Gasoline Price To Stay Firm Against Crude, Based On Foundational Gasoline Market Dynamics

Gasoline price under pressure to decline, but looks foundations of gasoline market sepearate from crude 

Gasoline prices, while having declined, have not experienced the same degree of decline witnessed by crude oil. According to the U.S. Energy Information Administration, West Texas Intermediate (WTI) averaged more than $100/bbl over the first four months of 2012. WTI then went from $106/bbl first of May to $83/bbl in June. Where oil fell some $23, retail gasoline prices have held comparatively firm.

April saw a peak in retail gas at $3.90/gal declining to $3.57/gal by June. This 8% fall in gas price contrasts with crude's 22% fall. Oil falling substantially, but not translating into proportionate if not congruent declines in gasoline seems counterintuitive. Some blame the spread of Brent crude over WTI and its strains on refinery margins. According to this explanation, gasoline tends to price based upon higher costing Brent crude, instead of cheaper WTI. However, Brent has recently declined in similar fashion as WTI, due to concerns of declining global demand.

Brent and WTI price relationships are certainly a part of the puzzle, but puzzle pieces also include declining gasoline supplies despite declining demand. Add to this margin challenges among East Coast refineries, and gas prices look to stay firm against crude decline. What’s more, gas prices appear resistant to correlation with crude pricing, such that declines in crude aren’t flowing into retail gas.

Background on crack spreads, their fall against emerging markets and end of QE1

Decoupling gas prices from crude pricing seems to be a refiner's goal, especially where gas prices can sustain levels even when crude declines. Crack spread is the price difference between a barrel of refined product and a barrel of crude. Resulting difference is the money a refinery is left with to cover production costs and generate profit. For example, with RBOB gasoline trading $2.66 and crude at $83, the crack spread is $28.72 (convert $2.66 into barrel value by multiplying it by 42 gallons in a barrel and subtracting the product from crude barrel price). 

Putting crack spreads into perspective, refineries found themselves taking losses through 2009 and into 2010. Entities were projecting extended losses for American refineries, with refinery closures. Example can be found in 2010, which was easier for refineries than 2009.

July of 2010, crack spread was at $10.41, down 45% from a 15 month high of $18.77. This 15 month high occurred only two months prior in May, indicating a truly volatile market. By August, crack spreads were in serious decline reaching a nine month low of $4.00. These low spreads reached into early 2011. Accounting for decline was weak U.S. refined products demand, perhaps associated with an end to QE1 in March.

Divergence of WTI from Brent oil supporting U.S. gasoline price 

A curious price divergence started between WTI and Brent in late summer of 2010 and became convincing by December. WTI became comparatively cheap against more world oriented prices of Brent. Causation is a wealth of oil plays coming on line in the U.S., generating major gluts at U.S. crude hub in Cushing, Oklahoma.

Where WTI traded equal to or higher than Brent, this convention reversed. Overtime, and with continuing Cushing WTI gluts, Brent pricing exceeded WTI by up to $30 witnessed in 2011, to averaging just under $20 typically, and currently more in the $12 area.

Complicating matters were refineries reliant on Brent priced crude. East Coast refineries were essentially dependent on oil supplied from overseas, which translated into Brent prices, not WTI prices. This was due to no real infrastructure to take American oil (WTI) to East Coast refineries. Given that the U.S. is a heavy net importer of crude, it’s no surprise that U.S. infrastructure is designed for inflow, as opposed to outflow...even with domestic crude flowing from interior locations outward.

When U.S. crack spreads based on WTI were weakening late in 2010 due to declining demand, U.S. Brent based spreads moved negative. All due to pronounced declines in U.S. demand for refined products while both WTI and Brent did not decline in similar fashion.

Emerging markets, however, experienced rocketing demand for both crude and refined products. China experienced a severe diesel shortage. These economies bought crude based on Brent prices, not landlocked WTI.

Emerging market demand for petroleum created disparity with developed country surplus

November, 2010 U.S. crack spreads bottom feed, hurting U.S. refinery margins, while Asian spreads sought nine month highs. Asia hit a spread of $163/metric ton, translating into $23.34/bbl (roughly 7 bbl to 1 MT). Asian high demand compares with U.S. $4.00 spreads. U.S. also had a net petroleum surplus at the time while overheating emerging markets addressed shortages. Brent was setting itself for a serious premium over WTI prices.

Where U.S. demand for crude and refined products waned stateside, WTI albeit landlocked priced higher than U.S. market dynamics, together with gas. Where emerging market demand rocketed, it set Brent prices likewise parabolic versus WTI and U.S. Brent based gasoline pricing.   

U.S. midcontinent refineries closer to Cushing found themselves at a considerable profit advantage over coastal refiners. Not only did a WTI glut disturb market balance, but emerging market petroleum demand lifted Brent prices against WTI, which ultimately lifted all petroleum. For developed countries, lifts in all petroleum weren’t necessarily correlated with real economic demand or supply. Very divergent crack spreads between U.S. and emerging countries evidence deeper fundamental divergence.

Consequences of reversing traditional petroleum pricing

Incongruence between emerging and developed economies and resulting price differentials between WTI and Brent pressured U.S. refineries based on geography. Most stressed are East Coast refiners. Such stress is noticed in refinery closures, idling and hoped for sale.

 According to EIA, Sunoco closed its Eagle Point New Jersey plant on February, 2010, losing 145,000/bpd. September, 2010 Western Refining closed its Yorktown, Virginia 66,300/bpd operation. Idled are Sunoco’s Marcus Hook Pennsylvania 178,000/bpd plant and ConocoPhillips Trainer, Penn 185,000/bpd plant. Looking to sell is Sunoco’s Philly 335,000/bpd facility. All leading to current major concerns of sustained East Coast refinery supply capability.

Recent developments show that Delta Airlines bought the ConocoPhillips Trainer plant….Airline operating a 185,000/bpd facility, story all by itself. Every day now Sunoco gets closer to a deal with Carlyle Group on their 335,000/bpd operation. Earlier this month (June 7), Enbridge opened its reversed Seaway Pipeline. Now it flows crude out of Cushing and into Gulf refineries and export terminals.

Overall, 2011 saw interesting dynamics maturing from 2010, especially with QE2 influences. 2010 events set today’s foundational proposition. Currently, the balance might be turning with declining emerging market demand.