Every month the Breakthrough®Fuel Applied Knowledge team gathers Breakthrough® clients with a live webcast to discuss information found in our monthly Advisor publication. In these webcasts they discuss transportation fuel market updates, fuel market forecast updates, and special features in the marketplace – most recently the California tax increase and Hurricane Harvey.
This month the team got together to reflect on 2017 price behavior and market dynamics to discuss how inventory affected the fuel market landscape throughout the year.
Please note that this webcast provides a high-level look at 2017 price history, and a more in-depth and comprehensive analysis of data from the last year will be in our annual Advisor Atlas review in January.
The Global Inventory Story
A lot of focus in 2017 surrounded crude oil and refined products inventory levels. As demand outweighed supply, OPEC made a lot of progress towards their goal of achieving a 5-year average of global inventory levels with their production quotas.
Throughout the duration of 2016, conversations surrounding potential OPEC production cuts influenced diesel price behavior, even without any actual changes to global supply-demand fundamentals. OPEC instituted a production cut of 1.2mmbd – exempting only Nigeria, Libya, and Iran due to economic constraints. OPEC’s total cuts exceeded expectations by reaching 1.4mmbd on average in 2017. Considered highly successful, the cuts will continue through 2018, with reevaluation to be expected mid-year. If cooperating OPEC countries sustain their commitment to these quotas, much of the global oil production will remain stable next year. The long-term outlook suggests that oil demand will continue to rise, supporting crude oil and diesel prices.
Another point of significance in the global inventory story is the collaboration among non-OPEC members to reduce oil production. Outside of OPEC’s 1.2mmbd commitment, non-OPEC countries pledged another 0.6mmbd of curbed oil output (roughly half from Russia). The results of this group were around 75-80 percent compliance in 2017. While this level of compliance is far below the adherence of OPEC, it has been seen as a success for a group of countries that are not bound in any formal manner to cooperate on oil production.
The combined efforts of OPEC and non-OPEC members led to a target production cut of just under 2 percent of the world’s total oil production. While this may not seem like a significant amount, it was enough to allow demand to outweigh supply for the first time since Q1 2014, changing the market’s focus to how quickly the world will dwindle the bloated inventories that have been building from three years of oil oversupply.
In response to both OPEC members and nonmembers hitting production targets, prices were propped up throughout the year. While production continued a downward trend globally, the US saw the cuts as an opportunity to increase domestic market growth and seize market share. The result was an annual increase of 6 percent in US oil production, closing 2017 at a new record level of production above 9.8mmbd The US is poised to break 10mmbd in 2018.
What does this mean for the price of diesel at the pump?
Lowering supply led to increased crude oil and refined products prices throughout the duration of 2017, with the disruption caused by Hurricane Harvey causing significant diesel price increases—jumping over 20 cents to a sustained level above 250 cents per gallon.
Ultimately, the global energy market has shifted to following inventory levels of oil and petroleum products to measure the effectiveness of oil production measures. While global figures suffer from full data availability and timeliness to collect, the US has robust energy metrics published on a weekly or monthly basis. Specific to domestic inventory, combined levels of crude oil and refined products were at record highs in 2016, cracking 2 billion barrels per day in January and staying above the mark for the duration of the year. 2017 inventory levels were on a slight decline at the beginning of the year, reflecting the global production cutting levels, coming in at the end of August at 2 percent below the levels that started the year.
From September onward, inventories began to decline at a faster pace in the wake of Hurricane Harvey. The combination of efforts to restore pre-Harvey levels of refining operations and sizeable increases in US crude oil exports led to inventories decreasing an additional 4 percent since September (to total over 6 percent declines from the beginning of 2017). What is interesting about this year’s price history is that, very evidently, fuel markets had distinct “pre-Harvey” and “post-Harvey” price behavior.
Before Harvey hit east Texas, 2017 diesel prices averaged at 221 cents per gallon and saw low volatility month over month. Refineries were running above 95 percent utilization to produce record levels of refined products (consistently above 17mmbd).
In the wake of Hurricane Harvey, prices jumped to 255 cents per gallon. Twenty-five – thirty percent of total US refining capacity was taken offline at the time, causing significant price and supply disruptions throughout the country. Operations were restored within two months after Harvey’s disruption subsided, but refined product inventories have been difficult to replenish as refineries were running at near-peak levels prior to the storm. The result to end consumers has been increased prices – especially for diesel – as refiners capitalize on an elevated price point compared to the crude oil input cost (known as the refiner’s margin). Diesel’s elevated refiner’s margin is expected to last into 2018 with a gradual decline over time.
Price Dynamics in the Canadian Market
Canada saw similar price dynamics as the US market, with price premiums following Hurricane Harvey, though their fluctuations were more controlled due to a strong year for the Canadian dollar. Since Harvey directly impacted US refined products their spike was immediate, whereas Canada experienced a delayed pricing impact, as heavy Canadian crude exports to the Gulf Coast were backed up with the Houston-area refinery issues. This caused oil inventories to build up and prices to decrease in the short term. The commodity price of diesel eventually caught up to US movements, causing the Canadian diesel wholesale price to break 100 CAD¢/L for the first time since early 2015. Regional volatility also showed a marked difference following Harvey, as the subdued pricing differentials in early 2017 between Eastern Provinces (specifically Ontario and Quebec) and Western Provinces (British Columbia, Alberta, and Saskatchewan) became much more volatile after August. Pricing differentials between the East and West can cause quite a headache for Canadian shippers and carriers using the FCA schedule across the whole country, as the FCA utilizes pricing surveys for only Ontario and Quebec (not accurately capturing any pricing dynamics within the Western Provinces).
Canada also saw a greater impact of carbon pricing at the pump in 2017. The provinces of Alberta and Ontario instituted carbon policy to start the year, leading to impacts of around 5 ¢CAD/L for diesel in both provinces. The cost of carbon will become an increasingly important storyline in the years to come, as the Canadian government has mandated a gradual increasing minimum for carbon program pricing up to $50/MT by 2021 (which is equivalent to roughly 13 CAD¢/L for diesel). All provinces will be pushed for carbon plans in 2018 or will likely face penalties from the national government. 2018 will start with an increase to Alberta’s carbon price and an institution of Manitoba’s program at $25/MT. Shippers that hope to minimize their exposure to carbon price premiums should look to optimize the efficiency and carbon intensity of the mode and fuel type used to move their goods to market.
Mexican Energy Reform
Mexico fuel prices saw the largest amount of fluctuation compared to 2016, as fuel price liberalization began January 1 and ended November 30. Prices are predicted to rise into 2018, however volatility will be more muted than normal free market conditions as a result of the IEPs tax softening the effects of commodity price movements. The deregulation and liberalization of the Mexican Fuel market has been covered extensively in the Breakthrough Fuel blog.