Recap: Oil markets settled higher across the board yesterday, having started in negative territory earlier during the trading session. NYMEX ULSD (HO) bears were not able to hold onto a technical break down through the first price support level, falling short to what became the low on the day of $2.862. So ULSD bulls took over and proceeded to climb through 2 technical resistance levels and almost reached a third before settling at $2.8933, up 2.22 cents on the day. It seemed as though ULSD bulls prompted the rest of the complex higher as NYMEX RBOB (Gasoline) moved up 1.99 cents to $2.9576 after visiting a low on the day of $2.9273. Likewise, NYMEX Crude (WTI) advanced to $102.93, up 64 cents after hitting a low of $101.55. The WTI bulls created volume of 250,987 contracts on open interest of 208,280. ICE Brent Crude was the weakest gainer on the day, up 39 cents to settle at $108.67, and with WTI increasing more than Brent, the Brent-WTI spread narrowed to $5.71 upon settlement. As MarketWatch mentioned yesterday, "Although bearish features of the oil complex persist, potential bullish geo-political events could reverse this recent trend, including progressive tensions with Israel's battle with Hamas, and its regional political and military impact. Bulls have horns." Unfortunately, oil markets did reverse, and now the question will be are oil markets just consolidating a bit after a big move down, or have the bulls regained control? Clearly, on-going news headlines that 1) Israel was preparing to mount a ground war of 40,000 soldiers against Hamas, 2) Israeli targeted airstrikes have killed 80 Palestinians including civilians, and 3) Israel's Iron Dome missile defense system had intercepted most of the Hamas rockets fired upon Israel, has impacted markets. An Israel at war with a Palestinian Hamas terrorist organization, backed by Iran, is a convenient catalyst to oil market bulls, as a potential regional conflict could involve Middle Eastern OPEC nations.
Currently, oil markets are down across the board with NYMEX ULSD down 38 points to $2.8895, NYMEX RBOB down 1.17 cents to $2.9459, NYMEX Crude down 60 cents to $102.33, and ICE Brent Crude down 70 cents to $107.98. The August ICE Brent futures contract expires next week on July 16th, and it will be interesting to see if recent long liquidation in this contract motivates the rest of the complex to move lower ahead of the weekend. All looks quiet in the Atlantic Basin as far as the potential of any tropical storm/hurricane this weekend.
Analysis: 4 Reasons why the East Coast (PADD 1) is waiting for the U.S. Oil Revolution to reach its shores:
Background--- an oversimplification: If the basic equation of U.S. production was to supply only U.S. demand, then production would equal demand. When demand increases beyond US production, distillate imports are required. If production is in excess of demand, no imports are needed, and this excess gets sold in the export market and any remainder ends up in storage. For example, current weekly US distillate production is now at 5.056 MMbpd and demand is at 3.966 MMbpd. Subtract demand from production and we have 1.09 MM left over every week. Add in nominal imports of .088 MM, and we are back up to 1.178 Million available for exports. US Distillate exports were 1.146 MMbpd, so subtract this from 1.178 and we are left with a measly .032 MMb left for inventory. (Actually the DOE total distillate increase was .2 MMb due to some rounding, timing, "lost gallons", etc.) It looks like the U.S. distillate picture is "in balance"; however, the PADD 1 (East Coast) distillate picture looks very different. Why?
1) Distillate Production-
Of the total 5.056 MMbpd US distillate production, PADD 1 production is .392MMb or only 7.75% !!
PADD 3 (U.S. Gulf Coast) produced 2.809 MMbpd for the week ended July 4, 2014, representing 55.6% of total US distillate production followed by PADD 2 (Mid West) at 1.129 MMbpd or 22.3%. However, PADD 1 production was not helped when, back in 2012, 3 Philadelphia refineries were on the chopping blocks because their cost of crude feedstock was based on the more expensive international crude benchmark being imported, Brent crude versus the U.S. Gulf Coast refiners that were using a cheaper feedstock based on the US crude benchmark, WTI. East coast refiners were losing margin with no end in sight, and in need of a light sweet, more expensive crude feedstock for their simple refineries. Sunoco shuttered its Marcus Hook refinery, but sold its Philadelphia refinery (Philadelphia Energy Solutions)to the Carlyle Group while Conoco Phillips sold their Trainer refinery to Delta Airlines. In the nick of time, North Dakota's Bakken light sweet crude production along with crude rail transportation, provided the right sweet feedstock at a cheaper price to these East Coast refineries allowing for positive refinery economics to keep them open. 2) Demand and Inventory.
Although the EIA does not segregate demand numbers for each of the five regional PADDs, we know that the bulk of US heating oil demand is in the Northeast, and that of the 5 PADD regions, PADD 1 distillate stocks are (and have been for the past 2 years) below the 5-year range (See EIA chart below). Currently, PADD 1 distillate stocks are 21.4% below the 5-year average, PADD 1A - New England is 50.5% below the 5-year average, PADD 1B (Central including NY) is 23.8% below the 5-year average. Yes, it is true that we have also seen the advent of backwardated NYMEX ULSD (HO) futures for the past 2 years -- again, another factor that does not incentivize suppliers to store product if current prices are more expensive than future prices (this is the opposite of a carry in the market). But, the other four PADDs are not below their five-year ranges like PADD 1. 3) Increasing Product Exports:
We know from a previously robust Brent-WTI spread (exploding at the beginning of 2011 to hold over $10 to as high as $25 by the end of 2011, but staying in the $10-$15 range up until the beginning of 2014) that there was incentive for refiners to export their product barrels at a higher margin overseas. Although the Brent-WTI spread is currently under $6, export agreements are not shut off overnight. So, from January 2010 to January 2014, we have seen U.S. distillate exports explode 198% from .45 MMbpd to 1.3 MMbpd. 4) U.S. Distillate Imports
have imploded from .297 MMbpd down to .088, or 238% from July 2010 to currently; however, even that smaller number, PADD 1 represents the bulk of these distillate imports at 84% !!
What this means is that any excess U.S. domestic distillate production does not find an easy distribution channel to the East Coast (no help from the antiquated Jones Act), so the East Coast region is in the most need of foreign distillate imports. And which countries topped the latest EIA import data by country of origin (April 2014)? Not surprisingly, our friends to the north, Canada accounted for 50% of April's imports, followed by Russia at 16%, Colombia at 11%, and Venezuela at 5%. The Bottom Line
, PADD 1 - East Coast distillate stocks are likely to stay constrained, particularly with specification changes to the new 500 ppm low sulfur heating oil requirement in 5 states. What can heating oil and diesel fuel marketers do to minimize supply risks? They would be wise to consider some type of basis protection along with securing reliable supplier agreements as the delicate balance between what can be supplied into PADD 1 region versus the demand requirements could result in more basis blowouts as witnessed during this past heating season. From the region that produced the original 13 colonies for the American Revolution, the North American shale oil revolution will reach the East Coast eventually. But until then, do what the Minutemen did: prepare now for the winter season. Click here to view today's Refined Products MarketWatch