Dude, Where's My Cheap Gasoline? The Truth About Oil Part III

by Ur-Turn
dude where s my cheap gasoline the truth about oil part iii

If you drive a Tesla, Leaf or a Volt, you may not have been to a gas pump lately. For the rest of us you’re probably wondering how in the Hell did he get it so wrong! There are some pretty amazing things happening in the oil industry, and a perfect storm gathered to spike gasoline prices in the short term, and has set up a tidal wave of oil that could completely collapse both crude oil and refined fuel products just as the summer driving season begins.

To get an idea of what is going on, you need to look at three charts, which paint a fascinating picture. First, take a look at West Texas Intermediate (WTI) oil prices (NYMEX short contract).

Next, take a look at ethanol futures (short contract):

And finally, take a look at gasoline futures (short contract):

The price of oil was very volatile in the month of February. WTI hit a basement on January 28, 2015 of $44.08 per barrel, and then rose 21-1/2% in just 20 days, closing at $53.56 on February 17th. It has since dropped 8% in just six more days, which is as much data that was available as of this writing. If we were talking about equities, I would be calling this a classic “ dead cat bounce.”

Now look at the price of gasoline futures. At the same time oil started to go up, gasoline prices spiked up even faster, with one key difference, the prices have largely kept going up, settling in at just under $2.00 per gallon even as oil went back down.

If we look at ethanol we can see another, apparently disconnected trend, with ethanol prices dropping and not mirroring the increase in gasoline futures, trading in a rather narrow band of about fifteen cents in February. What in the name of the Wild World of Sports is going on here?

The biggest driver of rising gasoline prices, as much as a dollar a gallon in just a month in places like California, has been caused by a significant number of disruptions to US refinery capabilities in just the last 30 days:

There has been massive disruption to oil refining capabilities causing the price of gasoline, diesel, and aviation fuel to skyrocket. US refinery utilization is normally at 81% to 85%, a 20% loss of capacity just from the strike, has created a situation where less motor fuel is being produced to meet the needs of the buyers lined up for products. Supply of gasoline has tightened, so the prices have gone up.

According to the US Energy Information Association, Weekly US Refiner and Blender Adjusted Net Production of Finished Motor Gasoline hit an all-time production record of 10,195,000 barrels per day in December of 2014. By the week of February 6th, production had dropped a whopping 15%. Gasoline production is tied more to just-in-time economics, so disruptions in refinery capacity due to accidents, weather, normal seasonal transition from winter to summer blends, and work stoppages have swift impacts to prices. So, now you understand why gasoline prices have shot up, but what about oil?

Oil prices spiked, bouncing off the $44 basement, and have settled in to a narrow range of $49 to $50 a barrel. The reason these two trend lines have disconnected, with gasoline continuing to climb up and oil starting to decline again is simple economics of supply and demand. Refiners buy crude oil to turn it into finished motor fuels. But if refiners are offline due to strikes, accidents, weather, seasonal change over, or all of the above, then they are buying less oil, and that is exactly what is happening.

Crude oil markets are faced with a no win situation. They can either cancel contracts on the oil they promised to buy, and pay huge penalties on top of an already battered market, or they can accept the oil and stockpile it in storage tanks waiting for the refinery disruptions to end. With fall 2015 oil futures at higher prices than the current market, oil producers have little incentive to send their oil to refiners anyway, so they’re incentivized to stockpile, which is exactly what they’re doing. Currently, the United States is producing and importing about one-million excess barrels of crude oil a day.

This issue of over capacity has gotten worse because of the Flanagan South Pipeline. Haven’t heard of it? It hasn’t been very news worthy because Flanagan South isn’t USDA prime click bait that generates the fury of a thousand suns that headlines around Keystone XL create. The 36” pipe went online in November, and is now pumping 550,000 barrels a day of heavy oil from western Canada directly to the United States through Pontiac, Michigan. It is what Keystone XL is proposed to do, already happening today. Huge amounts of crude oil from Canada oil sands are moving to Illinois refineries and Cushing, Oklahoma for storage.

Here is the critical problem. The United States is running out of room to store oil. By April every forecast is indicating the United States will be at tank top. Producers are already signing leases for oil tankers to store crude oil off the coasts of the United States in anticipation of hitting the top for onshore storage. The 13 pipelines that flow into Cushing, Oklahoma are pouring 1.7 million barrels of oil a day into the facility.

It is a perfect storm coming together. Diminished refinery capacity nationwide sent gasoline prices up swiftly, but reduced the need for crude oil at the same time. Crude oil producers having no incentive to send their oil down to the Gulf of Mexico refineries for production and export, because current futures prices indicate more profit can be made if they wait, and the refineries can’t use it anyway because of the strike. Record amounts of oil are already in place and have reached the critical point where all possible storage for crude oil will be filled up.

Fine, so why doesn’t China just buy the stuff, or Europe, or Brazil? China oil consumption is down as their economy has cooled and Europe had a rather normal winter and near flat economic growth. The fundamental issue of too much oil and not enough consumption hasn’t changed. What has changed for the short term is a tightening of gasoline supply within the United States causing a temporary spike in gasoline prices.

So what happens if we top out in April? Commodity price Armageddon is what happens. Oil will start to flow southward and refiners will be under huge pressure to increase output, into a market with an oversupply problem as it is. Refiners will be under huge pressure to settle with the United Steelworkers union to get production back up.The price of oil and motor fuels will have nowhere to go but down, and there is a growing chorus of analysts saying that crude oil will drop to below $30 a barrel, and take gasoline with it.

If the crude oil has nowhere to go, producers will be forced to throttle back production. That means any plunge in both oil and gasoline prices will be short lived. The pendulum will swing back the other way as the supply tightens quickly, and that ugly price spike that I wrote about coming in 2016 right around the time of US elections, that would be the next step.

I still think it’s still OK to plan that cross country drive in your Challenger Hellcat, but maybe time it closer to Labor Day.

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3 of 73 comments
  • Sector 5 Sector 5 on Mar 07, 2015

    Nothings more opaque than a capitalist run oil indistry. We need Stalin and one minister. At the drunken table, conversation centers on the minister being shot if oils too low or high. The rest will sort itself.

    • Landcrusher Landcrusher on Mar 07, 2015

      When you say : "We need", do you mean "We party members?" Cuz if so, you're right for sure.

  • Sllloyd Sllloyd on Mar 11, 2015

    A couple of things I would like to point out. First, it has become uncommon for US refinery utilization to drop below 86% in the last couple of years, and NOT uncommon at all for it to be higher than 90%. Second, two words: 'banked wells.' Sure, E&P companies are reducing capex budgets, laying down rigs, and only drilling wells to keep leases or contractual obligations, but they still have a very large number of wells that have been drilled, but not completed. Think of it as an oil well inventory. These wells just need to be hooked up, and they can be producing in a relatively short time span.

  • Tassos What was the last time we had any good news from Ford? (or GM for that matter?)The last one was probably when Alan Mulally was CEO. Were you even born back then?Fields was a total disaster, then they go hire this clown from Toyota's PR department, the current Ford CEO, Fart-ley or something.He claims to be an auto enthusiast too (unlike Mary Barra who is even worse, but of course always forgiven, as she is the proud owner of a set of female genitals.
  • Tassos I know some would want to own a collectible Mustang. (sure as hell not me. This crappy 'secretary's car' (that was exactly its intended buying demo) was as sophisticated (transl. : CRUDE) as the FLintstone's mobile. Solid Real Axle? Are you effing kidding me?There is a huge number of these around, so they are neither expensive nor valuable.WHen it came out, it was $2,000 or so new. A colleague bought a recent one with the stupid Ecoboost which also promised good fuel economy. He drives a hard bargain and spends time shopping and I remember he paid $37k ( the fool only bought domestic crap, but luckily he is good with his hands and can fix lots of stuff on them).He told me that the alleged fuel economy is obtained only if you drive it like a VERY old lady. WHich defeats the purpose, of course, you might as well buy a used Toyota Yaris (not even a Corolla).
  • MRF 95 T-Bird Back when the Corolla consisted of a wide range of body styles. This wagon, both four door and two door sedans, a shooting brake like three door hatch as well as a sports coupe hatchback. All of which were on the popular cars on the road where I resided.
  • Wjtinfwb Jeez... I've got 3 Ford's and have been a defender due to my overall good experiences but this is getting hard to defend. Thinking the product durability testing that used to take months to rack up 100k miles or more is being replaced with computer simulations that just aren't causing these real-world issues to pop up. More time at the proving ground please...
  • Wjtinfwb Looks like Mazda put more effort into sprucing up a moribund product than Chevy did with the soon to be euthanized '24 Camaro.