Now in Bear Territory, Will Low Gasoline Prices Push Demand Higher?

By Brian Milne

U.S. retail gasoline prices declined to their lowest point in 2017 a day ahead of July 4, even as demand was expected to surge during the holiday weekend, with elevated stock levels again snuffing out a rally in gasoline futures.

Increasingly, it appears the New York Mercantile Exchange gasoline futures contract–reformulated blendstock for oxygenate blending–reached a 2017 price peak in April at $1.7710 per gallon. If so, with oil futures moving into a bear market in June, RBOB plumbed a $1.3955 low, might gasoline demand in the U.S. pick up its pace against 2016 when the consumption rate set a record high?

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The broader oil market has been both mesmerized and frustrated by U.S. shale producers, which seem to some to have the capability to turn the flow of oil from a well on or off like a bedroom light. As nearly 1.8 million bpd in production cuts by a coalition of the Organization of the Petroleum Exporting Countries and 10 non-OPEC oil producing nations rallied oil prices early in the year and again in April and May, US crude production soared.

The coalition, which in late May extended the six-month agreement by nine months through March 2018, hurt their efforts in drawing down global oil inventory to its five-year average before the agreement took effect.

“By increasing output in 4Q16 ahead of cuts in 2017, OPEC’s credibility has taken a big hit,” said Bank of America Merrill Lynch in their Global Energy Weekly at the end of June.

These extra barrels were hitting the global oil market in the first quarter while world oil demand was less robust during the first half of 2017 than forecast, swelling inventory. Instead of declining, commercial oil supply held by the 35 developed economies that are part of the Organization for Economic Cooperation and Development was higher in April then when OPEC reached its production cut agreement in November 2016, according to data from the International Energy Agency. OECD commercial oil inventory sits at more than 3.0 billion bbl and in April, 292 million bbl more than their five-year average.

The analysts with the bank said OPEC didn’t fully comprehend the new dynamic in global oil supply.

“At the heart of the issue is the fact that shale oil responds to prices within 3 to 5 quarters. This incredibly fast reaction time compares to 3-10 year cycles for most non-shale non-OPEC projects,” said Bank of America Merrill Lynch. “In our view, a lack of understanding of these shale impulse-response times has caught OPEC completely wrong-footed.”

NYMEX West Texas Intermediate, the US crude price marker, sunk to a $42.05 bbl 10-month low on the spot continuation chart on June 21, with US crude production reaching a 9.35 million bpd 22-month high on June 16, according to data from the Energy Information Administration. On June 29, EIA reported a 100,000 bpd drop in domestic production for the week ended June 23 while oil services provider Baker Hughes, Inc. reported a two-rig decline in the U.S. oil rig count for the final week of June, which was the first decrease in the rig count in 24 weeks.

Some in the market have quickly concluded that the lower oil price would constrain even more U.S. crude output.

“The growth in the rig count may be slowing to some degree, but given the record 5,946 drilled but uncompleted wells (DUCs) as of May 31 we don’t foresee any real change in the production trend anytime soon,” said New York-based Tim Evans, energy futures specialist with Citi Futures.

DUCs came about during the oil price crash, in some cases to maintain land leases. The partially drilled wells mean drillers can complete the well more quickly and at a lower cost since some of the drilling expense has already been paid.

In addition to U.S. oil production gains, other non-OPEC producers that are not part of the coalition in cutting output have ramped up production, including Canada. Meanwhile, production recoveries by Nigeria and Libya in the second quarter, both OPEC members but exempt from the output agreement because internal violence amid civil war and militant activity over the past few years had hobbled their oil production and harmed their economies, are estimated to have led to a roughly 250,000 bpd increase in OPEC output in June.

“Another barrier to higher prices has been high supplies of gasoline,” noted Washington, DC.-headquartered Alan Levine, chairman of the Powerhouse brokerage, indicating gasoline demand fell 2.7% in the first quarter. [G]asoline stocks are near the top of the five-year range as competition from European refiners increases.”

EIA data shows total gasoline supply held along the East Coast more than 4.0 million bbl below year ago but historically high at 68.202 million bbl in late June, down from a record high of 76.285 million bbl reached in February.

For the first time in six years, Colonial Pipeline did not declare an allocation on gasoline deliveries for its main line 1 for a five-day cycle in late June, with the 40-inch pipeline having consistently been oversubscribed since 2012. Line 1, which runs from Houston to the tank farm in Greensboro, North Carolina, has a flow rate of 1.272 million bpd. The gasoline line interconnects with main lines 3 and 4 at Greensboro, which run to Linden, N.J., and Dorsey, Md., respectively.

In 2017, implied gasoline demand in the United States averaged 9.099 million bpd through late June which is strong historically–289,000 bpd or 3.3% above the five-year average, yet 266,000 bpd or 2.8% less than in 2016, a year when gasoline consumption set a record high at 9.35 million bpd.

Low gasoline prices incentivized driving in 2016, and there are expectations that the current low retail price would again spark more driving demand during the summer. At $2.26 gallon on July 3, the US retail gasoline average was the lowest since early December 2016, according to EIA’s weekly survey. The average, which is 3.1cts lower than a year ago, slipped below the comparable 2016 price point for the first time this year midway through June.

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