Phil Flynn is writer of The Energy Report, a daily market commentary discussing oil, the Middle East, American government, economics, and their effects on the world's energies markets, as well as other commodity markets. Contact Mr. Flynn at (888) 264-5665
It is too bad you can’t run your truck, boiler or factories on crude oil. The American Petroleum Institute (API) reported another massive 7.83-million-barrel crude build led by an equally massive 3.07-million-barrel increase in Cushing Oklahoma. The number was shockingly bearish, but the oil products numbers told a much different story. The API reported yet another 3.64 million drop in U.S. distillate supply, driving inventories to well below average range for this time of year and could raise concerns about the potential of shortages of supply this winter. U.S. refiners really need to start to turn this around because it is not just the U.S. that is short of supply but also Russia and China, just to name a few. Gasoline supply did not do much better falling by 1.209 million barrels but still well above average for this time of year. Refining margins are good and that should help, but they will need to run at a record pace to try to meet demand and let’s hope winter is not too cold or it might be tough to stop a big distillate price spike. My trucker friends already know that they are not seeing the price drop at the pump that we’re seeing in gasoline. And it probably won’t get much better anytime soon. Regardless, while the complex right now is being driven by weakness in the crude price when winter comes, we will be driven by distillate.
The Energy Information Administration (EIA), in their “Short Term Energy Outlook”, said that distillate inventories declined from September to October, which was the first monthly decline since May. U.S. refiners produced a record level of distillate from June through September 2018, which helped to rebuild inventory levels after they fell in May to the lowest level in four years. However, distillate production declined in October, and consumption combined with exports increased, leading to the September to October decline in inventories. ULSD crack spreads were also supported by a tight international market for distillate fuel. In other words, users of diesel need to be hedged because with supply this tight there are significant upside price risks.
The oil market also saw pressure from the Energy Information Administration “Short Term Energy Outlook ” that projected an increase in U.S. crude oil production to a record high average 12.1 million barrels per day in 2019. Yet, I think they wrote that report when Crude was above $70 a barrel when U.S. shale oil producers’ prospects were a bit brighter. They also made that prediction before Democrats won the U.S. House of Representatives and who is already talking about more tax and regulation on energy, thereby thwarting U.S. energy production progress. This is just what the shale oil producers need, as they still try to take in more money than they spend when they produce a barrel of oil. In October the EIA say that U.S. crude production fell to 11.4 million barrels a day because of hurricane-related outages in the Gulf of Mexico.
As far as gasoline goes, the EIA reports that U.S. regular gasoline retail prices averaged $2.86 per gallon (gal) in October, an increase of 2 cents/gal from the average in September, marking the sixth consecutive month that U.S. prices averaged between $2.85/gal and $2.90/gal. EIA forecasts the average U.S. regular gasoline retail price will fall to $2.57/gal in December 2018. EIA forecasts that regular gasoline retail prices will average $2.75/gal in 2018 and in 2019.
The EIA also addressed the issue on the natural gas situation where we have low supplies but increasing production. The EIA says that despite low storage levels, EIA expects strong growth in U.S. natural gas production to put downward pressure on prices in 2019. EIA expects Henry Hub natural gas spot prices to average $2.98/million British thermal units (MMBtu) in 2019, down 4 cents from the 2018 average and down from a forecast average price of $3.25/MMBtu in the fourth quarter of 2018. NYMEX futures and options contract values for February 2019 delivery traded during the five-day period ending November 1, 2018, suggest a range of $2.06/MMBtu to $4.94/MMBtu, encompasses the market expectation for February Henry Hub natural gas prices at the 95% confidence level. Yet, that’s assuming a normal winter! To be safe I’d still be long both puts and calls because as we saw with recent market action, we can pop on cold weather but if it’s warm we might tank. Best to go both ways.
Oil hit bear market territory, falling 20% from the October highs but it is likely we will see a rebound. Price crashes in oil have consequences just like elections. The price drop will hamper shale output. The Price drop will cause more energy projects to go on hold. The price drop may cause OPEC to rethink their production increases especially after the Trump Administration granted some buyers of Iranian crude waivers. The Midterms are over so Trump will have less incentive to drive down prices and with refiners needed to ramp up, they will need all the oil they can get their hands on.
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