I’m no agrarian, but I hear you need a three-legged stool to milk a cow. Anything less than three legs and the cow gets nervous – and that’s the wrong end of the cow to start psyching out because a squirt of milk in your eye may be the least of your worries!
Come on, you’ve got to admit you have no idea where I’m going with this one, and neither did I – until 30 seconds ago. So let me take the mystery out of the metaphor.
There are three ways that the oil industry can milk the bovine consumer; they can:
Manipulate crude input costs to their refinery sector;
Adjust the refining margin to balance out shortfalls in the prices of crude, or in utter desperation and when all else appears to be failing;
Adjust the pump margins to their favour, applied to the street level prices.
These are the three legs of the price milking stool, all of which are rapidly collapsing from all the pressure.
The crude price drama with West Texas Intermediate (WTI) and Brent hovering at $26/bbl is only the first act of a three act play – Q1 and Q2, 2016 will be the times that shale oil forgot or was forgotten as many drillers will be lucky to see, or even want to see, the summer of 2016.
Many, including this writer, have placed the blame of the crude oil surplus and current basement level prices on OPEC in general, and the Saudis in particular.
The surplus will get worse with 500,000 bbls of US led-sanction-free crude about to come on the market, to say nothing of the brain-numbing decision by the Obama administration to lift the ban on domestic crude exports. Although the shale oil producers may blame the Saudis for the below cost crude, they really have only themselves to blame, along with the lack of foresight by the Obama administration.
By bowing to the financial influence of the environmental activists, and after seven years of turning down the Keystone XL Pipeline, this only accelerated shale oil production assisted by cheap and free flowing financing from a misdirected banking fraternity. Over-production by all game players has reduced the financial stability of US shale oil to the point where bankruptcy is an attractive option.
Ironically, the only way that the industry can be viable again is for many wells to shut down. With the banks undergoing their financial reviews coming up this April, it will be a rock bottom month for crude oil, and expect a slow recovery by Q4 to $38 to $40/bbl at best. Global refining margins fell 34% in Q4 2015, which is the steepest decline in eight years. The reason given is the mild late fall weather we had, and the equally tame winter so far, which has resulted in distillate inventories well over the five-year average, and erosion of the typical refining margins enjoyed over the last two years.
So with crude prices cratering and refining margins eroding, that leaves only retail pump margins to prop up the three-legged milking stool. But with this being the low demand period for gasoline, any increase in pump margins is negated by localized price wars – the purpose of which is to try to maintain market share, which is a losing battle because demand is down.
So the only profit centre at any service station complex is the convenience store margin, and to get consumers in the store guess what? You lower your pump price and say goodbye to the gasoline margin.
Enjoy the low gas prices now and the $5 apples, but beware the Ides of April….I’m not fooling around.
Roger McKnight is the Chief Petroleum Analyst with En-Pro International Inc.
Roger has over 25 years experience in the oil industry, and has held senior marketing management positions responsible for national and international accounts. He is the originator of the card lock concept of marketing on-road diesel that is now the predominant purchase method of diesel in Canada. Roger's knowledge of the oil industry in North America, and pricing structures has resulted in his expertise being sought as a commentator by local, national, and international media. Roger is a regular guest on radio and television programs, and he is quoted regularly in newspapers and magazines across Canada. All posts by Roger McKnight