The New Oil Order

The build in Atlantic distillate inventories this year has been large, following near-record refinery utilization in both the US and Europe, only modest demand growth, especially relative to gasoline, and increased imports from the East on refinery expansion and rising Chinese exports.

Atlantic basin distillate storage utilization is alarmingly high
Distillate storage utilization in the US and Europe is nearing historically high levels, following near record refinery utilization, only modest demand growth (especially relative to gasoline), and increased imports from the East on refinery expansion and Chinese exports. This raises the spectre of 1998/2009 when distillate storage hit capacity, pushing runs and crude oil prices sharply lower. This also raises the question of whether today’s oil market can rebalance through financial stress – prices remaining near their current low level through 2016 – or if operational stress – breaching storage capacity and forcing prices below cash costs – is unavoidable.

Tank tops not our base case, but too close for comfort
Our EU and US distillate balances do not currently lead us to expect reaching storage capacity at current 4Q15-1Q16 forward margins. The storage buffers are limited, however, at 200 kb/d in the US and 160 kb/d in Europe. This is too close for comfort as it would take 50 fewer HDDs than normal in Europe to fill that storage – a probability of 15% to 30% each winter month. We also see risks to our forecast for European imports from the East as skewed to the upside, given strong Chinese gasoil exports, lackluster Asian diesel demand, and the potential for sustained exports from new distillate geared refineries in the Middle East. The US outlook is more sensitive to industrial activity which has disappointed lately. This holds for Canada and Russia as well – where recessions could support exports to the US – and Latin America, the key market for US exports.

Financial rather than operational stress to rebalance market
As we forecast additional distillate builds into year-end, we expect heating oil and gasoil timespreads to remain weak, currently nearly incentivizing floating storage. A modestly larger distillate surplus than we forecast would need to push margins lower with run cuts spilling over into weaker crude timespreads and prices. For example, should EU storage capacity be reached, EU distillate production would need to be cut by 160 kb/d, requiring margins to drop by $3/bbl for runs to decline by 550 kb/d. As a result, while we reiterate our forecast that financial stress remains the likely forcing mechanism to rebalance the global oil market, with prices near current low levels required through 2016, the risks of having to balance the market through operational stress instead are non negligible.

Damien Courvalin, Abhisek Banerjee, Raquel Ohana – Commodities Research – Goldman, Sachs & Co.