U.S. crude oil inventories have finally started to decline, a potentially momentous turning point in the three-year market downturn. Oil storage levels have been climbing relentlessly since the end of last summer, but inventories have been dropping ever so slightly since early April.
That should be cause for celebration. Surely the end of one of the biggest headaches for oil markets should spark an oil price rally? While the data seems to be encouraging, there are growing fears that the glut could simply be shifting from upstream to downstream.
The U.S. refining industry has ramped up processing over the past month, boosting processing by more than 1 million barrels per day (mb/d). For the week ending on April 21, U.S. refineries churned out an average of 17.285 mb/d, "a record for any time of year and coming well in advance of the summer driving season," as Reuters recently described it.
Maintenance season has come to a close and refineries are operating full tilt, sucking crude oil out of storage and spinning it into gasoline and diesel at a record pace. That has helped bring crude inventories down from an all-time high of 535 million barrels at the end of March, falling to 528.7 million barrels as of April 21, a small but meaningful decline.
Oil traders have been anxiously awaiting such declines in storage, a key metric supporting the theory that the supply glut is coming to an end. But what if the extraordinary surge in refining is merely shifting the supply surplus downstream?
For evidence of that, gasoline inventories (as opposed to crude oil inventories) started rising again in April – after months of declines – just as refiners started ramping up. Total gasoline stocks jumped from 236 million barrels in early April to 241 million barrels two weeks later. Gasoline stocks had been converging comfortably back into the five-year average range, but in April they began to climb once again.
What is arguably more important is the fact that upstream oil producers are not slowing down. U.S. oil production continues to climb, week after week, hitting 9.265 mb/d on April 21, up 118,000 bpd from a month earlier.
"Refiners have come racing back out of maintenance in the biggest way since November 2015. We've processed a record amount of crude oil last week, and you would think that will be bullish for crude oil," John Kilduff of Again Capital said on CNBC on April 28. "But unfortunately the increased production of oil from the shale players keeps coming."
Unless U.S. motorists burn through all the extra supply of refined products, the crude oil glut will transform into a refined product glut. But there is little chance demand will surge sufficient to soak up all the extra product. "Demand for refined products remains weak for this time of the year, which will be a cause for concern over the coming weeks if demand fails to recover," Abhishek Kumar, senior energy analyst at Interfax Energy's Global Gas Analytics, told Reuters last week.
So, we have U.S. oil producers continuing to boost production, refiners responding by ratcheting up processing, but ultimately there is no place for all that gasoline and diesel to go, leaving WTI and Brent no better off. Indeed, crude oil benchmarks dropped over the past few weeks, touching one-month lows on May 1.
The current trajectory is unsustainable. Refiners are probably going to have to back off before they fill up inventories too much. But, of course, cutting back on refinery runs could contribute to more gains in crude oil stocks, leaving us back where we started. Ultimately, oil prices might have to fall unless the market starts to see some other signs of tightness.
Without motorists picking up the slack, the one other way to drain both crude oil and refined product stocks is for refiners to export. But, again, absent a strong increase in demand, more gasoline and diesel sent abroad would only add to global stockpiles. In any event, the U.S. has seen a recent uptick in imports, which would seem to offset the surge in exports. In other words, it doesn't look like exporting will rescue the industry.
In short, crude oil inventories have finally started to fall after more than six months of strong increases, but the glut has not gone away; it has just moved downstream. The lack of gains in oil prices reflect this reality.
By Nick Cunningham of Oilprice.com
