For those hoping for a sustained rebound in oil prices, U.S. inventories might present a mixed picture. First the bad news: crude oil inventories are still near record high levels and are continuing to rise on a year-on-year basis. Gasoline and ultra-low sulfur diesel (ULSD) inventories are also increasing year on year but to a lesser extent. Inventories of all three remain near seasonally-adjusted record highs.
The good news is that the pace of inventory accumulation is slowing rapidly. For a while in 2015, crude oil inventories were rising as much as 31% year on year. Currently, they are just 5% greater than a year ago (Figure 2). Gasoline inventories are up about 4% from last year while ULSD inventories are up about 7% from a year ago. At their peak rate of increase, gasoline inventories rose at about 11% year on year, while ULSD inventories increased by as much as 27% year on year.
A slower pace of inventory accumulation is, on balance, welcome news for energy producers and those who have financial exposure to them. It’s a sign that energy supply and demand are moving more closely into alignment. That said, inventories are still rising year on year and the summer driving season didn’t alter this trend. This might make it difficult for crude oil to sustain its current price level or to advance further, especially if the Organization of Petroleum Exporting Countries (OPEC) and key non-OPEC producer, Russia, don’t adhere to their agreed production limits. Moreover, crude oil, in particular, faces the risk of an inventory liquidation that has the potential to send prices down towards a retest of February’s low at around $30 a barrel.
One remarkable feature of the inventory accumulation is how much larger the build has been in crude oil than in the products. A large part of the reason for this relates to the lack of growth in refining capacity, which contrasts sharply with the massive growth in crude oil production. The fact that crude oil production has largely outstripped growth in the production of refined products explains why crude oil inventories have expanded so much more quickly than that of gasoline and ULSD.
This disparity in inventory growth has the potential to be more bearish for crude oil than for gasoline and ULSD, and could possibly widen the spreads between the products and crude oil. Neither gasoline nor ULSD are trading at anywhere near record spreads (Figures 3 and 4).
One factor that is probably holding down the crack spreads between gasoline and ULSD versus crude oil is that U.S. crude production is no longer growing. It peaked in April 2015 and has since fallen by nearly 10%. Crack spreads were at their widest when crude oil production was growing at its fastest pace between 2011 and 2014. The recent OPEC + Russia agreement to limit production should also keep a lid on spreads, if the agreement is adhered to, which is a big “if.” U.S. production stabilized in July, and has since stopped contracting. A rebound in U.S. production could be bullish for crack spreads.
Even so, a sudden liquidation of crude inventories would probably hurt the price of crude oil more than it would the price of ULSD or gasoline given the differences in inventory build for crude versus the products. Likewise, a sustained rally in crude oil could lead to a rebound in U.S. production, which could also help to widen out crack spreads.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.
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