A Simple Metric Every Energy Investor MUST Follow
As my title within The Oxford Club suggests, I’m fond of trends.
Following them has made me one of the most successful traders in the business.
Most importantly, following trends just makes sense.
Now, I watch a slew of metrics and data points. Some are more complicated than others. But my favorite metric is the most consistent and the easiest to understand. Every investor has access to it…
I’m talking about refinery utilization rates.
We may have a surplus of oil now… but everyone forgets about refined products.
In the past two weeks, U.S. gasoline inventories have declined 1.8%.
In turn, we’ve seen U.S. refinery utilization rates surge.
During the week of February 17, at the maintenance season low, refinery utilization was 84.3%. A few weeks ago, it was 87.4%. The week of March 24, it was 89.3%.
This was the biggest one-week jump in three years.
And to close out March, refinery utilization was 90.8%.
This is the highest rate we’ve seen in March in more than 10 years.
And it’s well above the average refinery utilization rate we typically see this time of year…
It’s going to have to continue ramping up as gasoline inventories decline.
In the past, I’ve discussed how important refinery utilization is to crude demand. And it can often be overlooked by investors.
But it’s such a simple and powerful metric to forecast demand. And it gives investors some confidence in where the price of crude could go next.
When refineries go into their maintenance seasons, utilization rates fall sharply. We can see this in the long-term monthly trend of the past three decades. But as refineries prepare for the summer driving season, utilization rates surge from their lows in February to their peaks in July.
The standard rule of thumb is that every percentage point in refinery utilization represents at least 150,000 barrels per day in demand. But it can be much more.
In fact, the 6% increase in utilization in the past month and a half shows refinery demand has grown 1.158 million barrels per day. That’s an increase from 15.271 million barrels the week of February 17 to 16.429 million barrels the week of March 31.
Plus, in the past week, refinery demand has increased by 203,000 barrels per day.
And utilization rates will continue to tick higher from here.
Now, what does that mean for the price of U.S. crude?
Here’s the average price of crude per month over the past 30 years…
When I started out in the oil and natural gas industry, this was one of my first lessons in seasonality.
And it’s really simple to understand… When refineries aren’t using crude, there’s slack in the system. The price of crude falls, typically bottoming in February – much like we saw in 2016. But once those refineries come back online – consuming more crude – prices rise, hitting a peak in the summer months.
Let me show you another chart. This is how the average price of U.S. crude has performed from January to July since 1986…
During the mid-1980s and through the 1990s, the price of West Texas Intermediate (WTI) was a lot more volatile. Peak U.S. production and limited supply in the late 1970s caused a price spike. That led to a supply shock in the mid-1980s. Saudi Arabia wanted to regain control of the oil market in 1986, and it ramped up production.
Shortly after the Iran-Iraq War ended, the U.S. entered the first Gulf War.
During that time, crude largely traded between $10 and $20 per barrel, and investment dried up.
But since 2000, the price of crude has fallen only four times during those months.
It may not seem like it at times, but the crude market stabilized. Asia – led by China – burst onto the scene. And U.S. production was revitalized by the shale revolution.
Think about it…
The collapse in crude began at the end of July 2014 – just in time for the winter-blend switchover for refiners. Historically, gasoline demand drops heavily in September. So in the second half of 2014, prices were cut in half. But from January through July 2015, WTI gained. Then prices turned south again to close out the year. By February 2016, during spring maintenance season, crude was at a low we hadn’t seen in more than a decade. WTI then surged from there.
A collapse in crude prices rarely occurs this time of year. Prices typically find a bottom between January and March. Basic market fundamentals will buoy the price of crude until July. And this trend has strengthened over the past 18 years.
Now, as an energy investor, all of this is positive. The only real downside is if you’re planning to take a road trip this summer… Gasoline prices are expected to increase $0.40 per gallon by the peak of driving season.
But those are the gives and takes of being an energy investor: High prices reward your portfolio… but hurt your wallet.