News

The profit from making gasoline may slide to the lowest level in 10 months as faltering U.S. consumer growth hurts refiners that have boosted production in anticipation of an economic rebound.

Marins on gasoline, the difference between what producers pay for crude and how much they get for the refined fuel, are poised to drop as much as 75 percent in coming months, according to James Cordier, president of futures brokerage Liberty Trading Group in Tampa, Florida. Margins, or crack spreads, were $10.07 today, down 46 percent from the 15-month high of $18.77 on May 13, based on futures prices on the New York Mercantile Exchange. They reached $2.23 in September 2009.

Refiners have accelerated output by 11 percent since the end of March on forecasts of rising demand, driving stockpiles to a two-month high as of the week ended July 16, according to the EnergyDepartment. Now the profit is being eroded by declining factory production and consumer confidence at the lowest level in a year.

Profit margins and gasoline futures rose to a 2010 high in May while demand climbed to this year’s high in June, encouraging companies such as Exxon Mobil Corp. and Valero Energy Corp. to increase output. Refinery use, after dipping to a 16-month low of 77.7 percent on Jan. 29, reached 91.5 percent last week, the highest level since August 2007, Energy Department data show.

Peak Demand

Consumption peaked for the year on June 25 at 9.46 million barrels a day, according to Energy Department data. Demand, measured as the amount refiners and blenders supply to wholesalers, rose 3.9 percent in the week ended July 16.

Supplies of gasoline increased 1.1 million barrels in the week ended July 16 to 222.2 million, an 11-week high, according to the Energy Department.“Refiners have to go back to low runs or else face collapsing margins,” said Sander Cohan, an analyst with Energy Security Analysis Inc. in Wakefield, Massachusetts.

Crude oil climbed for the first time in four days as U.S. equities rallied on better-than-forecast earnings and takeover offers.

Oil rose as much as 2.2 percent as the Standard & Poor’s 500 Index rebounded from the biggest drop this month after Halliburton Co. reported profit that beat estimates. Futures fell earlier today when the National Association of Home Builders/Wells Fargo confidence index dropped to 14 this month, the lowest level since April 2009, from 16 in June.

Crude oil for August delivery rose 41 cents, or 0.5 percent, to $76.42 a barrel at 1:02 p.m. on the New York Mercantile Exchange. The August contract expires tomorrow. More- active September futures increased 45 cents, or 0.6 percent, to $76.83 a barrel. Nokia Siemens Networks said it will pay $1.2 billion for wireless network assets from Motorola Inc., while buyout firm Onex Corp. and the Canada Pension Plan Investment Board are considering a 2.9 billion-pound ($4.4 billion) bid for Tomkins Plc.

The S&P 500 gained 0.3 percent to 1,068.51 at 1:06 p.m. The Dow Jones Industrial Average increased 0.4 percent to 10,136.15.

“A higher S&P is an indication that the investor outlook is improved,” said Chris Barber, a senior analyst at Energy Security Analysis Inc. in Wakefield, Massachusetts. “Investors are following broader signals to get a handle on the future demand outlook.”

Natural gas may fall below $4 per million British thermal units if the August contract breaks below a key supporting level, according to a technical analysis by Chris Kostas, a senior analyst at Energy Security Analysis Inc. in Wakefield, Massachusetts.

A break below the August contract’s all-time low of $4.07 per million Btu, reached on May 6, will send the futures below $4 before it expires on July 28, and gas futures will approach $3 by September, according to Kostas.

“It’s going to spell trouble for the bears if we break into a new contract low and we can go down to the lower $3” range, said Kostas. “It’ll be bearish for the August contract, the September contract and the October one.”

Natural gas for August delivery fell 3.4 cents, or 0.8 percent, to settle at $4.354 per million Btu yesterday on the New York Mercantile Exchange. The futures have declined in six of the past seven days and are down 12 percent from a month ago even as forecasts showing above-normal temperatures in the U.S. signaled stronger demand from power plants.

“It’s supposed to be hot and the trend is still bullish,” said Kostas. “But if it doesn’t hold we could move lower.”

Crude oil was little changed, retreating from a two-week high with U.S. equities after minutes from the Federal Reserve showed policy makers saying the economic outlook has “softened somewhat.”

Oil declined as the Standard & Poor’s 500 Index dropped for the first time in seven sessions. Prices rose earlier after an Energy Department report showed that inventories of crude oil declined more than expected, refineries bolstered operating rates and fuel stockpiles increased.

Crude oil for August delivery slipped 11 cents to settle at $77.04 a barrel on the New York Mercantile Exchange. Futures reached $78.15 today, the highest intraday price since June 29. Oil on the Nymex for August delivery is 41 cents a barrel lower than for September, the smallest divergence between front- month contracts since April 20.

Brent crude for August settlement increased 12 cents to end the session at $76.77 a barrel on the London-based ICE Futures Europe exchange. August Brent futures expire tomorrow. The more- active September contract slipped 7 cents to $76.66 a barrel. The S&P 500 declined 0.4 percent to 1,090.72 at 3:12 p.m. and the Dow Jones Industrial Average lost 36.53 points, or 0.4 percent, to 10,326.50. The indexes gained after the oil market settled, closing little changed.

‘Softening’ Outlook

“The economic outlook had softened somewhat and a number of members saw the risks to the outlook as having Inventories have dropped 12 million barrels in three weeks to the lowest level since March 19. It’s the longest string of declines since December. Supplies are 7 percent above the five- year average for the period, the department said.

“On the face of it, the crude oil number looks very bullish, but on second look it’s not so worrisome,” said Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Massachusetts. “We still have more than 350 million barrels of oil, so stocks are by no means tight.”

On June 25, the US Congress voted overwhelmingly in favour of legislation that provides for penalties on companies supplying petrol to Iran, as well as on international banking institutions involved with suspect Iranian organisations including, but not limited to, the Islamic Revolutionary Guards.

The new law targets petrol suppliers because of Iran’s dependence on imported fuel. Despite its status as one of the world’s largest oil producers, Iran does not have sufficient refining capacity to cover its own fuel consumption.

The Iranian government responded to news of the Congressional vote in the same fashion that it did during the months of discussion leading up to the event: It loudly proclaimed that the US sanctions did not matter, partly because some companies were still willing to deliver petrol and partly because the country was taking steps to boost domestic supplies. President Mahmoud Ahmadinejad, for example, boasted on June 28 that Iran could, if necessary, achieve self sufficiency in petrol “within one week.” The following day, Farid Ameri, the managing director of the National Iranian Oil Refining and Distribution Company (NIORDC), said that the country had enough petrol in storage to last until the end of the current Iranian calendar year in March 2011. Then on June 30, Oil Minister Masoud Mirkazemi said that Tehran was not having any problems accessing world fuel markets. Iranian companies are still able to conclude contracts for petrol, take delivery of it and put it into storage, he said.

Feedstocks

According to Vivek Mathur, the lead petrochemical analyst at Energy Security Analysis, Inc. (ESAI), Iran’s approach to the matter has been problematic. “What Iran seems to be doing is using processes that maximise the production of petrol additives and, in the process, trying to obtain low-quality [petrol] by sacrificing aromatics production,” he told MEOG by e-mail.

Specifically, he said, Iran appears to have decided on diverting petrochemical feedstock – pyrolysis gas (pygas) and reformate, both of which are produced from naphtha – away from the manufacturing of benzene, toluene and xylene. This is bound to have an impact on the Iranian economy, since, as Mathur explained, these aromatics “are in demand for the manufacture of the raw materials that go into making anything from polyesters to various engineering plastics.”

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A new $27 billion pipeline transporting oil from the depths of Siberia may see Russia supplant the Organisation of Petroleum Exporting Countries as the preferred oil supplier to the world's fastest growing economic region.

"One of the long-term strategic changes is that [the pipeline] will prove a direct threat to OPEC in the big three consumer markets in Asia—China, Japan and Korea," said Andrew Reed, an analysts for Energy Security Analysis, Inc.

Until now, Far Eastern markets haven't had their own large, local source of crude. The Eastern Siberia-Pacific Ocean pipeline, known as ESPO, which began construction in 2006 after more than a decade of planning and negotiation, is already revolutionizing the way refiners do business in the region, giving them more choice and therefore bargaining power to cut deals with OPEC.

In its heyday, OPEC's tight grip on supply made developed economies cower, but it's long been losing market share to independent producers such as Russia, and former Soviet nations. The group's weaker position was underlined last year when it asked independent producers for production cuts to help prop up sagging global prices.

Reed says ESPO crude will displace Middle Eastern grades not just because of its much lower transportation costs, but also because of its quality. Most Asian refineries are technically better geared to process the lighter, sweeter ESPO crude rather than the heavier sour crude from the Middle East.

"ESPO crude is the perfect replacement for China's own declining supply," Reid said. The crude is a blend of oil from the Verkhnechonsk, Talakan and Vankor fields in Eastern Siberia. When construction is finished, the pipeline will be 4,857 kilometers in length, running from Taishet near Lake Baikal, to the Pacific Ocean port of Kozmino in Russia's Far East. Currently only the first section of the pipeline, 2,757 kilometers in length from Taishet to Skovorodino, is open, the oil finishing its journey to the coast by rail. The remaining 2,100 kilometers of the pipeline is scheduled for completion in 2012.

Russian oil production slumped during the post-Soviet Union era, but flows through ESPO are already helping revive Russia's oil production with output hitting a record high in June, above 10 million barrels a day. The first phase is ramping up to reach a capacity of 600,000 barrels a day, but 1 million barrels a day could be flowing by 2013, an amount comparable to Saudi Arabia's current exports to China. This output is eventually expected to climb to 1.6 million barrels a day by a later date.

Also of importance is a 1,000 kilometer spur of the pipeline from Skovorodino to Daqing in China, which will divert half the 600,000 barrels a day to provide 300,000 barrels-a-day dedicated supply to China, scheduled to complete end of the third quarter this year. The spur itself is a game changer for China, securing it a substantial share of Siberian oil, delivered to its doorstep. Crude oil traders say availability of a short-haul good-quality crude has already changed China's buying tactics, Clarence Chu, oil trader at Hudson Capital in Singapore said: "Resources are scarce and China definitely wants to secure as much oil as possible as their demand is growing 3-5% per annum." China "will keep buying as long as oil is at a desired price level even though they currently have ample supply. Chinese crude buying continues to provide support to global crude prices," he said.

Another casualty of the BP Plc oil spill may be the quiet shelving of a piece of boilerplate U.S. policy that has weathered eight presidencies: ending America's dependence on foreign oil. While the ambition to be self-sufficient, or nearly so, in its energy use will likely remain a long-term U.S. goal, the rising anxiety over offshore oil drilling and a raft of new regulations are almost certain to temper the pace of future production from the prolific Gulf of Mexico.

With no obvious means to quickly substitute oil imports with onshore production or alternative energy sources, the United States will likely accept an increase in its dependence on foreign crude, including an up to one-third rise in Middle Eastern imports over the next five years. That may not compel U.S. President Barack Obama to change his rhetoric, but it will likely force him to defer the date at which American motorists are no longer reliant on foreign oil -- a target that has receded further into the future under every president since Richard Nixon.

And with oil prices in OPEC's $70 to $80 a barrel sweet spot and fast-growing consumers in China and India of increasing importance, Obama can continue to decry foreign oil without fear of alienating Middle East Gulf allies, unlike in decades past. Obama met with Saudi Arabia's King Abdullah on Tuesday at the White House and oil was not a major feature of the talks, signaling the long-standing relationship between the allies.Meanwhile, U.S. oil imports in April hit 9.7 million barrels per day, the highest level in 15 months as highway travel jumped.

AFTER SIX-MONTH BAN, REGULATIONS LOOM

Oil imports actually fell last year after record prices of $147 a barrel helped lead to the recession that cut demand. But the worst ever oil spill in the United States is expected to lead to more regulations and costs for drillers operating in the Gulf of Mexico, which should keep the country highly dependent on imports for decades. Assuming a 20 percent increase in drilling costs, the United States would be importing slightly more than it does today through 2035 even if U.S. oil demand fell, according to Stephen Brown, a fellow at Resources for the Future.

Sarah Emerson, the director of Energy Security Analysis, Inc, said the disaster will help boost imports from the Middle East Gulf about a third by 2015 to 2.4 million bpd.

Those would likely come from Saudi Arabia and Iraq, the countries with the most spare capacity. Saudi Arabia alone has nearly 20 percent of the world's proved oil reserves, compared with 2.1 percent for the United States.

To boost its exports, Saudi Arabia would likely have to get approval from OPEC, which levies output quotas on its members. But that should not be a problem as the kingdom often acts as the swing producer of the group.

In the case of Iraq, U.S. lobbying would not do much good. Although internal struggles for control of oil in Iraq continue, the lifting companies are working quickly to develop the resource.

Oil, heading for its first quarterly decline since the end of 2008, may fall in the second half on signs that the economic recovery in developed countries is slowing. Crude slipped 9.3 percent since the end of March to settle at $75.94 a barrel today on the New York Mercantile Exchange. The U.S. Labor Department is expected to report July 2 that the economy may have lost jobs in June, the first decline since December, according to a Bloomberg News survey of 51 analysts.

The U.S. Energy Department trimmed its crude-oil demand and price forecasts for 2010 this month. World consumption will average 85.51 million barrels a day this year, down from the 85.55 million predicted in May, the department said June 8. West Texas Intermediate oil, a global benchmark blend, will average $78.75 this year, down from $82.18 forecast in May, the department said.

Surplus Stockpiles

U.S. crude oil supplies rose 0.6 percent to 365.1 million barrels in the week ended June 18, leaving stockpiles 11 percent above the five-year average for the period, according to the Energy Department.

The Organization of Petroleum Exporting Countries lifted crude output by 0.6 percent to 29.372 million barrels a day in May, a Bloomberg News survey showed. The increase left the 12- member group with about 5.5 million barrels a day of spare capacity.

“The underlying fundamentals haven’t changed,” said Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Massachusetts. “There will remain a tremendous amount of crude available. Once demand lets up in September we should see a correction in prices.”

Crude climbed to $87.15 on the New York Mercantile Exchange on May 3, the highest level since Oct. 9, 2008, before trading as low as $64.24 on May 20.

Natural gas futures show hurricane season in the Gulf of Mexico will do less damage to production than in 2005 as supplies from off shore wells decline.

Government forecasters say the current hurricane season may be the worst since that year, when storms including Katrina, which devastated New Orleans, damaged platforms and pipelines in the Gulf of Mexico and helped send gas to a record $15.78 per million British thermal units by December.

The premium of futures for delivery in September over July was almost five times higher in 2006, the first season following Katrina, than it is this year, as production moved to more reliable onshore sites. About 10 percent of U.S. gas output comes from federal waters in the Gulf, down from 17 percent five years ago, according to the Energy Department in Washington. Natural gas for July delivery rose 4.8 cents, or 1 percent, to settle at $4.804 per million British thermal units yesterday on the New York Mercantile Exchange, down 14 percent this year. Gas for delivery in September, when forecasters expect the most storms, closed at $4.895 per million Btu, a premium of 9.1 cents, or 1.9 percent to July. The premium of September over July for delivery in 2006 was 43 cents, or 6.9 percent.

Oil Market

Crude for August delivery dropped $1.50, or 1.9 percent, to $76.35 a barrel yesterday in New York. September futures were up 68 cents, or 0.9 percent, from August at $77.03. The premium of September to August in 2006 was 90 cents, or 1.3 percent.

Marketed gas production from federal tracts in the Gulf fell 700 billion cubic feet, or 22 percent, to 2.43 trillion cubic feet in 2009 from 3.13 trillion in 2005, Energy Department data show.

Output has dropped by 52 percent since 1999, when the Gulf accounted for about 25 percent of U.S. production. Marketed gas, representing supplies available for consumers, is overall output minus impurities and gas used in the production process.

Production rose 2.97 trillion cubic feet, or 16 percent, to 21.9 trillion in 2009 from 18.9 trillion in 2005, amid increased output from wells in shale formations from Texas to Pennsylvania, according to the department.

“We rely on offshore production a lot less and prices will have a hard time getting to $6,” said Chris Kostas, a senior analyst at Energy Security Analysis Inc. in Wakefield, Massachusetts. “Hurricanes will only have a marginal effect.”

Most years, refiners operating in the Atlantic Basin generally breathe easier during the spring and summer as a seasonal increase in demand for gasoline from US consumers boosts margins on both sides of the Atlantic. This year has also seen margins widen during March and April and then retain their strength, but the driver of this trend is somewhat distinct. Part of the surge is due to a counter-seasonal tightening in the “middle distillate” market for diesel and heating oil.

According to a recent report by Boston based consultancy Energy Security Analysis Inc. (ESAI), the improvement in middle distillate fundamentals has been precipitated by greater demand from the US, Latin America and even Europe.

The consequences of this include improved margins, increased throughput and a more positive refining outlook, at least for the near-to-medium term. “[Middle] distillate demand has sprung to life in the US and in other Atlantic Basin markets,” says ESAI. Rather than simply showing a year-on-year increase from a dismal 2009, ESAI says “demand truly surged” in the US in May, rising by 600,000 barrels per day to 4 million b/d as the economy picked up and stoked demand for fuel needed to transport goods.

Demand should grow by about 250,000 b/d, or 7%, this year. the report said. Lower run rates and middle distillate yields prior to the recovery in margins helped reduce inventories in the US and Europe, which often receives excess supply from the US. Meanwhile, “higher demand in several Latin American countries caused a large share of US exports, a surprising 73%, to flow south,” notes ESAI.

Even in economically beleaguered Europe, demand for middle distillates is improving in France, Germany and the UK, while Italy is “no longer expected to have negative growth in 2010,” says ESAI. Growth in demand for diesel fuel should total 50,000 b/d for 2010, while German demand for heating oil was “unseasonably strong” in May.

Improving middle distillate balances should continue to support refining margins and drive higher refinery utilization rates as the “distillate disincentive” — a reluctance to run plants close to their capacity because of poor margins — dissipates.

In its report, the consultancy revised upward nearly all of its middle distillate margin forecasts, led by an increase in New York Harbor spot heating oil’s premium over West Texas Intermediate (WTI) crude in June to $10.50 per barrel from $7.25 in a prior forecast. The June spot margin prediction in Rotterdam for ultra-low-sulfur diesel versus Brent was $14/bbl, up from $10.50. These margins should dip only slightly through the summer and return to similar levels by November.

US refiners are already taking advantage of improved middle distillate margins, increasing yields above 34% for the first time since 2008, says ESAI. Throughput during the three months to May was up 400,000 b/d from a year earlier, all of this along the US Gulf Coast, where refiners are well placed to service Latin American demand.

In Europe, improved margins also encourage higher runs, but “those refiners with spare capacity that has not been mothballed will be careful to avoid over-producing and undermining margins,” according to the report. For the June to November period, throughput should be around 10.9 million b/d, up 200,000 b/d from the prior year. Asia’s export refiners will also look to take advantage of improved margins in Europe, ESAI says.

The downside to this, however, is that the gasoline market could suffer as high retail prices deter demand while higher throughput levels support supply. In the US Northeast, gasoline prices were 70¢ higher year on-year during the first quarter, although increased supply could lower prices and boost demand, ESAI suggests.The gasoline outlook is far from bullish and ESAI has revised down its margin forecasts. The New York Harbor Rbob gasoline spread over WTI should increase to an average of $13.50/bbl in July from $12.50 in June, but it could fall to $7 by September and $3 by November according to ESAI.“Once fall and winter arrive, high supply and declining demand will give way to weaker [gasoline] margins,” the consultancy adds.

Crude oil rose to a one-month high after gasoline surged on a report that U.S. refineries cut operating rates and supplies of the motor fuel declined. Refineries operated at 87.9 percent of capacity, down 1.2 percentage points from the prior week. Gasoline supplies fell 636,000 barrels to 218.3 million last week, the Energy Department said. Analysts surveyed by Bloomberg News were split over whether stockpiles of the fuel would rise or fall.

Crude oil for July delivery rose 70 cents, or 0.9 percent, to $77.64 a barrel at the 2:30 p.m. close of floor trading on the New York Mercantile Exchange. Futures touched $78.13, the highest level since May 10. Prices are up 10 percent from a year ago. Gasoline climbed 2.32 cents, or 1.1 percent, to $2.1447 a gallon in New York. The contract reached $2.1591, the highest level since May 14. Heating oil for July delivery increased 4.31 cents, or 2.1 percent, to $2.1116 a gallon, after touching $2.12, the highest level since May 14. U.S. gasoline consumption peaks during the period from the Memorial Day weekend in late May to Labor Day in early September. Gasoline demand rose 1.6 percent to 9.34 million barrels a day, the highest level since the week ended Aug. 28.

Crack Spread

The decline in gasoline supplies and refinery operating rates pushed the margin, or crack spread, for processing three barrels oil into two of gasoline and one of heating oil to the highest level since June 3. The margin increased 5.9 percent to $12.097, based on futures prices. "The drop in refinery runs comes as a surprise given how strong the margins are," said Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Massachusetts.

Supplies of crude oil rose 1.69 million barrels to 363.1 million in the week ended June 11, the department said. Stockpiles were forecast to fall 1 million barrels, according to the median of 15 analyst responses in a Bloomberg News survey. Inventories of distillate fuel, a category that includes diesel and heating oil, increased 1.8 million barrels to 156.6 million. A 1-million-barrel gain was forecast, according to the median of analyst responses in the Bloomberg News survey. "Demand is creeping up, and there's plenty of supply to meet any increase," Mueller said. "The fundamental story is unchanged."

Crude futures reversed earlier losses Wednesday, setting a new six-week high on strong U.S. gasoline demand figures.

Light, sweet crude for July delivery traded 88 cents higher at $77.82 a barrel on the New York Mercantile Exchange. The intraday high of $77.90 a barrel was the highest since May 10. Brent crude for August delivery on the ICE futures exchange traded $1.10 higher, at $78.20. The U.S. Energy Information Administration Wednesday reported a larger-than-expected decline in gasoline stocks for the week ended June 11. Forecast to remain unchanged, U.S. inventories declined by 636,000 barrels, to 218.34 million barrels, their lowest level since December, while gasoline demand rose 144,000 barrels a day in the week to 9.338 million barrels a day, the most since Aug. 28, 2009.

Front-month July reformulated gasoline blendstock, or RBOB, recently traded 3.38 cents, or 1.6%, higher at $2.1553 a gallon, after hitting a high of $2.1591 a gallon, the highest since May 14. Wednesday's rise in prices came despite inventory builds in crude oil and lower refinery runs. The EIA reported crude stockpiles rose by 1.69 million barrels, while analysts had expected a decline of 1.3 million barrels. Crude inventories had declined in each of the two weeks prior to Wednesday's report.

Refinery utilization fell to 87.9%, down 1.2 percentage points from last week's figure, while a slight increase was expected.

"This week we had a pretty big dip [in refinery use], but the market is discounting that a bit and saying that won't be continued," said Rick Mueller, director of oil markets at Energy Security Analysis Inc. "If you look at the underlying demand numbers, it's a stronger market than that."

Crude oil fell for the first time in four days after U.S. retail sales unexpectedly dropped in May, spurring concern that economic growth in the world’s biggest energy-consuming country will slow.

Oil slipped as much as 2.9 percent after the Commerce Department said that purchases decreased 1.2 percent, the biggest decline since September. Retail sales were projected to increase 0.2 percent, according to the median estimate of 76 economists in a Bloomberg survey. Crude oil for July delivery fell $1.84, or 2.4 percent, to $73.64 a barrel at 12:50 p.m. on the New York Mercantile Exchange. Futures touched $73.26 during the session. The contract is up 3 percent this week.

The retail sales number sent equities lower. The Standard & Poor’s 500 Index fell 0.2 percent to 1,084.36, and the Dow Jones Industrial Average slipped 29.17 points, or 0.3 percent, to 10,143.36.

"Any concerns about the economy are going to have a major impact on oil,” said Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Massachusetts. "The strength of the market has been built on expectations of an economic rebound."