Market Talk - 2022 july
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Diesel Prices Ran Into A Wall At The $3.80 Mark Thursday And Quickly Dropped By 16 Cents In An Emphatic Demonstration Of Technical Resistance
Diesel prices ran into a wall at the $3.80 mark Thursday, and quickly dropped by 16 cents in an emphatic demonstration of technical resistance, leaving the energy complex in its sideways trading range. RBOB initially followed that pattern, dropping more than a dime after hitting the top end of its trading range, but then the expiring August contract decoupled from the rest of the energy train and continued moving higher, and setting a new record premium vs the 2nd month contract.
Today is the last trading day for the August RBOB and ULSD contracts, and the lack of volume on expiration day is already causing fireworks that look impressive on the charts, but won’t matter to almost everyone who buys fuel, since the September contracts will determine tonight’s pricing moves. For example: As of 8am central, August RBOB prices are up 15 cents/gallon, but most cash markets are following the September RBOB contract which is “only” up 6.
The extreme backwardation in gasoline prices is not just showing up in the futures market. Prompt RBOB values in the NYH are trading some 40 cents above values for barrels delivered 2 weeks from now, and 68 cents higher than RBOB on the Gulf Coast as a short squeeze for summer gasoline grips parts of the East Coast, even while other parts of the country are having trouble finding buyers. This seems to be a less extreme example of what we saw in April and May when New York Harbor diesel prices spiked to premiums of $1.20/gallon or more compared to its neighboring cash markets. The forward pricing curve suggest that this spread will collapse in August, just as we saw diesel premiums collapse in May (see charts below).
One extra challenge for the East Coast, there were several forecasts when the war in Ukraine started that European refiners would run full out to make as much diesel as possible, and end up with excess gasoline to be sent to the US, but some of those facilities are now running well below capacity as soaring natural gas costs (and/or limited supply) make operations uneconomical for some and unfeasible for others. For those that remember last year’s freeze induced natural gas price spike and shortages that led to every refinery in Texas to cut operating rates, this scenario playing out in Europe is easy to understand, as is the potential fallout from the lack of output.
Right on cue, PBF announced it is bringing its idled crude unit in Paulsboro NJ back into operation after shutting it down to try and avoid bankruptcy during the depths of the COVID demand slump.
In other earnings news, Pemex announced that they made $862 million in EBITDA in the first 6 months of operations at the Deer Park refinery, which is $150 million more than they paid for their interest in the facility. Still no word from Shell if they’d like a do-over on any of the refineries they dumped in the past two years.
Valero joined most other refiners, smashing its records for profitability during the quarter, increasing run rates to 94% of capacity, up from 74% 2 years ago. The company also had record renewable diesel production, and expects its next RD expansion project to be completed by the end of the year. In a sign of the market’s skepticism over the forward outlook of fuel demand, the company’s stock dropped after the announcement even though earnings surpassed most published expectations.
The senate spending deal that surprised many this week has good news for biofuel producers in that the $1/gallon blenders tax credit is expected to be extended for another 2 years. One potentially painful mistake however is that the bill also includes a $1.25/gallon tax credit for sustainable aviation fuels, which means producers will get an extra 25 cents/gallon to make SAF instead of BIO or RD, which could heat up the feedstock wars once again and send fuel that had been used over the road for the past decade into the skies. The bill includes numerous other potential credits and incentives for both renewable and traditional fuel production, and capturing the carbon created by those projects.
Diesel Prices Are Trying To Drag The Rest Of The Energy Complex Higher This Morning
Diesel prices are trying to drag the rest of the energy complex higher this morning as their weekly rally has now surpassed 40 cents in less than 4 days. Gasoline prices are resisting the pull higher so far, despite some positive demand signals in yesterday’s DOE report, and remain range-bound for now, while WTI is facing a big test near $100.
We said yesterday morning that the ULSD contract looked like it was ready to make a run at $3.80 after breaking through resistance on the charts around $3.60 and it didn’t waste any time already reaching that mark this morning. The last time ULSD touched $3.80 3 weeks ago, it dropped 20 cents the next day, so today’s tug of war with gasoline could prove pivotal. A break and hold above $3.80 opens the door for another 40 cent run higher for diesel, while a failure sets up a drop to the lower end of the July trading range.
All sorts of news out of Washington that may influence markets as the Senate has made a surprise breakthrough on a bill that includes nearly $370 billion in energy and climate change programs, while the commerce department just reported it’s GDP estimate showing the US is now “not officially” in a recession with a 2nd straight quarter of contracting GDP.
Bad news is good news when it comes to the stock market reaction to FED policy, and it seems like the Chairman’s statement that the US economy shows signs of slowing yesterday was enough to send stocks rallying once again, as it implies that the pace of increase for interest rates is going to slow down after their largest increase in over 40 years. The big rally in stocks following that announcement seemed to spill over to the energy arena in the afternoon, but could also create more volatility if today’s confirmation of that economic slowdown sends the big money funds to the sidelines.
If you’re an energy bull, you may note that we’ve already lived through the recession, and yet yesterday’s DOE report showed a healthy recovery in fuel consumption which could mean the worst is behind us…not to mention that the world still doesn’t have a solution to replace Russian natural gas and distillate supplies.
Notes from yesterday’s DOE Report:
US crude oil exports surged to an all-time high last week north of 4.5 million barrels per day. That means a total of roughly 32 million barrels of oil (more than 1.3 billion gallons) were sent overseas last week, which makes the inventory drop of 4.5 million barrels in total for the week suddenly less impressive.
Refinery output dropped for a 2nd straight week, with 4 out of 4 PADDs declining, with the Midwest (PADD 2) leading the way with another major decline in run rates. Given the weakness in Group 3 and Chicago basis values, it doesn’t seem like anyone is worried about declining output in the middle of the country - most of which is unable to be exported – although this could spell trouble in the fall if rates don’t pick back up as Gulf Coast facilities seem to have their hands full trying to keep up with demand from Europe and the rest of the Americas.
Demand for gasoline and distillates were estimated to have climbed for a 2nd straight week putting both products back close to their seasonal 5 year averages after dropping below their seasonal range earlier in July. A big drop in gasoline imports, and the decline in refinery run rates are combining with that tick higher in demand to draw inventories lower after more than a month of gains.
The inventory declines are most pronounced on the East Coast, which helps explain why RFG gasoline in New York is worth 50 cents more per gallon today than it is in Houston, and nearly 70 cents more than its conventional counterparts in the Midwest.
See charts below.
Week 30 - US DOE Inventory Recap
The Choppy Action In Energy Markets Continues This Week
The choppy action in energy markets continues this week after a large reversal in gasoline and natural gas prices over the past 24 hours.
RBOB prices made a 45 cent run from the bottom end of their July range to the top in just 4 days, but were greeted by stiff resistance that knocked prices down 18 cents from their Tuesday morning high. The buyers are giving it another go this morning, with inventory draws, stronger equities and a weaker dollar all getting some of the credit for the early buying.
WTI has traded down to its 200 day moving average in each of the past 5 trading sessions, but has always managed to settle above that level. If sellers fail to break that mark (currently just above $94) that could be a springboard to the next push north of $100, while a break sets up a move below $90. ULSD is looking the most bullish of the NYMEX contracts, with the early move north of $3.60 making a run at $3.80 look more likely.
The API reported that US Oil stocks (outside of the SPR) dropped by 4 million barrels last week, while gasoline and distillates had small draws of 1 million and ½ million barrels respectively. The crude oil number seemed to have surprised many who estimated stocks would continue to hold relatively steady thanks to those SPR releases. The DOE’s weekly report is due out on its normal schedule of 9:30 central.
US Strategic Petroleum Reserve (SPR) stocks have dropped to their lowest level since 1985, with nearly 1 million barrels/day being released in recent months to prop up US and global supplies. The non-SPR inventories in the US are just barely hanging on despite these consistent injections, which has brought the combined total of US oil inventories down to its lowest level since 2004.
While much has been written about the boom in profits for refiners who were able to survive the fallout from COVID lockdowns and the global push to villainize fossil fuels, the global refining story is much more complex as some Asian facilities are now seeing their lowest margins since the early days of the pandemic.
A big reason for the plunge in profits in the Eastern hemisphere is China unleashed its refineries to ramp up their utilization and exports just in time for a major slump in regional gasoline and plastic-production demand. Another contributing factor is new refineries in Kuwait and Saudi Arabia are also now competing in the export market. In other words, while the Americas and Europe are struggling to keep supplied due to a lack of refining capacity, Asia is facing the opposite problem.
That phenomenon may be a key contributor in West Coast cash markets trading below most of their counterparts in the eastern half of the US, which is a relatively rare occurrence given the more stringent specs and limited shipping infrastructure west of the Rockies.
Gasoline Futures Have Rallied 43 Cents Since Setting A Low Of $3.02 Last Thursday
Gasoline futures have rallied 43 cents since setting a low of $3.02 last Thursday, and diesel prices are up 20 in less than 2 days after the low end of the July trading range held support and now the bulls look like they’ll make a test of the top. This type of action is common in a sideways pattern, where the path of least resistance is a big move higher when sellers fail to breach chart support, and the reverse is also true if this rally fails to break resistance.
The $3.50 range looks like it could be a pivotal test for RBOB futures, with a run at $3.80 likely if that layer of resistance fails to hold. The outlook is less clear for ULSD, but a sustained move above $3.60 should be enough to get another 20 cent rally in the near future. Some good news in the rally for consumers: Most US markets are resisting the pull higher from futures, with basis values continuing to decline. The exception is the NY Harbor market which continue to outpace futures by 20 cents or more, and holding 50 cents above its Gulf Coast counterparts, which has caused values for space on Colonial’s line 1 to jump this week.
Russia’s latest move in the global energy chess match is getting much of the credit for this week’s rally, with natural gas prices spiking on news of yet another reduction in flows to Europe on the Nordstream pipeline, and the rest of the petroleum complex going along for the ride. European countries have agreed to a 15% gas supply cut this winter in their counter-move, but that announcement has done little to calm prices so far. This WSJ article explains why the clean fuel push of the past few years made Europe more susceptible to Russia’s energy weapon with the current result that coal usage is rapidly increasing with other options holding somewhere between slim to none.
It’s the busiest week of the quarter for earnings releases, and refiners are expected to smash profitability records after crack spreads spiked during the second quarter. Even though margins have dropped over the past month, and the forward curve has them priced in lower than current levels, the outlook remains strong for those companies that were able to get their facilities through the pandemic. See charts below.
The CME’s FedWatch tool shows the market pricing in a 75% chance of a 75 point hike in its target interest rate tomorrow, and an 80% chance that they’ll increase an additional 1% by year end. With so much certainty that the FOMC will continue its most aggressive monetary tightening in decades this year, the big bets now seem to be whether or not those rates will start to ease again in 2023.
Given that the two most influential groups for energy markets globally are OPEC and the US Federal Reserve, it’s not too surprising that the CME is now publishing an OPEC watch tool along with its FedWatch tool. That tool estimates an 83% chance of the Cartel keeping its production plans “as is” at next week’s meeting, while 13% are betting on additional increases, and 3% are betting on a lower output agreement.
Energy Futures Are Attempting To Rally To Start The Week
Energy futures are attempting to rally to start the week, after surviving a test of the low end of their July trading range. Both RBOB and ULSD futures had moments in the past few days of looking like they’d break down on the charts and spark another big wave of selling, but both contracts managed to find enough buying to keep them in a sideways pattern for a while longer.
It’s not just gasoline futures that have been dealing with heavy selling in July. Most regional basis values in the US have dropped 20 cents or more since the July 4th holiday, suggesting that the demand slowdown is not just a theoretical issue anymore. Severe backwardation in the futures market also seems to be contributing to the negative values in prompt basis, as prices will drop 20 cents or more once the September RBOB contract takes the pole position, incenting sellers to discount barrels to the August contract while they can, and taking a big bite out of refinery margins that hit record highs in the past few months.
Baker Hughes reported that the US oil rig count held steady last week, while the natural gas rig count increased by 2. With supply & labor bottlenecks keeping the pace of drilling relatively subdued compared to previous booms in the energy market cycle, the global thirst for US natural gas may suddenly be influencing the amount of oil production as drillers have to compete for workers and other assets. The Dallas FED predicts that Texas Job growth will hold north of 4% this year after surging north of 7% in June, with new well permits and other energy related activities a key indicator of strong job growth continuing in the state.
The EIA reported this morning that the US became the world’s largest LNG exporter this year, as new capacity came online at the (only) 7 facilities in the country equipped to freeze and ship natural gas overseas. US natural gas prices have surged from $5.50 July 5th to $8.50 this morning, with the record setting heatwave hitting large parts of the country getting the blame. Those prices are still less than a third of what European and Asian spot markets are trading at, which will most likely keep the export demand high for years to come.
Money managers seem to be getting more comfortable betting on higher petroleum prices, increasing their net length across the board for a 2nd week. European grades are seeing the most activity, with Brent net length held by large speculators increasing by almost 50% last week alone, while Gasoil contracts increased by 37% on the week. Open interest remains near 5 year lows, so if the big money funds continue to pour money into these contracts, it could have a larger influence on prices than when liquidity is higher.