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Energy Production & Transmission Committee

Energy Production Committee

Understanding the Petroleum Industry

Price Overview | Demand | Supply | Trade and Imports | Refining | Stocks
What's Hot: Demand | Supply | Trade and Imports | Refining | Stocks

What's Hot in Stocks

What's Hot: Secondary and Tertiary Stocks
  • At any level, global, national etc., primary inventories are the inventories that correspond to the supply and demand data. The difference between supply and demand in a particular time period equates to the change in primary stocks over that period.
  • Secondary and tertiary stocks are stocks held in the distribution system beyond the points at which demand and supply are measured. They therefore include, for example, gasoline in the tanks of automobiles. Changes in secondary and tertiary stocks are subsumed into the changes in supply and demand, and only rarely reported. However, by their distortions of either supply or, more often, of demand, they can still play a role in the oil market and in determining prices.
  • The Asian crisis demonstrated this. Its plummeting exchange rates, savage credit squeeze and widespread bankruptcies caused consumer stocks in countries like S. Korea and Thailand to be slashed to unprecedentedly low levels. Use of these stocks pushed demand even lower than the economic collapse itself was doing, causing a larger, faster build up of reported stocks, and exacerbating the winter 97/98 slide in oil prices.
  • Or remember how panicking consumers, trying to keep their tanks full, exacerbated the gas lines triggered by the 1973 Arab oil embargo? If all the gas tanks in today’s fleet of 200 million U.S. automobiles and light trucks were suddenly being kept 90% rather than a half full, that would abruptly pull an additional 30 million barrels out of the supply system -- the equivalent of over 3½ days of U.S. gasoline consumption.
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What's Hot: Contango, Backwardation and Stocks
  • The key futures market differential is the spread between the price in the "prompt" or nearest month for a particular crude or product and its price in some "outer" or later month. When a market is in surplus, supplies available promptly sell for a discount. In this situation, where current or prompt supplies are lower priced than the supplies available for future delivery, the market is said to be in contango. When the market is tight or undersupplied, there is a premium for prompt barrels. In this situation, where today's supplies are lower priced than tomorrow's, the market is said to be in backwardation. The contango market encourages storage; the backwardated market discourages it.
  • A contango market provides a low-risk or even a no-risk way to build stocks, because a company can lock in a profit by putting oil into inventory and simultaneously selling an equal volume of futures contracts for some later month. To start the process, the contango has to be large enough to cover the cost of the working capital incurred in holding stocks (plus any costs associated with the financial instrument). If the surplus is too large to be absorbed in this way, then the contango will widen further, to draw other players, such as those that rent storage, into the storage game.
  • Once the surplus has been contained, the process will reverse. The contango will start to shrink, shrinking the number of players that can justify building stocks and so slowing down the build. Eventually the contango will be too small or will have been replaced by backwardation. Then, the build will turn into a draw, because holding stock will have been transformed from a low/no risk to a high risk activity.
  • Because the NYMEX provides the most actively traded family of oil market futures contracts -- West Texas Intermediate crude oil at Cushing, OK, and distillate and gasoline in New York Harbor -- and third party storage is readily available, the market with the most effective hedge is the U.S.
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What's Hot: Specialty Products and Market Fragmentation, from the Inventory Side
  • The strongly-held, consensus view was that the proliferation of specialty products like RFG would more than offset the stock-reducing benefits of industry restructuring, resulting in a net increase in product tankage and, therefore, in stocks. The record-setting lows reached by both distillate and gasoline stocks in 1996 proved this view wrong.
  • What the consensus misjudged was the downstream industry’s determination to contain operating costs, especially as it became increasingly clear that specialty products were just higher in quality, not in profitability. Consequently, instead of adding tankage in a business-as-usual response, the industry aggressively adopted a trade-off between overhead and both flexibility and independence. Changes included:
  • sharing terminals, so others could be closed;
  • increasing the use of product exchanges, so each company individually carries fewer grades but can still supply a full range;
  • offering fewer (usually the higher quality) grade choices in certain markets, e.g. low instead of low and high S diesel;
  • moving blending as far downstream as possible, e.g. blending mid-grade gasoline as it is delivered into tank trucks rather than storing it as an extra grade at terminals; or moving oxygenate blending from the refinery to the terminal/blender.

 

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