I am a believer that things go backward because it makes no sense to go forward. Yes, but if you keep looking backward you can’t see where you’re going. Take that Confucius!
Confusion would be an appropriate word to describe or explain the hazards lurking in the murky logic pool of taking a futures position in crude oil or its refined derivatives.
I have expressed concern lately over the diminishing crude oil inventories at Cushing, which, as we all know, is the pricing fulcrum for the WTI futures contracts. Current inventories are at 23.4 million bbls, which is 60% below year-ago levels and nearing the minimum operating level, which is in the range of 15 to 20 million bbls.
So, why not just fill up the tanks and quell the fears?
Enter the magic of futures trading.
Crude is not going into storage as the market is in “backwardization” – meaning the futures price is higher than the spot. Therefore, it makes no sense to put the crude into storage, but better to buy now and release it to the open market. This tells me that there is a feeling within the fraternity of traders that prices in the short term are set to increase. I see some reasons to agree with this pricing emotion: U.S. refinery runs are at pedal-to-the-metal levels due to record exports, a continuing healthy demand for transportation fuels supported by a strong U.S. economy backed by positive consumer confidence, and record high crack spreads, or refining margins.
The question is: how long can the refining industry run at 98% capacity?
Gasoline inventories are 5% above the five-year average, but the driving season is over, and has been for over two weeks as far as the refiners are concerned.
Futures traders should not be looking with glassy-eyed awe at gasoline supply and demand, but the distillate equation, which is out of balance and is the reason for the rumbling thunder on my pricing horizon.
We are entering the period of semi-annual refinery maintenance, as preparations are made for the upcoming heating oil season. This will reduce refinery outputs and lower inventories of both crude (due to lower refinery demand) and refined products, including distillates – a family of products that includes diesel. This is a problem as diesel demand jumps in late September and October to cope with the harvest season, and the stocking of warehouses for the Christmas holidays.
To top it off, we have the U.S. sanctions on Iranian crude starting in November, next to zero supply from Venezuela, and Mexican crude is diminishing to drip levels.
So, when we get into fall, consumers may look back to August in envy, not in anger.
Leave the anger for this winter as there will be a lot of that around.
~ The Grouch
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