The Whole Truth About Rising Oil Inventories

by | published January 21st, 2011

We expect oil and oil product inventories to rise around this time of year.

In the cyclical nature of the oil market, January traditionally has been a time when refineries raise both crude oil on hand and gasoline being produced in anticipation of a coming rise in demand a few months down the road.

Of course, gasoline is hardly the only oil product. Unusually cold winters will increase the need for low-sulfur heating oil and propane (a higher-end distillate that serves as the major heating fuel in most rural areas nationwide), too. And then there is the ongoing difficulty of producing an adequate volume of diesel (a middle distillate).

This time, however, it is not the inventory expansions, but their actual size that is prompting some jitters in the market.

In its weekly figures (released Wednesday, January 19), the Energy Information Administration (EIA) – a division of the U.S. Department of Energy – reported that both crude oil and gasoline inventories are at 10-month highs and well above five-year averages.

As I am writing this, the price of crude oil is down about 3% from its last high on January 12.

RBOB (Reformulated Blendstock for Oxygenate Blending), the NYMEX gasoline futures contract, has also declined. Yesterday it fell almost 2.5% – the single largest daily drop in three months.

With crude above $90 per barrel and gasoline at $2.47 a gallon before this slide, these percentage falls are not overly disconcerting in themselves. However, any time we see a short-term spike or dive in prices, the analysts and pundits need to explain why.

And it is here that they continue to get only half the picture.

Two demand elements are paramount to – and figure prominently in – the sound bites now permeating the airwaves: concerns over demand in the U.S. market and question about the impact of inflation in China.

But, as you will see, most analysts are missing something. And it points to serious profits for us…

Two Demand Concerns Are Causing Market Jitters

First, deliveries from refineries in the U.S. to wholesalers continue to be down. That guarantees that we’ll hear a broad-based assumption about the strength of the recovery in the American market.

Of course, one could just as easily ascribe the brunt of it to other factors – the continuingly bad weather in places like the Northeast (cutting travel), for example, or the fact that this is the time of year in which demand usually declines, for cyclical reasons.

I would suggest in response that the more pervasive dynamics in the market ought to be the overriding indicator.

Keep in mind the following: While the inventories of finished product are increasing, so are the processing runs. In other words, refineries were operating at 83% of capacity last week (the Wednesday EIA figures tell us what the market was doing as of the previous Friday) but actually producing more while moving less onto the market.


Refineries are building inventories of both raw material and finished product in anticipation of the normal yearly rise in demand starting in March. They want to be ready to profit.

And this year, that demand surge is shaping up to be an unusually pronounced one. So concerns about genuine demand levels in the current – very short-term – window seem unwarranted.

There is one anecdotal way of seeing this trend. The February contract gasoline crack spread (comparing contracts in crude oil to contracts in gasoline) is narrowing. This usually happens when a balancing is taking hold between the two.

Looks to me like a base is forming for the move up.

Then again, the decline in pricing has been quite subdued.

Despite the continued angst over the demand-economic recovery connection, the futures trade is actually taking place in a rather narrow band. Daily trading must consider short cycle demand concerns. Yet the subdued pricing declines means there is considerable upward pressure in the market suppressing more pronounced declines.

Second, the Chinese situation poses a longer-term question.

With the introduction of mechanisms to cool off a clearly overheated economy, Beijing’s decision to raise interest rates and bank reserves is a sign that the specter of inflation is raising its head.

Analysts rightly note that a slowdown in Chinese development should translate into a reducing need for energy. This aspect of the demand equation would then lead to a further depressing of prices for both crude and finished oil products.

Yet I find the basic argument unconvincing.

Despite Beijing’s moves, Chinese performance continues to accelerate, as does the need for gasoline in a rapidly expanding personal transport sector and for petrochemical feeder stock and products for a developing industrial network.

There is no energy crisis, industrial contraction, or domestic market implosion coming around the corner in China. And demand is moving north elsewhere in the world, too.

The two primary demand-side concerns, therefore, while valid, are hardly a disaster waiting to happen.

It is the other side of the situation that the pundits are missing…

The Real Reason Oil Inventories Are Soaring

The consolidation occurring in refineries is happening in the shadow of a much more protracted upward pricing pressure.

The traditional factors I follow in estimating future pricing levels – demand (especially industrial), currency exchange (forex) developments, supply concerns (more quality and processing costs, rather than simply availability), infrastructure strictures (like inventories), and sector M&A (concentrating control, reducing competition) – are still pointing strongly up.

The new element in the mix is the uncertainty of where to place the acceptable futures pricing levels (volatility).

We have seen such an element before, indicating a difficulty in equating proper pricing for futures (paper barrels) with consignments of actual oil (wet barrels).

But nothing like the one that is developing this time around.

What’s occurring very short-term (next month’s futures contract, for example) may be the horizon that limits the talking heads.

On the other hand, we know that the more encompassing combination of traditional elements and rising volatility will be driving these prices higher moving forward…

…and our profits right along with them.



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  1. felix mosso
    January 21st, 2011 at 16:14 | #1

    ? I live in the Inland Empire of California very near the COLTON
    TANK FARM. I just filled up with Reg yesterday at $3.25/gal,

    WHY are we always paying MORE than the rest of the Country ??


  2. Charles Parsons
    January 21st, 2011 at 16:38 | #2

    Hay Felix, Ilive in Northern Westchester County, NY and I’m already paying 3.34 for regular.

  3. publius
    January 21st, 2011 at 16:45 | #3

    Because you live in California, with the most insane environmental regulations and wanton disregard for business and capital formation. This is also the reason your state is now bankrupt, despite having unimaginable assets and advantages.

  4. Dave
    January 21st, 2011 at 16:58 | #4

    The explanation I have always heard is that there is greater demand in CA. We have a HUGE Chevron refinery right on the edge of SF Bay, yet prices are considerably higher in the Bay Area than in the Central Valley, also allegedly due to greater demand.

  5. Tod Floyd
    January 21st, 2011 at 16:59 | #5

    In the past, you have written some encouraging words on the price of natural gas both in the near term & longer term (exporting natural gas etc). Have events recently changed for you to be less optimistic in the light of the successful drilling for shale gas. The over supply figure is quite daunting. How long before we see a price of say $6.00 per mcf & staying around there.
    Best wishes,
    Tod Floyd.

  6. Average Consumer
    January 21st, 2011 at 17:51 | #6

    With gasoline supplies always in question, why is there a gasoline station on every block with no alternative?
    In Brazil they only use ethanol because it costs half what gasoline costs, then they sell expensive gasoline to us.
    We have natural gas reserves for many years to come, however, it is not sold in stations.
    What is the truth? There is always a crises and rise in price, then a cut to keep alternatives dead.
    Don’t worry about it, there will be an answer when the supply is really gone.

  7. Charles Primbs
    January 21st, 2011 at 23:29 | #7

    @ felix mosso
    Taxes my friend. For several years the state of California has stolen gas tax money for other purposes. This is in spite of two initiatives that have been passed that claim to restrict gas tax money to be used for only roads and highways. The people who write the initiative measures are obviously in cahoots with the legislature and the legislature must be laughing at the stupid public which passes these initiatives.

  8. lena
    January 22nd, 2011 at 00:45 | #8

    Hello,Kent.What do you think about to use XES as OIH?Lena

  9. David
    January 22nd, 2011 at 02:00 | #9

    The biggest reason you are always paying more than most of the rest of the country is called state taxes. Every state levies a different amount per gallon on motor fuels. California has some of, if not he highest per gallon motor fuel taxes in the U.S. Try filling up in London, or Berlin. Their motor fuel taxes are in the range of $2.00 to $5.00 per gallon. That’s just taxes. That’s on top of the $3.00 or $4.00 per gallon price of the fuel to begin with.

  10. Ima Nemisis
    January 22nd, 2011 at 03:33 | #10

    Felix, check out the taxes Sacremento gets and the regulations under which your producers and refiner’s operate. All are higher than elsewhere. Lobby Sacrament for offshore drilling as offshore Louisiana or Texas and the state will collect substantial royalties and transport coast will plummet (est 75% of CA crude comes from far outside the State driving up P/L and road transport costs. Come to Texas and live free.


  11. Herman Hazebroek
    January 22nd, 2011 at 03:59 | #11

    Hi Felix.

    Don’t complain. I live in the Netherlands and we pay 1,60 euro for one litre. That is about 2 us dollars for one litre. And that isn’t even the highest price you pay for a litre. I think in the Scandinavian countrys they pay even more. So stop complaining and buy a cheaper car.

  12. Austin Dom
    January 22nd, 2011 at 07:39 | #12

    To Felix : Because your state regulators think they know more than the rest of the US, and put onerous environmental restrictions on gasoline, requiring specialized blends from the refineries. In addition, your state taxes including those on gasoline, are among the highest in the country, yet CA’s fiscal balance sheet is among the poorest. Again, you can thank your state government for spending your money like drunken sailors. Why don’t you join many of your former neighbors and come to Texas where the free market is still king?

  13. B.R.Patel
    January 22nd, 2011 at 11:21 | #13

    recently i have joined with you. prices of mee is fluctuating lot.should i sell and take a loss or hold it. Thank you very much

  14. Larry
    January 22nd, 2011 at 13:05 | #14

    Two reasons…there are probably others,

    1- CA state tax on gasoline is the highest in the country 64.5 cents per gallon.

    2- CA State Air Resources Board requires “special blends” to meet regional and or seasonal requiremants. These blends / requirements which result in “lower air polution” result in higher costs of production.

    Nevada & Arizona state taxes are 51 and 37 cents (average of 20 cents than CA), and throw in 10 increased cost for “special blends” and you have 30 cents per gallon more for gasoline in CA.

  15. Jim Mog
    January 22nd, 2011 at 13:31 | #15

    I live in central Fla. and our gas prices have been moving up in 4 and 5 cent increments per week to $3.10 per gal as of today.
    Where do you buy it for $2.47 per gal.?

  16. Wayne
    January 22nd, 2011 at 14:06 | #16

    I remember reading one of your articles that oil prices would reach $150 a barrel by springtime.
    I don’t see that happening. Do you?

  17. Mike Clancy
    January 22nd, 2011 at 23:18 | #17

    I was told by a friend that our oil refineries are exporting gasoline for other countries. Is that true and how much is being exported and does that have an impact on our USA pricing?

  18. Kris Roberts
    January 23rd, 2011 at 14:20 | #18

    We have the same question here in central North Dakota, with a Tesoro refinery just across the river from us. We are alway $0.10 to $0.30 higher than the eastern part of the state. We always hear that there is more competition in other parts of the state due to pipeline depots. A whole lot of us think this is bunk.

  19. anish poojara
    January 24th, 2011 at 03:46 | #19

    The argument is appealing but not convncing. Need some more inputs to be fully convinced.

    anish poojara


  20. Neil
    January 25th, 2011 at 05:17 | #20

    Gas @ $3.25/gallon? Can I have some please – in Scotland we are paying £1.30/litre, over $9.00/gallon…..!

  21. twwhiz
    January 26th, 2011 at 22:27 | #21

    Produce from the shale regions, both gas and oil while expanding refining capabilities and we’ll become net exporters of product. Problem solved. Our financial status here and abroad will be strong enough to allow us to control our destiny and help others along the way. Freedom is what this country was founded on and we should respect the founding fathers vision and live it.

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