Hurricane Gustav is barreling toward the most critical refining region on the globe, evoking some already myopic memories of Hurricane Katrina and what represented (on Labor Day weekend 2005) what was then a near apocalyptic vision for U.S. fuel values.
As I write this, the storm appears headed toward landfall in an arc of the Gulf Coast that includes about 40% of all the gasoline, diesel, and jet fuel produced for the lower 48 states. The worst case scenario would be if the storm’s infamous northeastern quadrant slammed into the New Orleans area, disabling perhaps 1-million bbl per day of vital U.S. refined products’ output. The next worst case might be if the storm targeted the Lake Charles, Louisiana area where ConocoPhillips and Citgo operate critical plants. Then, it’s a geographic leap to the golden triangle of Pt. Arthur, Beaumont, and Houston, Texas where a huge cluster of U.S. fuel production is located.
I mentioned in a previous post (8/21/2008) that our supplies of fuel were very scarce (See my notes on Hurricane Chicken Little). Inventories actually decreased since that post.
Network news appears to be concentrating on the oil rigs which dominate deep and shallow water off Louisiana, but traditionally, storms have not delivered knockout blows to U.S. offshore output. And keep in mind that we have more than 700-million barrels of a variety of crude oil blends in the Strategic Petroleum Reserve, and recollect that the Bush Administration has been willing to release these barrels stored in underground salt domes if offshore production or the flow of imports are interrupted by tropical weather.
Crude Won’t Be The Story
In other words, the rigs that dot the Gulf of Mexico may provide for striking graphics on television, but I suspect that U.S. refined product supply will be the story as September gets under way.
Hurricane Katrina should not be regarded as a template. But it does remind observers that hurricanes destroy not just supply, but demand as well, particularly on the crude oil side. We probably won’t need the offshore Gulf of Mexicocrude production in September, but we will need the gasoline, diesel, and jet fuel barrels produced at Louisiana and Texas refineries.
Late Sunday, there was some trading in the electronic markets. Crude oil futures’ prices were up $1.50-$1.75 bbl or so, while gasoline blendstock (RBOB) and heating oil futures’ quotes were up 6-8cts gal.
The problem is that these values represent prices for physical product that is to be delivered more than a month from now. If there is to be a supply squeeze, it will be focused on September.
The U.S. Gulf Coast “spot market” –where gasoline and diesel trade in pipeline, barge, and cargo sized lots in the largest bulk market of its kind in the world - -can easily become disconnected from those oil futures’ quotes you see on your Bloomberg, CNBC, CNN, or Fox Business screens. During the aftermath of Hurricane’s Katrina & Rita, we saw these physical markets trade for 50cts gal to $1.00 gal over the futures’ quotes. If that were the case as Gustav comes ashore, we might stare $4.50-$4.75 gal gasoline or $5-$6 gal diesel in the face for the remaining weeks of Summer.
How Does This Affect Me?
I’m borrowing that question from my daughters, who I have sent off to university this weekend at prices that are truly outrageous, when compared to fuel prices in any corner of the globe, including Monaco and Fiji.
We will begin September with average retail gasoline prices of about $3.70 gal nationwide. When Katrina struck, we saw a retail spike of 18% - - it would have been larger if not for reticence by major refiners, who appeared reluctant at the time to increase wholesale prices for gasoline more than $25 bbl above the price of sweet crude.
Gulf Coast gasoline prices surged last week as computer models accurately predicted the birth of this Category 3 storm, but Friday’s Gulf Coast wholesale gas price of $3.06 gal was about $14 bbl over the cost of sweet crude. If gasoline prices were to match the $30-$50 bbl premiums to crude of past price spikes, we would be looking at wholesale costs nearly $1 bbl higher than Friday, and that would point to retail gasoline prices of $4.50-$4.75 gal.
I don’t think that will happen, even if nearly 1-million bbl per day of Gulf Coast refining production gets incapacitated.
If we matched the 18% increase in street prices that followed Katrina, we’d be looking at a 66cts gal uptick or about $4.35 gal. That is probably not likely as well, and I suspect that we’ll see a more modest surge of 10-30cts gal for gasoline. I reserve the right to be wrong on this prediction, and as an aside to those who have sent me hate mail or even caustic voicemail, duly note that I have no money invested or speculated in oil futures, stocks, bonds, or equities. Everything has gone to the offices of the Bursars at evil NYU and quasi-evil Pace University.
These predictions are, of course, temperate and I suspect they’ll be ignored by folks looking for a more frightening scenario, or for an aftermath that suits their investment portfolios.
Some Other Significant 36 Month Differences - -Katrina vs. Gustav
- Crude oil prices soared to a then record level of more than $70.50 bbl in late August 2005, but by the end of September in that same year, prices of $61-$62 bbl were more commonplace. It’s not about the crude- -this storm will almost certainly destroy plenty of U.S. demand for crude - - it’s a question of whether it merely idles or significantly disables U.S. refining capability.
- The U.S. will see a surge in gasoline imports, mostly from Europe, in the aftermath of this storm. Gasoline imports rescued the U.S. in 2005 from an almost certain rendezvous with a $1.50 gal price spike and $4.00 gal (at the time) retail.
- We will not, however, see a surge in diesel, heating oil, or jet fuel imports. Gasoline supplies are quite comfortable throughout the planet – intergalactic supplies of diesel and jet fuel are not.
- The storm comes at a time when a great deal of U.S. refining capacity is “on the shelf” with nearly 2.5-million bbl per day of output not utilized recently because of poor refining margins (yes, it is true, despite what you may think!) and soft U.S. demand for the marquee product - - gasoline. Precisely where that shelf capacity lies is not clear - - some of it may be among refineries targeted by the storm, although underutilized capacity is clearly visible in the Midwest and on the West coast.
- Katrina’s impact resulted in an immediate surge to $3.057 gal (a hike of about 46cts gal) but by end-November 2005, retail gasoline prices slipped back beneath $2.20 gal. This demonstrates just how volatile U.S. fuel prices have been and will continue to be.
- Gasoline demand when Katrina hit was quite brisk. In contrast, U.S. Summer 2008 demand has been subdued -- - the Energy Information Administration has been sporting numbers that show year-on-year demand destruction of about 2%, but I believe the real number is closer to 4%. This is a critical issue - - if demand is already down 4% from year ago, can motorists cut back if supplies are tightened in September? The typical post Labor Day demand slide this decade has been on the order of 440,000 b/d or about 4% to 4.5%. Can demand slide by as much this year?
- The International Energy Agency (IEA) and the Department of Energy (DOE) both took extraordinary measures in September 2005 to loosen global supply. DOE made some 30-million bbl of Strategic Petroleum Reserve (SPR) crude available for Gulf Coast refiners who saw feedstock supplies temporarily displaced. The IEA authorized the release of approximately 60-million bbl of crude and gasoline for U.S. import.
- The Environmental Protection Agency (EPA) also took extraordinary measures in 2005. EPA waived Summer gasoline requirements and enabled suppliers to sell non-Summer gasoline before the normal September 15 start date in several Gulf Coast states. Most marketwatchers believe that a similar move could be forthcoming if Hurricane Gustav knocks out significant Gulf Coast output.
- More problematic, however, will be any action on a waiver for diesel fuel. In September 2005, EPA and IRS coordinated moves that enabled the sale of high sulfur No. 2 oil as on-road diesel in several states. Since that time, a much stricter 0.05% sulfur standard has become the norm for most on-road diesel. With some contemporary truck engines engineered to use only an ultra low sulfur diesel standard, any relief on diesel specifications is now much more complicated and challenging.