Gasoline Futures Surge 12% in December to New High

Article by Brian L. Milne, Energy Editor, Product Manager with Schneider Electric

The gasoline futures contract traded on the New York Mercantile Exchange surged 12% in December, with reformulated blendstock for oxygenate blending futures establishing a new calendar year high for 2016 at $1.7038 gallon between the Christmas and New Year’s Day holidays. Gasoline futures outpaced the advance by West Texas Intermediate and ULSD futures in December which both rallied 9%, as bullish sentiment took control of the market.

Spurring the market’s bullish psychology were agreements to reduce production by the Organization of the Petroleum Exporting Countries on November 30 joined by a companion pact on December 10 when 11 non-OPEC producing countries also agreed to cut output. Combined, the two agreements call for a 1.758 million bpd cut in production that, if adhered to, would push global oil demand over production midyear, according to several analysts including the International Energy Agency.

The agreements took effect January 1 and are for six-month terms, although country commitments call for an average at the quota level to be reached by June, so some production cuts might not start right away. This feature could puzzle analysts during the interim as they scrutinize monthly production data for compliance, likely sparking increased price volatility.

Noncommercial traders, also known as speculators since they are not using a futures contract to underpin a physical position in the underlying market, covered short positions and accumulated long positions in NYMEX RBOB futures in reaction to the November 30 agreement. A long position is taken on expectation prices would move higher over time.

A rebalancing market will still need to contend with an abundant quantity of oil in inventory. However, the production cuts would gradually chop down the mountain of supply that has grown over the past couple of years and, in turn, underpin a higher global oil price.

This expectation was lent support late in 2016 on a string of data suggesting a quicker expansion of the US economy in 2017, with the Bureau of Economic Analysis in late December reporting a 3.5% annualized growth rate in US gross domestic product for the third quarter 2016–the largest quarterly expansion in two years. Greater economic activity consumes more oil.

The US Federal Reserve lifted the federal funds rate in December for only the second time in 10 years on evidence it finds supporting a stronger US economy that, in large part, propelled the US dollar to a 14-year high. Consumer confidence in the United States reached a12-year high in December, with a new administration in Washington, DC, seen creating broader economic opportunity.

A confident consumer is willing to spend more of his or her hard earned currency which bodes well for fuel retailers. As we look at RBOB futures forward curve, we see an increasing premium built into gasoline prices in early 2017 which reach the mid to upper $1.80 gallon range in April, May and June.

Climbing gasoline prices could erect a speed bump to higher sales volume for retailers and suppliers alike in 2017 should demand slow, as witnessed in in late 2016. Although implied gasoline demand set a record high in 2016, demand slowed late in the fourth quarter against the comparable year-ago period as gasoline prices gained.

EIA data shows during the four-week period ended December 23, gasoline supplied to market averaged 9.045 million bpd that, while a strong reading, trailed the same four weeks in 2015 by 260,000 bpd or 2.8%. For the year through December 23, implied gasoline demand averaged 9.367 million bpd, up 211,000 bpd or 2.3% against 2015.

The US average for regular grade gasoline sold at retail outlets reached a six-month high of $2.364 gallon on December 26, according to EIA data, 32.5cts above year prior. The lower price point in late 2015 was seen incentivizing demand.

In a recent note to clients, Tim Evans, futures specialist with Citi Futures, highlighted gasoline demand’s response to prices, saying, a decline in gasoline prices in 2015 lent support to demand with growth up as much as 3.4% in the 12 months ended in September 2015.

“Since then we’ve seen a slowing to 2.0% growth in the 12 months through September 2016. Looking ahead to next year,” said Evans on December 22, “we would not be surprised if growth slows to something more like 1.0-1.5%, a more sustainable pace in our view.”

Gasoline exports from the United States, which are included in the products supplied statistic, surged in 2016, reaching a weekly record high of 1.1149 million bpd in late December. Moreover, the trend looks sustainable, as US refineries produce more gasoline than needed by the domestic market amid the country’s oil and gas renaissance.

Much of those exports have been shipped to Mexico, where growing domestic consumption joined refinery constraints and outages to spur the demand for US barrels. Mexico is gradually liberalizing its gasoline market, including on imports, which would aid US refineries that are producing well above their historical average.

To learn more about Schneider Electric’s energy and commodity trading platform, DTN ProphetX click here.

Is the US Gasoline Market Defying the Seasonal Downturn?

Article by Brian L. Milne, Energy Editor, Product Manager with Schneider Electric

Gasoline demand in the United States is weakest during the winter months, which Is certainly no surprise considering cold and sometimes hostile weather that limits road travel after the holidays. Yet, despite the seasonal decline in consumption, futures speculators are the most bullish they’ve been in seven months.

During the first two weeks of December, nearest delivered reformulated blendstock for oxygenate blending futures traded on the New York Mercantile Exchange settled above $1.50 gallon and at 110% of the $1.3930 2016 average through December 15 every session, putting the value at a spring premium–a time of year when the gasoline contract typically sets the calendar year high. In 2016, the settlement high was established on May 24 at $1.6544 gallon.

Gasoline supplied to the primary market, which reached a record weekly high in June and is on pace to set an annual record high in 2016, remains strong late in the fourth quarter. The implied domestic consumption rate has slowed against year prior in late November, early December, when nearest delivered RBOB futures traded roughly 25cts gallon less. The lower price point in late 2015 was seen incentivizing demand.

However, while the domestic demand rate has eased from mid-year highs, export demand has grown sharply, offering an outlet for strong production at US refineries. Gasoline export activity expanded in the second and third quarters, data from the Energy Information Administration shows, and surged to a 1.131 million bpd weekly record high in early December.

Much of those exports have been shipped to Mexico, where growing domestic consumption joined refinery constraints and outages to spur the demand for US barrels. Mexico is gradually lifting restrictions on imports, with the government to end price controls in northern Mexico in April 2017, which would aid US refineries that are producing well above their historical average.

The abundance of US crude oil has been a boon for the US refining sector, boosting margins. The gasoline crack spread, which subtracts the cost of crude from the gasoline price, held below the strong margins experienced in 2015 in 2016, as crude prices advanced relative to gasoline and, in large part, to sharply higher gasoline inventory.

Yet, strong gasoline demand and an expected quicker pace of economic growth coupled with an improving US labor market supported a strengthening crack spread in December. Anticipation for a tighter global oil market in 2017 as agreements by the Organization of the Petroleum Exporting Countries and several non-OPEC oil producing countries to reduce production kicks in has also bolstered gasoline values.

World crude values crested above $50 bbl early in the fourth quarter as OPEC oil ministers shuttled between member countries to secure commitments for a production cut after two years of global oversupply that had cratered oil prices and decimated many oil-dependent economies. Amid the long courtship, which began in early August, global oil prices rallied and sold off based on the latest newswire headlines and monthly production data until an agreement was reached on November 30 by OPEC and a companion pact on December 10 by several non-OPEC producing nations.

Effective January 1, OPEC agreed to cut 1.2 million bpd in their crude production through June 2017 and non-OPEC producers agreed to reduce another 558,000 bpd of output that, if adhered to, is seen balancing the market in 2017. This expectation has turned market sentiment bullish, and not only supports crude prices but also gasoline. A look at the forward curve suggests RBOB futures will take out the 2016 high on the spot continuous chart in 2017, with the May contract trading just under $1.80 gallon in mid-December.

While this explains the spring-like premium in December gasoline prices, it doesn’t mean seasonal features have disappeared. The market is in contango through May 2017, a market structure in which nearest delivered futures trade at a discount to deferred delivery, which is consistent with gasoline’s seasonal cycles. Moreover, the discounts in the calendar spreads at the front end of the forward curve are widening, illustrating gasoline’s weakest season during the first quarter.

There are times when the seasonal pattern fails to materialize, which happened in the second quarter 2016 when the front end of the forward curve failed to move into backwardation, a market structure in which futures nearest to delivery trade at a premium to deferred delivery. An oversupplied gasoline market, especially along the East Coast, tamped down the typical summer premium in nearest delivered futures. A modest backwardation compared with historical spreads in contracts nearest to delivery didn’t take hold until late in the driving season when summer contracts moved into a premium against fall delivery. The front end of the curve again widen in September and briefly in early November amid the outages on the Colonial Pipeline’s main gasoline line.

To learn more about Schneider Electric’s energy and commodity trading platform, DTN ProphetX click here.

U.S. Biodiesel Industry Again Waiting on Government Largesse

Article by Brian L. Milne, Energy Editor, Product Manager with Schneider Electric

The higher cost of biodiesel compared with petroleum-based diesel fuel, especially in the third year of low global crude oil prices, requires a bridge to incentivize demand, and for several years the biodiesel industry in the United States has had those incentives amid multiple government programs.

Indeed, the US biodiesel industry ratcheted up production from 20 million gallons in 2003 to 2.1 billion gallons in 2015, according to the National Biodiesel Board, with an increasing amount of output, 24.5% of the 2015 total, renewable diesel. NBB, the industry’s national trade organization also reports 2.1 billion gallons of biodiesel was used in the United States in 2015.

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The US biodiesel industry is an exceptional growth story, but also a challenging one that has seen a large number of bankruptcies, and frustrated traders too, when federal programs lapse or lack clear direction on how they will be implemented. These waiting games have pushed otherwise promising companies that lack protracted financial durability out of business or into distressed sales. Indeed, the industry continues to consolidate that defines its maturing status as much as it demonstrates the risk in government dependence.

In early November, and deep in the shadows of an extraordinarily contentious US presidential race, the US biodiesel industry awaits the finalized mandate for renewable fuel demand for 2017, and the renewal of a tax incentive to encourage blending. Even as clarity is sought on these two programs, a stream of news releases from the US Department of Justice highlights the fraud seemingly endemic in government programs, and so frequently twinned with unintended consequences.

The US Environmental Protection Agency appears to be on target in meeting its end of November deadline in issuing the volume obligation for renewable fuels under the Renewable Fuel Standard for 2017, having submitted their finalized Renewable Volume Obligation to the White House Office of Management and Budget in mid-October. OMB reviews such government diktats to ensure conformity with the administration’s goals and policies.

The law establishing the current mandate, which is known as RFS2, lists the volume of renewables obligated parties must use every year, which vary across several nested categories of renewables, and increase annually through 2022. However, the EPA, the administrator of the RFS, must review the market to ensure there will be enough supply to meet the mandate, and that pushing this supply into the market doesn’t cause serious harm to the economy or environment.

The legislated mandate for 2017 is that 24.0 billion gallons of renewables in five categories of varying quantities are used in lieu of petroleum-based products, although the EPA proposal released in the spring at 18.8 billion gallons is well below the target due to an inadequate supply of cellulosic fuels and limited space in the gasoline pool based on current fuel specifications, auto manufacturer restrictions and consumer choice.

Of that 18.8 billion gallons, biomass-based diesel fuel accounts for 2.0 billion gallons, with biodiesel also able to satisfy the advanced biofuel mandate proposed for 2017 at 1.68 billion gallons. Oil refiners and importers must meet their RVO, whether through blending or in buying a compliance credit in the market known as a Renewable Identification Number.

RINs vary in inherent value based on the renewable they were generated by, with D4 RINs satisfying the biomass-based diesel nested category trading over $1 gallon from late September through the full month of October. A finalized RVO above the proposal would likely trigger a higher RIN value in response in December, with RIN valuations seen climbing in 2017 as obligated parties struggle to squeeze more ethanol into the US gasoline pool.

The RIN is a critical component in a producer’s income stream. Since a RIN can be separated from the renewable as it moves through the supply chain and sold in an open market, speculators have done the math and have squeezed RIN prices higher, knowing the RIN market will continue to tighten.

There’s also been a considerable amount of fraud around the RIN program that have caused harm to obligated parties amid the EPA’s buyer beware policy. Doug Parker, president of E&W Strategies and a former Director of EPA’s Criminal Investigation Division who oversaw investigations into the Deepwater Horizon disaster and Volkswagen’s defeat device fraud case among others, said current RFS-related fraud cases reflect $271 million in documented fraud and another $71 million in seizures of illicit profits.

“In my experience this represents a fraction of the actual overall fraud impact, and significantly larger losses will be formally identified in upcoming court filings,” said Parker in a white paper issued early September commissioned by Valero Corporation.

RINs associated with the fraud will be retired, and parties that bought those RINs will be forced back into the market to reacquire a compliance credit, further tightening the RIN market.

A tax credit that pays $1 per gallon for blending biodiesel into a petroleum-based fuel known as the blender’s credit expires at year’s end, and has stymied forward term transactions for biodiesel because of the uncertainty in knowing whether the credit will be passed by the US Congress for another year or more. The tax credit has been allowed to expire four times over the past 10 years, and has been made retroactive at times, creating windfall profits, yet the uncertainty has challenged business planning and trading activity.

A bitterly divided Congress adds another layer of concern that the tax credit will again be extended, and in what form. The blender’s credit has been criticized since imports can also qualify for the tax subsidy with one estimate forecasting US biodiesel imports would reach 800 million gallons this year. There have been calls to move the credit from the blending level to producers.

A bill to extend the credit, H.R. 5994: Biodiesel and Renewable Diesel Incentive Extension Act of 2016, was assigned to a committee in mid-September that will consider sending it to the House or Senate for a vote. PredictGov gives the bill a 1% chance of being enacted.

Producers ramped up production in August and September, with EPA qualified biomass-based diesel output at 1.79 billion gallons for the first three quarters of 2016, which compares with 1.81 billion gallons for all of 2015 when you strip out renewable diesel. Renewable diesel uses the same feedstocks as biodiesel but employs a different technology.

Spot transactions for biodiesel remain limited early in the fourth quarter, but when completed are primarily transacted in a differential against the ULSD (ultra-low sulfur diesel fuel) futures contract that trades on the New York Mercantile Exchange. After a rally from September lows into October, ULSD futures were range bound until a selloff in closing out the month.

To learn more about Schneider Electric’s energy and commodity trading platform, DTN ProphetX click here.

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