Gasoline Glut--Now that prices are up demand is fading

Many have been playing up gasoline demand in 2016.  And it was very strong to start the year.  But it is beginning to look like many were stocking up on cheap gasoline and now that it has risen demand is fading.  Also global supply of gasoline has surged while demand for distillates is soft.  Some have started to point out the gasoline glut in China and the rest of Asia.

Business Insider--Gasoline Glut in China

Indeed yesterdays EIA report foretells soft demand for refined products as refinery inputs plummeted below 2014 and 2015 levels for the week, after a very strong showing in March and April.

psw01 2016-4-27

A more detailed comparison of refinery inputs vs gasoline supplied clearly shows the large surge in gasoline supplied to start 2016.  But it has also fallen off in the last 2 weeks.  The surge in refinery inputs in March can be seen ahead of the gasoline supplied surge in April likely caused by refiners having a surge of orders in March for April delivery.  If we assume a large portion of the additional demand went into storage in preparation of seasonal demand that would mean about 36MM bbl of gasoline is spread around waiting for customer demand.  Given increased demand for gasoline during the US summer, this would still mean enough gasoline is already spread around to cover that increased demand relative to 2015 mid April demand to completely through early July.

Additionally it looks like US refiners have tweaked their processes to increase the output of gasoline vs distillates/diesel to account for increased gasoline demand, weak diesel demand and a glut of diesel in storage.  In the past US refiners were able to reach a ratio gasoline to diesel of 2.3 to 1.  In recent years the ratio has tended to run about 1.9 to 1 in the summer, but last week the ratio was 2.1 to 1.  This means refiners get about 10% more gasoline per barrel of crude.  This would weaken summer demand by up to 10%.   If this were to reach a ratio of 2.3, refiners would get 20% more gasoline.  Going forward if diesel demand remains weak we can easily see refiners lower demand by 10-20% just by adjusting their processes.

Canadian imports up, US crude inventories may not fall this summer

When crude was below $40 I was pretty bullish on oil.  Even expecting a possible run into the $60s this summer and certainly by year end.  Still there are some technical indicators that seem to indicate a near/midterm top around $52.  BUT much of that bullishness was predicated on a Canadian oil sands downturn.  For that to happen WTI needed to stay low enough to keep tar sands operations below cash costs throughout this spring's maintenance season to encourage operators to find ways to slow production.  Instead prices shot above $40 allowing oil sands producers like Suncor to lock in prices with hedges just above cash costs.  When you factor in that the refining operations are very profitable, this will keep oil sands production at peak levels and likely growing since the operations become more efficient and profitable with higher production.  Indeed Suncor has promised to increase output this year.  Growing Canadian production will likely spur the Saudis to avoid a freeze deal since one of the highest cost producers can stay online in the mid $40s and even grow production.

During the summer of 2015 US crude inventories dropped about 37 million barrels.  But where did that reduction primarily come from?  The chart below shows the 2015 inventory drop and indicates the seasonal nature of US crude inventory, typically falling through the summer.  Typically refinery utilization is highest through the summer adding demand and helping draw down inventory, but supply must not keep up with demand to get a draw obviously.  

psw01 2016-1-13

Getting to supply.  Canadian oil sands operations had scheduled maintenance during the summer of 2015 likely affecting output, but output was likely affected much more during the summer by a major forest fire near the oil sands operations and fire damage to some of the operations.  In 2016 oil sands maintenance was scheduled for April, so those operations are likely at full strength already and certainly will be this summer.

The chart below clearly shows that through the summer of 2015 imports from Canada dropped 500k to 900k bbl/day throughout the summer.  When the summer Canadian import declines are accumulatd relative to the spring import peak, the total lost imports for the summer was 44.1MM bbl.  But previous years comparisons clearly shows this is not a seasonal drop.  So now after oil sands maintenance and an April Keystone pipeline break in South Dakota caused some production/import declines in March and April, imports are likely to surge back towards 3.3-3.4MM bbl/day.

psw08 2016-4-27

The likely conclusion is the entire decline in US crude inventories was created by a slump in Canadian imports which is not likely to repeat in 2016.   Yesterday and today's price action in crude and gasoline futures has been bullish in the face of a very bearish EIA report.  The only two bullish points were a small US production cut relative to the inventory situation and a significant drop in total imports.   The import drop was largely due to a big drop in Saudi imports, which is unlikely to continue in coming weeks based on history and the large number of tankers sitting in the Gulf of Mexico and elsewhere.  Also a big dip in Saudi imports tends to precede a huge surge.  Apparently a lot of professional money is taking the import dip as a sign of a seasonal trend of lower imports.  But if Canada doesn't bear that load as they did last year.  Who will?  Iran is boosting production, which will keep the Saudis and others from freezing or cutting.  In fact the Saudis have said they would boost production, and if Canada is boosting it's output I don't see the Saudis allowing them to grow market share aggressively as they have continued to do in the face of a weak market.

A look at total crude + petroleum products (refined) inventory indicates a continued surge.  Even last summer's big drop in crude inventory had a negligible affect on total inventories when viewed over the longer term.

psw01 2016-1-13

For the coming week I expect the market to be shocked with a 10MM bbl build in crude+refined products and potentially a 9-10MM bbl build in crude alone as Canadian imports are at full throttle and an expected surge in Saudi imports.

It looks like crude oil prices will face more headwinds this summer than I previously expected and this will become a very bearish scenario for the fall when refinery demand weakens and US inventories have continued to build through summer.

Mister market just saved Canadian oil sands and capped oil upside

Note:  The big dip in Canadian imports in April 2016 was caused by a pipeline that broke in South Dakota in early April.

psw08 2016-4-27

It looks like Mister Market moved up just in time to save Canadian tar sands producers.  Imports from Canada were back up to 3.3 million barrels per day (MM bbl/day)  this past week and look to be heading back towards 3.4-3.5 MM bbl/day.  Last summer Canadian production was hurt with tar sands maintenance and with a large forest fire around some of the oil sands operations shutting them down and causing some damage.  It looks like Canadian imports could be up to 1MM bbl/day higher this summer than last.

Many in the oil market are very focused on US production which is certainly falling by around 100k bbl/day/month, but in the near term Canadian production looks to wipe out those losses.  It appears tar sands producers are happy to just cover operating costs, so will likely be locking prices in now that WTI is in the mid $40s with hedges.  Suncor Q3 2015 financials show a $410MM operating profit while WTI averaged about $46/bbl over the quarter.  Others have indicated oil sands operational break even is achieved around WTI mid $40s.   Indeed in recent weeks as crude has broken above $40, short positions with swap dealers which provide hedges to producers have risen, just as they did into year end 2015.  Notice how Canadian imports actually increased into the new year even as crude spot prices plummeted.

Source:  CME Group data provided by CFTC.gov

This along with Iran increasing production will spur the Saudis to increase output as well as their exports to the US have lagged in recent weeks and are well below peak levels last seen in 2013.  This week was a big down week for Saudi imports to the US so a makeup week next week is to be expected along with a bigger surge to follow with prices in the $40s.  I doubt the Saudis want to concede market share to Canada anymore than they want to concede share to US shale producers or Iran.

psw08 2016-3-16

Other Oils Tailwind for Summer Crude Prices

psw01 2016-4-20

Other oils inventory acts as a tailwind for crude prices during the spring and summer since few pay attention to other oil inventory and more generally the total inventory of crude and petroleum products or the total inventory of refined/petroleum products.  During the summer refineries run in a mode that produces an excess of other oils.  Other oil builds seasonally at a rate of about 2MM bbl/week effectively decreasing crude and the more monitored refined inventories of gasoline and distillates by 2MM bbl/week and hiding it in plain sight in other oil inventory.  This has the affect of making demand appear to be 2MM bbl/week higher than the underlying demand for gasoline and distillates would imply.

However, in the fall when the refineries switch to winter mode crude is cracked such that less of the other oils are left behind and more gasoline and distillates are produced.  Also it is likely that some of the other oil inventory is actually cracked to produce gasoline and distillates.  Therefore during the fall/winter starting in about September crude oil demand is effectively dropped by 4MM bbl/week as other oil inventories decrease typically at 2MM bbl/week and the false demand of putting 2MM bbl/week into inventory disappears.

US oil rig count down big again, shale not nearly as robust as most believe

North America Rig Count 2016-2-19

US Rig count is down big again this week, 8 or 2.3% of the total.  Over the last five weeks 8% of working rotary rigs have been idled.  Yet, many still seem to believe a turnaround in rig count is imminent.  I've seen some that thought rig count would surprise to the upside this week.  Others are saying rig count will move up starting in the $40s.  People we are already in the low to mid $40s and producers idled a huge percentage of rigs this week with the bulk coming from the Permian basin, one of the best most economical basins to drill in the US.

It seems that false premises are hard to break.  Late last year and into this year the oil bears kept saying US shale economics is great in the $40s and good in the $30s.  They'd pump like crazy to make up for lost revenue with more barrels.  Now we are in the $40s again and there is no indication US shale is ready to ramp up.

History doesn't repeat but it rhymes.   See my comparison of WTI to rig count.  US rig count increases over $60/bbl

One way the US is losing on trade

When the discussion of corporate income tax rates and VAT or a national sales tax comes up, the conversation almost immediately becomes one of comparing a tax on profits or work vs. a consumption tax.  It quickly turns into a political football of whether the rich corporations or poor consumers are being taxed.  The reality is all corporate taxes are included in the price of the good sold, so the consumer pays all taxes, all the time.  The discussion really needs to be about how, why and how much we are losing on trade with foreign countries.  This subject is made to seem complicated, but it isn't. just follow the lead of countries like Ireland that lowered their corporate rates.  Why reinvent the wheel?  But to be clear I'm NOT proposing an extreme 23% VAT like Ireland has, but a VAT rate that is net neutral in terms of tax burden on US sales with about a 10-12.5% corporate income tax rate.

I chose to use Ireland in this example because companies inverting or moving from the US to Ireland is in the news a lot these days.  Also as free trade agreements came into being and duties and tariffs were reduced Ireland dropped their corporate income tax rate from 50% in the 1980s to 12.5% today.

One of the ways the US is losing on trade is the high corporate income tax along with the lack of VAT or nation sales tax.  One of the main functions of the VAT in countries with low corporate income tax rates is to replace lost income tax revenue.  VAT also insures imports experience a heavy tax.  Lets look at a hypothetical example

Sales in the US
	US Company	Irish Company
Sales Price	$10,000,000	$10,000,000
Before Tax Profit	$1,000,000	$1,000,000
US Fed. Tax	$350,000	$0
Irish Tax		$125,000
After Tax Profit	$650,000	$875,000
Tax Savings		$225,000

Using an example where a US company and an Irish company make the same sale in the US with the same before tax profit and no duties, the Irish company saves $225k on a $1 million before tax profit, making $875k compared to the $650k profit for the US competitor.  This is a difference of 22.5% of the pretax profit.

In the real world that $225k savings goes to pay for shipping and other related costs to making the sale in the US rather than Ireland.  And some is used to undercut the price of the US company.  But with such a large savings, 2.25% of the total sale, some likely also stays in the pocket of the Irish manufacturer.  Almost certainly this leaves $150k-$200k for the Irish company to use to undercut the US competitor on price if needed.

Now you ask how does the Irish gov't get along with all the lost corporate income tax.  Easy they replace it with revenue from a national VAT or sales tax.  The Irish rate is 23% of the total sale.

Sales in Ireland
	US Company	Irish Company
Sales Price	$10,000,000	$10,000,000
Before Tax Profit	$1,000,000	$1,000,000
US Fed. Tax	$350,000	$0
Irish Income Tax		$125,000
Irish VAT	$2,300,000	$2,300,000
Irish total Tax		$2,425,000
After Tax Profit	$650,000	$875,000

If the same sale occurs in Ireland, the Irish gov't receives $2.3 to $2.43 millions in tax depending on whether the sale was from a US or Irish company.  In this scenario the Irish company still has the $225k advantage over the US competitor.  But now this time the US competitor has the added overhead of overseas shipping and other costs associated with making a sale in a foreign country.

Many of our trading partners have similar tax structures with low corporate rates and high VAT or national sales taxes.  This example clearly shows how and why the US is losing on trade.

Here is what happens to the sale if the US tax code is restructured to lower the corporate rate and add a VAT or national sales tax.

Sales in the US
	US Company	Irish Company
Sales Price	$9,742,857	$9,742,857
Before Tax Profit	$742,857	$742,857
US Fed. Inc. Tax	$92,857	$0
US VAT	$257,143	$257,143
Irish Tax		$92,857
After Tax Profit	$650,000	$650,000
Tax Savings		$0

Notice the corporate income tax savings leads the manufacturer to reduce the selling price while maintaining the same after tax profit.  The US gov't gets the same tax revenue because the VAT is also added to the sale.  In the end the consumer gets the same product or service for exactly the same price.  While we get the added benefit of taxing the sale made by the foreign company as well without violating any free trade agreements.  Now with no tax savings the Irish company has no advantage over the US company.  In fact they are handicapped by distance and the associated shipping and delivery costs.  This example uses a 2.6% VAT.  This leads one to believe that the corporate income tax rate could be lowered and replaced by a 2-4% national sales tax or VAT.

It is plain to see this is a win win scenario to lower corporate rates and initiate a VAT or national sales tax.  There are other benefits as well.  Our companies would thrive leading to more hiring at higher wages.  This is good for our people, but would also increase federal revenues through increased individual income taxes.  Total federal individual income taxes are 5 times more than corporate income taxes.  This leads one to the conclusion that raising employment and raising wages for everyone will have a far greater affect on federal revenues than focusing on corporate rates.

Crude oil inverted head and shoulders, long term bullish breakout

psw11 spot 2016-4-20

Inverted Head and Shoulders Pattern
Around March 31 and April 1 many analysts started talking about the head and shoulders pattern that was forming in oil ETFs such as UCO.  When I read it, I just about rolled laughing, thinking more like we were running into the neckline on the right side of the inverted head and shoulders pattern.  A month later my thoughts were proved to be 100% correct.

It is interesting to note that on the May futures contract there was actually a bearish breakout below the left shoulder.  However, it did not break below the left shoulder on the multicontract chart.  Predictably on 4/1 and 4/2 many bears jumped onto the short side, triggering a 2 day 10% slide.  Which was promptly taken back by the market in the next 2 days.  Those professional analysts sure earned their money on that call as we are now almost $8 off the 4/5 bottom.

It was interesting reading all the posts from the permabears who were again convinced that $20 oil was soon to be had.   Their joy was great but very short lived just as it has mostly been since late January.  I have not seen a single analyst or writer post about the inverted head and shoulders in crude oil or the bullish breakout from the downward channel.

Bullish Breakout from Bearish Channel
After the May contract expiration drove crude oil out of the bearish channel around 3/17/2016, the breakout was confirmed when trend resistance broke again on 4/8/2015.  Again, little or nothing has been said about this.

DeMark Bullish TD Price Flip
Of course those that use DeMark Indicators saw a bullish price flip the week of 2/29/2016.  Over the years DeMark indicators have proven to be fairly reliable.  The Bullish TD Price Flip on the weekly chart was a giant clue that the talk of a head and shoulders pattern forming with more downside ahead in crude was way off base.  The DeMark Bullish TD Price Flip occurs when the week closed above the closing price from 4 weeks earlier while the previous week's close was below the close from the week 4 weeks ahead of it.

There have been multiple very bullish technical indicators in crude oil since February, yet it is practically silent from the mainstream media and professional analysts.

Saudis--Freeze still on the table in June. No surprise!

Surprise, surprise a freeze in oil production is still on the table.  Could it be that sub $40 oil is unsustainable.  Really sub $50 is unsustainable since so many governments need the additional revenue.  I pretty much laughed at all the empty and essentially empty threats from Iran, Saudi Arabia, Russia, Venezuela, et.al. to raise production through the roof.

Iran
The will raise output to 4MM bbl/day by June and then they will discuss freezing.  In other words they will be happy to freeze at 4MM bbl/day.  If it is all about not self sanctioning and turning this into a dog eat dog fight for market share why not keep on going after that.  After all they said they sold oil at $6 in the 80's, $20 oil would be a windfall.  If they can raise output 800k bbl/day in 6-8 weeks why not continue to add 300-400k bbl/day/month until nearly all US & Canadian output is shut in along with many other high cost producers.  It's simple, it's about revenue.  Also, Iran has more than likely been producing much higher levels for years and selling it on the black market, so they are now just incrementally claiming production increases for show.   If Iran was really cranking out as much new oil as they claim Brent would not be in backwardation for June/July.  Iranian oil would be more than plugging that gap, either directly or indirectly.

What does Iran really want?  $70-$80 oil.  This was their goal even after knowing the sanctions would be lifted and they would double output.  So they want double output and double price.
Iran urges OPEC to cut oil output to raise prices to $70-$80
Bloomberg: Iran seeks $70-$80

Saudi Arabia
The Saudi's latest threat.  We can raise output 1-2MM bbl day rapidly.  They won't  They want to build a $2T wealth fund.  How will they do that with $20 oil when prices in the $30-$60 range cost them $150-$200 billion from their foreign reserves.  Their $600 billion in foreign reserves would be gone in 2 years with $20 oil.

What does Saudi Arabia want and expect?  $60 oil by end of 2016.  Well that's easy to achieve just get on board with a freeze or event cut a little.  They absolutely have to have $60 crude if they want a decent price for 5% of Aramco in the IPO offer they would really like to get done in 2017.
SABIC expects $60 oil by end of 2016
CNBC: SABIC expects $60 oil in 2016

Russia
After Doha Russia threatened to raise production if Iran and Saudi Arabia increased.  Yah right.  When crude was in the $30s many of their oil fields were not covering cash costs

What does Russia want?  $45-$50/bbl is "acceptable"
http://www.reuters.com/article/us-russia-opec-freeze-idUSKCN0X30M0

Venezuela
Venezuela joined the post Doha empty threat party by claiming they would raise output if the Saudis and Iran did.  Yah right.  Prices were already low enough in 2015 that their output was in decline.  Early this year when prices were in the $30s they couldn't even afford to import light crude to mix with their very heavy crude so they could export it.  It's pretty bad when you can't even afford to keep the the business which is your very lifeblood alive by purchasing the necessities of said business.

What does Venezuela really want/need.  $75-$80/bbl
Venezuela says $75-$80/bbl is a fair price for crude

The moral of the story is to load up on crude as it dips to about $40 over the next week or two, because a freeze deal in June is almost guaranteed.  And US shale is locked into a multi year decline.  It will take $60 oil just to get US production to stop falling with only 360 rigs working.  And few rigs will come back until $60 is topped.  As prices increase the Iran, the Saudis, and the rest of OPEC will stay ahead of the curve to claim any new demand for themselves, keeping the fear in US shale producers and their rigs on stacks.
$60 crude drives oil rig increases

DUCs Gone in Time for Duck Hunting

NA Rig Count 2016-2-19

Using the an approximately 3900 drilled but uncompleted (DUC) count from a recent Bloomberg article , Baker Hughes Rig count data and reports on well completion rates from the states of Texas and North Dakota a projection of US DUC count was created.  You can see by fall 2016 the DUCs will be all or mostly completed based on current and projected rig count should prices stay below $55.

While this is just an estimate and it is unlikely that completion rates are planned to fall off so dramatically in a single week, the projection does make a lot of sense in a general way.  Burning through the remaining DUCs over the summer when demand is high and prices are typically supported by both high gasoline and refinery demand makes sense.  Falling into a much lower completion rate just ahead of refineries going into their seasonal maintenance in October also makes a lot of sense.  Reducing supply just as demand briefly softens.

Reports from around this same time last year had the DUC count close to 5000, meaning the DUC count has fallen by over 1000 with most of it likely happening since August 2015 given that is when the rig count really started to fall.  The pace of depletion of the fracklog is accelerating with a falling rotary rig count.

It won't be long and others will be talking about how shale is no longer the swing producer and that it can no longer ramp up quickly to meet demands given the fracklog that was used to create rapid production increases will be non-existent.  The headlines will be OPEC is back in control again.  I expect $60-$70 oil ahead of the Aramco IPO in 2017 or early 2018.   OPEC back in control and much higher crude prices should maximize what the Saudis can get for a 5% stake in Aramco.

Russians the Lynch Pin in OPEC/Non-OPEC Production Freeze

This week the Russians have started talking about $45-$50 being an acceptable price for crude.  They urgently need higher prices.  The Russians are also contracted to help Iran boost their production by providing rigs and other work on their infrastructure.  Iran has said they plan to boost their output in cooperation with other producers.  i.e.  Others cut and Iran will increase.

In the $30s many Russian wells do not cover cash costs to produce, much less actually turn a profit.  Russia cannot subsidize their government/economy by just meeting cash costs they need a profit.  Therefore they are highly motivated to boost prices.

The Russians could easily allow their expensive wells to naturally decline at about 5%/year and not drill replacements.  This is what they will be forced to do anyway if no agreement is reached April 17 since prices will crater back below $30.  So one part of any compromise can be that Russia cuts production by 1-3%/year, which would be a cut of 120-360k BPD by year end starting now.  Iran would then agree to limit their production increases to not exceed what Russia is cutting.  They could also be encouraged to delay increases for a few months to accelerate a market balance.

Other countries may not be adverse to making a very small cut as well to accelerate this balance.  Many of these countries have boosted their volume in recent years, and they all know that with the US cutting production in a major way, only a very small commitment on their part is needed to solidify a deal to support prices.  In the end even the Saudis can save face by not cutting.  In reality the Saudis may unofficially cut, because they have been pumping at such a high rate recently that they are potentially damaging the long term output of their wells by overproducing.