00:00Paul Sankey of Sankey Research is joining us around the table.
00:02He writes the following, an industry running at 98% capacity is risky.
00:07Paul joins us now for more.
00:08Paul, good morning.
00:09Good morning.
00:09How close are we to a big problem?
00:12One refinery going down.
00:13So if we have a major refining accident here,
00:15which thankfully we haven't had hurricanes as yet this season
00:18and we're getting quite deep into it, that was one concern.
00:22The biggest downtime we ever had in U.S. refining was Winterstorm Uri,
00:26which was in 21, in February 21.
00:28So that, you know, is still out there depending on how you view El Nino.
00:31But in fact, with inventories,
00:33I think distillate inventories are at operational minimums now.
00:36We've never seen them go lower than this.
00:38That's the observation.
00:39So this is the lowest they've ever gotten, as we would say.
00:42And as a result, any major outage in refining,
00:46particularly in the U.S., would be, you know, extremely damaging
00:50and give you more upside right at harvest time.
00:53So one of our concerns here is that the farmers are priced inelastic.
00:58They have to harvest.
00:59And so they're going to have to pay this price.
01:01And that's tough.
01:02And as you can see, the president has tuned in that the problem is diesel,
01:05not how much oil Saudi is getting out.
01:07Although, of course, that will bring down the price of crude.
01:10So you mentioned the farmers.
01:11They're the ones that are pushing the president to actually, or Congress,
01:16to announce an embargo on diesel.
01:18Walk us through what that would mean for refineries if we would see an export ban.
01:23Well, there's the unintended consequences, right?
01:26And so we've talked about how strongly the refineries have been running.
01:30This is not only the highest sustained utilization they've ever performed.
01:35So 98% utilization is where we're at today.
01:37It's also the highest low.
01:39So we've had almost no turnarounds this year.
01:42And as a result, basically, what potentially would happen is if you blocked certain cargoes
01:48or if you said certain cargoes have to be approved and then didn't approve them,
01:51I think the refiners would actually shut down quite a bit and take their turnarounds.
01:55Now, they can't completely just turn around early because it's a planned process.
01:59But I think you would see them probably take their foot off the accelerator of producing diesel
02:03because obviously the reason they're running so hard is because margins are so high.
02:07And so if you were to trash margins, they might take the opportunity to rest the refineries
02:12at the margin.
02:13That's one thing.
02:14Within the U.S., yes, it would bring down the price of diesel.
02:17There's no question about that.
02:18But for how long if refiners are going to put past pause?
02:21You know, off the top of my head, it's about 1.4 million barrels a day of exports right now.
02:25So it would be a dramatic impact at the margin and it would be a disaster for Europe
02:29because Europe's short gas inventories going into winter and is dependent at the margin on heating oil.
02:35So it's a total mess.
02:37And I think the whole Hormuz debate we've characterized as pushing on a string.
02:41You know, whether or not there's oil coming out, I think both sides are getting militarily exhausted right now, actually.
02:47So there's going to be more oil.
02:48I think there's a herd effect that the ships can all go through and only a few get hit.
02:53You know, I think that the crude side is actually okay.
02:56And the question to me became, is China still buying with oil above $100 a barrel?
03:00And I think they probably took their foot off the accelerator there too.
03:04So we can see signs that you're getting military exhaustion, you're getting more oil out of the Hormuz.
03:09So the final thing to solve is going to be distillate.
03:11And that's going to be a tricky one because essentially you're at 98% capacity
03:15and you need to shut down the refineries to turn them around, which we think will happen in 2027.
03:21So it's a complex situation.
03:22And it's interesting to hear the president highlighting diesel as the problem finally.
03:27Although it's actually like the European gas crisis.
03:30We had a gas crisis before in Europe.
03:32Russia invaded Ukraine.
03:34Here we pretty much had very, very tight diesel before we got the Hormuz situation.
03:39We see Brent under $100 this morning.
03:41You thought $150 was potentially one of the crazy price targets.
03:45For Brent, didn't you?
03:47Probably.
03:48I mean, I think what we said was that look at diesel at $150 and look at jet fuel at
03:54$250
03:55as we increasingly thought that the problem was refining.
03:58In fact, I think all along we focused on the shutdown of refining in the straight and foremost.
04:02The crude situation was always a disaster, but one that you know was basically solved by the Chinese
04:08as much as anything and the Saudis.
04:10So now if you have a combination of the Chinese backing off buying oil at over $100, which I think
04:15they will, and Saudi supplying more, you can see that crude will come under pressure here
04:20at a time of year when naturally it comes under pressure.
04:22But the reality is we still have to rebuild inventories.
04:26We still have a fundamental shortage of diesel globally.
04:29You know, there's a number of issues here that will keep the product side of the market
04:33in that $150 to towards $250.
04:36Diesel at the pump in the US is over $250 a barrel.
04:39And that's where we've been focused, really saying that the crude side is almost like a
04:43notional price.
04:44We say, you know, it's difficult to know how it can price when refineries at maximum.
04:49Huge, huge numbers.
04:50The president, as you indicated, is not just putting a spotlight on product.
04:54He's also putting more of a spotlight on Ukraine and Russia.
04:57Russia, of course, has had somewhat of an embargo on diesel exports for a while now.
05:01Can you explain to us all how much influence that's had on the global price, the fact that's
05:06come offline and stayed in Russia?
05:08Yeah, absolutely.
05:08Russia was the second biggest exporter of diesel.
05:10And obviously, you know, that's been a major, major loss at the margin for a market that's
05:15structurally tight.
05:16As you know, the US economy is also pretty strong here.
05:19So we haven't seen the kind of demand destruction.
05:21I think that's been one of the other big themes of the year, particularly in the US.
05:24You just haven't seen the demand destruction that you would have anticipated potentially
05:29as gasoline goes through four and diesel goes towards five and diesel even higher.
05:36So it's been a very powerful environment for prices simply because demand hasn't reacted.
05:41That's the way you solve these problems is less demand.
05:43And diesel has then gone to a price of demand destruction.
05:47But there are elements of the diesel economy basically that are priced inelastic because
05:51you have to run the trucks and you have to run the combine harvesters.
05:55So it's an interesting dynamic with one allowing for the lack of inventory and how low global
06:01inventories are.
06:02For example, Australia is trying to build inventory.
06:05They haven't been able to supply themselves, but they've realized why we can't keep going
06:10with these insanely low inventories, ignoring the IEA emergency requirements.
06:14So next year, the interesting combination is going to be much more refining down time and
06:20inventory building.
06:21So I think I'm getting conviction that the on-market environment stays very elevated through the
06:25end of 2017.
06:26So I think I'm getting conviction that the on-market environment is going to be able to go to the
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