The Tax Man Cometh

Jim Brown
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Refiners are running scared after crude inventories rose to the second highest level this year. With the tax deadline only 20 days away they are dumping oil as fast as possible.

The EIA reported a whopping -10.6 million barrel decline in crude inventories after a -5.6 million barrel decline the prior week. These were the first declines in over two months. The combined -16.2 million barrel decline is above normal but we do get declines in December. As I have reported before the refiners have to pay personal property taxes on any oil in storage on December 31st. This gives them a huge incentive to refine that oil and push it out into the distribution channels as refined products.

Inventory levels have declined from 391.4 million barrels the week before Thanksgiving to 375.2 million for the week ended December 6th. As you might expect the corresponding inventories of gasoline and distillates has spiked considerably.

Gasoline inventories rose for the third consecutive week after five weeks of declines. Gasoline levels rose +6.7 million barrels, also a huge increase compared to estimates for a gain of +1.7 million barrels. The rise in inventory levels was helped by a -525,000 bpd drop in demand.

The decline in crude was helped by a drop in imports of -947,000 bpd. Obviously refiners don't want to add to their yearend tax problems so they reduce imports until January. U.S. oil production rose to 8.075 mbpd and the highest level since 1988. Inventories at Cushing rose +600,000 barrels even though TransCanada said this week they had begun filling the Keystone pipeline with oil. It will take 3.0 million barrels to fill it before deliveries will start on January 3rd with a goal of 700,000 bpd.

Distillate levels rose +4.5 million barrels after a +2.6 million barrel gain the prior week. Analysts were expecting only a 1.0 million barrel gain. Distillate demand declined by -246,000 bpd and imports fell by -126,000 bpd.

Refinery utilization rose slightly to 92.6% and a level almost never seen this time of year even though refiners are trying desperately to reduce oil levels. Refiners with access to cheaper WTI are probably running near 100% of capacity so they can profit from the huge spread between Brent and WTI. That spread is declining this week but it will fall even further if Iran gets permission to sell more oil. There are rumors that Iran is already offering the oil on the market even though they are limited by the nuclear deal to 1.0 mbpd for export. Once the Keystone pipeline to the Gulf becomes operational in early January that will also impact the spread as WTI becomes available to a broader market.

Note how well the current inventory line (red) in the charts below is conforming to the five-year average over the last several weeks.

Another factor is weighing on crude prices in the USA. Previously Shell had a pipeline to ship oil from Houma Louisiana to Houston Texas (Ho-Ho). This pipeline sent Louisiana Light Sweet (LLS) crude to the Houston refineries. However, with more WTI pouring into the Houston area from the Eagle Ford and Permian the demand declined for the higher priced LLS crude, which was priced closer to Brent since it was available to the same port refineries as Brent imports.

Shell decided to reverse the Ho-Ho to take advantage of the cheaper WTI building up in Houston. In August they halted westward deliveries and began the reversal process. The price for LLS promptly tanked since there was an immediate oversupply in the Louisiana area. Shell expects to have the Ho-Ho reversal completed in early 2014 and the cheaper WTI will then be available all along the Gulf Coast thanks to the oil moving east from the Eagle Ford and Permian and the oil coming down from the Bakken through Cushing. This will further pressure prices for LLS and Brent in 2014.

The CME is considering a new futures contract for LLS with a delivery point of either the Louisiana Offshore Oil Port (LOOP) or the Enterprise Product Partners ECHO Terminal near Houston. The new contract would bridge the gap between Midwest crude (WTI) delivered to Cushing and waterborne crude (Brent) delivered to the Gulf ports. It would value U.S. production capable of being delivered to ECHO or the LOOP as a waterborne equivalent to Brent. With more than 30 companies trying to get an export license for crude this contract would be even more appropriate. While I seriously doubt the government is going to let crude be exported in any large quantity those companies are free to ask. Valero just received a license to export 60,000 bpd to a facility in Canada so anything is possible.

The EIA expects U.S. production to rise from the current 8.08 mbpd to 8.5 mbpd in 2014. That is their average for the year so we can assume something closer to 8.75 mbpd by yearend. That means a drop in imports of crude indexed to Brent of about -750,000 bpd by yearend. We currently import about 7.25 mbpd on average. Of that more than 2.0 mbpd comes from Canada and Mexico. Another roughly 1.0 mbpd comes from Venezuela. The EIA projects imports will fall to 5.8 mbpd by next December. Imports are already falling below our current pace of production.

Reuters Chart - Imports vs Exports

You would have thought a -10.6 million barrel drop in crude levels would have been bullish for prices. Another factor weighing on prices was news from Libya their ports would reopen by this weekend. Libya has more than 1.0 mbpd of light crude exports that have been offline for a couple months because of unrest in Libya and workers strikes and protests at ports and oil facilities. If Libya reopens for business that production will push Brent prices lower. It remains to be seen if the ports will actually open but the military has given some pretty serious warnings in recent weeks about what will happen if the strikes don't end.


There is trouble brewing in the equity markets. The rising confidence that the Fed will begin tapering QE at the December meeting is weighing on equities. With fund managers afraid of losing their bonuses and their gains for the year the indexes are seeing some accelerated selling.

With more than $1 billion in stock for sale at the close of the NYSE today the Dow lost -129 points and closed near the low for the day. Even worse the Russell 2000 closed at a four week low and came close to ending the day under 1100. The Nasdaq gave back -56 points and closed at a two-week low at 4,003 to barely escape closing under that critical sentiment level.

With four trading days left before the FOMC decision there is plenty of time for fund managers to see their bullish resolve weaken and decide to take profits. I would not be surprised to see a day with a major downdraft based on today's closing lows. Winter is coming in the markets.

Jim Brown

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