The U.S. Energy Department’s weekly inventory release showed a surprise climb in crude stockpiles, while distillate supplies posted a smaller-than-expected draw. The agency’s bearish report further added that refiners continued to cut production, and are currently operating at their lowest rate in two decades.
This has instilled renewed doubts about the health of the U.S. economy, and pulled down oil prices to a seven-week low of around $71 per barrel. The only saving grace came in the form of gasoline supplies, which defied market expectations and fell from the week-ago period.
The federal government’s Energy Information Administration (EIA) reported an unexpected 2.3 million barrels jump in crude inventories for the week ending Jan 29, 2010, against expectations of a drop. The increase in crude stocks, the 3rd in the past 5 weeks, can be attributed to rebounding imports and an unexpected decline in refinery run rates.
At 329.0 million barrels, crude supplies are 17.1 million barrels below the year-earlier level but remain above the upper limit of the average for this time of the year (depicted in the first EIA chart below). The crude supply cover increased from 23.7 days in the previous week to 24.0 days. In the year-ago period, the supply cover was 24.2 days.
Supplies of gasoline fell by 1.3 million barrels from the previous week, defying analyst expectations for a rise, as decline in production more than offset steady demand. At 228.1 million barrels, current inventories exceed the year-earlier levels and are above the upper half of the historical range, as shown in the following chart from the EIA.
Distillate fuel inventories (including diesel and heating oil) were down by 948,000 barrels last week (less than expected) to 156.5 million barrels, reflecting lower output. However, it remains above the upper boundary of the average range for this time of year. This is shown in the following chart, also from the EIA.
Refinery utilization tanked 0.8% from the prior week to 77.7%, higher than analyst expectations, as they slashed processing in response to lower fuel demand. Utilization levels are at the lowest rates since at least 1989 (outside the immediate aftermath of a hurricane) amid too much supply of petroleum products in the face of sharply lower demand.
The overall demand picture remains weak, as reflected by the dip in the total refined products supplied over the last four-week period, a proxy for overall petroleum demand. It fell by 2.0% from the year-earlier period, with gasoline down 0.5%, distillates (includes diesel) down 9.1% and jet fuel up 0.2%.
With crude reserves rising unexpectedly, we take this as an indication that energy consumption in the world’s biggest economy remains slack. As a result, following the EIA release, oil prices tumbled the most in six months. However, an unexpected drawdown in fuel stocks (especially gasoline) helped limit the price weakness, although the decline in supplies followed a drop in production, rather than a much-awaited pick-up in oil demand.
In particular, refining activity remains weak with utilization rates hitting their lowest point since the 1980s. With U.S. oil product demand showing little signs of a recovery, refiners had no appetite for additional barrels.
Given that the overall environment for refining margins is likely to remain poor, we have a bearish stance on oil refiners like Sunoco Inc. (SUN), Tesoro Corp. (TSO), Valero Energy Corp. (VLO) and Western Refining Inc. (WNR). The sharply lower refinery utilization (at just 77.7% of capacity) provides enough evidence that refineries are cutting back on production because the economy is still struggling on the demand side.
Firms like Chevron Corp. (CVX) and Marathon Oil Corp. (MRO) — oil majors that have significant refining operations — are also expected to remain under pressure until pricing and demand improve. The companies recently released weak fourth-quarter 2009 results which were hampered by sharply lower downstream results on the back of depressed refining margins.
We would also like to maintain our cautious outlook (Neutral recommendation) on oilfield service firms until the demand outlook improves. Companies such as Schlumberger Ltd. (SLB), Baker Hughes Inc. (BHI) and Weatherford International (WFT) fall in this category. These entities reported substantial fall in fourth-quarter earnings (compared to the year-ago period) due to significantly lower activity levels, contraction in customer spending and price deterioration.
Read the full analyst report on “SUN”
Read the full analyst report on “TSO”
Read the full analyst report on “VLO”
Read the full analyst report on “WNR”
Read the full analyst report on “CVX”
Read the full analyst report on “MRO”
Read the full analyst report on “SLB”
Read the full analyst report on “BHI”
Read the full analyst report on “WFT”
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