A Place Where There's No Oil Glut

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Includes: OIL, SCO, UCO, USO, UWTI
by: Daniel Jones

Summary

When people think about the current oil glut, images of the world overflowing with oil comes to their minds.

Although there are some categories in a state of glut right now, the data seems to indicate that distillate fuels, while elevated, are not experiencing a glut.

This is the second category (the other being motor gasoline) where I concluded that a glut doesn't seem to exist.

As the market does sort out the oil glut, investors should keep an eye out on distillate fuels.

With oil and petroleum product inventories hovering near all-time highs, many investors may assume that the glut that exists is spread everywhere. While this is an easy line of thought to try to rationalize, I showed in a previous piece that the market seems to have overlooked motor gasoline, one petroleum product category that is in anything but a glut at the moment. After coming to the realization that the picture for gasoline doesn't look all that bad, I figured it may actually be a good idea to look at some other categories in this space to see whether or not the domestic glut is being exaggerated. What I found is that, although the picture for distillate fuels isn't as appealing as it is for motor gasoline, it's hard to claim that this category of product is in any meaningful glut.

A look at distillate fuels

Distillate fuels, as presented by the EIA (Energy Information Administration), are broken down into a number of subcategories. The single largest one represented in the organization's data is diesel No. 2 for On-Highway sales, which goes largely to semi-trucks. During 2014, the most recent year for which complete annual data are available, this subcategory accounted for nearly 63.4% of all distillate fuel consumption, which came out to roughly 924.91 million barrels or 38.85 billion gallons. The second-largest subcategory was Residential, which accounted for only 6.3% of all distillate fuel consumption for the year.

Interestingly, as the economy changes and as new technologies develop, the consumption patterns of distillate fuels are changing drastically. In the graph below, you can see a breakdown of all distillate fuel subcategories with the exception of On-Highway demand (including On-Highway demand in the graph makes the other lines look mostly flat). Of these areas, consumption has been mostly declining, primarily in the Residential, Commercial, Other, and Military subcategories, which saw consumption fall by 53.7%, 54.1%, 100%, and 68.5%, respectively, between 1984 (the furthest back for which data exist) and 2014. While some areas saw growth, such as the Oil Companies, which grew consumption by 148.2% during this time frame, the strongest contributor was On-Highway, which grew by 129.4%.

It is really only because of On-Highway demand rising that distillate fuels have been able to stay relevant but, because of strong economic growth (and in spite of two recessions), this has pushed total consumption up by 34.3% (if you include estimated 2015 data) from 1.09 billion barrels to 1.46 billion. Looking at the total increase, which can be seen in the graph below, it's clear that distillate fuels are still very much relevant today. In fact, after demand bottomed out in 2009 following the last crisis, aggregate demand through 2015 is estimated to have grown by 13.3%, which comes out to an annual increase of 2.1%.

There may not be a glut in distillate fuels

Now that we know the significance and growing demand of distillate fuels, I want to answer the question of whether or not a glut seems to exist in this space. Based on my own results, the answer appears to be no, but I will leave that up to you to decide. You see, while inventories of distillate fuels currently stand at 160.5 million barrels, 20.9% above the 132.7 million barrels seen the same time a year earlier, the picture isn't so clear-cut.

One valuable metric in this space to look at is "days of consumption". Over time, as inventories rise and fall and as consumption rises or falls, the number of days the U.S. has stored up will also change. In the graph below, I took total consumption per year (assuming that 2015's estimated demand totaled 3.96 million barrels per day and assuming that it will average 4.03 million barrels per day this year, pursuant to the EIA's Short Term Energy Outlook), divided it by the number of days per year (adjusting for leap years), and then divided that sum by the amount of distillate fuels that have, historically, been in commercial storage. The result is that the picture doesn't look all that bad.

In 1984, the number of days of distillate fuel consumption stood at 54.2, the highest in the data presented. This means that, if all production of distillate fuels vanished, we would have 54.2 days worth of supply available before completely running out. The general trend, while volatile, has been toward fewer days of consumption being on hand, but the recent and large uptick in inventories has pushed this metric higher. Based on my own calculations, using EIA data, current inventory levels imply that we have 39.8 days worth of inventories in hand, which is even with the 39.8 days that we've averaged every year starting in 1984.

Interestingly, I have to wonder if the EIA is, itself, making a mistake somewhere because they also report this metric and, as of the time of this writing, it stands at 47.4, implying that the U.S. has 47.4 days worth of excess distillate fuels in storage. I don't understand the disparity since my data is derived from the EIA's Short Term Energy Outlook and from its Weekly Petroleum Status Report, but even if the EIA's numbers are correct, the difference is minimal. At this elevated level, 4 out of the last 31 years (the most recent being in 2009) saw distillate fuel levels stand higher, using this metric, than where they are today. That implies an occurrence rate of 12.9%. Using my own calculations from the EIA's data, the number comes out to 14 years, which implies an occurrence rate of 45.2%.

The only other explanation that comes to mind relates to storage capacity. If storage capacity is nearly full, it wouldn't matter so much what inventory levels are, since nearing maximum storage capacity would necessitate a firesale of product. This, however, is not the case. Using the same methodology from a previous article of mine but updating the data to reflect a recent uptick in inventories, commercial storage of distillate fuels stands at just 62.5% full. This isn't even remotely close enough to justify panic.

Takeaway

Based on the data I collected, it seems as though distillate fuel inventories are elevated but they aren't at a level that constitutes a glut, very similar to how motor gasoline is (though it was not even elevated when I analyzed it last). This does not mean that other categories like crude oil aren't in a glut, but what it does mean is that investors probably shouldn't panic by thinking that every single fuel category is behaving similarly.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.