Over the last few weeks, I’ve provided a few different views of oil market fundamentals with a focus on the large scale picture at work within North America. In this piece, I am going to focus on the latest development in the petroleum markets and the ramifications for North American oil (USO). It is my belief that the news out of Venezuela is not substantial enough to roil the market and the bearish thesis remains in place, with or without Venezuelan crude reaching the United States.
Late last month, the United States imposed sanctions on PDVSA. These sanctions effectively:
- Banned imports of Venezuelan crude to the United States (Source)
- Banned exports of diluent from the United States to Venezuela (Source)
While it is hard to attribute market movements to individual fundamental and technical catalysts, it was said by main pundits, traders, and analysts that the rally leading up to the announcement was in anticipation of looming sanctions. While there may be some truth to this, it’s in moments like this where investors can achieve attractive returns through examining the underlying thesis which appears to be driving market action in light of the true fundamentals.
Simply said, Venezuela really is just a flash in the pan for the overall United States’ petroleum industry. As you can see in the chart below, exports from Venezuela account for very little of the overall imports into the United States.
Prior to the sanctions, Venezuela exported an average of about 500-600 MBD to Gulf Coast refiners. While this may sound like a substantial amount of crude oil, it represents a pretty small fraction of total imports into the United States as seen in the following chart.
In terms of overall imports, Venezuela only represents about 9% of imports into the United States. While 9% may sound substantial, this volume can easily be made up by a few different sources.
With Venezuelan crude, the average barrel imported into the United States was largely heavy and sour. Conveniently, Canadian production of WCS and other major grades largely is similar in API and sulfur content. As you can see from the following chart, the United States continues to import greater and greater quantities of crude oil from Canada.
In fact, imports are so strong that not only are Canadian imports average more than 6 times larger than Venezuelan imports, but over the last year Canadian imports have increased almost one and a half times as much as the total amount of crude imported from Venezuela. If that weren’t convincing enough, crude by rail exports from Canada has gone parabolic.
In other words, even if the pipelines from Canada to the United States are full, rail continues to clear and we are liable to continue to see surging exports by rail, especially while the WCS-WTI differential remains wide.
As you can see from the analysis above – it generally pays to ignore the popular opinion of the day and look at the fundamentals. The United States refining industry losing half a million barrels of imports by water can be easily replaced with very similar barrels which can be had at affordable costs. Yes, the bearish thesis remains solidly in place.
As you can see in the following chart, oil balances continue to remain oversupplied with inventories over the 5-year average.
This increase in crude stocks comes in the face of strong demand drivers. First, refining utilization remains strong for this time of year.
And second, crude exports continue to remain strong with a sustainable low seen around the 2 MMBD level for the foreseeable future.
The main culprit impacting the supply and demand equation is of course production. As you can see in the following charts, production continues to surge with new levels seen almost every month.
What is particularly noteworthy about this production is that the lion’s share is occurring in the Permian Basin. As seen in the following chart, the Permian presently accounts for almost half of the drilling activity in the United States.
Not only is production strong in the Permian, but the backlog of DUC wells (drilled but uncompleted) shows that there is substantial latent production waiting to come online.
When these DUC wells are finally completed, production can surge rapidly, bringing even more supply online. Given the Permian’s proximity to the Gulf Coast as well as numerous pipeline projects underway, the Gulf Coast is liable to see increasing supply for the foreseeable future.
Simply said, the United States is oversupplied. Investors and traders were hoping that Venezuela would be the golden ticket that would bring balance to the market…but this simply isn’t going to be the case. A decrease in waterborne sour imports can be easily offset by Canadian grades like WCS which can reach U.S. Gulf Coast refineries by both rail and pipeline.
While the market remains oversupplied, investors and traders should be treating every rally as a selling or shorting opportunity. The only feasible short-term savior I can see for the outright price of WTI would be driving season which starts in May. Until then, bearish fundamentals will dominate the crude markets and investors should look for opportunities to sell and sell short.
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.