I landed in New York after a 24-hour flight from Asia on Friday, only vaguely aware when I left that there was a monster storm looming for the US East Coast. The long list of emails I received as soon as I turned on my phone got me informed quickly, none more so than a note from economist Phil Verleger, a subsequent phone call with him on the drive home, and then this week’s publication of his “Notes at the Margin” report.
He sees the impact of Sandy as big….very big. Here are a few excerpts from this week’s report.
“The East Coast petroleum market faces a catastrophic disruption if the storm comes ashore in New Jersey early Tuesday morning. If this occurs, two or three major refineries will cease operations for a significant time due to flooding and power loss. The situation could be worse if the docks used to move products by barge around the East Coast are damaged.” (There are precautionary shutdowns or cutbacks in place as the storm nears, including Hess’ Port Reading FCC plant and Phillips 66’s Bayway refinery.)
He described the East Coast as “totally unprepared for this disaster,” due to its low inventories. And the culprit here? “This has occurred in large part thanks to the efforts of Obama CFTC appointees Gary Gensler and Bart Chilton to curb the nonexistent impact of speculation on petroleum prices. Their efforts have discouraged or prevented passive investors and speculators from accumulating long positions in distillate and gasoline, which has pushed markets into backwardation.”
(At this writing, the November-December heating oil backwardation on NYMEX is about 3 cts/gallon; in RBOB, it’s close to 11 cts, which is huge.)
Because of the low inventories, “the bidding for the dregs that remain will send product prices to record levels.” He gets a swipe in at his two least-favorite CFTC commissioners by arguing that Sandy should be renamed Bart or Gary.
Phil makes an argument he has been making repeatedly in recent months: that with companies like ExxonMobil out of the East Coast, “ownership of terminal facilities and tanks has been transferred…to firms such as George E. Warren, Gulf Oil and even Delta Airlines. Few if any of these firms will hold significant inventories today without offtake contracts with buyers or contango in the futures markets.”
The numbers truly are stark. According to the Energy Information Administration, PADD I gasoline inventories hit their recent low at approximately 45.1 million barrels in the first week of October, having risen slightly since then. The corresponding weeks in the prior three years showed inventories of 53.1, 55.6 and 58.6 million barrels, respectively. For distillates, the drop is even more stunning. Stocks in the most recent report for PADD I were 39.5 million barrels. In the prior three years in the corresponding week they were 58.3, 75 and 74 millon barrels. Even in 2008, when companies were dumping stocks like crazy in the wake of the fiscal crisis, they were 48.4 million barrels.
What Phil thinks will fix all this will be a waiver of the Jones Act, allowing non-US flagged vessels to take supplies from the Gulf Coast (assuming full capacity on the Colonial Pipeline) to bring product up to the East Coast.
(An addendum: one way of looking at the storm is that it will cause an enormous drop in demand, which could offset some of the issues spelled out by Phil Verleger. Analyst John Kilduff’s daily report today addressed that issue: “Traffic reports this morning in New York cited near ghost town conditions on the highways and bridges.” Over the years, these disruptions are usually bearish for oil and refined products, but equities can get a lift, due to the fact that the necessary rebuilding and replacement of vehicles can be somewhat stimulative.”