- In contrast to the past two years, gasoline demand in the Atlantic Basin has fallen by 1% YoY, likely driven by higher prices
• Still, US and Europe economic fundamentals are positive and strong exports to EMs should lend support to gasoline near term
• Heading into the winter, we see downside to gasoline cracks on high stock levels and expect diesel to reclaim a firm premium
Is this year’s driving season over before it began?
In a U-turn from the last two years, gasoline consumption in the Atlantic Basin has fallen by 1% on last year. In the US, lower demand growth seems largely a function of higher retail gasoline prices, underscoring how price elastic oil consumption is. Gasoline intake in the US tends to peak around the July 4th weekend, when Americans drive for pleasure, but demand is down by 2% on last year. With this backdrop, RBOB gasoline relative to US diesel prices has collapsed in recent weeks and is now trading near parity. RBOB gasoline has been too weak to drive crude oil prices and has not been able to establish its usual seasonal leadership over the oil complex. Increasingly, one has to wonder whether the summer driving season is over before it has even begun.
Gasoline may see a late-summer pop to the upside…
While US gasoline demand may have peaked in absolute terms last year, economic fundamentals are still firm enough to suggest a growth uptick in the coming weeks. In fact, weekly apparent demand data have been constantly revised upward. Demand still compares favorably to the five-year average and miles driven also continue to grow YoY, albeit at a much lower rate than in the past two years. Strong gasoline exports to emerging markets are another reason to be a bit more constructive on gasoline near term. In particular, persistent and deep refining woes in Latin America have opened a massive gap between local production and fast-growing demand, leading to a strong pull on gasoline from the Atlantic Basin.
…but there is no structural tightness in sight
However, any mid-to-late-summer rally in gasoline, if it materializes, is unlikely to be sustainable. Simply because there is a lot of work left in draining gasoline inventories before the end of the driving season. Contrary to common wisdom, gasoline stocks are anything but tight in the Atlantic Basin, even relative to both demand and exports. Flagging refinery utilization rates in places like LatAm or Africa have increased demand on other regions to run harder, in part explaining why US crude runs recently pushed to a record level, while European runs are also elevated. Strong margins suggest a pullback is unlikely. Plus, refiners in the Atlantic Basin have already maximized a yield switch to diesel. After the summer, gasoline cracks are likely to see further downside and we expect diesel to reclaim a more typical pronounced premium to gasoline this winter.
- Gasoline demand is extremely price-elastic – In a U-turn from the last two years, when demand growth for gasoline was running at phenomenal speed, gasoline consumption in the Atlantic Basin has fallen by 1% on last year. In the US, lower demand growth seems largely a function of higher retail gasoline prices, underscoring how extremely price elastic oil demand is. Annual growth in miles driven has slowed to 1.5% from 3.4% in the same period last year. Higher prices are turning people back on to smaller and more fuel-efficient cars, reviving the well-established trend prior to 2015. Sales growth for SUVs, which averaged 7% YoY in 2016, has now slowed to 2%, allowing fuel efficiency gains in the US fleet to come through more forcefully. More recently, slowing employment growth, as well as a slowdown in construction activity, may have also played a marginal role.
- Is this year’s summer driving season over before it began? – But the latest weekly data is somewhat disconcerting. Despite a sequential pick-up, gasoline demand is 180 thousand b/d, or 1.8%, down on the same four-week period last year. Gasoline demand in the US tends to reach a peak around the July 4th weekend, when Americans drive for pleasure, and then declines sharply between mid-August and late September, which is what creates the seasonality in the gasoline futures curve. But, increasingly, one has to wonder whether the summer driving season is already over before it has even begun? Indeed, RBOB gasoline relative to US diesel prices has collapsed in recent weeks and is now trading near parity.
- RBOB is too weak to drive crude oil higher – Weak gasoline demand in the middle of the driving season has clearly weighed on prices. The simple fact of the matter is that RBOB has followed, rather than led, crude oil. WTI crude oil witnessed a staggering recovery, nearly $4/bbl off the lows hit on June 21st, and RBOB gasoline managed to move up in sympathy, but clearly failed to be in the driver’s seat. More generally, RBOB gasoline has also failed to establish a stronger lead relationship to crude oil during this year’s driving season, which is somewhat unusual. Our Granger causality tests show that, since May, gasoline showed no lead/lag relationship with crude oil, which is unusual for this time of the year. Indeed, heating oil has outperformed gasoline and, more recently, even crude oil outperformed gasoline. To us, a sustained crude oil rally at this time of the year does require some strength in gasoline demand and pricing
- RBOB crack spreads have just moved sideways – Put differently, while gasoline relative to crude oil has generally moved sideways, heating oil crack spreads have moved higher and are now trading up YoY. US gasoline crack spreads to Brent are still trading at healthy levels, but are only slightly up YTD and have generally traded at the bottom of the recent price range. We doubt that diesel can maintain such an important role, as demand tends to weaken seasonally post US Independence Day, but what is clear is that gasoline has failed to take center stage, as it normally does at this time of the year. Even a strong rebound in RINs prices, which are now trading back above 70 cents/gallon, from as low as 40 cents/gallon in early May, failed to give RBOB gasoline cracks a much needed push higher. After months of speculation on a potential major change in RFS volumes for the upcoming years, the EPA finally proposed to hold the 2018 fuel ethanol target at the same level as this year. In this context, the RINs market is likely to stabilize in the short term, and gasoline cracks should reflect actual fundamentals.