LOUISVILLE, KY. (DTN) — Commercial crude stocks rising for the third consecutive week to new record highs in the week ending June 12 continues to highlight an oversupplied crude market suffering from depressed demand. But both the Energy Information Administration’s refined product data and refining margins appear to be a signal that product demand and refinery runs are turning a corner. An outlook for potential recovery of U.S. shale crude production (in addition to gradually normalizing refined product demand) should help boost refining margins further in the coming weeks.
Refined Product Stocks and Demand
In recent weeks, we have focused our analysis on weakness in refined product demand, not only due to the implications for fuel prices but also as a leading indicator of future crude demand. Crude production cuts have been instrumental in slowing builds to crude stocks, but production cuts must eventually be met with declines in refined product stocks amid rising fuel demand for the industry to get on track for a sustained recovery. This week, we may have seen early signs of such a recovery taking hold.
Distillate fuel oil inventories fell 1.4 million bbl in the week ending June 12, according to EIA data. Although this still leaves diesel stocks 46.7 million bbl or 36.5% above year-ago levels for the period, the first draw to stocks since the week ending March 27 is a welcomed and noteworthy development.
On both a three-week and four-week moving average basis, builds of distillate fuel oil are slowing for the second consecutive week, highlighting a potential shift in trend. Furthermore, and most importantly, the draw to distillate fuel oil stocks came despite both stronger refinery runs and weaker distillate exports during the week. Therefore, domestic demand had to have grown at a pace to more than offset the 112,000 bpd decrease in exports and 116,000 bpd increase in refinery runs. To that point, the EIA’s proxy for both domestic and export demand – distillate fuel oil product supplied – rose 253,000 bpd from the prior week despite the drop in exports.
After falling 1.7 million bbl to 257 million bbl last week, gasoline stocks now sit just 10.2% or 23.8 million bbl above year-ago levels. While domestic demand continues to show signs of recovery, this week’s data also points to demand for U.S. gasoline exports rising as well. As we have pointed out in past weeks, with the United States being a net exporter of refined products, U.S. refiners need to see a rebound in global and not just domestic demand to return to more normal levels of activity. This week, the EIA reported gasoline exports moving higher for the third consecutive week, hitting their highest since the week ending May 1 at 495,000 bpd.
The combination of global refined product demand continuing to recover over the past two weeks while crude prices have stalled has helped lift refining margins. This too is a positive development not just for refiners but for all parties hoping for a more balanced crude market.
While still well below year-ago levels, both diesel and gasoline margins have moved higher over the past month. Gasoline refining margins based on WTI are up 20% from month-ago levels and 27% from week-ago levels, at $13.55 bbl. Brent-based gasoline refining margins are now slightly above year-ago levels, at $10.90 bbl. Based on WTI, diesel margins have increased 38% from this time last month and have moved 24% higher over the past week, at $11.55 bbl. Although refining margins still have a long way to go to reach year-ago levels, this rebound in margins is certainly a welcomed development.
With the EIA consistently reporting a negative adjustment of more than 900,000 bpd for the five consecutive weeks through the week ending May 5, it became increasingly clear that the agency was consistently overestimating U.S. crude production. Production data in this week’s EIA report was skewed by the outage of offshore production amid Tropical Storm Cristobal, but a sharp drop in reported production by the EIA finally led to a contraction in the adjustment factor. The EIA cut their weekly production estimate 600,000 bpd from the prior week. Given that storm-related shut-ins accounted for a drop of 465,000 bpd for the week, this means the EIA cut production 135,000 bpd in addition to the offshore production shut-ins.
With the adjustment factor narrowing by 247,000 bpd on the week, this points to the EIA’s weekly production estimate falling closer in line with reality. It could also signal that actual U.S. crude production has bottomed and is beginning to tick higher. This may be an early sign that reports of a potential 500,000 bpd increase in U.S. shale production in June could already be showing up in the data.
The continued recovery in both domestic and global product demand is already providing reason for optimism in an ailing industry. If U.S. crude production begins to grow in the coming weeks, providing headwinds to a continued rally in WTI, this (coupled with rising product demand) may finally result in the rising refinery runs needed to bring the crude market back in balance.