Traditional relationships between crude prices and fundamentals such as inventories and deliveries appear to be breaking down — or at least changing in some significant way. Crude prices have doubled in the last three years and have been above $40/bbl for 16 months. Prices for distillate products, though, have increased much more quickly, boosting crack-spreads to new highs. The factors which now appear to be influencing crude and product prices are distillate crack-spreads, refinery utilisation and middle distillate demand. The upward pull on prices from all of these is currently outweighing the downward pressure from rising crude stocks.
The historical inverse relationship between stocks and crude and product prices has broken down during the last two years as prices have moved to the new higher level. Heating oil stocks in the US, for example, have remained well within the historical range (between 40 and 55 mn bbls) during 2004-2005 yet distillate prices have risen by over 50%, with the 12-month average price peaking at $64/bbl in September this year. Plotting crude prices against US distillate crack-spreads also reveals a new relationship emerging sometime in the first half of 2004 when the two series show a significant correlation which was not present up to 2003. Similar results were found using distillate prices in other regions. No clear relationship, however, was found in any of the three regions between crude prices and gasoline crack-spreads, suggesting that middle distillates are currently a more critical factor in determining crude prices than gasoline.
Product prices have, in the past, had a cyclical inverse relationship with refinery runs (and hence with utilisation), but over the last two years capacity utilisation and product prices have risen in tandem. Last year, in contrast to previous periods, the increase in refinery inputs was driven by a surge in middle distillate demand, particularly in China and the US. Thus, additional output was immediately snapped up by consumers, and prices continued to rise, preventing the usual cyclical downturn.
Further evidence of the upward pressure on prices from middle distillates is provided by a significant link between WTI prices and the ratio of US diesel demand to refining capacity. In the last two years, the two variables show a significant correlation of 92%, with tightening diesel supplies and less spare capacity pulling up both distillate and WTI prices.