GAITHERSBURG, Md. -- The year 2018 was far less orderly than anticipated, but disorder in October, November and December translated into the best fourth-quarter retail margins ever chronicled by Oil Price Information Service (OPIS), Gaithersburg, Md. Conversely, the fourth quarter translated into some of the worst of times for U.S. refiners, with gasoline retreating into “most unwanted hydrocarbon” to end 2018 and begin 2019.
All annual projections are biased in that there is a temptation to predict something reasonably close to what just happened. There is also a tendency to predict what one secretly wants to happen, and anyone in the news business favors a dynamic, ever-changing landscape with plenty of action.
Aware of those tendencies, here are some trends that OPIS has identified as compelling factors that will shape what has been a tumultuous decade for crude oil, gasoline and diesel.
Don’t underestimate the resolve of Saudi Arabia to “balance” crude-oil supplies worldwide. That resolve increases thanks to the pending initial public offering (IPO) for the Saudi state oil company Aramco that will be measured in trillions of dollars. Firm oil prices are a must if the Aramco IPO is to succeed.
One should also recognize that markets always overreact, and the end-2018 flirtation with $40-per-barrel West Texas Intermediate (WTI) and $50-per-barrel Brent represented a classically oversold market. One of the most significant factors contributing to the steep fourth-quarter 2018 declines came via a massive exit of financial fund money from futures’ markets. Open interest, which is the statistical measurement of participation in the futures’ market, dropped by about 20% from where it stood in May. OPIS believes that this money will return and being “long oil” will again be a popular midyear strategy among money managers, whether they are cowboy speculators or sleepy passive investment funds.
We see the price of Brent crude, the blend that most drastically influences U.S. gasoline and diesel prices, rising to the low $70s in the second and third quarters of 2019. WTI will be a laggard, trading for about $10 per barrel under Brent through the first nine months of the year. It will then benefit from thousands of miles of new pipelines that will bring crude from shale plays to world markets and its discount to Brent may narrow to $6 per barrel or so. The ease of getting barrels to refining centers and tidal water will probably push U.S. crude-oil production close to 13 million barrels per day (bpd), or considerably more than Russia or Saudi Arabia.
Refining 2019: To have and have not
Upcoming regulations from the International Maritime Organization (IMO) on shipping fuel (more on that later) will alter the performances of individual refineries. Plants near the coast that have sophisticated processing capability (coking, for example) will be big winners. Light sweet crude refiners in the middle of the country could be big losers.
All signs point to U.S. refiners breaking records established in 2018 for daily and quarterly run rates, as well as the annual run total. Gasoline should be profitable for refiners from roughly March through August, but the star products will be diesel and jet fuel. High margins on those fuels may supplement poor refining returns on gasoline.
There may be some more movement to reintegrate. The Marathon business plan (where much of the company’s gasoline output goes through a dedicated system) is coveted by other refiners. The joint venture BP did in late 2018 that routes some Midwestern gasoline to Thornton’s stations may be duplicated elsewhere. The days of the merchant refinery may be limited, particularly if gasoline inventories remain sloppy and lofty east of the Rockies. The all-time gasoline inventory record is just over 259 million barrels, and it may be surpassed in spring or autumn 2019.
Retail’s regional diversity
The U.S. has long had incredible variation in real estate values, often dependent on vastly different state and local circumstances. In 2018, that variation was witnessed in gasoline prices, and OPIS expects that 2019 will bring more of the same.
We project that the nationwide average price in 2019 will be $2.549 per gallon, which would be 17 cents per gallon (CPG) below the aggregate annual number for 2018. But nationwide averages are very misleading. California may well see average gasoline prices that again are in the $3.50-per-gallon neighborhood, and price spikes to above $3 per gallon are possible in virtually every state that touches the Rocky Mountains or Pacific Ocean.
Last year saw about 70 CPG separate the national low ($2.265) from the high ($2.97). The first 10 days of January may have already presented the 2019 low, and the apex of 2019 is likely to occur in the second quarter. Hurricanes are the wild card, particularly if storms threaten Texas and Louisiana in July or August. But without tropical weather, the final 100 days of 2019 should see sloppy high inventories of motor fuel accumulate, possibly pushing wholesale numbers to their yearly low.
Retail gasoline margins
The year 2018 provided the ultimate “big inning” for gasoline retailers. Even the most competitive markets ended with a calendar quarter that represented the best rack-to-retail margins of the 21st century.
OPIS chronicled an average margin of 34.3 CPG in the quarter, easily topping the fourth quarter of 2014 that represented the previous record level of 31.5 CPG. All the other calendar quarters in the Top 10 ranged from 22.1 to 29.3 CPG, emphasizing just how special of an ending we saw in 2018.
The stellar period helped 2018 record an annual overall margin of 23.8 CPG, topping the previous record of 22.4 CPG set in 2014. The past five years have consistently delivered much better margins than similar periods in this century, and this is not going unnoticed. EBITDA (earnings before interest, taxes, depreciation and amortization) multiples paid for prime retail real estate were consistently high, with refiners and private-equity interests pursuing fuel chains from coast to coast.
OPIS does believe that retail margins will moderate in 2019, but the revision to the mean will keep those margins close to 20 CPG, thanks mostly to the high returns in New England, the Rocky Mountain states and the West Coast. Don’t be surprised to see more interest from multinational oil firms, or foreign entities that view the U.S. fuel market as a warm, hospitable place to do business.
Demand will most likely be a fourth year of "deja vu all over again,” to quote the late, great Yogi Berra. The U.S. Energy Information Administration (EIA) does not measure demand for any petroleum products with a precision instrument. Their reports simply reflect what is moving out of primary reportable storage to other tanks that aren’t covered in government surveys. At best, 2019 should present domestic demand that is within a rounding error of what was reported in 2016, 2017 and 2018.
In 2018, the difference between the lowest consumption month (January) and the highest demand month (July) was 1.056 million bpd, or approximately 1.37 billion gallons in the month. The difference between the weekly high and low water marks was 1.23 million bpd, or approximately 362 million gallons each seven days.
OPIS sees the possibility of EIA publishing a 10-million bpd statistical week in 2019 but does not rule out a visit to an 8-million-bpd trough. An economic slowdown or recession could do major damage to off-season demand numbers.
Great Lakes should retain volatility title
Fuel marketers are the beneficiary of volatility, even though upward price swings arrive like an unwanted guest at times. The gold medal for gasoline volatility in 2018 can be awarded to Chicago spot prices. A whopping $1.27 per gallon separated the high and low points of the year in this market, which is the Sylvia Plath in the bipolar world of gasoline. The Pacific Northwest was a close second with $1.10 per gallon separating spot bottoms and tops.
The more illiquid the market, the greater the volatility. OPIS suspects that West Coast venues will see the greatest pricing disparities in 2019. California is always a single refinery event removed from a price spike, and the Golden State didn’t see any major processing incidents in 2018. The Pacific Northwest saw common disruptions and often featured the highest wholesale prices in the country.
There were points in 2018 where diesel commanded wholesale costs that were 60 to 70 CPG above regular gasoline. This “muscle in the middle” of the refined products’ barrel will return in late 2019 as IMO 2020 regulations loom.
Those regulations essentially require a much lower sulfur fuel to power ships on the high seas. Hydrocarbons that would normally go into U.S. on-road diesel, or jet fuel or even heating oil will instead be routed to provide marine fuels. The middle of the barrel—diesel, jet fuel and heating oil—has been the primary growth product that boosted global petroleum demand above 100 million bpd in late 2018 and the pace of the growth will quicken.
As the January 2020 IMO regulations approach, diesel will turn more expensive. It could regularly fetch $25 per barrel over the price of crude or sell for about $2.40 per gallon at wholesale even before bio components are factored into costs. This is the most significant change to international fuel specifications since the desulfurization of diesel more than 10 years ago and it provides a fertile ground for diesel fuel spikes. Coastal states may see wholesale and retail prices some 50 CPG higher than inland states, and some regions may well find a late 2019 retail diesel price advance to over $4 gallon. There will be instances where pump prices for diesel are more than $1 per gallon higher than unleaded regular.
Energy quick hits
Some more expectations for 2019:
- U.S. motorists averaged a daily spend of $1.06 billion for gasoline in 2018, well above the $831 million to $936 million outlays in 2015-2017, but considerably below the $1.3 billion in daily bills witnessed in 2011-2014. OPIS anticipates that 2019 will be a cheaper year, with a daily spend of about $995-million.
- This year still presents plenty of obstacles for widespread usage of E15. Even if regulatory hurdles are clear, early 2019 economics no longer give the 88 octane blend much of a pricing edge. Outside of the corn belt, the price of ethanol is higher than the price of hydrocarbons and cheap RINs don’t reduce the overall price much.
- OPIS’ view of a midyear ascent for crude oil does require further tinkering by the Vienna alliance (Organization of the Petroleum Exporting Countries, or OPEC, plus Russia) when they meet in April. Unless the world loses more crude from Iran, Libya, Venezuela or other unstable countries, the alliance will have to extend and perhaps deepen cuts.
- Brisk export rates for gasoline and distillate were the rule in 2018 and departures may well accelerate in 2019. But some changes loom in 2020 with the anticipated revival of significant Caribbean refining capacity.