Driving Discussions: The resilience of US spot markets

Author Argus

How have refined products spot markets been handling rapid change?

Over the past several months US spot markets have seen their fair share of change. In this episode of Driving Discussions John Demopoulos, vice president North America refined products, and Dave Ruisard, editor US Products, discuss just how well these spot markets have been handling shifts in demand and supply, low utilization, refinery closures and what they could face next.  

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John: Hello and welcome to "Driving Discussions". In this series, we'll discuss the forces that affect road fuels globally. And in this episode, we're going to be talking about how the refined products spot markets have been responding to the rapid changes in demand that we've seen over the past several months. "Driving Discussions" is brought to you by Argus Media, which is of course a leading independent provider of energy and commodity pricing information. My name is John Demopoulos. And I'm the vice president of North American Refined Products here at Argus. And with me today is Dave Ruisard, editor of U.S. products.

Dave: Hello. How are you?

John: Dave, great to have you here. I knew we would get you on "Driving Discussions" eventually. I wanted to talk to you a little bit about the spot markets because we've talked to several people recently last week or the week before. Steve Weber told us a little bit about the way that COVID has impacted refineries, their operations, their value, who wants them, but I wondered if you could give us a sense of how some of these shifts in demand have impacted the spot markets that you observe so closely?

Dave: I think it's interesting because the spot markets are pretty resilient, they're designed that way. And as Steve mentioned, a lot of the refiners have made very difficult decisions about closing refineries in some places in the U.S., you know, a big one to me that comes to mind is of course, you know, Marathon's operation on the West Coast. But when these things happen, when you have demand destruction like we did that was so noticeable with the onset of corona COVID-19 and the resulting quarantines, it's provided opportunities for some of the other refiners to increase production, right? To meet some of the demand there. So when we're looking at, you know, how production...of course utilization of the refineries is still way down, we're at 80% but if you look at it just a few months ago, we're down to like 70%. So things are sort of starting to climb back, but typically during this time of the year, you'd be looking at 90% to 95% of operating capacity would be being utilized across the U.S. So that tells you we're still from a production standpoint, at least 20% off, 10% off of where we'd normally be. How the spot markets reacted is, you know, there's two things, you have the supply, you have the demand and then, of course, you have the prices in between there. Prices have been climbing back, they've been rising because what you've seen is you've seen the turning off of the supply, meanwhile, demand has been coming back, some things are a little bit slower and less resilient than others, though.

John: Yeah, and in terms of the sort of liquidity that you see day to day, I mean, I know that that's kind of the bread and butter of what your team does is observe market liquidity, come up with the indexes and the market prices that the industry uses to settle contracts, you know, and form back-office functions, all sorts of things, how has that liquidity changed recently? And is it something that you expect to continue changing over the remainder of this year?

Dave: Well, there's two types of liquidity, right? And basically inside these spot markets, you have companies that are long, there are companies that are short, a few are balanced but, you know, if you're someone who's supplying gasoline to your own service stations and you have a problem while you might've been balanced, suddenly you're short, right? And that causes people to come in and make trades. A person who's trading, whether it's for a refinery or a strict, you know, international trading company they prefer to see volatility, right? And that inspires them to get in and out of markets because you can make money as the markets go up and down but as far as true liquidity is concerned, we're seeing a different type of trading take place, we're seeing less interest in what most people would consider a standard trade, meaning David sells to John at, you know, a certain value and then he backs off. Instead to sort of minimize some of the risk and the impact as things that have been swirling around a lot of these barrels have been termed up which basically means David sells to John on whatever the Argus price might be for that day. For people who aren't in the business, it would be kind of like just agreeing to sell your car to an individual at the blue book value and not haggling over it. That's a good way for some of these guys to lay off some of their risk as they're moving barrels through a system but what it does is it cuts down on the amount of actually negotiated deals. So the more deals you have done in a spot market on an index basis, the less information there is out there to actually set that index and they can give perception, the reduction in liquidity, that liquidity is actually the same, it's just shifted to a different style of trading if that makes sense.

John: Yeah, that absolutely does make sense. I think we've heard as well the idea that some of the regular term contracts out of the Gulf Coast and down into South America may be expiring and not being renewed and that some Latin American importers companies purchasing cargoes from the Gulf are choosing to move to spot purchases only. Is that something where we could expect to see, you know, more spot cargoes trading?

Dave: I think it's a little bit trickier than that. So, you know, if you're, for instance, a state-owned oil company and you're bringing in product, there's two ways to go out and source that product. Many moons ago, you would simply put out a tender and there would be an international trading supply company that would bid for that tender. Just think, you know, Acme Trading. And they would win that over general trading. And then what Acme would have to do is they would have this short into a country, they would then go and buy those barrels straight from the refiner and their job was to make sure that they had a certain amount of profit margin to make sense.

More and more over the last few years, you've seen refiners get interested in selling those barrels directly into foreign countries, you're seeing them participate more in tenders than they used to. And I think what some of the national oil companies have decided to do is instead of having these long-term contracts at set prices, they're thinking it might be better to simply come in on a one-off and say sometime in the next two weeks, I need, you know, 200,000 barrels of gasoline. Now are they gonna buy 200,000 barrels in one fell swoop? I don't think they will because going back to our car example, it would be like if you walked into the Chevy dealership and said, I'll buy every single Chevy pickup that you have, you'd probably be smarter off to kind of go from one dealer to the next dealer and sort of negotiate them individually until you had a 100 Chevy pickups instead of just buying them all from one guy right there at one time because you may not get as good of a price because you'd realize that you're under distress.

So how do you go out and buy 200,000 barrels on one fell swoop in the Gulf Coast and have it all loaded onto a cargo and delivered to you is a little bit tricky because even if you were to negotiate those deals individually, well, some of the barrels would be in Corpus Christi, some of the barrels would be in the Greater Houston area, inside the Greater Houston area, some would be at Deer Park, some would be at Pasadena, some would be at Texas City. So solving those logistics is a lot trickier than many people realize so when they have come out and said, we're gonna buy cargoes in the spot market, I'll be interested in seeing exactly how that transpires because it's not as simple as saying, I'm not going to take a tender anymore. There's a reason why people did tenders and it's because it worked and I'm not sure that buying an individual cargo, a huge amount at one fell swoop is actually gonna provide you with more price stability.

John: Yeah, and you can imagine that as a buyer you would really need to find a partner, you know, a refiner, a competitive field of refiners that could offer you a full cargo at competitive prices rather than wanting to pick individual pieces of that cargo up from different refiners, which I agree sounds very burdensome somehow.

Dave: Right. So here's a good example, okay? If you're looking at, let's say you and I are running a country, God help the people that live in that country, but we're running a country Demopoulos Land and on another continent...

John: It's called Ruisard Land, it's got a nicer name to it.

Dave: And, you know, we're short 300,000 barrels of gasoline every three weeks but probably the best thing to do that's gonna give you the fairest price possible is to get in touch with a major refiner which would probably be in the U.S. because we have some of the lowest refining costs and you would say to them, I will buy on an Argus basis this much. And it benefits you both because now you've got a guaranteed supply and if you're doing it on an Argus basis then you have a steady, fair market value price. You're not gonna beat the market buying 200,000 barrels every couple of weeks. But you don't really need to beat the market because what you really want to do is you want to make sure that the people living in our fictional country, Demopoulos Land, are being asked to pay what would be considered to be a fair price, it's not overly burdensome to them and you also don't want to bankrupt Demopoulos Land by making poor decisions in how you're purchasing the fuel.

John: Well, I can tell you that the Demopouloses get very rebellious when their gasoline is not charged at a fair price. So I agree with you entirely there.

Dave: The little things, right? It's the little things that send us all crazy.

John: Yeah, the little things. And that is also, I guess where import parity pricing comes in because if the marginal barrel being imported into Demopoulos Land, let's say is a barrel from the Gulf Coast, then the price of all of the barrels being produced even at refineries within Demopoulos Land needs to be charged at that price, right, whatever it is Gulf Coast plus cost of freights in order to establish a market price for everybody that's fair and that relies on the marginal barrel.

Dave: Yeah, correct. Yeah, speaking of export terms, you look at the data, things fell apart on exports sorta April, you know, to the end of May. The latest data shows that we're actually exporting more products again than we did this time last year by a significant amount. So the export businesses is still a fairly good business to be involved in and there's definitely demand for this material.

John: Yeah, that is interesting. And is that, I mean, you may not be able to see it in the data right now but is that primarily gasoline being exported over the normal kind of range or more distillates than normal? I can sort of imagine that with the demand losses that we've seen over here especially on the jet and the gasoline side that refiners will be kind of queuing up to make use of their docks and ship it out abroad wherever they possibly can.

Dave: Yeah, we've seen gasoline and diesel leaving. Jet fuel continues to be a major drag on refining systems because jet fuel itself is naturally part of the distillation curve of every single barrel. So you can't simply look at a barrel of crude and say, "Hey, stop producing jet, right?" So you have to do something with it. But as we've seen, like Steve Weber talked about a couple weeks ago, there's still some jet fuel demand out there and on the West Coast, they're looking at the highest rate of jet fuel imports coming from Asia that they've seen in something like 13 months now. So when you look at the grand scheme of things, stuff is sort of starting getting back to sort of normal levels on what demand looks like, or at least demand is getting balanced with the production that we have currently in place.

John: And that will be music to the ears of any refiner in the United States because they've certainly been through a very torrid period lately. You mentioned some of those kind of, you know, changes in individual product availabilities and demand but what about something that I think we talked a little bit about recently, New York Harbor, there's been a bit of a NAFTA shortage but there's been a real glass of octanes, you know, high-octane blendstocks. Can you give us any sort of sense for what's going on there with gasoline blending in the Harbor?

Dave: Right. New York Harbor is an extremely interesting animal. What you're basically have seen in New York Harbor is you've seen a real inability, you know, production-wise, things are fine, right? Production is balanced out with what the natural demand is. Where they're having issues is they can't get some of this material out of tank fast enough to bring in newer material to blend with. So if you have, you imagine there's only so many pieces of Tupperware in your cupboard at a certain point, what are you gonna do with all these leftovers? And that's kind of the same situation they're looking at because if you have a certain amount of alkylate, for instance, which is a gasoline blendstock used to make Rbob, if you have too much of that in tank and you can't bring in any more NAFTA for storage then you can't blend that alkylate with the NAFTA because you're out of room and that's the problem they're looking at. And, you know, Colonial Pipeline looked at it and said, okay, well, they have a NAFTA shortage and we have now created spare capacity on our pipeline because of reduced demand, we can let people ship NAFTA which were really long on NAFTA in the Gulf Coast into New York Harbor. The problem is it's coming a little bit too late because by the time this stuff will show up and the rules are in place, the blends will have changed and people aren't gonna be really looking for NAFTA and it doesn't matter anyway, because they don't necessarily have anywhere to put it. So that's their problem.

John: But and all of this at a time when we're supposed to be producing tier-three standard gasolines, which only have 10 PPM of sulfur in them anyway, so NAFTA wouldn't think would be the most obvious blendstock. But, Dave I know we have to draw to a close now. It's been a pleasure talking to you. Thank you. And if you enjoyed this podcast, please do be sure to tune in for other episodes in our series, "Driving Discussions". And for more information on Argus's global refined product coverage, please visit argusmedia.com/oil-products.