Fuels: Mission Control

U.S. refiners and retailers navigate new forces shaping the energy market

CHICAGO — "Will the crude abide?”

The question was posed by Tom Kloza, global head of energy analysis for Gaithersburg, Md.-based Oil Price Information Service (OPIS), as he shared his oil and fuel outlook for second-quarter 2019 and beyond with attendees of the NACS State of the Industry Summit.

One interpretation of “abiding” might envision global crude falling in line, largely from a production standpoint, to accommodate market conditions and requirements, seasonally and geographically.

However, uncertainty currently prevails: After crude prices dropped significantly at the end of 2018, they have rebounded mightily since the start of 2019. During the first week of April—the same week as the conference—Brent crude prices rose to $72.11 a barrel, hitting a high for the year.

Pressuring crude prices were production cuts imposed by the Organization of the Petroleum Exporting Countries (OPEC), along with U.S. sanctions levied against Venezuela and Iran.

Kloza said OPEC producers have “overcomplied” and made deeper production cuts than originally anticipated. The United States has countered some of this decline in supply with its own increased production.

“We will see a lot of U.S. crude oil in second half of 2019, regardless, and that will be something to watch,” Kloza said. U.S. crude production stood at about 11.81 million barrels per day in early April.

In the United States, demand for gasoline is flat, while globally, it is growing for jet, marine and diesel fuels. Kloza predicted that gasoline prices, which typically crest in May, will do so even earlier—in April—with the highest wholesale prices until the hurricane season.

“We’ve seen this movie before, where people abandon crude and refined products during the wintertime, not realizing that when the days get longer, there will be more demand for gasoline,” Kloza said.

Big Oil Ramping Up Retail?

Today, U.S. gasoline supply is “sloppy,” which could encourage U.S. refiners to invest more heavily in retail to find a home for their product. As an example, Kloza pointed to BP’s partnership with ArcLight to acquire Thorntons. “It’s going to be compelling to have that downstream real estate … to know your product is going to go to dedicated places,” Kloza told CSP earlier this year. “That is probably half of the BP rationale” for the ArcLight alliance.

The major oil companies—BP, Shell and others—have spent almost 30 years “figuring out ways to extract oil from the ground,” Kloza said. “I suspect you will see some of them try to buy downstream assets.” That said, these major brands have since “been left in the dust” in terms of per-site fuel gallons thanks to the current market leaders, he said.

Kloza pointed first to warehouse club Costco, which reportedly has fuel gallons approaching 500,000 per store per month.

“Gasoline is magical to Costco,” and the Issaquah, Wash.-based membership club perceives gasoline as “a carrot to get people inside the store,” he said.

Privately owned independent c-store companies are driving market efficiency (a metric OPIS calculates by dividing market share by outlet share) thanks to winning formulas that balance gasoline sales with margin performance, plus strong one-stop-shopping competencies paced by quality foodservice.

“People abandon crude and refined products during the wintertime, not realizing that when the days get longer, there will be more demand for gasoline.”

According to OPIS, the market-efficiency leaders in 2018 were Buc-ee’s, Wawa, QuikTrip and Sheetz, with no majors ranking within the top 10. Fuel market share places Shell at the top, followed by Exxon and Marathon Petroleum Corp.’s Speedway retail brand, Kloza said.

Leading the way in operational efficiency are Marathon and Chevron, the former armed with a model that other oil companies would like to emulate. “The word ‘control’ might be a bit strong, but Marathon has the ability to navigate where its fuel goes,” Kloza said. “This is a big deal because gasoline, on balance, will be in surplus over the next few years rather than tight—that’s a lot of fuel to account for.” Besides BP having designs on retail expansion, Shell is another one to watch, he said.

While retailers enjoyed record margins in 2018, Kloza doubts they will be repeated in 2019, “but I don’t think it will be a poor year either,” he said. Early April to early May will see pressured margins, however, as marketers feel the constraints that come with wholesale rising faster than they can move retail prices.

“It might be a typical second-quarter dump to build margins,” he said.

The Haves and Have-Nots

Kloza cited some other trends and developments to watch in the years ahead:

Geographic refining. He views U.S. refining in the 2020s as a case of the “haves and have-nots,” with states east of the Rockies being led by facility efficiencies from many of the Gulf Coast refineries. “East of the Rockies, refined product is in good shape—there might actually be too much capacity,” he said, pointing out that this is a compounded dilemma if a mini or larger recession were to occur. “The narrative will see a cheaper year than 2019 for pretty much everything except marine, jet and diesel fuels.”

Kloza reinforced that the U.S. “refining system was built unevenly,” marked by a preponderance of Eastern refining density while Western states sport a much smaller network, leading to always-looming supply disruptions. That said, Western refineries enjoyed a flush year marginwise in 2018 and registered one of the best quarters on record so far in 2019. Of the 20 U.S. markets and gasoline margin leaders, most were metro areas in Western states.

A bull market for jet, marine and diesel fuel. Jet fuel is currently the fastest-growing commodity, a trend chalked up to an increase in international travel. Kloza cited the inordinately high number of visas issued for travel to China. Jet-fuel demand will be better met when refiners switch to heavy sour crude needed to refine that fuel stock—shifting some production from sweeter crude, which is optimal for gasoline.

With regard to diesel, Kloza doesn’t agree with those predicting its price could hit around $7 per gallon in the next year, although he said the price “might flirt with $4.” Providing the price pressure: new international regulations limiting sulfur content in the fuel of oceangoing vessels, set to take effect in January 2020. This would affect supply of on-road diesel as many shippers turn to it to meet the new requirements. Refiners in the United States will be rushing to meet this demand.

“The sidebar is that gasoline will be more than plentiful in 2020 because when you run refineries high, and we’re talking about runs at 2 million [barrels per day] higher, you make a lot of gasoline,” he said.

“The word ‘control’ might be a bit strong, but Marathon has the ability to navigate where its fuel goes.”

Demand and fuel efficiency. The Trump administration, through the National Highway Traffic Safety Administration and the U.S. Environmental Protection Agency (EPA), have proposed to weaken Corporate Average Fuel Economy (CAFE) and greenhouse gas emissions standards for model-year 2021 to 2026 passenger cars and light trucks that were set by the Obama administration. Regardless, this move will not stop the growing fuel efficiency of the U.S. vehicle fleet. As more fuel-efficient vehicles roll off assembly lines, it could mean lower gasoline and diesel demand. Kloza perceives it as a larger threat to demand growth than electric vehicles.

Disruption watch. As c-store retailers focus on Amazon’s disruptive potential, some have suggested that the e-commerce giant could venture into fuel. “I performed due diligence and can’t find the tea leaves that suggest they will,” said Kloza, who regards Amazon as a fringe disruptor and does not believe it has the appetite for the complex fuel business.

“The people who handle fuel and all the handoffs [necessary] have some special talents—it’s not like selling books online,” he said. However, Amazon might get a “toehold on the fuel side” by offering cloud-based services for the energy industry.

Another more imposing disruptor on the international stage is Saudi Aramco, the Saudi state-owned energy company. Aramco is currently entertaining a public offering—an IPO that would be valued in the neighborhood of $1 trillion.

Aramco is a “disruptor that’s not getting enough attention,” Kloza said, pointing out that it recently acquired a Saudi affiliate for $70 billion. In the United States, “that gets you Marathon and Valero,” he said, as well as the capability to buy good fuel corners in the United States. Aramco will have enough resources to make acquisitions in the Western hemisphere “if it chose to,” he said.

Click here to view complete NACS State of the Industry Summit coverage.

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