The downstream refining sector has rebounded a bit, shrugging off the glut of gasoline seen earlier this year. But another product surplus could be looming in the second half of 2019 and into 2020.
Refiners worked at elevated levels last year, helping to produce a global gasoline surplus that ran into the early part of this year. However, refiners undertook extensive maintenance in the first few months of 2019, and the volume of refining capacity that has been offline recently has been higher than normal. According to Bank of America Merrill Lynch, refining outages have run about 300,000 bpd above year-ago levels so far in 2019. The downstream outages have been a big negative for crude oil, but they have helped trim the glut of refined products.
That helped bring gasoline stocks drastically down in a rather short period of time. “OECD gasoline inventories started 2019 at five year highs, but refinery issues and weak margins helped draw stocks down to three year lows by May,” Bank of America Merrill Lynch wrote in a note. Earlier this year, refining margins were in the dumps, but they have strengthened more recently.
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“The US driving season has peaked but the global gasoline market remains tight, and cracks are holding firm,” Bank of America said.
However, the respite could be brief. The global economy continues to slow. Global manufacturing activity, as measured in PMI estimates, was in negative territory for two consecutive months in May and June for the first time since 2012. The U.S.-China trade war may not be getting worse, but it is frozen in place with 25 percent tariffs on $200 billion worth of Chinese imports, and reciprocal tariffs on U.S. imports to China. Meanwhile, auto sales around the world have pulled back sharply. Related: Mexico Confirms Major Tax Cut For PEMEX
All of these factors serve to undercut demand for gasoline. “In the US, gasoline demand stalled recently after several years of very strong growth,” Bank of America said. “As a whole, OECD gasoline demand has contracted by 70k b/d over the past year. The last time OECD demand declined for four consecutive quarters was in 2013.”
The investment bank said that demand could move a bit higher due to falling prices. Fuel demand is price elastic, especially in developing economies.
But in addition to weaker economic growth, another big problem looming for gasoline markets is the expansion of refining capacity. “Significant growth in processing capacity and higher runs at China's teapot refineries have overwhelmed the Asian product markets, and new refinery starts will only compound this problem,” Bank of America warned. “Asian margins have already slumped to levels that force economic run cuts and should remain weak until capacity rationalization occurs, regional demand growth emerges from its slump, or more volume finds a home in the Atlantic basin.”
Ultimately, this spells bad news for gasoline margins and prices. “Gasoline cracks had a rough start to the year and although fundamentals improved through mid-year thanks to refinery outages, cracks for the remainder of 2019 and 2020 look weak from a historical perspective,” Bank of America concluded. Related: Is This Big Oil’s Next Secret Weapon?
One of the most disruptive events in years affecting the downstream sector is a few months away. New rules from the International Maritime Organization (IMO) on sulfur concentrations for marine fuels take effect at the start of 2020. In the recent past, many analysts thought that the IMO regulations would wreak havoc on various markets – gasoline, diesel and ultimately for crude oil. A shortage of low-sulfur fuels would, in theory, lead to a spike in diesel prices, which would push up crude oil as well. This was particularly true since the crude oil market was considered to be tightening at various points last summer and earlier this year.
But economic malaise is likely going to take the sting out of the new IMO rules. The recent slide in distillate prices can be seen as evidence of a slowdown in manufacturing, trade and construction. Motorists everywhere might not mind lower gasoline prices, but refiners won’t be too pleased.
By Nick Cunningham, Oilprice.com
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