Another Sharp Crude Drawdown

Yesterday, the U.S. Energy Department's weekly inventory release showed a sharp drop in crude stockpiles. However, this piece of positive data was somewhat tempered by reports of increases in refined product supplies like gasoline and distillate fuels.

The federal government’s Energy Information Administration (EIA) reported a 4.7 million barrels drop in crude inventories for the week ending September 11, far more than analyst expectations. This is the second successive week in which the crude drawdown has been more than originally anticipated. Major contributing factor to the inventory drop was a fall in crude oil imports.

Current crude oil stocks, at 332.8 million barrels, are 14.1% above the year-earlier level and remain above the upper limit of the average for this time of the year (depicted in the first EIA chart below). The supply cover decreased from 22.9 days in the previous week to 22.3 days of supply, but it remains above the year-earlier level of 20.4 days.
 

 
Supplies of gasoline increased by 500,000 barrels over the previous week (lower than estimates that expected a bigger build) as demand continues to weaken with the peak summer driving season over. At 207.7 million barrels, current inventories are above year-earlier levels and remain in the upper half of the historical range, as shown in the following chart from the EIA.


 
Distillate fuel inventories (including diesel and heating oil) grew by 2.2 million barrels last week (more than anticipated) to 167.8 million barrels and are above the upper boundary of the average range for this time of year. This is shown in the following chart from the EIA.
 

 
Meanwhile, refinery utilization was down less-than-expected to 86.9%, as refiners slowed run rates. Utilization rates continue to hover below seasonal norms due to low profitability for products.

The overall demand picture remains weak, but for the third successive week, total refined products supplied over the last four-week period, a proxy for overall petroleum demand, went up. It was up 3.7% from the year-earlier period, with gasoline up 3.5%, distillates (includes diesel) down 6.8%, and jet fuel down 6.1%.

The higher-than-expected crude stockpile drop and the sustained rise in U.S. petroleum demand have raised hopes that the worst of the recession-induced slump may be over. Oil prices also reacted positively to this news and gained more than $1.5 per barrel, settling above the $72 per barrel level. But the increases in gasoline and distillate stockpiles, along with still higher supplies for all, will limit any sustained crude gains, in our view.

Considering this uncertain scenario, we prefer to maintain our cautious outlook for integrated oil players such as Chevron Corp. (CVX - Analyst Report), Marathon Oil Corp. (MRO - Analyst Report) and Hess Corp. (HES - Analyst Report), as well as oilfield service names such as Schlumberger Ltd. (SLB - Analyst Report), Baker Hughes Inc. (BHI - Analyst Report) and Weatherford International (WFT - Analyst Report). We currently rate shares of these companies as Neutral.

We also prefer to stay on the sidelines with oil refiners like Sunoco Inc. (SUN - Analyst Report), Tesoro Corp. (TSO - Analyst Report), Valero Energy Corp. (VLO - Analyst Report) and Western Refining Inc. (WNR - Snapshot Report), given the sharp build up in gasoline and distillate stocks -- a combination that will continue to hurt their profitability.