With crude oil dropping like a stone again, you’d think prices of gasoline might be falling too. But they’re not.
Prices at the pump have always been notoriously slow to respond to dropping crude prices, though it’s probably fair to say that the 15 percent drop in crude prices in the past week is likely to work its way to motorists relatively quickly. But don’t expect much more than that.
Writ large, global “liquid supply”—to borrow the International Energy Agency’s nomenclature to describe crude and condensate—is up 3.1 million barrels a day from the 2014 average. That increase comes from around the world, even as U.S. supply increases derived from fracking show signs of slowing, Paris-based International Energy Agency (IEA) said.
That said, gasoline prices are being supported in the U.S. by a surge in demand, which is up year-on-year in July by 7 percent, according to the Washington, D.C.-based Energy Information Administration. Also, so far in 2015, demand is about 4 percent of the same year-earlier period.
Apart from demand increases, however, there appears to be a mismatch on a global scale between increasing supplies of crude and existing refining capacity, the IEA said in its report published on June 11, 2015.
Too Few Refineries?
“More than the rise in demand itself, it is that mismatch between product supply and product demand that seems to have supported prices,” the IEA said in its latest outlook on the oil market.
That mismatch helps explain the chart below of two of the ETF market’s more popular futures-based crude oil and gasoline funds. The United States Gasoline Fund (UGA | C-98) has risen almost 14 percent this year, and the United States Oil Fund (USO | B-100) is down by about 15 percent.
In fact, UGA was the best-performing commodity ETF in the first half, according to data compiled by ETF.com.
A Classic Margins Story
With feedstock prices plummeting and refined product prices rising, it’s a good time to be a refiner.
“This is a classic margins story,” said Talley Leger, founder and investment strategist at Macro Vision Research, a New York-based firm that specializes in equity sector analysis. “It’s not rocket science,” he said, arguing that weaker crude oil prices have always translated into improved profit margins for oil refiners.
Crucial elements to the current dynamic, such as the strengthening-dollar trend that correlates so strongly with crude oil weakness, look like they’re going to persist. That means that the gravy train for refiners probably will keep chugging for a while, Leger says. Historically, the period of wide “crack spreads” is framed by the driving season, firing up in early spring and fading by the end of summer.
Moreover, any additions to the refining infrastructure—including units that are better suited to handle theextremely light crude oil coming out of the fracking fields in North Dakota and elsewhere—will likely take years to complete, let alone begin. That’s good for refiner profit margins too.
“Whether you look at this seasonally, cyclically or structurally, I find it hard not to make a bullish case for refiners for an extended amount of time,” Leger said, referring to the positive effects of falling oil prices on the oil refining business.
The point is that the “upstream” oil industry that finds and produces oil is feeling the pinch of collapsing crude prices and is now in a bearish mode, while the “downstream” part of the business that concentrates on refining and marketing is in an increasingly bullish mode.
Hurry Up With That Refining ETF
As anyone with even passing knowledge of the exchange-traded fund industry knows all too well, the ETF industry is only too happy to serve up the latest red-hot investment idea in an ETF wrapper.
So, what’s that refining ETF called and where is it? It’s called the Market Vectors Oil Refiners ETF and it’s still in the regulatory pipeline after it went into registration with the Securities and Exchange Commission in May.
Comparing an ETF like the Energy Select Sector SPDR Fund (XLE | A-96) that reflects the effects of falling crude prices with that yet-to-be-launched Market Vectors fund isn’t possible. So until that refiner ETF goes live, we’ll have to use as a proxy for the whole refining industry the biggest independent U.S. refiner: San Antonio, Texas-based Valero Energy Corp.
That’s the picture below, with high-flying Valero depicted in black. It gives a clear sense of what investors and speculators interested in a diversified refiner play are missing. If there were ever a need for another ETF to have launched yesterday, there it is, plain as day.
Charts courtesy of StockCharts.com