A little while back, I received an email about a weird phenomenon in the oil industry.
The email was in respect to a comment I had made about oil and gas. Specifically I said when oil prices shoot higher, gasoline prices at your nearby station immediately follow. Pretty simple logic, right?
The question, and a good one I may add, was why we’ve never seen prices drop precipitously overnight at our local station.
Today we have a case study of this, pertaining to the recent “flash” crash in oil prices.
If indeed oil prices feel nearly 10% in the past 2 weeks, why the heck aren’t prices at the pump down a similar amount? Let’s take a look, and see if there’s any way to play this dynamic energy move…
There’s a lot going on in the U.S. energy space, especially in the oil industry.
But, when you take a deeper look at some of the numbers – there’s a real head-scratcher that needs to be addressed: the oddly high price of gasoline.
To get a grip on this situation, let’s follow the oil flow…
Oil production in the U.S. over the past few years has really ramped up. In fact, according to a report from the Energy Department, last week, U.S. oil fields produced 6.5 million barrels a day – representing the highest level of production since 1997.
So to be sure, there’s plenty of black goo floating around in domestic pipelines, railways and tanker trucks. Plus, according to yesterday’s release of weekly petroleum data from the U.S. Energy Information Administration (EIA), “At 365.2 million barrels, U.S. crude oil inventories are above the upper limit of the average range for this time of year.”
We’re producing more oil and we’ve got more oil in storage… so far so good!
Taking a look at the spread between the price of crude oil here in the U.S. (WTI crude, trading at $90 a barrel) and the world-benchmark (Brent crude, trading at $102) there’s still reason to believe the U.S. is enjoying a glut of cheaper-than-average oil.
In fact, this abundance of cheap oil led to a rebound in the most unlikely of industries: refining.
Today, U.S. refineries that take advantage of cheap WTI crude are making a killing. Just take a look at some of the year-to-date gains from the refining sector:
Alon USA Energy (ALJ) 55%
HollyFrontier Corp (HFC) 72%
Tesoro (TSO) 77%
Valero (VLO) 47%
Western Refining (WNR) 96%
Bigger players like Phillips 66 (PSX: NYSE) and Marathon Petroleum (MPC:NYSE) are also raking it in, both up 40% and 59% respectively.
These refiners are selling some of their product to the winding-down U.S. gasoline market, but a lot of this profit potential is coming from crude products sold into the global market, through exports. This gets us to the main factor behind high gas prices.
Take a look at the export boom we’re seeing here in the U.S.:
According to the Associated Press, “Exports of petroleum products reached a record 914 million barrels last year, and were the biggest U.S. export category by value.”
Not to mention, “Petroleum product exports were 11 percent higher this year through May,” the article adds.
Exports are great for the U.S. economy – indeed, this is taking the raw crude wealth we’re pulling from the ground in North Dakota, Texas and other shale plays, and refining it into an exportable, value-added petroleum product.
Although, while this is great for the economy, it’s also keeping U.S. retail gasoline prices stubbornly high. See, instead of turning a glut of cheap oil into a glut of cheap gasoline, U.S. refiners are selling petroleum products, including gasoline into the world market – where arbitrage opportunities abound.
Love it or leave it, it’s a free market at work. In fact, depending on what happens in the U.S. oil patch over the next 12 months, the refiners listed above could sustain even higher share prices – it could be your free market way to play this trend. Time will tell of course, and right now I’m not making any guarantees (especially with the refiners paying paltry dividends around 1%.)
Commodity market data backs up this thesis, too.
Although crude oil prices are 15% off their April highs, reformulated gasoline contracts are trading very close to their April highs. So the modest discount to April’s high gasoline pump prices are true to the trading data.
Looking further out, the price of future reformulated gasoline doesn’t look to be headed much lower, either. Although we may see a 5-10% dip, we may very well see stubbornly high prices for the coming months. Buyer beware.
Simply put, whether refiners are holding prices artificially high or if they are lowering U.S. gasoline output to increase exports, the outcome is the same: stubbornly high prices. In other words, the refining industry has one thing to tell you: tough noogies.
That’s all for today.
Keep your boots muddy,
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