Gasoline supply stumbled badly in Q1 19 but the market should be more concerned about the state of demand. Despite lower retail prices and strong employment in the US, demand is struggling. The market found temporary strength amid the supply disruptions, but the return of supply last month led to a much bigger rebound in stocks than expected. If demand growth does not perk up, this market is headed for a lot of trouble.
The slow start to the driving season stands in stark contrast to the sense of optimism derived from the latest macroeconomic data, which show a US economy still growing, even if the headwinds from trade disputes are starting to weigh on the expansion. Even more surprising, demand remained weak even as nationwide average gasoline prices fell q/q by nearly 30 cents per gallon in Q1 19. If gasoline demand cannot grow in the US when employment is strong and fuel is cheap, then this is a serious problem given the growing overhang of light ends in the world oil market.
The US is not an isolated case here. Gasoline demand shrank y/y in Latin America, Europe and the FSU in Q1 19 and slowed considerably in Asia-Pacific. Supportive trends such as the growing Asian middle class, Europe reverting to buying gasoline-fuelled vehicles and Mexico’s crackdown on fuel smuggling have not been enough to get demand growth up to the pace needed to deal with the oversupply in the market caused by rising refinery conversion capacity and the lightening of the crude slate.
Indeed, many in the market are now pinning their hopes on Tier 3 sulphur standards in the US and IMO 2020 putting a big enough dent in supply to get the gasoline market back on an even keel, but it is not clear these will be sufficient in the face of a demand slowdown. If the economy worsens, the picture could get dire quickly.
If global gasoline demand growth cannot accelerate over the next six months, the coming year is likely to be one of severe pressure on gasoline cracks. New refinery additions in Asia (which are gasoline-biased plants) and the Middle East, combined with growing conversion capacity worldwide and a lightening crude slate will boost gasoline yields even as some VGO is diverted to the marine fuel pool. Yet the growth in refinery runs we expect next year mean that whatever VGO is pulled into VLSFO is going to be balanced by new supplies of VGO from higher crude runs.
In the end, supply growth is all too easy to achieve given the lightening of the crude slate. Even in the best of circumstances when IMO 2020 is diverting VGO from the gasoline pool at the same time as Tier 3 rules are limiting octane output in the USGC, gasoline supplies will keep growing. This means that gasoline markets will remain vulnerable to slower-than-expected demand growth. Efficiency appears to be winning the race in the developed world and while demand growth East of Suez is impressive, it is not enough. If demand growth stays the way it has been over the last year, we will be discussing Atlantic basin refinery closures sooner rather than later.