2020: The Year of Shut-ins— Crude Stocks Declining

U.S. commercial crude stocks fell last week amid sharply lower production, as the probability of a disastrous storage max-out continues to decline. End-market demand shows signs of strength, as gasoline demand rose again. Still, crude imports and refinery inputs of crude oil, particularly in PADD 3, showed signs of weakness. This mismatch in crude inputs and gasoline demand will have to be resolved one way or another in the coming weeks. A growing glut of diesel inventories could also weigh on refinery operations and lead to diverging outcomes in gasoline and distillate markets.

We believe it is still too soon to declare victory in the battle against storage max-out. Even though the probability of reaching tank top continues to decline, the public health crisis continues to drive all economic outcomes, including in energy markets. Will a second wave of COVID-19 infections hit the U.S. and other key markets as societies emerge from lockdowns? How much personal risk will consumers tolerate? Uncertainty from COVID-19 continues to dictate market outcomes. The probability of a storage tank max-out is clearly lower than even three weeks ago, but it is still too soon to declare victory.

Crude storage draws in Cushing

U.S. weekly stocks of crude oil, excluding the Strategic Petroleum Reserve, totaled about 531.5 million barrels for the week ending May 8^th, DOWN by about 0.7 million barrels from the prior week. This is the first national-level weekly withdraw from commercial reserves since early January, in pre-COVID times. As the Strategic Petroleum Reserves received injections of 1.9 million barrels, however, total U.S. crude stocks rose by about 1.2 million barrels.

Cushing inventories fell last week, although we caution against reading too much into that data point. Cushing has likely been full commercially for weeks, and storage levels have been so high that physical operations have been constrained. It’s therefore not too surprising that Cushing stocks fell – let’s wait for more data before drawing too many conclusions about future weeks.

Commercial stocks in PADD 3 (the Gulf Coast) were level at about 282 million barrels. The rate of injections to PADD 3 inventories has slowed considerably over the last four weeks, even after accounting for the 1.9-million-barrel injection to the SPR.

The recent stability in crude storage levels could be misleading. If demand bounces back to, say, 90% of pre-COVID levels there could be sizable stock drawdowns. If, on the other hand, a second wave of infections occurs and consumers take rational precautions by staying at home, crude product demand could fall even more and inventory builds could begin again. It’s difficult to assign probabilities to these two contingencies, which could be a major reason why refiners are processing fewer volumes.

Refineries and gasoline: something has to give

Refinery inputs of crude oil fell sharply by ~0.6 million barrels per day (MMBPD) last week to 12.4 MMBPD. Some refineries may be closing down units, while others may be waiting for product stocks to return to more normal levels before ramping up production again. Finally, sharply lower jet fuel demand and re-optimization of refineries could lead to oversupply of distillates.

Indeed, gasoline stocks of about 253 million barrels remain well above 5-year highs. While inventories fell again last week, some refineries are likely gauging consumer responses to COVID-19 developments before ramping up output. If consumers resume their old driving habits, gasoline stocks could fall to “normal” levels as early as June. On the other hand, consumers could continue to respond cautiously to COVID-19 developments, limiting gasoline consumption.

Consumers appear willing to return to pre-COVID conditions. Gasoline supplied for the week ending May 8^th totaled about 7.4 MMBPD, up sharply from 5.1 MMBPD in early April. If current trends hold – a big assumption – U.S. gasoline supplied could return to normal levels by early June.

Diesel and jet fuel demand dynamics are complicating refinery operations, however. Jet fuel demand stands at 0.35 MMBPD, off 80% – yes, 80% – from a year ago. Jet fuel stocks are basically unchanged from a year ago, however, with inventories at around 40 million barrels. Diesel demand has held up much better than gasoline and is recovering to pre-crisis levels.

Even as diesel demand recovers, inventories are surging. Why? Mainly because refineries are re-orienting themselves to produce higher volumes of gasoline and distillates as jet fuel demand plummets. Diesel inventories are close to 5-year highs and could skyrocket if refineries increase crude inputs and gasoline production. Before they increase gasoline production, refineries must not only contend with the possibility that a second wave of COVID infections could blunt demand: they must also grapple with the glut in diesel stocks that would accompany any premature increase in crude inputs.

Something has to give: gasoline demand and refinery inputs are moving in sharply different directions. If gasoline demand returns to “normal” conditions, refineries will have to sharply ramp up inputs and production. In that scenario, we could see sharply diverging outcomes in diesel and gasoline markets, particularly during the summer driving season. On the other hand, COVID fears could lead drivers to scale back consumption, limiting refiners’ incentives to scale up output. We don’t think the market will find a sustainable equilibrium until the COVID picture becomes clearer.

Production cuts continued

For the week ending May 8th, the EIA estimates production fell by about 0.3 MMBPD, to 11.6 MMBPD. Volumes are down by ~1.5 MMBPD from late February, pre-COVID levels. As the number of active oil rigs has also halved since March, there is ample evidence of dramatic production cuts.

More signs that U.S. crude averted a disaster

With commercial crude stocks falling, production declining, and gasoline demand strengthening, the probability of a storage max-out is much lower than it was a month ago. Still, it is too soon to declare victory. A secondary wave of infections, at home or abroad, could stamp out re-awakening gasoline demand. The response to COVID-19 will continue to drive crude outcomes.