Refined Products Futures Prices Are Up This Morning

Refined products are up 4% this morning while stock markets are seeing a wave of selling after the U.S. levied tariffs on its 3 largest importers, which wasn’t even the most surprising trade news of the weekend.

Canadian energy imports are “only” taxed by 10% under the new tariff plan, in a slight nod to how dependent the U.S. supply network (and economy) is on those low-cost supplies. Canada immediately announced retaliatory measures, while Mexico has not yet announced details of how it will fight back.

The big question of the week is whether the tariff war will escalate, or if the negotiating brinksmanship will find a resolution that will calm things back down? Given the push higher in time-spreads this morning, there are definitely some bets being placed that the increase in energy prices will be short lived.

While crude oil tariffs are the biggest concern given that Canada accounts for 60% of the imported oil bought by U.S. refiners, we also buy 550mb/day of refined productions (280mb/day of which are gasoline and ULSD) from our neighbors to the north, the equivalent of 2 above-average U.S. refineries. Irving Oil’s 320mb/day refinery in St. John, New Brunswick is the largest importer with the majority of its output hitting the population centers in the North Eastern U.S., which is a big reason why refined product futures (which deliver in NY Harbor) are feeling the direct impact of this announcement even more than WTI.

Could a refiner like Irving find a loophole in the tariffs to perhaps exchange fuel with a European or Caribbean country that in turn imports the products to the U.S. and bypasses the new tax? It’s certainly possible if you’ve paid attention to the numerous ways Russia has bypassed sanctions over the past 3 years, although any attempt to circumvent the new rules would at the very least increase shipping costs given Irving’s strategic location to the ports in New England and New York.

U.S. Mid-Continent refiners will feel the sting of the tariffs most directly, with the majority of their oil coming from Canada, and steep discounts for the heavier-sour grades critical to keeping those facilities operating even though they don’t enjoy the product export options of their coastal neighbors. The next best option for heavier-sour crude comes from Mexico (scratch that off the list) and then from Iraq, which just so happens to be a long way from Illinois.

On the flip side of the coin, while mid-continent refiners depend on Canadian crude to operate profitably, Gulf Coast refiners depend heavily on Mexico’s purchases of refined products to clear their production that exceeds domestic demand by a wide margin. More than 1 million barrels/day of refined products are sold to Mexico from the U.S. daily, and any lasting upset in those purchases will risk backing up supply that will lead to refinery run cuts. Could Gulf Coast refiners send more of their supply north to offset the Canadian imports? Theoretically, yes, but due to capacity limitations on Colonial and other pipelines leaving the Gulf Coast, and the Jones Act restrictions on domestic shipping, the options are physically limited and would add anywhere from 5-20 cents/gallon to shipping costs.

PBF’s San Francisco area refinery caught fire over the weekend, prompting authorities to issue a shelter-in-place warning to nearby residents. That facility had been preparing for maintenance on several units, which may alleviate the supply impact of the event, although it’s still unclear which operating units were impacted by the blaze.

Money managers certainly didn’t act like they saw increasing fuel prices last week, with large speculators reducing their long bets in WTI, RBOB, ULSD and Gasoil contracts while increasing their short positions. Brent crude was the exception to the rule with a healthy increase in speculative length, in what appears to be in part driven by spread trading with WTI. How the notoriously fickle hedge funds that make up the majority of the managed money trade category react to the new trade war will likely go a long way in determining if we see this morning’s rally continue, or fizzle out as the week goes on. Short positions are relatively muted, so the likelihood of forced short covering is low.

Baker Hughes reported an increase of 7 oil rigs active in the U.S. last week, erasing the prior weeks’ decline, while the natural gas rig count declined by 1.