In the final quarter of 2018, the price of crude oil plunged. The NYMEX crude oil market traded to its highest price in 2018 at $76.90 per barrel at the start of Q4 2018. By the end of December, the price had declined to 42.36, a drop of 44.9% over the three months.
We are now in the final quarter of 2019, and it is starting out a lot like last year. As Yogi Berra would have said, it seems like “déjà vu all over again.”
The stock market began to sink on October 1 and selling picked up steam on October 2. Crude oil was leaning towards its technical support level at just over $50 per barrel. Time will tell if the coming three months will be a repeat performance of last year, or if the market has something else in store for participants. One thing seems inevitable, we are going to see lots of price volatility across all asset classes in Q4, and crude oil is no exception.
On September 14, Iran’s fingerprints were all over the attack on Saudi production that took out 50% of Saudi output and 6% of the world’s supplies of petroleum, temporarily. There had been no retaliation for the attack as of the end of last week. Iran continues to be a factor that underpins the price of the energy commodity, and that is likely to continue.
Meanwhile, the levels of crack spreads for gasoline, and distillate products have been rising since early September. Rising crack spreads are no guaranty that the price of crude oil will follow their trends. However, they are a sign of demand for energy as product prices outperform the raw energy commodity. Valero Energy Corporation (VLO) is in the business of refining crude oil into products. The company’s earnings are a function of the level of crack spreads. When they move higher, profits tend to rise.
Crude oil falls to the bottom end of its trading range
With the legacy of the fourth quarter of 2018 facing the oil market, the price of the energy commodity has been dropping during the early days of October 2019.
As the daily chart of November crude oil futures highlights, the priced traded to a low at $50.99 on Thursday, October 3. The low was just 51 cents above the August 7 low. Crude oil has dropped steadily since the September 16 high at $63.89 when the drone attack on Saudi production caused a price spike to the upside. At the end of September, Saudi output was back at capacity levels, according to Aramco.
The technical picture provides conflicting signals for the price of the energy commodity. The daily chart shows that price momentum and relative strength metrics have declined into oversold conditions. Daily historical volatility has returned to just under the 24% level at the end of last week. The metric moved to a high at over 75% in the aftermath of the attack. While the market looks ripe for a bounce, open interest has increased from 2.030 million to 2.132 contracts since September 25. Falling price when the number of open long and short positions rise is a technical validation of the current bearish price action.
While the price of oil is trending to the downside, processing spreads have gone in the opposite direction.
Gasoline cracks rally during the offseason
We are now in the offseason for gasoline demand. The peak time of the year for gasoline is during the spring and summer seasons. Gasoline crack spreads provide a window into demand for the fuel. Since the beginning of September, the gasoline refining spread has bucked the trend in crude oil.
The daily chart of the November gasoline crack spread shows that it moved from $6.97 on September 4 to a high at $13.64 per barrel last week. The spread was at over the $13 level on Friday, October 4. The spread is around the same level as last year at this time, with the price of crude oil around $20 per barrel low. However, the appreciation in the gasoline processing spread is a sign of a robust demand for gasoline. The fuel has outperformed the price of oil over the past month.
Distillate spreads move higher
Heating oil is a distillate fuel. The heating oil futures contract serves as a proxy for other distillates like diesel and jet fuels. Distillates display less seasonality than gasoline. The heating oil crack spread has also appreciated over the past month.
The daily chart of the nearby November heating oil crack spread moved from a low at $21.56 to a high at $27.09 per barrel last week and was trading at around the $26.80 level on October 4. Last year during the same week, the distillate processing spread was around the same level with oil $20 high and on its way down.
The price action in the gasoline and heating oil crack spreads has been supportive of the price of oil, but the energy commodity has experienced pressure.
Inventory data reflects seasonal trends
Meanwhile, the latest inventory data supplied few surprises when it comes to oil products as both reflect seasonal influences as of the week ending on September 27. Last week, the American Petroleum Institute reported that gasoline stockpiles rose by 2.133 million barrels, but the Energy Information Administration said they decreased by 200,000 barrels. The week before, the API and EIA said that gasoline stocks rose by 1.9 million and 500,000 barrels, respectively.
As of September 27, distillate stocks fell by 1.741 million barrels according to the API, and the EIA said they declined by 2.4 million barrels. The week before, both reported respective declines of 2.2 and 3.0 million barrels respectively.
VLO will benefit from higher crack spreads
The recent strength in processing spreads could provide support for shares of those companies that refine crude oil into products. Valero Energy Corporation will report its third-quarter earnings, and market consensus expectations are for $1.62 per share. VLO has beat consensus estimates over the past four consecutive quarters.
Meanwhile, the overall weakness in the oil market and oil-related equities has VLO shares trading appreciably lower during the first week of October in 2019 compared to last year at this time. During the week of October 1, 2018, VLO traded in a range from $112.55 to $120.72.
As the weekly chart shows, last week, VLO traded in a range from $81.30 to $86 per share and closed the week at just over the $84 level, almost $30 per share below the lows during the same week in 2018.
VLO has a market cap of $34.561 billion and pays shareholders a dividend of 4.35% at $84.14 per share on Friday, October 4. The recent action in both the gasoline and heating oil crack spreads will likely support earnings for VLO. At the same time, since the company is also involved in ethanol production, the recent move in ethanol prices could also bolster profits.
The weekly chart shows that the price of nearby ethanol futures illustrates the price of the biofuel rose from $1.252 in mid-August to a high at $1.573 last week. Ethanol was just over the $1.40 per gallon level on Friday, October 4.
Last December, VLO shares fell to a low at $68.81 per share as the pressure from both the stock and crude oil markets weighed heavily on the price of the shares. The gasoline crack spread fell to a low at $3.64 per barrel in December 2018, which was the lowest level since 2009.
At $84.14 per share, VLO is a lot closer to last December’s low than the price the stock traded at this time last year. I would be a scale-down buyer of VLO shares on any price weakness over the coming weeks and throughout the final quarter of this year. The over 4% dividend is an attractive yield for shareholders as they wait for capital appreciation in the oil refining stock.
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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.
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