The global oil market appears to be well-supplied, even as the OPEC+ production cuts begin to whittle away at excess barrels. But while crude may be ample, there are growing problems within the market for refined products, including an emerging glut of gasoline.
The bottom line is that gasoline supply is surging while the market for other products is tightening up. There are multiple reasons for this. First, the crude slate itself is helping to create these imbalances. The surge of U.S. shale production has made the global crude mix lighter and sweeter. Light sweet oil tends to produce relatively more gasoline when it is refined. Medium and heavier oils produce more diesel and other middle distillates, and less gasoline.
Shale output has surged in recent years, leaving refiners with more gasoline-friendly crudes to process. At the same time, because of skyrocketing shale production, OPEC+ is backing out barrels in order to avoid a glut of crude. But many producers within the cartel churn out medium and heavy barrels. So, light oil from U.S. shale is surging while medium and heavier barrels are being held back.
There are a few more factors driving the divergence in the crude slate. Venezuela has been suffering from steep declines for well over a year. The South American OPEC member produces heavy oil. Any unexpected outage in Venezuela, due to unfolding political crisis there, would magnify these trends. Mexico, another heavy oil producer, has seen its output deteriorate for years, albeit at a more gradual pace than Venezuela. Iran, too, is losing supply. Related: The Most Important Oil Factor In 2019
Again, the upshot is that light oil from U.S. shale has surged at a time that heavier producers from elsewhere have suffered declines. Heavier and sour crudes, which have historically traded at a discount, are seeing upward pricing pressure. "Sour [crude prices are] strong because the West is net short sour crude," a Singapore-based trader told S&P Global Platts.
The effect on the products markets is even starker - prices for gasoline are slumping but those for diesel and other distillates are trading at a premium. While refiners can tweak their inputs somewhat, there are limits to how they adjust to the changing mix of crude. Some refiners are simply more equipped to handle heavier oils, others can handle lighter mixes.
Still, as product prices go haywire, refiners are trying to ramp up supplies of diesel and other distillates. But, with more diesel comes more gasoline. Refiners can't simply produce one without the other. As a result, as refiners chase diesel barrels, they are dumping more gasoline onto the global market, exacerbating the emerging glut.
The "gasoline glut keeps getting worse," U.S. investment bank Jefferies said in a note on Friday.
"Last week saw gasoline stocks reach their highest level since records began, so it comes as no surprise that crack spreads for gasoline are under pressure," Commerzbank wrote in a note on Friday. "Crack spreads in the US are at a 5½-year low of just $5.5 per barrel, while in Europe they are even negative." European refiners are having trouble finding a home for their gasoline, Bloomberg reports. Related: Canadian Heavy Crude Producers Find New Ways To Ship Oil
There are still more reasons for the disruption in the oil supply mix. The International Maritime Organization (IMO) has rules on marine fuels that take effect at the start of 2020. Those rules require ships to cut the concentration of sulfur in their fuels significantly. That means that ships will have to stop running on heavy fuel oil, which is high in sulfur. To replace dirtier fuels, many ships will switch to middle distillates. That may ease the pressure on heavier sour oils, but it could also put even more pressure on diesel and gasoil (another distillate) supplies.
At some point, refiners may not be able to take on more light oil as they reach a limit. "If you analyze the refining system of the world, they are designed to take a certain percentage of light crude that cannot be changed dramatically," Pedro Antonio Merino Garcia, chief economist at Repsol said at the Argus Americas Crude Summit in Houston, Texas.
Ultimately, that means refiners may have to curtail processing rates, which would undercut demand for crude oil, potentially pushing crude oil prices down.
By Nick Cunningham of Oilprice.com
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Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. More