By Ryan M. Couture and John Auers
Last week, we discussed the surging levels of gasoline demand in the U.S., which have come as a result of a strong reaction by consumers to lower pump prices. But even as U.S. gasoline demand has been breaking weekly and monthly records, gasoline margins have not fared as well. In fact, rising inventories have pushed product margins in the direction of distillates, prompting refiners to consider adjusting operations to increase yields of jet and diesel. While this seasonal transition happens every year toward the end of summer as gasoline demand slows and refiners begin preparing for the heating oil season, it seems to be coming earlier in 2016. In today’s blog, we explore some of the reasons why it appears that “Winter is Coming” despite the fact that July has just begun. We will take a look at demand trends from a global perspective and explore the other side of the supply/demand equation: gasoline production levels.
King of the East?
Of all the key product groups, gasoline has reacted the strongest to the precipitous drop in crude prices. In 2015, global gasoline grew by 3.3%, much greater than the overall product demand growth of 2.0%, and more than twice that of distillates (1.6%). Demand growth has varied significantly by region, impacted not only by demographic and economic factors, but also by differences in government policies (taxes, subsidies, retail price controls, etc.) in many cases, which distort the relationship between petroleum market prices and prices at the pump. Despite these differences, growth showed strength throughout the world; even Europe saw positive increases in demand (however small) for the first time in many years. In the end, however, it was the developing countries of the East which surpassed even the strong responses in the U.S. and lead the world, with demand growing by over 7% in the Asia Pacific region as a whole and by almost 11% in China (see Figure 1, below).
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Yet despite this high demand, which has continued through the first half of 2016, stocks have grown throughout the world, and gasoline margins are slipping. This begs the question, if there is so much demand growth, why is there the appearance of a growing glut of gasoline? What has happened in the last several months and what does it mean for the future?
Oversupply – “He always comes back!”
Although U.S. gasoline demand has stayed strong, supply is growing as well. This is coming not only from high utilization rates, but also increases in capacity from projects incentivized by the growth in light tight oil. According to EIA data, U.S. operable refining capacity has increased by 500 MBPD since the beginning of 2015, reaching 18.3 million BPD currently. This has led to gasoline production growth of over 2% thus far in 2016, setting an all-time weekly record of almost 10.3 million BPD during the week ending June 17, and an average of nearly 10 million BPD over the last two months. As a result, gasoline inventories, which hit records in February, have remained high even as U.S. drivers keep buying more gasoline. In fact, gasoline inventories currently are the highest they have ever been at the beginning of July (almost 240 million barrels), almost 10% above levels last year at this time.
Even in China, where gasoline demand growth remains strong after the 2015 surge, refiners are beginning to export gasoline. This is coming because supply is growing even faster than demand. One reason is that refiners have shifted toward increased gasoline production as diesel demand began to slow in mid-2015, outpacing their own demand (Chinese diesel exports have increased by over 400% in recent months compared to a year ago). Another factor is the increased run rates at Chinese teapot refineries as a result of the relaxation of crude import restrictions over the past year.
In Europe, refiners saw strong margins in 2015, which prompted an increase in runs for the first time in a decade. Europe is a diesel-driven market, though, and is historically long on gasoline; almost 1/3 of gasoline produced in Europe is exported. These increased runs mean increased exports. The natural export destination has been the U.S., but in the past few weeks, these cargoes have had trouble finding a home. Several have sat offshore, unable to unload, before ultimately being diverted to Latin America. The U.S. East Coast has its fill of gasoline, despite being peak demand season.
Challenges to Global Growth – “I’m not going to stop the wheel. I’m going to break the wheel.”
So you can see that the cause for the current glut of gasoline is not because of a lack of demand (although there has been some slowing in parts of the world recently), but an excess of supply. The global crude market has been oversupplied since mid-2014, and crude prices have fallen by as much as 75% from their peak in 2014. Low prices prompt increased consumption, but there are several key factors that impact consumption, and they vary regionally. The regional economy, demographics and taxes all play a key part in dictating both consumption and market elasticity.
Europe (including the EU and Eurasia) was the only region that saw a fall in total gasoline demand in 2015. Western European countries have a high proportion of diesel passenger vehicles (over 50%). Additionally, the taxes on motor fuels comprise a much larger portion of the total fuel price in Europe than most other countries in the world (see Figure 1 in our previous blog). Since gasoline consumption is driven in large part by consumer demand, the lower number of gasoline-powered vehicles coupled with higher fuel prices less linked to oil price have drastically reduced market elasticity there, and kept growth much lower. As you move east, Russia has grappled with a substantial recession brought on by sanctions, devaluation of the ruble and the dramatic fall in oil prices. This has impacted total petroleum demand not just in Russia, which dropped by over 5% in 2015, but in the entire ex-USSR region which is highly commodity-dependent. Gasoline demand in the region actually fared better, dropping by only about 3% regionally.
Latin America is coping with a recession that has pushed several major economies into negative GDP territory. The region is highly dependent on commodities, which have sharply fallen in value. Starting in mid-2015, Brazilian demand began to fall from a year-on-year perspective in stark contrast to steady growth for the proceeding 14 years. Argentina, which has faced inflation and government controlled energy prices, has not seen a sharp rise in demand, as consumers have not seen the impact of low prices at the pump. Mexico has had subsidized energy prices for years, and while low prices have removed some burden from the government, it has done little to impact consumer fuel prices. Venezuela’s economy remains on the brink of collapse as it struggles to keep even basic services running, while Colombia, Ecuador and others are facing the challenges that come with low commodity prices.
In late 2014 and into 2015, several African countries grappled with Ebola. In addition, the region has faced persistent internal conflict, which has had significant impacts on some key producing countries such as Libya and Nigeria, greatly impacting supply. While Africa has seen some of the highest regional demand growth at 6.5%, the absolute change has been rather small at only a quarter of the absolute growth the U.S. or China has seen. With the continued low prices, the region’s dependence on commodities and continued conflict, absolute demand changes will be kept in check.
While the U.S. remains the largest gasoline market, the growing middle classes in China and ultimately India are destined to take over the top spot at some time in the future. Within Asia/Pacific, developed and developing nations have vastly different demand dynamics. In the developed countries, predominantly Japan and Australia, demand has seen a slow decline in recent years. Both countries have high fuel taxes (Japan particularly so), and both have struggled with economic weakness (Japan with deflation, Australia with low commodity prices), hurting demand.
Among the developing nations, China and India dominate demand, comprising about half of total Asia Pacific demand. China has seen rapid growth, doubling total petroleum demand over the last 12 years; but recently, China has the world on watch. After years of consistent growth, China’s growth engine has sputtered, and the economy has slowed. This has led to a lower rate of growth in petroleum product demand (although still quite large, especially given the size of the market), predominantly for diesel. As shown earlier, gasoline demand was strong in the country last year (almost 11%), but early results from 2016 indicate a significant slowing. It is important to note that the retail gasoline market is controlled, and although the government has begun price reform, it still maintains a “price floor” on fuel, keeping prices stable, but somewhat higher, that they might otherwise be in the current low price environment.
India is the shining star of demand. While only a third of Chinese demand, India’s total petroleum demand has reached double digit growth rates. In the year ending March 31, gasoline demand rose by 14.5%, almost double that of diesel. If this shift continues, as the IEA expects, India could consume 10 million BPD of petroleum by 2040, much of that gasoline. Over the past year, amid falling prices, India has removed fuel subsidies for motor fuels. This has helped to spur demand amid low prices today, but may negatively impact demand growth as prices recover in the future.
Conclusion – “We go forward. Only forward.”
Globally, the glut of crude appears to be transitioning into a glut of products. Even low prices and a strong demand season has not been enough to get ahead of gasoline stockpiles. With inventories building, refiners may be put in the position of trimming rates to meet demand without filling their tanks to the brim. This will shift the inventory back to building crude. As we approach the second half of the year, “Winter is Coming” and with it the traditionally weaker demand for gasoline and refining margins as a whole. Will distillates come to the rescue? They certainly didn’t in 2015, partially due to the warmer than normal winter and depressed demand for heating oil. Will the second half of 2016 be different? A variety of factors will determine this, including weather (hurricane disruptions, heating degree days, etc.), U.S. and global economic performance, regulatory impacts, crude price developments, etc.
Turner, Mason & Company develops specific regional and global demand forecasts as part of our 2016 Crude and Refined Products Outlook Mid-Year Update which we will be releasing at the end of this week. It will include an analysis of the changing global supply and demand dynamics that are impacting gasoline markets, as well as a deep dive into the issues mentioned here as well as others. The Outlook also includes an assessment of the regional prices and margins for gasoline, diesel and other petroleum products. For more information on this product or on other specific consulting engagements with which we may be able to assist, please send us an email or give us a call.