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Fuel: Kloza's Call

Analyst predicts more cheap oil as demand continues to slide

As Tom Kloza walked out to “I Can See Clearly Now”—a song that debuted in 1972, the last time the United States was producing more crude oil than it is today—he faced a vastly different gas and oil landscape than he has in years past. Specifically, oil prices are about 50% less than they were this time last year, he said.

“I’m used to getting up during this time of year with very high prices in the background and suggesting to you all that prices are too high,” said Kloza, global head of energy analysis for OPIS, Wall, N.J. “Maybe some of the things we saw in 2014 in terms of the pricing collapses, dramatic volatility and stupid money chasing stupid money will indeed happen again this year.”

Before breaking down why we might be in for another dramatic decrease in oil prices this year, Kloza examined the factors behind the extended period of high oil pricing. They included:

Outages: Unplanned supply outages have been a key feature of the global oil market since 2011 and have occurred all over the place. Almost 3 million barrels per day (bpd) were compromised at one point, Kloza said.

Bad Data: Kloza likened the precision of data on world oil prices to giving someone a haircut with a chainsaw. World analysts underestimated the United States, and outside of this country, non-OPEC production has declined over the past several years—despite years of elevated prices. Outside of Saudi Arabia, Kuwait and the United Arab Emirates, the rest of OPEC has floundered.

Unbalanced Market: Even during a period of very sluggish oil demand growth, as it has been since the recession, and exponential growth in U.S. production, until recently the Saudis had to produce at record levels to keep the market balanced.

The Saudi Problem: Kloza said this focused on how to supply enough oil to the market, not how to stabilize it.

In terms of what led to last year’s dramatic drop in oil prices, he listed:

Sloppy Atlantic Crude Market: It turns out there was a lot of money on the wrong side. “We look at professional hedge-fund managers and make the mistake of thinking that because they’re very rich, they must be very smart,” Kloza said. “There was so much money in paper, it was an unbalanced position that couldn’t be sustained unless you did have some production cuts from OPEC.”

Overly Optimistic Demand Forecasts: As Kloza pointed out, emerging countries don’t “unlearn” fuel efficiencies. Weak demand growth has been a long simmering trend. While it didn’t cause the decline, it didn’t help.

Crude from West Africa: Beginning around June and worsening by August, marketers of West African crude (Nigerian crude in particular) struggled to place their cargoes. Libya was “lucky”: Its production went from 450,000 bpd to 900,000, and there were more than a dozen paper crude positions for every short.

Saudi Arabia’s Big Move: Saudi Arabia made it clear on Thanksgiving Day that it would no longer be the swing producer. But the country’s motives, and patience, are not clear. What is clear? The Saudis can survive for quite a while with lower oil prices. “The truth is, they have a tremendous amount of money in foreign reserves,” Kloza said. “The Saudis can manage many, many months and years in a world where oil is $50 per barrel.”

Deciphering Demand

Another big argument against crude oil pricing returning to $80 to $100 per barrel—besides the factors that led to the crash to begin with—is the simple fact that demand isn’t what it used to be. Yes, the U.S. Energy Information Administration (EIA) shows fuel demand is up 2.9% from 2014, and 3.8% from both 2013 and 2012—but Kloza described EIA’s collection and reporting process as “very misleading.”

“We’re just not seeing demand rise to the level of EIA estimates,” he said. “Demand is higher, don’t get me wrong. But I believe EIA is counting gas exports and gasoline going into storage.”

A weekly OPIS survey paints a very different picture. Of the 5,000 stations polled, 53.4% sites said volumes were down vs. 2014, and 60.7% down vs. 2013; Kloza acknowledged “somewhere in between lies the truth.”

Decreasing demand is something that was addressed throughout the various summit presentations, pointing to more urban dwellers, fewer young drivers and more fuel-efficient cars. Though lower gas prices should improve some of the demand, Kloza said it’s not just about what’s happening in the United States.

Fu Cheng-Yu, owner of China’s largest refiner, recently acknowledged the possibility that China will hit peak oil demand by 2017.

“That’s only China, but when you think about growth and global growth, China has been the cornerstone,” said Kloza. “If the conversation changes from talking about peak supply to talking about peak demand, that’s really something the industry has to wrestle with.”

CONTINUED: Retail Realities & Trends

Retail Realities

The combination of historic levels of crude oil production (at least in the United States) and decreasing demand at least suggests oil prices won’t fully rebound anytime soon. For the time being, that has been great news for retailers.

“You’re not going to see a year like 2014 that often,” Kloza said, pointing to great rack-to-rail fuel margins throughout the latter half of the year, peaking at 35.1% in December. “It’s slowed down this year—I don’t think we’re looking at anything like last year unless we get one of those tremendous downswings … which is possible.”

Seasonality is also a reason why we may not be seeing such positive margins in 2015. (They had dropped to 19.3% as of March 2015). Kloza said the numbers were similar in March 2014, with improvement coming later in the year.

Though it’s difficult to predict what oil prices will be in the next five days, Kloza was adamant that the trend for the next five months will be toward lower prices. There’s about 90 million to 100 million more barrels of crude oil than refined transportation products (e.g., gas, diesel and jet fuel), which Kloza said will lead to an overage of transportation fuels in the near future.

“We’re really going to see a glut of crude oil transferred into something of a glut of refined products,” he said. “Cheap oil will prevail for this year and into 2016.”

Kloza anticipates that by time the NACS Show rolls around in October, oil prices could drop as low as $39 per barrel—and a rebound to $80 per barrel is a ways off.

“The market is going to be biased toward lower prices,” he said. “For the remaining SOI meetings in this decade, we’re not going to see $80 costs. There’s just too much production.”


Refining Trends

Kloza predicts the following trends related to oil refineries around the globe:

  • U.S. Gulf Coast refineries are the most privileged plants in the world. More expansions are forthcoming, with an emphasis on diesel.
  • European refineries are in hospice. Based purely on economics, many should close and U.S. imports of gasoline from Europe should be negligible in the second half of the decade.
  • Refiners still expect flat to lower gasoline demand trends over the next six years. Global diesel could be questionable. Some European countries are moving away from it.
  • Mergers and acquisitions will quicken. The “Marathon model” has fans. Refiners are very worried about placing gasoline they’re going to produce; expect to see refiners getting into retail (often through acquisition) so their gas has a home.

Rig-o-nometry: An Inexact Science

Kloza scoffs at the attention that’s been paid to the number of oil rigs in recent years. “Essentially, this is a statistic that’s meant nothing for 40 years, but has been grabbed onto and overhyped by Wall Street,” he said. “I would submit that it doesn’t mean all that much.”

Why? Because manufacturing practices—or “manu-fracturing,” as Kloza dubs it—have become more efficient, reducing the need for more rigs.

“Productivity gains are more than likely to offset lower rig numbers,” said Kloza. “The breakeven numbers are evolving very, very quickly.”


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