Lights Out

Another power outage in Venezuela should start to raise concerns about a total shutdown of Venezuelan oil output. The Venezuelan situation is getting more dire and even Russian planes and troops won’t help the situation if they can’t keep the power on.  Even though Venezuela exports to the U.S. are already at zero, the continuing loss of heavy crude is going to take its toll on U.S. distillate products. That may be one reason the crude oil held strong even after the American Petroleum Institute (API) reported a surprise 1.927-million-barrel increase in crude supply last week. Yet, what should start to disturb the markets at some point, is the fact that we are seeing U.S. supply of distillate fall further below the five-year average as supply dropped by a whopping 4.278 million barrels. The drop means we could be on a path to sharply higher prices if the supply side does not improve. Still, on the product side, the market seems more fixated on gasoline as there is some concern that we will have a tough time getting enough blend ready for what should be a record-breaking travel weekend this upcoming Memorial Day. The supply side issues may look a bit cloudy in coming weeks, as the shutting down and reopening of the Houston Shipping Channel will cause delays and may in effect slow what had been record-breaking U.S. crude oil exports.

Yet some of that oil that the U.S. exported may be coming back. It appears that some Asian crude buyers have been rejecting some U.S. barrels of shale oil because they have been tainted. Bloomberg News reported that two refiners in South Korea -- the top buyer of U.S. seaborne supply -- have rejected cargoes from the Eagle Ford shale basin in recent months due to contamination that makes processing the oil difficult. Because of the way the shale is produced and transported and because it is so light, it picks up impurities rather easily.

Throughout its transit from pipes to tanks and onto vessels, foreign compounds from other fuel or chemicals for cleaning tanks or stabilizing material can leach into the supply and foul up refining equipment. While crude passes through a similar chain in the Middle East too, the risk of impurities is lower because each oil variety typically has its own designated infrastructure. In the case of American condensates, a type of ultra-light oil pumped in shale fields, cargoes can get pollutants such as “oxygenates, metals and cleaning agents,” said Sebastien Bailer, senior vice president at South Korea’s Hanwha Total Petrochemical Co. “That’s causing uncertainty around U.S. oil quality, unlike purchases from the Middle East, where quality is stable,” he said.

This comes as U.S. shale producers are still in pullback mode as rig counts fall and spending is cut. This will cause the U.S. to reduce its number of U.S. shale rigs. Along with the Saudis now signaling additional production cuts, the road to tightening U.S. supply is almost certain. Iran sanctions still loom, and it is clear that every OPEC member needs a higher price so their commitment to cuts will be solid. And do not let the Russians fool you, they want higher prices as well. While we may see a build in crude today in the EIA report, use the break if you get one to get back long. Diesel buyers should use any break to hedge, as well as gasoline buyers. Seasonally, we look like we have another 2 months of upside risk. On top of that U.S. trade talks resume and we will most likely hear positive headlines on trade! The Chinese need a deal badly. Be prepared.