By Keith Reid
As we approach spring, it’s an interesting time to get projections from experts on what to anticipate with motor fuels prices going into the summer months. The new Trump administration in Washington, D.C., also adds some potential twists to market dynamics. Fuel Marketer News (FMN) spoke with Alan Levine and Brian Milne for their expert opinions relative to crude, gasoline, diesel (heating oil), propane and natural gas.
Alan Levine is the CEO and Chairman of Powerhouse, a group of seasoned energy experts and broker professionals working in partnership to meet the business goals of its customers. He is an internationally recognized expert in pricing and business practices in the energy industry. As a petroleum specialist for over 40 years, Levine is a highly regarded authority on the relationship of energy futures to cash petroleum markets.
Brian Milne is the Editor of Schneider Electric’s MarketWire, a real-time market and news service focused on U.S. oil product markets and relevant news and analysis, and the Editor of OilSpot, a weekly newsletter on the oil markets.
We also provided some input, where available, from the U.S. Energy Information Administration’s (EIA’s) latest Short-Term Energy Outlook as of February 7, 2017.
While FMN’s audience tends to be motor fuel marketers and retailers, what’s currently happening in the crude world cannot be ignored since the cost of crude oil makes up the predominant cost of refined products. At the time of writing (mid-February), crude has been running in the $50 – $55 per barrel (/b) range for West Texas Intermediate (WTI), and slightly higher for Brent.
There is abundant supply of crude internationally and in the United States. EIA anticipates a 2017 average WTI futures price of $53.46 and a Brent price of $54.54. According to our experts, there are a variety of factors at work that should stabilize crude prices, at least in the near future.
OPEC’s recent production cuts are propping prices up, which is a reversal on its previous policy of keeping production high (and prices low) in an attempt to damage the U.S. fracturing industry.
“We have OPEC with their production cuts, and they’ve been joined by 11 non-OPEC producing countries, namely Russia, who have said they’re going to cut 300,000 barrels per day (bpd),” said Milne. “It was a total of about 1.75 million barrels per day (MMbpd) in cuts. Maybe if they just get 1 – 1.1 MMbpd out of this whole thing, it’s still considered pretty supportive. Sentiment is bullish. If you look at speculators, they’re extremely net long in the market.”
A chronic issue with OPEC production cuts tends to be the motivation of various members to “cheat” with hidden production and to earn more profits while prices are high. So far, that does not seem to have developed to any serious degree.
“We’re seeing claims of high levels of compliance by the overseas producers,” Levine said. “The reality seems to be that the compliance is coming from where it always comes from—in simple terms, Saudi Arabia, and Russia to some degree, though I’m skeptical of that. They’re doing their best to keep their finger in the dyke.”
In addition, Milne noted that Saudi Arabia has committed to even deeper cuts in production should cheating start to increase.
On the other side, the production of shale oil is highly flexible, and the technology is getting even more efficient with every year that passes, though it’s still more expensive than conventional oil. Saudi oil is said to cost $10/b, for example. A Reuters article from November 2016 noted that the breakeven for Bakken shale oil is around $30/b compared to approximately $60/b in 2014. An international oil price of $45/b – $55/b is sufficient for that production to turn a profit.
“How do you scare me to death if you’re OPEC and you reduce your output and the price goes up $5 – $10? What does that really mean?” asked Levine. “The United States is largely willing and able to produce substantially more than we’ve ever anticipated. Every time you go over $55, U.S. producers use this as an opportunity to hedge, which is something they never used to do. Now they lock in that price. They can produce now even if the price falls because they have price protection.”
The end result is that, not only are the fears of $200/b oil that were discussed not all that long ago virtually unimaginable today, but $100/b oil seems increasingly unlikely in all but the most extreme circumstances. In fact, Milne sees $70/b as “the new $100.”
“It’s going to be difficult for the market to really move,” Milne said. “We’ll focus on WTI because there are indications that it’s going to strengthen and perhaps break out of the $50 – $60 range. You could see it get over $60 late in the year, even to $65 dollars, but it’s unlikely that it has any sustainability there based on what we know now. We’re probably looking at a $52 – $55 range for WTI. It could slip below $50, but there’s a tremendous amount of support below at the $50 level, and that is also unlikely unless events change—and, of course, they can.”
In addition, higher prices encourage U.S. crude exports, which are now legal. Levine and Milne agreed that exports can impact crude prices.
Where gasoline is concerned, the story is a familiar one: plenty of supply. All of this against a backdrop in the United States where demand remains fairly weak.
“Gasoline supply is at the second-highest mark on record, and records go back to 1980, so that’s pretty bearish,” Milne explained. “Refiners are producing a lot of gasoline—a lot of product—and it’s flooding the market. It’s a bigger problem in the East—the PADD 1 region—because it’s flooding the market. In the Gulf Coast [PADD 3] area, they can export it out.”
Milne explained that U.S. exports will likely help to prop up prices somewhat—along with the built-in increase from crude—and that retail prices are higher now than they were a year ago by roughly 50 cents.
Demand is currently weak, but should there be a significant boost to the economy going into summer, that will most certainly eat into supply and increase prices. “Employment is doing better. People are pretty bullish on the economy because of Trump. They’re expecting more job gains, and if you have more people employed I would suggest you’re going to see more demand,” Milne said. “Maybe it was just a blip in January, with the lower demand, but I do expect to see gasoline demand increase.”
Levine highlighted the range of mileage improvements that have taken place in the automotive industry—driven by the Obama administration’s stringent Corporate Average Fuel Economy (CAFE) standards—as another impediment to excessive demand, even under the new administration.
Another potential issue with the change in administration involves gasoline exports to Mexico.
“Gasoline exports have been strong, and Mexico is taking a lot of gasoline supply,” Milne shared. “Their demand is growing because of a stronger domestic economy, although that’s seen some headwinds recently. They don’t have enough refining capacity to address demand, and some of the refining capacity they have is either out of service or not able to handle some of the new crudes. We’ll have to see what happens with the politics involved, because Trump has certainly poked his thumb in Mexico’s eye.”
Levine sees gasoline prices remaining fairly stable at current levels into the summer, when it should start to increase steadily. “Whether you’ll get anything spectacular—that becomes a question of if we experience problems, particularly with refineries and other facilities. Overall, I just don’t see it changing all that much,” he said.
Milne finds pricing challenging with RBOB futures probably falling between $1.65 and $1.85. “It could be less if for some reason something is going on with gasoline demand, but I think you’re going to see it strong.”
EIA anticipates U.S. regular gasoline retail prices to average $2.27 per gallon (/gal) in February and then rise to $2.33/gal in March. It anticipates an average price of $2.39/gal in 2017.
Gasoline is generally seen as a retail fuel while diesel is seen as a commercial fuel (though many commercial fleets operate gasoline vehicles). As with gasoline, diesel prices have been fairly stable within a limited range.
“The demand is good for distillates, but again, we’re more or less stuck in this small range that we’ve been seeing over the past several weeks,” said Levine. “Volatilities are low. One thing you might consider is calls if you need to be a buyer because their prices have fallen. Calls are much cheaper now than they use to be. That might be valuable, particularly for end users. The products story is not as exciting.”
That sentiment is generally supported by Milne, though he sees demand as more stagnant. “We still have a lot of supply—a lot of inventory—but a lot of it is housed in the United States. That’s going to limit the upside, plus all the new production, but the export market should be a good escape valve,” he said.
One area where distillate demand is currently underperforming is No. 2 heating oil. So far, winter has been exceptionally mild, though the possibility remains for winter to finish strong.
As EIA notes, “With warmer-than-normal January temperatures in much of the United States, distillate consumption declined because of lower demand for home heating. EIA estimates distillate consumption averaged 3.8 MMbpd in January, the third-lowest level for that month in the past 15 years. Both total U.S. distillate stocks and distillate stocks in the U.S. Northeast, the region that uses the most distillate for home heating, set new five-year highs in January.”
Milne expects ultra-low-sulfur diesel (ULSD) contracts in the $1.50 – $1.70 range late in the second quarter. He noted that the infrastructure projects promised by Trump, if they indeed involve “shovel-ready projects,” could cause some upward movement on prices.
“If you start seeing this growth, especially if you see some of the major infrastructure projects he’s been campaigning and talking about, it could really drive up demand for diesel. If we do see [more domestic oil and gas production coming online with higher prices], that would help diesel as well. Part of the falloff in diesel that we saw a few years back was because we were drilling a lot less, as there is a lot of diesel used in that activity,” Milne concluded.
Propane is used in a wide variety of applications, from agricultural drying, to auto gas, to a primary deliverable home heating fuel. It’s an area where some of the more exciting activity is occurring at this time.
“Propane will probably lead exports going forward,” said Milne. “It’s really considered a strong, up-and-coming product. We exported nearly 1.25 MMbpd in late January, so that was a big number. That number has come off a little because of the warmer weather, but still, propane is going to be strong. It’s going to stay strong, and that’s probably true of all fuels when we’re looking at the U.S. as far growth potential. We’re not talking the raging bull, but we are talking consistent growth. The other global markets need the supply.”
Levine offered some additional insight. “I have been advising my clients that it’s to their advantage to become buyers of propane,” he shared. “If you look throughout time, the cost of propane a year from now is about 10 – 12 cents cheaper. You can actually buy it at a pretty good discount.
“It’s our belief that a failure of supply could have some bullish effect on propane,” Levine continued. “It’s also true that propane demand has picked up because of the way propane is priced per gallon. It looks much cheaper than heating oil, for example, even though it’s not really all that cheap on a per-British-thermal-unit (BTU) basis. It’s also become an alternative fuel in certain areas like road construction and landscape work. I think there is an opportunity, particularly if you are looking at 2018. You can see the curve out there.”
Natural gas serves as a primary utility-supplied heating fuel, an up-and-coming alternative motor fuel and an increasingly dominate electrical generation fuel. It’s a product that is growing in demand domestically along with liquefied natural gas (LNG) exports while production is slacked, and not currently growing.
“As the EIA said in their Short-Term Energy Outlook, they see upside pressure for natural gas prices over the next 16 – 18 months,” Milne noted. “They indicated that demand for natural gas outpaced supply within the U.S. for the first time in December, so that’s big. Part of that is because production has been limited overall for natural gas. Natural gas has been increasing its demand share domestically because we have been pushing out coal, so you see more natural gas using power generation.”
As the Short-Term Energy Outlook states, “Increasing capacity for natural gas-fired electric generation, growing domestic natural gas consumption and new export capabilities contribute to the forecast Henry Hub natural gas spot price rising from an average of $3.43 per million British thermal units (/MMBTU) in 2017 to $3.70/MMBTU in 2018. The New York Mercantile Exchange (NYMEX) contract values for April 2017 delivery traded during the five-day period ending February 2 suggest that a price range from $2.42/MMBtu – $4.38/MMBtu encompasses the market expectation of Henry Hub natural gas prices in April 2017 at the 95% confidence level.”
The mild weather has certainly had an impact. “The enemy in the case of gas can be stated in one word: weather,” Levine said. “It’s mid-February and I’m walking around in a light jacket. We’re just sucking wind compared to last year on the heating degree days (HDDs)—it’s really substantial. That’s the problem for gas, plus the fact that at $2.50 – $3.50 it’s hard to justify a drilling program. I would see natural gas in a more difficult position just because the weather is so important as a determinate of its price.”
Also lining up to have a substantial impact on natural gas prices are LNG exports, which should be wide open under the Trump administration as long as the eventual trade policy is supportive.
“I think the LNGs are a big deal, and I think you’re going to really see that number grow more rapidly, even if you’re looking at it just from a commodity point. But it’s also going to be used as geopolitical leverage,” Milne explained. “If you think about it, it’s part of a geopolitical strategy against Russia. For years they have been able to hold Europe captive at times because they leverage their natural gas supply. You could see some U.S. LNG going in there (Europe) in a future crisis. We’ll see.”