Oil Slides, Fuel Inventories Rise

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 amid renewed concerns about weak demand in the U.S., thereby more than offsetting the positive impact.

In its release, the agency said that crude inventories, following two weeks of increases, fell by 3.8 million barrels for the week ending December 4, against market expectations of a buildup. The primary reason for the surprise drop was a fall in crude oil imports and slightly stronger refiner demand.

Current crude oil stocks, at 336.1 million barrels, are 4.8% 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 marginally, from 24.5 days in the previous week to 24.2 days of supply but remain well above the year-earlier level of 21.8 days.



Supplies of gasoline rose by 2.2 million barrels from the previous week (analysts had hoped for a lower build), as motor fuel demand continues to be stifled on the back of high unemployment. At 216.3 million barrels, current inventories are above year-earlier levels, and are 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) grew by 1.6 million barrels last week (they were expected to fall) to 167.3 million barrels, reflecting mild winter and poor demand for transportation of goods. It remains 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 1.4% from the prior week to 81.1%, higher than analyst expectations, as daily gasoline and distillate fuel production increased. Despite the modest rise, utilization rates still remain much lower than last year’s levels.

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 3.0% from the year-earlier period, with gasoline up 1.2%, distillates (includes diesel) down 8.3% and jet fuel down 0.7%.

With gasoline and other petroleum product inventories rising last week, we take this as an indication that demand in the world's biggest economy remains slack. In particular, at this time of the year, distillates see rising demand as winter approaches in the northern hemisphere. As a result, following the bearish EIA release, oil prices fell below the $71 per barrel level, the lowest in two months. Additionally, the unexpected drop in crude stockpiles was triggered by falling imports 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 81.1% 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. In fact, crude consumption has fallen so much that recently Valero had to idle its Delaware City refinery.

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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Read the full analyst report on CVX

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Read the full analyst report on WFT