Friday, August 10, 2012

Crack Spread Plummets as Refineries Suffer Through Petroleum Supply Glut

U.S. refineries are in the midst of a petroleum supply glut that's driving down profit margins for refining crude --the crack spread-and depressing prices by over 25% since last week.

U.S. supplies of oil and all petroleum-based fuels were at the highest levels in at least 20 years, jumping to 1.81 billion barrels for the week that ended May 14, knocking profit margins at refineries off a 15 month high.

The crack spread--the profit margin that an oil refinery can expect to make by "cracking" three barrels of oil into two barrels of gasoline and one barrel of heating oil-traded as low as $11.33 a barrel Friday on the New York Mercantile Exchange (NYMEX). It touched $16.909 on May 13, the highest price since Feb. 12, 2009. The margin has dropped 62% from a record $30.479 reached on May 17, 2007.

The supply glut is likely to depress prices, despite an Energy Department forecast calling for the first increase in domestic consumption in four years amid signs of an economic rebound. Refinery utilization dropped to 87.9% last week, the lowest level in a month, Bloomberg News reported.

"Entering the summer driving season, the market is more concerned with supply outstripping demand than vice versa," Stephen Schork, president of the Schork Group Inc. in Villanova, Pennsylvania told Bloomberg. referring to the peak gasoline demand season in the U.S., which traditionally begins at the end of May and runs through early September.

Contract prices for crude-oil futures traded mostly flat on Friday after the June contract traded as low as $64.24 a barrel on the NYMEX before closing Thursday at $68.01. Since May 3, the June contract lost 21%.  Thursday's close was the lowest closing price for crude since Sept. 29.

Volatility measures have nearly doubled in the oil market in the past few weeks, reaching an eight-month high on Thursday.

"It's been a bloody market to trade in over the last several weeks," Matt Zeman, head of trading at LaSalle Futures Group told The Wall Street Journal. "I can't remember too many times that crude has dropped so far, so fast."

U.S. oil supplies have risen for 15 of the past 16 weeks, jumping 11% between Jan. 22 and May 14. Stockpiles were 6.5% above the five-year average last week.

According to a government report on May 19, gasoline supplies were 6% above the five-year average last week, Consumption fell 0.2% to 9.2 million barrels a day in the four weeks ended May 14. It was the second consecutive four-week decline after 11 increases, Bloomberg reported.

"Surplus inventories on the product side are more bearish than surplus inventories on the crude side," Tim Evans, an energy analyst at Citi Futures Perspective in New York told Bloomberg.  "If we have surplus inventories all the way around, there's not much of a credible risk of market tightness."

Still, the fundamentals for oil, while not great, aren't enough to justify the steep loss, analysts say. Oil has been trading on "disturbing" events, Charles Maxwell, senior energy analyst at Weeden & Co. told the Journal.

Crude's decline comes as concern about Europe's debt crisis raises fears it will slow the global economic recovery, crimping demand for oil and reducing the appeal of commodities as an alternative investment. Officials in China, the world's fastest-growing energy user, have also taken steps to cool their economy.
Additionally, U.S. inflation slowed in April to the slowest rate in 44 years, raising concerns about deflation. Demand for commodities tends to fall in a deflationary environment as consumers pull back on spending.

"That'll be very hard for commodities," Maxwell said.

The Dow Jones-UBS Commodity Index has now lost all the ground it has gained since September 2009.

Preliminary figures from the International Energy Agency in Paris showed last week that demand growth for petroleum in North America was flat in the first three months of the year, making it the first quarter without a year-on-year decline since the second quarter of 2007.

But that probably won't be enough to reduce the U.S. supply glut, which will continue to pressure prices, Tom Bentz, a broker at BNP Paribas Commodity Futures Inc. in New York told Bloomberg.

Demand forecasts "can always be adjusted down," Bentz said. "They're based on what economists believe the demand will be if the economy continues to go down the road it was on. I'm not sure they were factoring into that the slowdown in China and the slowdown in Europe. You may see some of those demand forecasts being adjusted down."

News & Related Story Links:

  • Wikipedia: Crack Spread
  • Bloomberg:
    Record U.S. Fuel Supply Cools Refining Margins: Energy Markets
  • Wall Street Journal: Oil prices continue to slide
  • Money Morning:
    European Debt Crisis Raises Caution Flags But U.S. Economy Won't Be Derailed
  • Money Morning: How the Little Guy Will Fix Oil Futures and Get In on the Profits

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