By John Auers and John Mayes
The 1969 Blood, Sweat and Tears song – “Spinning Wheel” – begins with the words, “What goes up, must come down, Spinning wheel got to go round.” Like a spinning wheel, U.S. gasoline and distillate demand continually cycle up and down, both impacted by long-term and short-term drivers. Recent data suggests both gasoline and distillate are poised for new demand trends: gasoline on the downside and distillate on the upside.
U.S. refining rates have been robust in recent years, propelled by a combination of strong domestic product demand growth and rising export opportunities. Since 2012, refining rates have increased by 1.2 million BPD while total petroleum demand has risen by 1.1 million BPD. Most of the demand increase has been associated with gasoline and distillate with gasoline likely to set new demand highs in 2016. Over the past few months, however, demand patterns for both gasoline and distillate began changing again.
Gasoline Demand
In 2009, Rex Tillerson, the former head of ExxonMobil and soon to be Secretary of State, famously forecast that U.S. gasoline demand had likely peaked in 2007 in stating, “We think going forward that because of the emphasis on energy efficiency, ongoing improvements in vehicle miles standards, and hybrid (cars), that motor vehicle gasoline demand is down, is headed down, and is going to continue to head down.” Gasoline demand did decline for several years, but in 2013 the fuel efficiency improvements began to stimulate purchases of larger vehicles and higher vehicle miles traveled. Lower gasoline prices beginning in the second half of 2014 also had a positive impact on consumer demand. As a result, gasoline consumption in 2016 will be around 9.30 million BPD, narrowly higher than the 2007 level of 9.29 million BPD.
By the middle of 2015 however, this upward trend reversed (Figure 1) as monthly year-on-year (Y–O-Y) demand change began to decelerate. Gasoline demand was still increasing, but at a steadily declining rate.
This decline in demand growth has continued and October 2016 gasoline demand (the latest reported number by the EIA) was lower than October of 2015, the first actual Y-O-Y decline since November of 2014 and the sharpest drop since February of 2013.
While gasoline demand is certainly impacted by price changes, the effect can be short-lived. Figure 2 compares the smoothed Y-O-Y demand changes (from Figure 1) with the average U.S. retail gasoline price as reported by the EIA. From June 2014 until January of 2015, gasoline prices fell rapidly, and, as expected, the increase in gasoline demand accelerated. From January of 2015 until June of 2015, however, these dynamics shifted as gasoline demand continued to accelerate while gasoline prices were rising. From June 2015 onward, the trend reversed. Gasoline prices have generally declined over the period while demand has decelerated. Is the October 2016 data point the beginning of a new trend?
At a minimum, it seems the enamor of low prices has worn out its stimulating effect. Unless there are counterbalancing economic growth factors or policy changes from the new administration, this trend may continue and higher crude prices will only serve to depress gasoline demand further. The steadily rising mileage requirements of the CAFE program will also tend to reduce demand. The targets for model years 2017 through 2021 will yield additional improvements and are not likely to be altered by the Trump Administration but the 2022 through 2025 targets are thought to be in jeopardy.
Distillate
Distillate demand swings have been even more erratic than gasoline shifts. Demand rose rapidly through 2014 and then peaked in 2015 (Figure 3). Demand fell rapidly in the fourth quarter of 2015 and through 2016 with the 2016 end-of-year demand level slightly below the beginning of 2014. While the demand collapse in 2016 was certainly depressing, the silver lining was the reversal of the Y-O-Y changes seen in the second half of the year (Figure 4). Throughout 2H2016, distillate demand was still declining but the rate of decline was falling.
Distillate demand growth in the U.S. generally correlates with economic growth. Since 4Q2015, however, this relationship has broken down. While tepid in the first half of 2016, U.S. economic growth accelerated to 3.5% in 3Q2016. Distillate demand growth did not respond accordingly and was in sharp decline.
There are many components within the commercial sector of the U.S. economy which contribute to distillate demand. One of these is U.S. oil drilling activity. Figure 5 compares the smoothed Y-O-Y demand changes from Figure 4 with the Baker Hughes oil rig count. As can be seen, the downturn in distillate demand correlates very well with the corresponding downturn in oil drilling activity. When oil drilling reached its peak in late 2014, it comprised around 12% of total distillate demand. At its lowest point in 2Q2016, however, oil drilling only comprised approximately 3% of distillate demand. It would thus be concluded that the rest of the U.S. economic activity contributed little if anything to distillate demand growth since September of 2015.
While drilling activity has impeded demand growth in recent months, it is now poised to increase demand in the coming months. Higher crude prices will stimulate increased drilling which will then accelerate this growth pattern. While gasoline demand seems to be transitioning from positive to negative growth, distillate demand growth is more promising. Distillate demand will also be stimulated in 2020 with the advent of low sulfur bunker fuel which will necessitate the blending of substantial amounts of distillates into the bunker pool.
These and other consumption trends will be discussed and analyzed in greater detail (including our demand forecasts) in the upcoming release of our Crude and Refined Products Outlook. This biannual publication evaluates the latest trends and drivers in the petroleum industry and will be published in February. For more information on this and other TM&C products, call Shanda Thomas at 214-754-0898 or visit our website at turnermason.com.