I'm back at my desk after some business travel, and the item in this morning's batch of news that caught my eye concerns the reliability of the oil industry data collected by the Energy Information Agency of the US Department of Energy. The article in today's Wall St. Journal (subscription may be required) described EIA's methods for tallying oil inventories and other industry data as "antiquated and out-of-date." Nor is the Journal the first to draw attention to this issue. Last year US News & World Report published a story that reached a similar conclusion as the Journal: the EIA doesn't have enough money in its budget to do both the work expected of it and improve its processes. Yet I can't help wondering whether the real issue we ought to be focusing on is improving the accuracy of the oil data, or getting the data for other, increasingly important energy sources up to at least the same level of timeliness, comprehensiveness and accuracy as those for oil.
Before writing this, I had a quick conversation with one of the experts at the American Petroleum Institute who is involved in reviewing and analyzing the weekly industry statistics API puts out to subscribers. Although gathered independently and on a voluntary, rather than government-mandated basis, API's reports generally reflect the same underlying data and sources as EIA's. The last time I was actually involved in submitting EIA/API data from an operating facility was in the early 1980s, when everything was faxed in and compiled manually. I was surprised to hear that some of the data still comes in that way, though most of it is apparently gathered electronically, either though electronic data interchange or via email. What he emphasized to me, though, was that regardless of how the data is actually assembled and reviewed, it actually represents an extremely accurate survey, covering something like 85-90% of the industry, with non-filers' results estimated from less frequent census-type reports. That's much more comprehensive than the sampling rate for many of the other economic statistics on which the market depends--and to which it sometimes reacts violently.
One of the problems with any such system involves how the information is used. As long as traders focus so keenly on week-to-week changes, rather than the totals, this will tend to amplify the impact of any errors that creep in. For example, in last week's EIA statistics, the entire US commercial inventory of crude oil stood at 344 million barrels, reflecting a 1 million barrel increase from the previous week. An error of just 2 million barrels in either direction--or 0.3% of the total--could have increased that inventory build to 3 million barrels or swung it to a 1 million barrel drop, with very different outcomes for oil prices. While it would be nice to think errors of that magnitude could be avoided entirely, should the market be so sensitive to such changes, knowing that no assessment like this can ever be made 100% accurate, no matter how precisely it is assembled?
While the system might lend itself to improvements such as requiring electronic data submission by all participants and adding more analysts to scrutinize the filings for errors and omissions, I suspect the more urgent priority is expanding its scope to encompass all of the energy sources on which we now depend. After all, when the current national energy information system was first devised petroleum-based fuels were essentially the whole game for transportation energy, while still accounting for a significant portion of the input to fossil fuel power plants. Today ethanol satisfies roughly 8% of US gasoline demand, and the 14-16 million barrels of inventory that the ethanol industry keeps on hand is the energy equivalent of about 7% of the 200-230 million barrels of gasoline and blending components the oil industry has at any point. Those percentages are mandated by law to grow significantly in the next decade, as biofuels displace petroleum products.
How much longer should we be satisfied with production and inventory data for biofuels that are weeks or months out of date, when we require accurate weekly updates on petroleum and its products? And consider that this picture will only become more complicated as an increasing proportion of our needs are satisfied by various renewable and distributed energy sources. If we can spend billions improving the management and storage of health data, wouldn't it be worth widening our net and spending an extra few million to get a better handle on the energy flows and stocks upon which the entire economy depends?
Showing posts with label inventory. Show all posts
Showing posts with label inventory. Show all posts
Friday, March 19, 2010
Monday, July 07, 2008
Oil Prices and Inventory
Oil prices set another record last week, closing above $145 per barrel for the first time, on the strength of heightened fears of an attack by Israel or the US on Iran, combined with a dip in US commercial oil inventories below 300 million barrels, their lowest level since the end of January and at the bottom of their seasonal historical average range. But although lower inventories are generally a bullish signal for the market, we shouldn't forget that the relationship between prices and inventories runs in both directions. Current and expected future prices, along with actual supply and demand, play a significant role in guiding companies in setting their desired inventory levels. Determining whether a drop in inventories reflects tight supplies or expected future weakness depends on a broader array of indicators, including how seriously the oil industry takes forecasts of oil prices reaching $170-200 per barrel later this year.
The Department of Energy defines "crude oil stocks" as including "domestic and Customs-cleared foreign crude oil stocks held at refineries, in pipelines, in lease tanks, and in transit to refineries" and excludes the oil held in the nation's Strategic Petroleum Reserve (SPR). Some of this oil is required to ensure the uninterrupted operation of US refineries and pipelines, while the rest ebbs and flows with shifts in supply and demand and changing expectations for future prices. Although last week's figure looks low compared to average US commercial oil inventories since 2005 of 323 million barrels (MB), it is still 15 MB higher than the average during 2003-2004, and well above the 264 MB seen in January 2004. If nothing else, that suggests that current inventories remain safely above the minimum level required to keep the US pipeline and refinery network operating smoothly. That is consistent with the calculated 19.5 equivalent days of refinery supply at current consumption, compared to a low of about 17 days in September 2004.
There are two reasons why higher prices might lead companies to hold lower inventories. The most basic has to do with the carrying cost of owning high-priced oil. If a 200,000 barrel per day refinery had 4.4 MB of oil on hand when the price of West Texas Intermediate crude oil was $100/bbl, then the spike to $140 has increased its carrying cost for that inventory by the equivalent of $0.19 per barrel of output, assuming a corporate cost of capital of 8%. At $140/bbl, reducing plant inventory by 10% would cut the total carrying cost by 6 cents per barrel. While that might appear trivial on the scale of the profits oil companies are making, it would look very significant indeed to refineries that have experienced a gross margin between gasoline and crude oil of only about $8.00 per barrel so far this year. For a refinery manager seeking to contain costs, running a bit closer to minimum operating inventories looks like a good option, particularly when gasoline demand is dropping.
The other reason to reduce inventories has to do with expectations of future prices. While the market seems to be locked into a "shortage psychology", bolstered by pessimistic production estimates and forecasts of ever higher demand in Asia, the industry itself seems skeptical that current prices will last, despite futures markets trading at $142/bbl all the way out to 2016. If companies were planning their investments based on a return to $100/bbl or less, it would be hard for refinery managers to justify deliberately adding to inventory at today's price. And although the risk of a new war in the Middle East might alter that calculation, it must contend with the near-certainty that the government would release oil from the SPR to counter any actual disruption of supplies that would follow such an event. Moreover, rumblings in the Congress to release SPR oil to deflate a perceived speculative bubble in oil act as an additional deterrent to holding any more inventory than absolutely necessary.
For the present, then, falling crude oil inventories constitute another ambiguous component of the mixed bag of fundamental signals the market must interpret, including comfortably stable US gasoline stocks and falling gasoline demand, recovering diesel and heating oil stocks, weak refining margins and rising biofuels production. In the absence of a clear indication that supply will soon exceed demand, every mildly bullish indicator will push the market toward fulfilling the views of the growing cadre of analysts engaged in an apparent arms race of escalating forecasts, egged on by the media attention this attracts. But despite scare stories of $7 gasoline--which at current refining margins would require light sweet crude oil to reach at least $250/bbl--no one knows where oil prices will be in six months. Six months ago, crude oil was trading under $90. Can anyone look at the fundamentals and determine conclusively that it couldn't be back there this winter, rather than continuing on to $200? This reality makes even tactical planning for companies that are big energy consumers an extremely challenging undertaking.
The Department of Energy defines "crude oil stocks" as including "domestic and Customs-cleared foreign crude oil stocks held at refineries, in pipelines, in lease tanks, and in transit to refineries" and excludes the oil held in the nation's Strategic Petroleum Reserve (SPR). Some of this oil is required to ensure the uninterrupted operation of US refineries and pipelines, while the rest ebbs and flows with shifts in supply and demand and changing expectations for future prices. Although last week's figure looks low compared to average US commercial oil inventories since 2005 of 323 million barrels (MB), it is still 15 MB higher than the average during 2003-2004, and well above the 264 MB seen in January 2004. If nothing else, that suggests that current inventories remain safely above the minimum level required to keep the US pipeline and refinery network operating smoothly. That is consistent with the calculated 19.5 equivalent days of refinery supply at current consumption, compared to a low of about 17 days in September 2004.
There are two reasons why higher prices might lead companies to hold lower inventories. The most basic has to do with the carrying cost of owning high-priced oil. If a 200,000 barrel per day refinery had 4.4 MB of oil on hand when the price of West Texas Intermediate crude oil was $100/bbl, then the spike to $140 has increased its carrying cost for that inventory by the equivalent of $0.19 per barrel of output, assuming a corporate cost of capital of 8%. At $140/bbl, reducing plant inventory by 10% would cut the total carrying cost by 6 cents per barrel. While that might appear trivial on the scale of the profits oil companies are making, it would look very significant indeed to refineries that have experienced a gross margin between gasoline and crude oil of only about $8.00 per barrel so far this year. For a refinery manager seeking to contain costs, running a bit closer to minimum operating inventories looks like a good option, particularly when gasoline demand is dropping.
The other reason to reduce inventories has to do with expectations of future prices. While the market seems to be locked into a "shortage psychology", bolstered by pessimistic production estimates and forecasts of ever higher demand in Asia, the industry itself seems skeptical that current prices will last, despite futures markets trading at $142/bbl all the way out to 2016. If companies were planning their investments based on a return to $100/bbl or less, it would be hard for refinery managers to justify deliberately adding to inventory at today's price. And although the risk of a new war in the Middle East might alter that calculation, it must contend with the near-certainty that the government would release oil from the SPR to counter any actual disruption of supplies that would follow such an event. Moreover, rumblings in the Congress to release SPR oil to deflate a perceived speculative bubble in oil act as an additional deterrent to holding any more inventory than absolutely necessary.
For the present, then, falling crude oil inventories constitute another ambiguous component of the mixed bag of fundamental signals the market must interpret, including comfortably stable US gasoline stocks and falling gasoline demand, recovering diesel and heating oil stocks, weak refining margins and rising biofuels production. In the absence of a clear indication that supply will soon exceed demand, every mildly bullish indicator will push the market toward fulfilling the views of the growing cadre of analysts engaged in an apparent arms race of escalating forecasts, egged on by the media attention this attracts. But despite scare stories of $7 gasoline--which at current refining margins would require light sweet crude oil to reach at least $250/bbl--no one knows where oil prices will be in six months. Six months ago, crude oil was trading under $90. Can anyone look at the fundamentals and determine conclusively that it couldn't be back there this winter, rather than continuing on to $200? This reality makes even tactical planning for companies that are big energy consumers an extremely challenging undertaking.
Monday, April 21, 2008
Earth Day Pareto Principle
The Pareto Principle is familiar to many people in its more common derivation, the "80/20 Rule." How many times have we heard that 80% of some result comes from 20% of the associated effort, or some variation on that theme? Businesses often take this to imply that if employees could only be more effective with the other 80% of their effort, then they could deliver truly world-beating performance. This principle can be applied to many other areas, though, and it seems equally pertinent to tomorrow's annual celebration of Earth Day. Climate change has emerged as the largest environmental challenge, at least for the developed world, and a quick scan of the most recent US greenhouse gas inventory reveals that among the numerous sources of the gases implicated in climate change, an effective 80/20 rule applies as well.
As an outgrowth of a recent posting on the ongoing fuel vs. food controversy concerning biofuel, a reader provided a link to an article on a recent study suggesting that food type was more important than the proximity of food sources in determining the greenhouse gas (GHG)emissions associated with our grocery purchases. Surprisingly, the study found that only 4% of life-cycle emissions were associated with food transportation, compared to 83% for food production. With all due respect to cattle ranchers, it appears that reducing our consumption of beef would have a much bigger impact on food-related GHG emissions than avoiding foods grown far away, such as all that lovely Southern Hemisphere fruit that turns up during our winter. But while the global impact of such a choice is hardly insignificant, it would still rank relatively low on the overall 80/20 distribution for GHGs.
The inventory of US GHGs provides a clear hierarchy of priorities for reducing emissions. While the methane emissions from cows contribute more to climate change than cement manufacturing--widely viewed as a highly GHG-intensive industry--and actually make the top-10 of individual sources, they still pale in comparison to fossil fuel combustion. Here is the list, taken from the EPA's 2006 statistics, with some obvious combinations of line items, such as including the methane emissions of natural gas systems in the "Industrial/Commercial" fossil fuel category, and adding manure management and "enteric fermentation" to get "Animal Husbandry":
As an outgrowth of a recent posting on the ongoing fuel vs. food controversy concerning biofuel, a reader provided a link to an article on a recent study suggesting that food type was more important than the proximity of food sources in determining the greenhouse gas (GHG)emissions associated with our grocery purchases. Surprisingly, the study found that only 4% of life-cycle emissions were associated with food transportation, compared to 83% for food production. With all due respect to cattle ranchers, it appears that reducing our consumption of beef would have a much bigger impact on food-related GHG emissions than avoiding foods grown far away, such as all that lovely Southern Hemisphere fruit that turns up during our winter. But while the global impact of such a choice is hardly insignificant, it would still rank relatively low on the overall 80/20 distribution for GHGs.
The inventory of US GHGs provides a clear hierarchy of priorities for reducing emissions. While the methane emissions from cows contribute more to climate change than cement manufacturing--widely viewed as a highly GHG-intensive industry--and actually make the top-10 of individual sources, they still pale in comparison to fossil fuel combustion. Here is the list, taken from the EPA's 2006 statistics, with some obvious combinations of line items, such as including the methane emissions of natural gas systems in the "Industrial/Commercial" fossil fuel category, and adding manure management and "enteric fermentation" to get "Animal Husbandry":
True to our friend Pareto, the combustion of fossil fuels, along with other uses of them such as asphalt roofing and paving, account for 80% of our total GHG emissions--81.7% if you include the methane emitted from coal mining. The next five sources contribute 11.8%, and everything else, including iron and steel production, cement, and the entire chemical industry, tally to only 6.5% of our total emissions of 7 billion metric tons per year of CO2-equivalent gases. No other single line item exceeds 1% of the total.
That doesn't mean that the smaller sources are unimportant, particularly if they offer quick and easy opportunities for reducing emissions. However, it does mean that we can't solve the challenge of climate change without making enormous cuts in our consumption of coal, oil and, to a lesser degree, natural gas, and by extension in the fuel and electricity that we produce from them. No other rational interpretation of the data is possible. Achieving the Kyoto Protocol's US target of 7% below our 1990 emissions would require eliminating the equivalent of all current emissions from commercial and industrial uses of fossil fuels, while the 50-80% reductions mooted in various domestic cap & trade proposals could only be attained through the massive transformation of the entire energy sector, and indeed of most of the US economy.
Some suggest we can do all this in a manner that will pay for itself, creating new, high-paying industries in the process. As an optimist, I hope they are right; as a realist, I anticipate that we will encounter many painful bumps along the way, some of which might exceed the upheaval we are currently experiencing from the sub-prime crisis. In that sense, our current economic woes provide a useful test of our ability to tackle a problem on the scale of climate change with pragmatism and resolve, rather than with measures that place a higher priority on the appearance of action and the protection of key political constituencies. An effective response to climate change will also require the kind of persistent bi-partisanship with which we approached the Cold War, spanning multiple congressional sessions and presidential administrations. These might be useful criteria to keep in mind not just on Earth Day, but on Election Day.
Thursday, December 06, 2007
The Momentum Shifts
What a difference a few weeks makes. A month ago, I was contacted by a TV news producer who was lining up "talking heads" for the day when oil broke $100/barrel--then expected at any moment. Subsequently, instead of breaching that level, the most-watched oil price has receded by more than 10% and the entire shape of the market has changed. Yesterday in Abu Dhabi, OPEC apparently concluded that the risk of a price collapse exceeds that of killing demand and held its quotas steady. What has changed since early November, and is the current weakness any likelier to persist than the market's flirtation with the inflation-adjusted all-time high price did?
While I share the general sense of momentary relief that oil prices are heading back into more comfortable territory for the economy--no one can call $85/barrel normal--I'm also oddly disappointed, and not just because I missed a chance to be on TV, for now. Breaking $100/barrel would have sent an important signal about the fundamental shifts that have taken hold in the global oil market in the last few years, and it would have underlined the need for consumer behavior to change, while we wait for more efficient cars, homes, and devices to become mainstream. It also would have set a new record oil price, settling the annoying controversy over what the 1980-81 historical high means today. That no longer seems likely, at least for the next few months.
Media analysis of the change seems focused on slowing global economic growth, oil inventories, and the new intelligence on Iran's nuclear program. You almost have to smile at the perversity of some of this, when traders take the otherwise bullish news of OPEC's failure to increase quotas as a signal that economic growth must be so weak that oil demand will fall, and prices with it. This contrasts with the fall in reported US oil inventories this week, which puts them right in the middle of their seasonally-adjusted historical average range, hardly a bearish indicator.
While I share the general sense of momentary relief that oil prices are heading back into more comfortable territory for the economy--no one can call $85/barrel normal--I'm also oddly disappointed, and not just because I missed a chance to be on TV, for now. Breaking $100/barrel would have sent an important signal about the fundamental shifts that have taken hold in the global oil market in the last few years, and it would have underlined the need for consumer behavior to change, while we wait for more efficient cars, homes, and devices to become mainstream. It also would have set a new record oil price, settling the annoying controversy over what the 1980-81 historical high means today. That no longer seems likely, at least for the next few months.
Media analysis of the change seems focused on slowing global economic growth, oil inventories, and the new intelligence on Iran's nuclear program. You almost have to smile at the perversity of some of this, when traders take the otherwise bullish news of OPEC's failure to increase quotas as a signal that economic growth must be so weak that oil demand will fall, and prices with it. This contrasts with the fall in reported US oil inventories this week, which puts them right in the middle of their seasonally-adjusted historical average range, hardly a bearish indicator.
From "This Week in Petroleum", December 5, 2007, Energy Information Agency
The most significant change, other than the absolute price level, is the dramatic decrease in "backwardation", the difference between the price of the prompt oil futures contract and those of succeeding months. Less than a dollar per barrel now separates the January 2008 and April 2008 contracts. A few weeks ago that spread was $3/bbl. This shift reflects a market that is in much better balance. That could be a function of easing physical supply and demand, a reduction in speculative pressure--as OPEC would have it--or a bit of both. Either way, the impetus that was driving prices ever higher seems to have crested for the moment, and we might even see a return to "contango", if the prompt market becomes oversupplied.
One of my futures trading mentors liked to say, "The trend is your friend, until it ends." As oil approached $100/barrel--a level with more psychological than real significance--the price seemed to have a life of its own. You can ascribe that to the impact of speculation, or the degree to which most global oil consumption is insulated from day-to-day changes in oil prices, requiring truly big spikes to bring demand back into line with supply. But whether speculators lost heart and chose to take profits, thus ending the trend, or the prospect of record oil prices finally cast a large enough pall over the global economy, prices have returned to where they were in October. The one certainty in all of this is volatility. Global supply and demand remain tightly balanced, and depending on the nature of the events ahead, we could soon be on verge of $100 again, or of $50. That's hardly reassuring for those investing in alternative fuels.
Tuesday, September 11, 2007
Practical Energy Security
Since 9/11/01 many of us have accepted the notion that energy security matters, and that it is risky for the US to rely on unstable countries and regions for large portions of our energy supplies. However, most of our preferred responses to that situation seem to be long-term in nature. Nor have we asked the large domestic oil & gas industry for help in shoring up our energy security in the meantime; if anything, we appear more interested in penalizing it for the profits created by high energy prices. But while stricter vehicle fuel economy standards and renewable fuel and electricity standards will take years to affect our dependence on OPEC, there's something that the oil industry could do quickly that would improve our energy security in the meantime, and it has to do with inventories.
US policies on strategic petroleum inventories--epitomized by the Strategic Petroleum Reserve--were set decades ago when the country had ample refining capacity and was not a consistent net importer of petroleum products. Storing up emergency supplies of crude oil seemed sufficient to our anticipated needs. Now, US refineries run close to capacity, and we import on average 1.5 million barrels per day of gasoline, diesel and jet fuel--imports we may not be able to rely on in a crisis. That makes product inventories the critical cushion between a disruption and widespread runouts, as we saw after Hurricane Katrina. But even after adding in the uncounted ethanol inventories I mentioned last week (9/5), US gasoline inventories from 2002 to the present have consistently averaged lower than they did in 2001, in terms of the number of days of supply they represent. That hardly seems prudent for a nation facing the possibility of another major terrorist attack, particularly if it involved our energy infrastructure.
Why have commercial gasoline inventories failed to keep up with growing demand? It has everything to do with the way inventories are treated for accounting and tax purposes. As long as companies see petroleum product inventories tying up capital, attracting taxes, and dragging down their return on capital employed statistics, they have no incentive to increase them beyond the bare minimum necessary for normal operations, let alone building a permanent buffer against a future supply shock or terrorist attack; quite the contrary.
So how could we remedy the situation? I see three possible solutions:
US policies on strategic petroleum inventories--epitomized by the Strategic Petroleum Reserve--were set decades ago when the country had ample refining capacity and was not a consistent net importer of petroleum products. Storing up emergency supplies of crude oil seemed sufficient to our anticipated needs. Now, US refineries run close to capacity, and we import on average 1.5 million barrels per day of gasoline, diesel and jet fuel--imports we may not be able to rely on in a crisis. That makes product inventories the critical cushion between a disruption and widespread runouts, as we saw after Hurricane Katrina. But even after adding in the uncounted ethanol inventories I mentioned last week (9/5), US gasoline inventories from 2002 to the present have consistently averaged lower than they did in 2001, in terms of the number of days of supply they represent. That hardly seems prudent for a nation facing the possibility of another major terrorist attack, particularly if it involved our energy infrastructure.
Why have commercial gasoline inventories failed to keep up with growing demand? It has everything to do with the way inventories are treated for accounting and tax purposes. As long as companies see petroleum product inventories tying up capital, attracting taxes, and dragging down their return on capital employed statistics, they have no incentive to increase them beyond the bare minimum necessary for normal operations, let alone building a permanent buffer against a future supply shock or terrorist attack; quite the contrary.
So how could we remedy the situation? I see three possible solutions:
- We could create a federal strategic gasoline reserve, along the lines of the crude oil SPR.
- We could do what many European countries and other members of the International Energy Agency's emergency stocks program do: impose minimum compulsory stocks levels on the industry, set at a level to ensure some arbitrary number of days' supply on hand, typically between 60 and 90 days.
- We could eliminate the disincentives for companies to hold extra inventory. That would require the government to create special rules for inventory accounting and taxes, to render them neutral to the bottom line.
Of these options, the third makes the most sense to me. For all their perceived utility in a crisis, government-held strategic reserves create significant disincentives for holding commercial inventories, as I've discussed previously for the existing SPR. And the logistics of a federal gasoline SPR in a market made up of dozens of gasoline grades and environmentally-mandated formulations look extremely daunting. The second and third options share the virtue of maintaining dispersed inventories close to the point of demand, where it would be most useful in extremis. But requiring large compulsory stocks merely shifts a national strategic burden onto the backs of private companies, from which it would ultimately be passed to consumers. The third option would address the need for higher inventories at the least cost to consumers and taxpayers.
But let's be clear: the industry isn't asking for help on this, and as best I can tell they aren't remotely interested in pursuing it, at a time when there has been so much outcry over the industry-friendly provisions of the Energy Policy Act of 2005. The current Congress isn't motivated to do anything that might be interpreted as corporate welfare for a highly profitable industry. However, if we're serious about our desire to make the US more secure, including in energy terms, it's time to set aside our prejudices against this industry and begin to harness its capabilities, at least in this small way. The alternative is muddling along with the bare minimum of gasoline inventories, until some event exposes the folly of such a policy in the post-9/11 world, or until a recession punctures demand.
Wednesday, September 05, 2007
The Missing Inventory
While I was on vacation, a potentially important energy threshold was reached without much media attention, outside of Robert Rapier's energy blog. As gasoline prices declined steadily for the last month, except in the Midwest, gasoline inventories were dropping, too. Last week, for the first time since at least 1991, they fell to a level equivalent to twenty days' supply at current consumption rates. That ought to signal that gas prices will soon head back up, even though we're now past the traditional end of the peak driving season. However, a key factor is missing from these figures. Ethanol may only amount to 3.5% of our gasoline consumption, but its volume is growing large enough to affect our view of traditional industry statistics.
The energy industry produces a bewildering variety of data, but analysts pay particular attention to crude oil and refined product inventories, because they reflect the outcomes of the interaction of all current supply and demand factors. When inventories fall, prices generally rise, and vice versa. We certainly saw that earlier this year, when gasoline inventories dropped by 15% from the end of January to end-April, and retail gasoline prices rose by 35% in response. Something unusual has been affecting these inventories throughout the entire 2007 driving season. Total US gasoline inventories have remained below their seasonal-average range since March. While this is partly due to refining problems in the Midwest, inventories have been quite low on the East Coast and Gulf Coast, too. Something else is at work.
The chart below, taken from last week's edition of the DOE's This Week in Petroleum, expresses these inventories in terms of the equivalent number of days of gasoline consumption. This provides an even more focused view of inventories, because it takes the current level of demand into account. It shows that days' supply normally ranges between 21.5 and 25 days, with a strong seasonal pattern. When the EIA reports that this measure has fallen to 20 days for the first time since they've been monitoring it, we should take notice and possibly worry. In fact, the curve for this year's data is consistently 0.5-1 day below that for 2006. Besides refining problems, what else could explain this shift? I think ethanol provides at least part of the answer.
The energy industry produces a bewildering variety of data, but analysts pay particular attention to crude oil and refined product inventories, because they reflect the outcomes of the interaction of all current supply and demand factors. When inventories fall, prices generally rise, and vice versa. We certainly saw that earlier this year, when gasoline inventories dropped by 15% from the end of January to end-April, and retail gasoline prices rose by 35% in response. Something unusual has been affecting these inventories throughout the entire 2007 driving season. Total US gasoline inventories have remained below their seasonal-average range since March. While this is partly due to refining problems in the Midwest, inventories have been quite low on the East Coast and Gulf Coast, too. Something else is at work.
The chart below, taken from last week's edition of the DOE's This Week in Petroleum, expresses these inventories in terms of the equivalent number of days of gasoline consumption. This provides an even more focused view of inventories, because it takes the current level of demand into account. It shows that days' supply normally ranges between 21.5 and 25 days, with a strong seasonal pattern. When the EIA reports that this measure has fallen to 20 days for the first time since they've been monitoring it, we should take notice and possibly worry. In fact, the curve for this year's data is consistently 0.5-1 day below that for 2006. Besides refining problems, what else could explain this shift? I think ethanol provides at least part of the answer.
Consider how the growth of ethanol blending has changed the gasoline business, driven by a combination of gasoline reformulation, the phaseout of MTBE, and the introduction of a national renewable fuel standard. Since gasoline containing ethanol can't be transported in pipelines, refiners must produce a pre-ethanol blend for shipment, to which ethanol is added at distribution terminals close to the point of sale. In just the last two years, the share of total gasoline inventories made up of this "RBOB" pre-blend has increased from 10.7% to 20.2%, reflecting the rapid increase in ethanol production. But while RBOB is counted in gasoline inventory, the ethanol required to turn it into merchantable gasoline isn't. That means that EIA inventory data is missing at least 2% of the volume that will end up in total gasoline sales, the equivalent of 4 million barrels, or nearly a half-day's supply at the national level. A quick look at ethanol inventories, which stood at nearly 9 million barrels in April, validates this logic.
In other words, when we add in the ethanol held in storage for blending into gasoline that's also in storage, we find a volume sufficient to eliminate most of the days'-supply gap between the 2006 and 2007 data. Before we relax too much, however, we should recognize that even 21 days of gasoline inventory represents a pretty slim cushion, relative to typical historical levels. And if most of that uncounted ethanol is sitting in rail cars or in places where it far exceeds the 10% limit for blending into gasoline, rather than E-85, then it wouldn't do much good in a pinch--such as after another big Gulf Coast hurricane. But what seems pretty clear is that, as our reliance on ethanol grows, our use of inventory and other industry benchmarks must adjust to the reality of a non-petroleum blending component significant enough to distort the old patterns.
In other words, when we add in the ethanol held in storage for blending into gasoline that's also in storage, we find a volume sufficient to eliminate most of the days'-supply gap between the 2006 and 2007 data. Before we relax too much, however, we should recognize that even 21 days of gasoline inventory represents a pretty slim cushion, relative to typical historical levels. And if most of that uncounted ethanol is sitting in rail cars or in places where it far exceeds the 10% limit for blending into gasoline, rather than E-85, then it wouldn't do much good in a pinch--such as after another big Gulf Coast hurricane. But what seems pretty clear is that, as our reliance on ethanol grows, our use of inventory and other industry benchmarks must adjust to the reality of a non-petroleum blending component significant enough to distort the old patterns.
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