A few things once commonplace in the oil and fuel markets will likely never happen again.
They begin with crude-oil prices hitting $100 per barrel, or retailers having to pay $2.50 at the rack for a gallon of gasoline or diesel.
“It’s not going to happen. It shouldn’t happen. There are tremendous odds against it happening,” said Tom Kloza, global head of energy analysis for Oil Price Information Service (OPIS), Gaithersburg, Md., during his keynote on the closing day of the 2017 NACS State of the Industry Summit.
Even $75 to $80 crude is a long shot for 2017, said Kloza. This is despite oil prices’ recent upward trend and some bullish influences.
The Organization of the Petroleum Exporting Countries (OPEC) has largely stuck to the deal it and nonmember countries struck to cut oil production to 29.8 million barrels per day (bpd). If OPEC extends the deal through the second half of the year, as Kloza expects, global crude supply could slip 500,000 to 600,000 bpd by second-quarter 2017, below global demand. The result: slightly high er crude prices for 2017, likely in the $50 to $60 range.
But even $60 would be “a real push,” said Kloza. “Sixty dollars in crude is a little like 60 [home runs] in baseball. You can get there ... but everything has to go perfectly right.”
The oil market has what Kloza calls a “seven and seven problem” when it comes to supporting higher prices. That first “seven” refers to the seven years it takes a new, long-term production project to come to market.
From 2011 to 2013, several such projects were commissioned as crude hovered around $100; they are now finally poised to come online.
The second “seven” is the seven months it takes on average to bring short-cycle U.S. shale oil to market. These projects can launch even when oil prices are down to the $30-per-barrel point. (At press time, West Texas Intermediate, or WTI, was just shy of $53.)
“It’s a really, really a difficult proposition for crude-oil prices to get beyond that seven and seven,” said Kloza.
One of the only risks for this bearish outlook is the current government upheaval in Venezuela, which alone provides about 2 million bpd toward global supply. Even then, oil prices are not likely to hit $70, Kloza said.
Woe Is Demand
Gasoline demand hit all kinds of records in 2016, thanks to the lowest retail gasoline prices since 2004. According to the U.S. Energy Information Administration (EIA), gasoline consumption rose 1.6% to hit 9.327 million bpd in 2016, an all-time record that beat the previous peak, in 2007.
The year 2016 “will go down in history as the year that more gasoline was sold in the United States than in any previous year or any subsequent year,” said Kloza.
Demand in the first 100 days of 2017 is down about 1.6%, with some regions such as the Southeast and Northeast seeing steeper declines, according to OPIS data. The 3% drop in demand for the Southeast is somewhat baffling, considering that the weather has largely been good and it is home to high-opportunity states such as Florida, where many retailers are flocking.
Kloza believes rising gasoline prices may be behind some of the slump. In January and February, many states saw pump prices 15 to 16 cents per gallon (CPG) higher than the year prior, as rising oil prices trickled downstream. As a result, consumers reacted.
“They have an internal thermostat that tells them, ‘Twenty dollars was taking me through a typical week last year, and now I’m at $25.’ And some of those people cut back.”
As of early April, the national average for regular grade was 28 CPG higher than the same time the year prior, although some states saw 50- to 60-CPG increases. “It’s very, very cheap compared to 2011-2014, and probably not enough to really kick that internal thermostat into behavioral changes, but you never know,” said Kloza.
OPIS is expecting monthly gasoline expenses to average $240 to $250 per household, after sinking to $218 per household in 2016. This is still a long way from the $340-and-up highs of 2011 and 2012, but not insignificant. “Last year was the cheapest year for motorists and how much extra money they had to spend inside the stores since 2004,” said Kloza. “We’re not going to beat that.”
In the longer term, structural factors such as tougher Corporate Average Fuel Economy (CAFE) standards will weigh on demand as the U.S. vehicle fleet turns over. The EIA is projecting a nearly 23% decline in gasoline demand from 2016 to 2035.
“We’ve been wrong before, but those are pretty scary numbers,” said Kloza. “There are going to be a lot of small retailers who will not make it and be on hospice care, and having an alternative profit center or foodservice program is very, very important.”
And Woe Is Margin
With oil prices on the upswing, the retail fuel-margin environment has been tough for the first few months of 2017. Margins were off more than 15% on Jan. 1 and Feb. 1, 2017, compared to the same dates a year ago. March was looking better: Margins rose more than 4% in the early part of the month compared to March 2016, according to OPIS data. But a late-March spike in wholesale prices means margins for days 90 to 100 will be “pretty miserable” for most of the country, challenging the first quarter’s final performance figures.
Regionally, the greatest margin shrinkage was in the West, Southwest and Southeast in January and February. Most regions saw margins rise in early March, but that late wholesale price increase will erase some of those gains.
“The good thing is I think it will get better—this is not a long-term trend,” said Kloza. “But if you’ve had a tough 2017 so far, the numbers say we weren’t just whining uncontrollably; the numbers support the issue.”
Consider the Alternatives
On the regulatory side, change will be much more glacial, despite the new president in the White House.
While reports suggest the Environmental Protection Agency (EPA) under the Trump administration may shift the point of obligation in the Renewable Fuel Standard (RFS) downstream to large retailers, don’t expect it to happen in 2017, Kloza said. The EPA has not yet denied petitions by some refiners to move the point of obligation downstream, although under President Obama it proposed to do so. The Trump administration appears friendlier to the petitioners’ requests.
“It could happen in terms of a proposal next year, but there will be lawyers that bill bounties of money as this thing rages,” Kloza said. “EPA rulemaking cannot happen on a short-term duration, unless the president declares martial law.”
Prices for Renewable Identification Numbers RINs‑, the credits obligated parties such as refiners use to demonstrate compliance to RFS volume obligations, have fallen in recent months with the election of Trump and the appointment of Scott Pruitt, an RFS critic, to head the EPA. Large retailers such as Sheetz and Murphy USA that earn RINs from blending ethanol into gasoline—and are able to get an extra profit advantage on E10 and the 15% ethanol blend E15—may find it shrinking.
“The price of the RIN is much, much more the lever that determines that a Sheetz can sell 89 octane in E15 for 7 cents under E10 and make money,” said Kloza. “It’s a much better lever than the ethanol price being 20 to 40 cents less than the gasoline price.”
With OPIS projecting $50 to $60 crude and excess refining capacity, “we don’t really see a return to where ethanol prices could be 60 cents, 80 cents or $1 under the price of gasoline,” he said.
Instead, octane will be “the big battle” in the fuel industry for the next 10 years, as fuel refiners and the ethanol industry compete on who is best poised to raise gasoline’s
octane to meet the needs of efficient, turbocharged engines coming to the market. The biofuels industry will push for increasing ethanol levels to the 25% or 35% range, while refiners will argue they can raise octane other ways.
“The bottom line is, refiners want to sell more hydrocarbons, and they’re looking at lower sales under the best of circumstances, so they’re not going to embrace E15,” Kloza said.