The market is still searching for a price at which gasoline will balance. Demand will not shift in the short run, so this is going to have to be a supply story. So far, even negative gasoline cracks have done little to deter refiners from running in many markets, particularly in the US. FCC margins for USGC refiners, which are at the epicentre of the problem, have stayed positive in part due to support from alkylate values, even as gasoline cracks have sunk.
Barring a demand surge, gasoline is bound to struggle this summer even if turnaround season temporarily boosts cracks and timespreads. USGC gasoline cracks vs domestic MEH crude turned negative in early November 2018 and have largely remained so since, yet octane values have stayed relatively strong. Indeed, even with cracks at negative levels, model FCC margins for the USGC have stayed positive.
The culprit looks to be the rise in US shale oil production. Simply put, there is too much light crude, which means there is too much naphtha. If naphtha can be routed to high-value petrochemical manufacturing processes within the refinery, that is almost always the preferred destination. The next preferred destination for naphtha is the gasoline pool, since gasoline typically trades at a premium to naphtha.
European refinery gasoline production declined by just 73 thousand b/d y/y in November 2018 despite a 0.76 mb/d y/y drop in crude runs thanks to rising yields at refineries throughout the region. In some places, European refiners have even warned they risk hitting tank tops on gasoline inventories due to rising gasoline yields and a lack of local demand for the product.
Reducing output of a straight-run product like naphtha can only be achieved by changing crude slates to reduce the number of naphtha molecules coming out of CDUs, or cutting refinery runs, a cure that could be worse than the disease with diesel stocks tight in the Atlantic basin. Diesel values should rise to compensate refiners for their losses on light ends to enable diesel inventories to rebuild, especially with the IMO 2020 transition just months away.
Some respite for gasoline should come in Q4 19, when VGO will start to occupy a far more important role in refineries due to IMO 2020. But ultimately, this just means that the spread between gasoline and naphtha needs to widen towards year-end. Naphtha values relative to crude can still be weak.
The shale revolution in the US brought about a new era of lower oil prices and impressive production gains, but they have come at the cost of a naphtha surplus. A surge in diesel prices may be needed to correct these imbalances and bring the pace of diesel demand growth down to a more manageable level. Increasingly, it is clear to us that the limits to shale production will not be supply bottlenecks from pipes, export docks, frac crews or trucks. Instead, the limits will come from demand. The paradigms are shifting rapidly, with the question now increasingly becoming one of how much more shale oil the global refinery slate truly process without hitting containment problems in naphtha, gasoline and other light ends markets.