Gasoline prices will come under pressure…our demand will flatten out, and demand overseas will drive the market,” he said.
For the near future, the strong contango in the crude futures spreads essentially means that “crude oil is on sale,” Lipow said.
“The only way to make a contango work for you is to have storage so you can hold crude until prices rise so you can make a profit,” he said. As a result, “there’s a huge storage building movement right now.”
The crude oil storage hub at Cushing, Okla., which serves as the New York Mercantile Exchange’s delivery location for its light, sweet crude oil futures contract, hasn’t been enough to house all of the surplus crude. The Cushing hub currently has more than 50 million bbl of nameplate capacity with an operational fill of roughly 37 to 38 million bbl, with the lower rate necessary to maintain inflow-outflow pressures. In fact, millions of barrels of additional supply are currently held in tankers in the Gulf of Mexico as on-land storage fills and tanker rates were slashed by the dramatic decline in international trade that idled vessels.
In order to end the contango, supply would need to be drawn down from storage and sold into the market.
The distillate contango is already showing an increase of $1.75 bbl per month, Lipow said. Since the economic slowdown has decreased diesel fuel usage as shipping orders drop, on-land storage swells with ultra-low sulfur diesel while estimates place 60 to 80 million bbl of heating oil and jet fuel storage in tanks sitting idle in the water. Tanker storage is cheaper than land storage, he said.
The bearish fundamentals will continue to deliver strong contango markets or trigger a deep cash discount as cracks get “hammered until refiners stop production,” said Lipow. “This will happen especially if it’s not a cold winter this year.”
Despite the bearish fundamentals, traders have continually put a bullish spin on less-bearish economic news in recent months.
This is essentially an attempt to move investor cash at times when equities or other markets are less attractive than commodities, Lipow said. “They want to make some money for their clients, and letting the cash sit there doesn’t make that happen,” he said.
