Oil Down as Petroleum Supplies Rise

Yesterday, the federal government’s Energy Information Administration (EIA) reported an unexpected decline in crude stockpiles. However, the report also showed a larger-than-anticipated buildup in gasoline and distillate inventories, thereby offsetting the positive impact.

In its release, the agency said that crude inventories fell by 1 million barrels for the week ending October 2, against market expectations of a buildup. The primary reason for the surprise drop was a fall in crude oil imports and stronger refiner demand. This is in contrast to the previous week’s report, when U.S. commercial crude oil stocks rose more than expected on slower demand.

Current crude oil stocks, at 337.4 million barrels, are 11.5% 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 increased marginally from 22.8 days in the previous week to 22.9 days of supply, but is below the year-earlier level of 23.6 days.
 

 
Gasoline stocks showed a bearish 2.9 million barrels week-over-week increase (analysts hoped for a lower build) as demand continues to taper off with summer driving season over. At 214.4 million barrels, current inventories are well above year-earlier levels and are over 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 0.7 million barrels last week (more than anticipated) to a new 26-year high of 171.8 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.


 
Refinery utilization was up 0.4% from the prior week to 85.0%, counter to analyst expectations of a decline. Still, utilization rates continue to hover below seasonal norms due to low profitability for products.

The overall demand picture remains weak, but total refined products supplied over the last four-week period -- a proxy for overall petroleum demand -- went up. It was up 5.0% from the year-earlier period, with gasoline up 6.2%, distillates (includes diesel) down 9.5% and jet fuel down 3.3%.

The unexpected drop in crude stockpiles has raised hopes that the worst of the recession-induced slump may be over and demand is picking up. However, it did little to strengthen the price of the commodity, as higher-than-expected increases in product inventories (gasoline and distillates) more than offset this positive news. As a result, following the EIA release, oil prices pulled back about $2 per barrel to fall below the $70 per barrel level.

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 maintain our cautious stance on 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 buildup in gasoline and distillate stocks – a combination that will continue to hurt their profitability. In fact, crude consumption has fallen so much that recently Sunoco, the second largest refiner in the country, had to idle a refinery and cut its dividend into half.

Companies like ConocoPhillips (COP - Analyst Report) and ExxonMobil Corp. (XOM - Analyst Report) -- oil majors that have significant refining operations -- are also expected to remain under pressure until pricing and demand improve.