Gasoline Prepares For The Peak Season Of Demand

About: The United States Gasoline ETF, LP (UGA), Includes: VLO
by: Andrew Hecht

Lows in December lead to a huge rally.

The crack spread tells the bullish story.

The leader in the oil patch.

Good times ahead for refiners.

Valero has lots of upside.

Gasoline is a seasonal crude oil product. People still drive during the winter months when ice, snow, and poor driving conditions make long-distance journeys a challenge. Getting to work is a requirement but driving for pleasure is optional.

The spring, summer, and early fall months of the year are the times when driving is a pleasure, and the mileage tends to pile up on odometers all over the U.S. The driving season in the U.S. officially starts in late May when the kids get out of school, and many people take vacations. It tends to last through the beginning of September, but gasoline demand is typically strong when weather conditions are stable. Gasoline demand also relies on the overall health of the economy. Economic growth increases demand for fuel while contraction can stifle usage.

The price of gasoline can be highly volatile. Since the turn of this century, the price of gasoline traded in a range from 48.5 cents to a high at $3.631 per gallon wholesale. Gasoline is a crude oil product, and it typically follows the price of the energy commodity, but it can deviate widely because of seasonal factors. The most direct route for trading or investing in gasoline is via the futures and options that trade on the New York Mercantile Exchange division of the Chicago Mercantile Exchange. For those who do not venture into the volatile and highly leveraged world of the futures markets, the United States Gasoline ETF product (UGA) provides an alternative.

Lows in December lead to a huge rally

The price of gasoline staged a significant recovery since the late 2018 low.

Source: CQG

As the weekly chart highlights, the price has moved higher from a bottom at $1.245 per gallon wholesale on December 24 to its most recent high on March 13 at $1.8752, a rise of 50.6%. However, the increase was at least partially because of seasonal factors.

Source: CQG

Meanwhile, the daily chart which accounts for seasonality shows the price moved from $1.4254 per gallon on December 26 to $1.8752 or over 31.5% which is a sign of strength in the gasoline market. While the price of crude oil moved higher over the period which supported the oil product, gasoline outperformed the raw crude oil which is the primary ingredient in its production.

The crack spread tells the bullish story

The gasoline crack spread reflects the economics of refining a barrel of crude oil into gasoline.

Source: CQG

As the weekly chart shows, gasoline cracks rose from the lowest level since 2009 at $3.64 per barrel late last year to its current level at $20.29 per barrel.

Source: CQG

The daily chart of the April processing spread shows that the refining margin rose from $12.10 to $20.29 per barrel which shows the strength in demand for the fuel.

The leader in the oil patch

Gasoline has been the best-performing commodity in the crude oil sector since the end of 2018. As the season for peak demand approaches, the current level of the crack spread at $19.31 per barrel is at around the same level, it was trading at last year at this time which was slightly higher than in 2017.

The 2019 driving season will begin to gain momentum as the snow and ice melt across broad areas of the U.S. reaching a peak from Memorial Day weekend at the end of May through the Labor Day weekend in early September. Given the current level of economic growth in the U.S., it is likely that gasoline demand will continue to rise over the coming weeks and months.

Good times ahead for refiners

Those companies involved in processing crude oil into gasoline and other oil products have no direct exposure to the price of the input which is crude oil or the price of the output, in this case, gasoline. However, they are at risk for the refining margin between the input and output or the crack spread. Therefore, the crack spread in gasoline is a real-time indicator for the profitability of refining companies. The rise in the crack spread since late 2018 is highly supportive of rising profits in the refining sector.

As the administration’s chief economic advisor Larry Kudlow always said when he was a commentator on CNBC, “profits are the mother’s milk of stocks and the lifeblood of the economy.” When it comes to the refining business, it is likely that the current trajectory of the gasoline refining spread will support higher prices for the shares of these companies.

Valero has lots of upside

Valero Energy Corporation (VLO) is a leading gasoline refiner, and its shares have been on a rocky path since October 2018.

Source: CQG

As the chart shows, the price of VLO shares plunged from $120.72 in early October to a low at $68.81 in late December. Since then, the recovery in the gasoline crack spread sparked a recovery that has taken the price to over $84 per share as of March 13. Recently, VLO shares suffered a correction that took the stock to a low at $78.55, but VLO came roaring back rallying by around 7% since the March 8 higher low. As long as the crack spread remains strong, VLO and other oil refining companies will continue to print profits.

While refiners will continue to reflect the ups and downs of the crack spreads, the most direct route for an investment or trade in the price of gasoline is via the gasoline futures that trade on the NYMEX division of the CME. For those who wish to trade gasoline but do not venture into the volatile world of the futures arena, the United States gasoline ETF product (UGA) provides an alternative. The fund summary for UGA states:

The investment seeks the daily changes in percentage terms of the spot price of gasoline, for delivery to the New York harbor, as measured by the daily changes in the price of a specified short-term futures contract on gasoline called the “Benchmark Futures Contract,” less UGA’s expenses. The fund invests in futures contracts for gasoline, other types of gasoline, crude oil, diesel-heating oil, natural gas and other petroleum-based fuels. The Benchmark Futures Contract is the futures contract on gasoline as traded on the New York Mercantile Exchange that is the near month contract to expire, except when the near month contract is within two weeks of expiration.

The most recent top holdings of UGA include:

Source: Yahoo Finance

Since late December, April gasoline futures have rallied by over 31.5%.

Source: Barchart

As the chart of the UGA ETF shows, it rose from a low at $22.05 on December 26 to its most recent peak at $29.11 on March 13, a move of 32% which was equal to the rally in April gasoline futures.

With the peak season of demand for gasoline on the horizon, both VLO and UGA could have more upside potential over the coming weeks and months.

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.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.