Oil analysts at crude oil research firm HFI Research believe that U.S. refining margins are leading oil prices higher, and that a second wave of the epidemic and new restrictions do not appear to be hitting demand for crude oil.
The higher refining margins are reflected in one major piece of data – the crack spread. In the oil industry, refinery profits are directly tied to the difference between the price of crude oil and the price of refined products – gasoline and distillates (diesel and jet fuel) – a spread known as the crack spread.
The 3:2:1 crack spread is near several-month highs, indicating that refinery margins are increasing.
As for crude oil demand, the U.S. Energy Information Administration’s EIA crude oil reserves report released last Wednesday (Dec. 23) showed strong demand for crude oil and total crude oil reserves of more than 10 million barrels.
HFI Research notes that even non-experts in the oil industry can see that the recent surge in new crown cases has not really dampened crude oil demand. Theoretically, the surge in new crown cases would hinder the recovery in oil demand, but as it turns out, U.S. oil demand has barely declined.
The same is true for Europe. Despite new European government restrictions on travel, refining margins, a substitute for refined oil products, are beginning to rise, and refining margins are a key leading indicator of stronger-than-expected demand.
Here are HFI Research’s latest forecasts for U.S. oil demand.
HFI Research notes that oil extraction follows the cycle of.
“Demand recovers → refining savings decline → refining margins improve → crude oil production increases → crude oil savings decline → crude oil prices rise.”
As long as this pattern remains valid, then there is hope that oil prices will continue to grow. But the question is, can demand, which is not currently taking a hit, continue to grow in the future? Or, on the other hand, will demand start rising again when the embargo is lifted?
HFI Research says that theoretically there should be an increase in oil demand, but nothing is absolute and the reality of the market may be different from the theory.
In HFI Research’s view, the easiest way to measure the current recovery in demand is to focus on refining margins. If refining margins continue to rise, then demand from the demand side will also rise. Once refining margins reach a certain level, refinery production will rise, crude inventories will decrease and oil prices will move higher.
On the global crude oil reserves front, the latest data shows further reductions in both visible and floating reserves, and HFI Research believes that if market demand maintains its current rate of recovery and inventories maintain their current rate of reduction, all remaining visible reserves are expected to be emptied by the second quarter of 2021.
For now, the recovery in oil demand has been surprisingly better than expected, HFI Research said. Despite the implementation of new restrictions, demand has not fallen significantly, suggesting that the recovery in demand is actually better than expected. This will affect refining margins going forward, and if so, crude oil prices will continue to rise.
WTI crude will also hit a certain level and stabilize once the excess inventories are cleared, at which point oil production will increase.
HFI Research’s conservative forecast for WTI crude oil prices is $50 per barrel, and the agency believes that for this level of oil prices, energy stocks are currently cheap and demand is strong, and investors should increase their holdings of energy stocks.
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