OPIS Analysis: Markets Much More Vulnerable to Hurricane Impact in 2019

When the subject is tropical weather, the benchmark reference for measuring hurricane impacts is Hurricane Katrina, much as it is for its impact on U.S. consumers. But a close look at contemporary petroleum statistics and logistics suggests that it might not take a Category 3-5 hurricane to provoke explosive price moves or supply disruptions in crude and refined products.

The U.S. population has grown in the nearly 14 years since Katrina, with current estimates of some 327 million residents compared to about 295 million in summer 2005. Much of that growth has come in Sun Belt states that are served by U.S. Gulf Coast refiners.

That refining capacity has also grown considerably since 2005. U.S. input (crude and feedstock) totaled 16.8 million b/d in the weeks and month ahead of Katrina.

That national figure just crossed 17.8 million b/d this week, and the Gulf Coast counts for virtually all that 1 million b/d of growth. And notwithstanding talk of high Gulf of Mexico temperatures and a propensity for more active tropical weather, there are plans to add another 500,000 b/d or so of PADD3 output by 2025.

The most significant changes, however, involve ingress and egress of crude oil and refined products. Back in 2005, the U.S. was in the third decade of a ban on exports of U.S. crude. Nowadays, crude oil exports regularly top 3 million b/d, and by the 2020 hurricane season, the figure may rise 50% or more. Sea lanes and ship channels are much busier than they were 14 years ago.

A subtler change comes in closer scrutiny of regional U.S. crude oil production data. For some five years, domestic and international press coverage has properly focused on the explosion in U.S. shale output, with total U.S. crude production approaching 12.3 million b/d recently. That is approximately 118% above the nationwide number in 2005.

But much less attention has been paid to offshore Gulf of Mexico production, which may be threatened by soon-to-be Hurricane Barry in addition to other named storms in 2019. Most Gulf of Mexico production is within a few hours of New Orleans. Additionally, the industry is much more aggressive and vigilant in evacuating and closing rigs than it was 14 years ago.

More specifically, Gulf of Mexico production on federal lands is believed to be right around 2 million b/d (the last estimate came for late April at 1.982 million b/d). From 2010-2014, U.S. Gulf of Mexico offshore output averaged just 1.3 million b/d in the month of July. Ahead of Katrina, the measurement was 1.4 million b/d, but by September 2005 that figure tumbled to just 466,000 b/d.

July or August hurricanes can be particularly devastating since they occur while refiners are still struggling to manufacture summer-grade blends of motor fuel. And against the current backdrop, where global oil demand is exceeding supply thanks to the seasonal demand surge in the third quarter, the impact on gasoline can be amplified. Some of the lower-gravity medium blends of crude could be particularly volatile if storms impact the region in the next few weeks.

Then and Now -- Some Comparative Oil Numbers between Katrina and Barry

In what has to be viewed as elegant timing, commodity analysts at Morgan Stanley put out a July 1 research note on hurricanes. They stated the theme up front, noting that "a hurricane making landfall this summer "could cause a supply shock with more dramatic effects than in the past."

The bank noted (and OPIS data affirms) that typical refinery "cracks" expand rapidly in the wake of hurricane landfalls. Temporary increases in the 3:2:1 crack ranged from 300% post-Katrina to 350% after Hurricane Rita, with moves of 100% after Hurricanes Ike (2008) and Harvey (2017). Historically, Hurricane Harvey's landfall reflects the largest temporary subtraction of refining capability, with the storm removing about 4.4 million b/d of refinery output.

As is typical for merchant banks, the analysis included some commentary on potential beneficiaries in the equity market. Morgan Stanley believes that Midcontinent refineries with less coastal exposure in their networks might be the biggest winners after a landfall event. Delek, HollyFrontier and Marathon are cited as candidates for upside.

An additional wildcard trumpeted by the bank and others this year is the status of the Philadelphia Energy Solutions refinery in Philadelphia. There is talk about restarting the Point Breeze crude unit on the site, but most analysis suggests the refinery won't be contributing any gasoline or diesel in the Northeast in the second half of 2019.

Here are some other potential complications of an active tropical weather season, according to OPIS:

• From 2005 until now, the global shipping business used a 35,000-ppm fuel for marine bunkering. That business is now transitioning to 5,000-ppm in concert with IMO 2020. The last sprint of preparation for that epic change will come in September through November with an active global turnaround schedule.
  
  
• CME and ICE trading platforms are many times more active and dynamic than they were in 2005 or even in 2008 when several hurricanes impacted the Gulf Coast markets. There are many more financial funds trading futures and options. Back in 2005, open interest in unleaded gasoline (RFG) reflected about 175 million bbl of paper interest. At press time, that number was closer to 380 million bbl.
  
  
• Spread trading for crude has grown exponentially in the last 14 years. The consensus view is that a hurricane landfall in Texas or Louisiana would push up coastal and international prices much more than Cushing futures, resulting in a wider Brent/WTI spread. Light-to-heavy crude spreads could be particularly capricious in coming months as well.
  
  
• The first six months of 2019 represented the best first half of any year for rack-to-retail margins since OPIS has been monitoring profits in the sector. Hurricanes tend to destroy demand but render even greater short-term damage for fuel margins. July will be a challenging month for public and private retailers.
  
  
• A hurricane at the Gulf Coast might be more dramatic and long-lasting if there is landfall because of a refining system that already faces shutdown of the 10th largest complex (PES in Philadelphia)and an elevated fall turnaround season ahead of IMO.
  
  
• Hurricanes could alter blending economics substantially. June 2019 saw many markets where the price of ethanol and gasoline blendstock were close to parity. Ahead of Hurricane Barry, ethanol was as much as 75cts/gal under reformulated gasoline in some sections of the country.
  
  
• Export and import numbers for gasoline and diesel could be all over the board as cargoes depart or enter the Gulf of Mexico. Export numbers for refined products were negligible back in 2005, but now typically account for more than 2 million b/d of trade. Watch out for “funky” weekly API and EIA reports.
  
  
• Expect a much more volatile secondary market for Colonial Pipeline line space, where shippers trade rights on that line much like consumers trade tickets on Stub Hub.  A hurricane impact is troublesome for the many companies that have hoarded line space and regularly trade the right to ship barrels on the pipeline.
  
  

--Tom Kloza, tkloza@opisnet.com

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