Crude inventories reflect U.S. refiners' revamped strategy

How U.S. Crude and Stocks Have Shrunk [41573 bytes]

Low U.S. crude oil inventories reflect refiners' just-in-time strategies in a well supplied market where risk management and hedging play larger roles.

Such strategies lead inevitably to more volatile crude and products prices. But with most producers selling oil through transactions indexed to prices reported by the New York Mercantile Exchange, a refiner can still show a profit even though he might pay more for his feedstock of choice.

Countries around the world are moving away from tightly regulated petroleum markets in favor of allowing market forces to set crude and products prices. As long as crude supplies appear adequate, more refiners worldwide likely will adopt quality based feedstock strategies requiring them to tie up as little money as possible to maintain inventories.

As refiners around the world change the way they buy crude, supply patterns will change and suppliers and refiners will form more alliances to restore the vertical integration required to sustain profits.

"Beyond that, we're going to start seeing new types of relationships and changes in the structure of refinery ownership," says Guillermo Guariguata, Bonner & Moore Associates Inc., Houston.

Decline of crude stocks

Guariguata points out that refiners around the world essentially follow either supply based or quality based strategies to acquire crude oil feedstocks.

With the adequacy of crude supplies virtually assured, most refiners in the West focus on feedstock quality. That's based on the idea they can make better use of capital by not tying it up in unneeded stocks.

The trend has become especially pronounced in the U.S., as shown by American Petroleum Institute estimates of refiners' stock levels.

API data show crude oil stock levels in the U.S. averaged 318.6 million bbl in 1995, down from 343.7 million bbl in 1988. U.S. crude inventories at the start of last month had declined further to 279.4 million bbl, showing that the trend is continuing.

Some observers warn that entering second quarter 1996 with such low crude stocks could heighten chances for price volatility.

More stringent controls on refinery emissions and stiffer clean fuels mandates have heaped financial burdens on U.S. refiners. Low stocks in that context, Guariguata says, more likely reflect seasonal changes as U.S. refiners try to recover some of the money spent to comply with environmental rules in progressively more efficient markets.

"Until they are able to recover some of that investment, refiners' overall strategies will be the same whether we're entering a heating season or a driving season," Guariguata said. "Fluctuations in prices are going to affect both crudes and products, and a given refiner is going to try to maximize the margins of his units."

Spread to Asia-Pacific

U.S. refiners are able to acquire the feedstocks they want in part because North American crude markets are the top choices of many suppliers.

Although U.S. markets are relatively far from many key crude oil producing regions, the diversity of supplies supports feedstock strategies based on quality.

Most refiners in the Asia-Pacific region focus on adequate supplies rather than feedstocks with specific qualities. But that, too, likely will change.

Guariguata says that as Asia-Pacific crude oil demand grows, more suppliers will begin competing for market shares, bringing with them a more diverse supply. With access to more crude streams, the strategies of many refiners in the region likely will place ever greater emphasis on feedstock quality.

The evolution will be most dynamic in countries where supply diversity is matched by more reliance on market forces to set crude and products prices.

In Japan, Guariguata says, the advance of products markets deregulation will introduce efficiencies that will change the way Japanese refiners buy crude.

"If fluctuations on products markets don't reflect the same dynamics in crude sources, refining will be unprofitable," he said.

"But when you have an efficient market on the products side, profitability of a refinery is going to be determined more by how the refiner buys feedstock. Most likely in a more volatile market, Japanese refiners will become more interested in buying crude feedstock more often."

Changes in the way big consumers buy crude lead to changes back down the supply chain. Specifically, more dynamic feedstock pricing in unregulated products markets creates opportunities in which suppliers begin forming alliances with refiners to restore vertical integration and allow more robust profits.

If world crude markets remain well supplied, Guariguata says, alliances between crude suppliers and Asia-Pacific refiners could begin forming within the next 2 years.