Counterintuitive is counterintuitive for a reason
We have been saying — seemingly forever — that it made absolutely no sense for crude oil prices to go up when refineries had problems, since any problems in refineries would build stockpiles of crude oil, in theory lowering the price of crude. For the first time, we have now seen support for this in the financial paper of record. WSJ:
Refinery outages are increasingly playing a role in the surging price for oil, as snags at the facilities that turn oil into everything from gasoline to jet fuel inspire a rush to buy crude on commodities markets.
That result might seem counterintuitive — after all, the less oil a refinery can process, the more likely a barrel of oil will go unused and remain on the market. But some analysts say that in today’s jittery oil markets, with little wiggle room between world-wide supply and demand for crude, refinery outages tend to set off a chain reaction.
Since the “chain reaction” goes in the opposite direction from the economics of the situation, we believe that those blindly following this “chain reaction” trading strategy will someday (soon, we hope) be called, in the technical terminology of Wall Street: “suckers.”
UPDATE
Please read the comment by reader Jason. It appears likely that you’ll learn a lot more about this issue from him than you will from us.
August 12th, 2005 at 5:19 am
Once again, I have to point out there are several factors that are missing in your analysis of oil prices. The world is most definitely not awash in inventories of the high grade WTI crude that is constantly quoted. In addition, WTI crude is actually a very small percentage of the total crude basket that is currently in production. We are not awash in inventories because the demand for refined products (gas, jet, deisel, kerosene, etc.) keeps rising. On a days inventory basis, the oil market is quite tight.
All refineries are not equal. Marginal refiners only have the facilities to process high grade crude to make the cuts required for high grade refined product. There is severe tightness in the high grade (WTI, Brent North Sea, Arab light sweet) crude market, and this is driving up prices of those benchmarks.
Refiners are running at record capacity utilizations and record volumes and are closing/turning around facilities to accomodate new, lower sulfer regulations and to remove MTBE from the formulations here in the US. (If you take out MTBE and sulfer, you are reducing the volume of gasoline produced.) These turnarounds are primarily in the more complex refining facilities and not in facilities tha tproduce gasoline from high grade crude. One way to continue producing gasoline volumes is to use higher grade crude as the input as it has higher cuts of lighter hydrocarbons and discard the residuals back into the market.
As a result, those refiners with highly complex refineries that can crack residual heavy hydrocarbon inputs are producing record profits. These refineries can trade off purchasing residual as an input against the cost of purchasing lower grade crudes as an input. While the spread between high grade light crude and low grade heavy crude is not yet at the record levels of last year, the spread is again widening. The marginal crude supply, to the extent that it exists is almost exclusively heavy crude, so the spread differential is likely to continue to widen while the high grade market continues to tighten, desipte refinery turnarounds.
In summary, the high grade crude market is tight and will remain so, not in spite of refinery tightness, but because of it. When refinery output gets tight, they seek high grade input. Complex refiners who can use lower grade inputs benefit as the price of the refined product goes up due to supply demand tightness on the marginal gallon of gas produced, and the cost of lower grade inputs remains muted because the marginal supply of crude is low grade AND because less complex refiners can’t crack their heavy output and resell it to complex refiners who can.
Demand keeps rising for refined product, and this moves us up the highly inelastic supply curve for high grade benchmark crude. This is exactly in line with economic theory.
August 13th, 2005 at 12:29 pm
Yup…if you don’t have enough crank–the price up. If you have too much–crank the price up. Need another excuse? To hell with it, crank the price up and feed them BS. The futures are in a feeding frenzy.