Gasoline demand isn't what it was expected to be this summer. When refiners saw strong early demand in late winter, they figured a similarly strong summer would follow. This prompted increased gasoline production but the demand lost its wind and inventory soared. The effects of this overproduction now weigh on the crude oil markets and might be felt over the course of the next several months through lower prices.
So, what happened with gasoline demand?
Here's a look at a comparison between last year's gasoline demand and this year's. Pre-spring demand this year was exceptionally strong (note the high slope of the initial demand segment) owing to low gas prices. This set up an expectation of similarly strong spring/summer demand. But the slope of the demand curve abruptly changed in the March-April timeframe after prices came off their lows. The demand slope remained below last year's and the demand is now only just slightly greater than the peak demand of last year.
How did we end up with a gasoline surplus?
We see that average gas prices have remained relatively low this summer, being less than the year-ago prices throughout. Consequently, we might expect the overall demand to be higher throughout the summer, and we do see this. It looks like the very low prices early in the year led to the high slope.
I suspect that refiners saw the early strong rise in demand during the February-March timeframe and expected the demand to continue with the same slope. As we see now, it didn't. Even with consistently low gas prices.
The result of the gasoline overproduction relative to actual demand led to flat inventories, or equivalently, seasonally-adjusted gasoline stock buildups. This continued until a couple of weeks ago when refiners decided to enter maintenance early and change over from summer to winter blend because they had too much inventory.
We can see the seasonal inventory drawdown come early this year on the chart, during the last two weeks. We should expect to see gasoline inventory drawdowns for the next month or two until the winter blend comes on line.
Why did the demand slope change? There are a few possibilities.
We are seeing that extremely low gas prices are necessary to make significant short-term changes in driving habits, and these appear capped. The largest demand changes came when gas prices were lowest, which occurred around March. Subsequently, modest gas price changes led to modest demand changes for the rest of the season so far. We also seem to be adjusting to the low gas-price regime and require much lower gas prices to push demand to much higher levels.
The relationship between the price of gas and vehicle miles traveled per capita has different behavior pre- and post-Great Recession. This is shown in the chart below through May 2016. As expected, high prices tend to reduce travel and vice versa. But there was also a significant reduction during the Great Recession that seemed to rebaseline the relationship. We have become more sensitive to price and seem to be driving less regardless of price since the Great Recession.
Source: Advisor Perspectives
Consequently, we may also be hitting a new limit on driver miles traveled that is essentially price insensitive. Changes in driving habits are potentially starting to become marginally incremental owing to the Great Recession and possibly even the longer term presence of lower prices. It is relative prices that are important to short-term demand changes now, not so much absolute prices to which consumers appear to have adjusted.
Longer-term factors other than the price of gasoline price are also impacting driving. This includes a combination of economic and socio-economic factors.
A weakening economy is sure to affect driver behavior. Last quarter we experienced a slowdown in GDP. This likely had a negative impact on gasoline demand.
And then there are longer-term reasons that seem to have been strengthened by the Great Recession. According to Advisor Perspectives:
In the big picture, there are profound behavioral issues apart from gasoline prices that are influencing miles traveled. These would include the demographics of an aging population in which older people drive less, [unemployment factors], the ever-growing ability to work remote in the era of the Internet and the use of ever-growing communication technologies as a partial substitute for face-to-face interaction.
We'll have to see the impacts of these various contributors in the coming months and quarters to ascertain their effects on the upcoming demand side of gasoline. Also, the medium-term impact of refineries shifting to winter blend early is uncertain but could very likely lead to additional crude oil inventory in late winter, when such gasoline stocks are sufficient.
These types of events could explain the seasonality factor that have been previously observed in the crude oil inventory data. Nevertheless, this is a complex, dynamic situation that will undoubtedly add uncertainty to the crude oil markets.
In total, I suspect the events leading to the current situation will produce another gasoline-demand-induced crude-oil inventory buildup early next year. This, coupled with high distillate inventories, should keep crude oil inventories high and the price of oil in check until then.
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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.