Keep your eye on inventories. Granted, their recent behavior might make it a bit difficult to focus, but the underlying state of oil inventories will provide some firmness to the market's foundation in the weeks to come.
The key word here is "underlying." Market-watchers have been getting mixed signals on the state of inventories lately.
During the week ended July 12, US crude oil inventories posted another fall. Crude stocks were drawn down by 4 million bbl-down also by almost the same amount year-to-year. That continuing trend seemed to be inconsistent with a concurrent rebound in crude imports, up 700,000 bbl, and apparently flat refinery runs following the July 4 holiday in the US, said UBS Warburg analyst Matthew Warburton in a July 17 research note.
That contradiction was at its most distinct in Petroleum Allocation for Defense District (PADD) 2. Crude stocks in PADD 2 fell to their lowest level in almost a year in mid-July, Warburton noted, citing the counterintuitive rise in Canadian imports, which accounted for half of the 700,000 bbl rise in total crude imports.
"The continuing tightness of PADD 2 inventories should reinforce the backwardation in the marketellipsefurther attracting crude imports to the US and tightening global markets, given the persistently low Iraqi exports," Warburton noted.
Nevertheless, it was an increase in total combined crude and product inventories, up 300,000 bbl, that left a bearish footprint on the market in the postholiday period.
As a result, overall stock levels remain comfortable despite dipping below year-ago levels for the first time in 2002.
Gasoline stocks were not the culprit in swelling inventory levels. While gasoline stocks rose because of a 458,000 b/d slump in demand and a 116,000 b/d imports rise after the holiday, gasoline demand nevertheless remained robust-logging a 2.7% year-to-year increase from mid-June to mid-July.
Distillate glut
The real problem for oil markets in inventory levels is the sustained glut in distillate stocks.
Inventories of distillates continued their climb in the week following the holiday, posting a rise of 4.3 million bbl, with most of the buildup coming in PADD 1 and with imports sustained at strong levels.
Weakness in natural gas prices in recent weeks hasn't helped the situation, encouraging fuel-switching away from distillate fuels.
"With no material reduction in distillate yields, given the current level of gasoline demand, refiners could face an accelating invenotry issue as we progress through the US driving season, especially as natural gas inventories remain robust, with potential negative ramifications for (second half 2002) refining margins, which still remain below midcycle levels," Warburton said.
Shrinking inventories
The short-term wobbles and inconsistencies aside, crude oil prices are still being kept buoyant because of the underlying tightness in crude oil stocks.
Of course, that tightness is exacerbated by neverending geopolitical concerns and the resolve of members of the Organization of Petroleum Exporting Countries to keep a lid on production.
That restraint, coupled with the lower-than-expected level of crude exports from maverick Iraq (not subject to the group's quotas), will be a steady drain on stocks through the summer and thus keep a prop under oil prices in the third quarter.
"Critically, OPEC output remains less vs. estimated (second half 2002) demand for its barrels," Warburton noted.
Refiners' trough
Given the continuing likelihood of crude oil price strength persisting, coupled with the even more likely prospect that distillate stocks will continue to brim over, the outlook is for refiners to continue to languish in an earnings trough.
Margins in the key refining sectors were down across the board in the second quarter vs. a year ago, albeit marking a modest rise from the truly dismal first quarter.
A seasonal uptick in product demand, especially as refiners build distillate stocks ahead of the heating season, will help refiners stay out of a hole as deep as that in the first quarter. But refiners shouldn't expect a big improvement in margins unless a colder-than-normal, early winter sops up more distillate stocks or there's a turnaround in the natural gas doldrums.
(Online July 19, 2002; author's e-mail: [email protected])
