Mixed Signals in U.S. Oil Demand

The U.S. Energy Department's weekly inventory release showed a smaller-than-expected build in crude stockpiles, a surprise drop in distillates and improvement in refinery run-rates. However, this piece of positive data was somewhat tempered by reports of increases in gasoline supplies.

In its release, the agency said that crude inventories rose by approximately 1.0 million barrels for the week ending November 20, lower than analysts' expectations. The modest increase can be attributed to the turnaround in imports and Gulf of Mexico output following disruptions caused by Tropical Storm Ida. Current crude oil stocks, at 337.8 million barrels, are 6.1% 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).



Supplies of gasoline rose by 1.0 million barrels from the previous week (analysts hoped for a lower build), as demand continues to be stifled on the back of high unemployment. At 210.1 million barrels, current inventories are above year-earlier levels, and are slightly above the upper half of the historical range, as shown in the following chart from the EIA.



Distillate fuel inventories (including diesel and heating oil) dropped by 500,000 barrels last week (they were expected to remain unchanged) to 166.9 million barrels, but remain above the upper boundary of the average range for this time of year. This is shown in the following chart, also from the EIA.



Refinery utilization was up a 0.9% from the prior week to 80.3%, higher than analyst expectations, as refiners continued to boost throughputs to make up for the anemic demand.

The overall demand picture remains weak, as reflected by the dip in the total refined products supplied over the last four-week period, a proxy for overall petroleum demand. It fell by 2.9% from the year-earlier period, with gasoline up 0.5%, distillates (includes diesel) down 9.5% and jet fuel up 1.6%.

The higher-than-expected crude stockpile drop and the encouraging rise in the distillate inventories 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 gasoline more than offset this positive news. Moreover, the drop in petroleum stocks was triggered by weak refinery activity rather than a much-awaited pick-up in oil demand.

As such, we prefer to maintain our cautious stance on oil refiners like Sunoco Inc. (SUN - Analyst Report), Tesoro Corp. (TSO - Analyst Report) and Western Refining Inc. (WNR - Analyst Report), given that the overall environment for refining margins is likely to remain poor going into 2010.

The sharply lower refinery utilization (at just 80.3% of capacity) provides enough evidence that refineries are cutting back on production because the economy is still struggling on the demand side. Being the largest independent refiner, Valero Energy Corp. (VLO - Analyst Report) remains particularly exposed to this unfavorable macro backdrop. We see little reason for investors to own Valero and have an Underperform recommendation on the company.

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.

We would also like to maintain our cautious outlook (Neutral recommendation) on integrated oil players and oilfield service firms until the demand outlook improves. Companies such as Chevron Corp. (CVX - Analyst Report), Marathon Oil Corp. (MRO - Analyst Report), Hess Corp. (HES - Analyst Report), Schlumberger Ltd. (SLB - Analyst Report), Baker Hughes Inc. (BHI - Analyst Report) and Weatherford International (WFT - Analyst Report) fall in this category.

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