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EnergyFuelNews

The oil price war is on; what that means for buyers of diesel

Oil markets are plummeting as the business week opens, and it’s instructive to look at past Saudi-led price wars to see where prices may be heading. 

After the collapse last week of the talks between OPEC and a non-OPEC group led by Russia, Saudi Arabia let the world know it was planning on pulling the sword out of its sheath and launching an all-out price war. From various reports, it was doing this in two ways. 

First, it is planning on taking its production up to over 10 million barrels per day (b/d) from its most recent level near 9.7 million b/d. This may not seem like much, but remember that it would be doing so at a time when oil demand is collapsing because of the slowdown in economic activity created by the coronavirus. The always conservative International Energy Agency has predicted a drop in demand of 90,000 b/d this year, but that’s far less than what other analysts have projected. Several are seeing declines measured in hundreds of thousands of b/d. Note that demand generally increases every single year and a decline is extremely rare. 

The second step Saudi Arabia is taking is to slash its prices. Saudi Arabia prices its oil as a differential to key benchmarks: Brent in Europe, a basket of crudes in the U.S., etc. Each month it sets a closely watched differential to those benchmarks.

Over the weekend, Saudi Aramco, the state oil company, reduced that differential by $6/b, believed to be the biggest cut ever. That is the move that is most important to consumers of oil products like diesel. So we’re talking about trucking companies and railroads.

The move smacks of what Saudi Arabia did in its 1985-1986 price war. At that time, the Saudis undertook their “netback” strategy.

The strategy was complicated. It involved setting a price formula for its crude that essentially guaranteed refiners a profit. The result was that even as the price was collapsing, which might usually lead to a reduction in output at refineries, they kept chugging right along producing plenty of product. Why not? They were essentially guaranteed a solid margin through the netback formula.

The result was plenty of crude on the market being bought by refiners and plenty of product coming out of those refineries. The result was that from a high price of about $31/barrel just after Thanksgiving 1985, the price of WTI on the then-NYMEX contract bottomed out at $9.95/b on April 1. The price of WTI did not consistently move back above $20/b until June 1987. 

By slashing the differential in their price formulas, Saudi Aramco is trying to do much the same thing, albeit without the guarantee. But the differential is supposed to reflect what is going on in the market for that particular grade of Saudi crude. Across-the-board cuts of $6 to every market in the world doesn’t do that. It’s designed to make its crude cheap and attractive to refiners. And it’s a spur to have them run lots of crude and make lots of products.

That’s where it’s good news for most consumers of diesel. When markets plunge like this, refinery margins tend to – not always but often – come down also and refiners start to cut back. But in the summer of 1986, crude oil inputs in the U.S. were above 13 million b/d for most of the season. A year before, prior to the netback pricing, they weren’t above 13 million b/d for even one week. 

The Saudi price formula cut very well could mean that refiners who might otherwise be facing sliding margins that lead to cutbacks – and the start of a price recovery – instead might be greeted with increasing amounts of supply as refineries ramp up to run the cheaper Saudi crude. There’s only so much of it in the world and not everybody can process it. But other price formulas will need to adjust to stay competitive. 

Markets early Monday were not reflecting the idea of a market awash in products from refineries gorging on cheap crude but that’s not surprising. The first market reaction is always going to be in the price of crude because it is not just a feedstock into a refinery; it’s also a major financial asset. 

At approximately 10 a.m., WTI and Brent were both down about 19-20% from Friday’s settlement, but both had climbed off their earlier lows. For example, WTI did touch $30/b dead-on overnight. But by Monday morning, it was $33.21/b, near the highs of the trading session that kicked off Sunday at 6 p.m. Eastern. 

Ultra low sulfur diesel (ULSD), meanwhile, was down 16.4% to $1.158/g, a drop of 22.72 cents. If the market were to settle there today, it would be the lowest settlement since March 10, 2009, when markets hit their lowest point following the fall 2008 start of the fiscal crisis.

When will truck drivers see this benefit? Wholesale prices will be reacting to this today. The market for fuels at the wholesale level is extremely competitive and a supplier of wholesale diesel cannot afford to be uncompetitive with broader trends.Their prices will be slashed. 

Retail is a different matter. Owners of retail outlets, from the mom-and-pop station to the biggest truckstop chains, are going to hold off on declines as long as they can. The spread between retail and wholesale diesel prices that is reflected in SONAR’s FUELS.USA data series will reflect just how slow – or fast –  retail numbers are coming down relative to wholesale declines. In the short term, it’s likely the number in the data series will soar. These drops in market prices are practically unprecedented and retailers are not wired to make drastic cuts in their prices. 

How long might this decline last? Without offering an opinion on Saudi-Russian relationships, it’s instructive to note what happened with the Saudi-led price wars of the past. 

In the 1985-1986 price war, the decline from the highest settlement before the decline began and that April 1, 1986 date mentioned earlier was about 66%. It also took just five months.

In the 2014-2016 price war, when Saudi Arabia turned its guns on the U.S. shale sector (unsuccessfully), the drop from top to bottom took a lot longer, about 19 to 20 months for a drop of 75%. That saw the price of WTI decline from just over $100 at the end of July 2014 to $26.21/b on February 11, 2016.

If we take the midpoint between those two percentages, and apply a 70% decline to the recent high WTI settlement of $63.05/b, you’re looking at a price of $18.70/b as a bottom. But that’s just math; there’s a lot more to markets than that. 

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John Kingston

John has an almost 40-year career covering commodities, most of the time at S&P Global Platts. He created the Dated Brent benchmark, now the world’s most important crude oil marker. He was Director of Oil, Director of News, the editor in chief of Platts Oilgram News and the “talking head” for Platts on numerous media outlets, including CNBC, Fox Business and Canada’s BNN. He covered metals before joining Platts and then spent a year running Platts’ metals business as well. He was awarded the International Association of Energy Economics Award for Excellence in Written Journalism in 2015. In 2010, he won two Corporate Achievement Awards from McGraw-Hill, an extremely rare accomplishment, one for steering coverage of the BP Deepwater Horizon disaster and the other for the launch of a public affairs television show, Platts Energy Week.

2 Comments

  1. Noble1 suggests SMART truck drivers should UNITE & collectively cut out the middlemen from picking truck driver pockets ! UNITE , CONQUER , & YOU'LL PROSPER ! IMHO says:

    Contrarily to what is being reported in the video above the article , there was an oil glut BEFORE the coronavirus struck . The coronavirus did not create an oil glut , it simply contributed to it due to a lack in demand that had already occurred .

    I repeat ! All this talk about pump prices wouldn’t have an effect on a trucker’s bottom line nor would the trucker care about pump prices if truckers UNITED and created an Alliance which had a trading division which trades the markets .

    The cost of fuel for a transportation trucking company should be zero + put them in the green on the commodity . So rather than a cost on fuel they would be booking a profit on it .

    But hey now , we wouldn’t want truckers to know that now would we , LOL !

    If you could eliminate the cost of fuel plus reverse the cost into a profit , what effect could you have on rates ? That’s one element that could be used to “conquer” and obtain market share over your competition while eliminating your competition . You use that diminished cost & increased profit to increase truck driver pay while slashing rates .

    In my humble opinion .

    Note: Noble1 “suggests” SMART truck drivers should UNITE & collectively cut out the middlemen from picking truck driver pockets ! UNITE , CONQUER , & YOU’LL PROSPER ! IMHO

  2. Noble1 "suggests" SMART truck drivers should UNITE & collectively cut out the middlemen from picking truck driver pockets ! UNITE , CONQUER , & YOU'LL PROSPER ! IMHO says:

    Quote :
    “If we take the midpoint between those two percentages, and apply a 70% decline to the recent high WTI settlement of $63.05/b”

    Wow talk about speculating by picking numbers & calculations out of a hat !

    By the way the WTIC low according to the historical chart I’m looking at was not $26.21 as the author quoted .

    Where does the author come up with $63.05 WTIC price ??? The recent WTIC price should be Friday’s March 6 2020 closing price of $41.28 before the Saudi oil war was declared over the weekend according to the author’s example . That would suggest a low of approximately $12.38 per barrel which would make a little more sense pricewise by using the author’s “hypothetical” 70% calculation , in my opinion . It would also be within the 1980 &1998 price pattern window in the uptrend between 1910 & 2008 .That being said , I’m aiming at the lower end of price within that window between 1986 & 1998 .

    However, I don’t know why the author would use such hypothetical numbers and hypothetical percentages .

    Perhaps I’m misinterpreting the author’s “hypothetical math” example . I like the rough estimate of the $12ish price range though . We’ll see as the pattern further develops to hone in closer on a potential bottom price that would be more accurate .

    For now my window is quite large with a rough estimate between approximately $6ish & $12ish . With an average of 9ish , LOL !

    IMHO

    Due to some clown complaining about my headline next to my moniker I’ll add on a final closing note to my comment in case Freightwaves decides to side with his/her complaint due to misinterpreting it as an advertisement rather than a suggestion .

    I tell you these days in this trucking industry we appear to have some real special people on this planet who don’t want truckers to UNITE and fear that we do . Obviously the “complainer” is a middleman , LOL !

    NOTE : Noble1 “suggests” SMART truck drivers should UNITE & collectively cut out the middlemen from picking truck driver pockets ! UNITE , CONQUER , & YOU’LL PROSPER ! IMHO

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