The hot summer months are the boom time for U.S. gasoline sales, and naturally the season when refiners are all-in on pumping out the motor fuel for drivers on U.S. highways.
But an unusual glut of gasoline—just as refiners are ramping up to produce more—has caught them on the wrong side of distillate margins for the second time in less than 12 months.
Instead of minting bigger profits on refining gasoline, they are seeing margins shrink because of oversupply, potentially leading to disappointing earnings. U.S. gasoline inventories are currently about 9% above their five-year average, according to data from the U.S. Energy Information Administration.
The gasoline oversupply has presented refiners with the unusual dilemma of whether to switch summer output towards distillates.
It is a mirror image of what happened with distillate products in the winter, when weak demand for diesel and heating oil left a big surplus in those products, and hammered independent refiners’ earnings at a time when those products are normally in high use.
Typically, gasoline trades at a premium to diesel during the hot months of June, July and August. However, on Wednesday, gasoline’s premium to diesel and heating oil fell to a mere one cent, down from a peak of 29 cents in early April.
“Gasoline is on the verge of trading under diesel… in JULY!!! That’s insane,” a trader at a U.S. bank said in an instant message.
The industry as a whole has been churning out gasoline hard for the past year, as a golden period of refining margins emerged out of the ashes of the crude oil rout.
A mild winter led to swelling distillate stockpiles, resulting in a rare winter occurrence where heating oil traded at a discount to gasoline, catching refiners off-guard at a time when they typically increase distillate production to meet high demand for heating oil. As a result, independent U.S. refiners reported their worst quarterly profits in five years in April.
With better margins for gasoline, refiners moved in that direction. Phillips 66 CEO Greg Garland said in an April earnings call that the company had been running “pretty much max gasoline,” a point echoed by several other CEOs that month.
Despite strong demand, gasoline margins dipped in recent weeks as traders feared high imports and rising supply would make it harder to work through record inventories.
“Refiners killed the gasoline golden goose this year by overproducing. They were actually making summer gasoline during winter. That says it all,” said Nevyn Nah, oil products analyst at Energy Aspects.
Earnings per share at top U.S. refiners, including Phillips 66 (psx), Valero (vlo) and Marathon Petroleum (mpc), are expected to fall well short of analysts’ expectations in the second quarter, according to StarMine, a unit of Thomson Reuters.
The surprise strength in diesel has again caught refiners off-guard. Prices of distillates, which include heating oil and diesel, have seen an unusual surge in recent weeks due to robust overseas demand combined with lower domestic production. Refinery strikes in France have also propelled prices forward.
“This (strong distillate demand) will continue to run into back end of June. We still see strong demand into July right now, so I think it may have an even longer bull run,” an East Coast refining source said.
Seasonally, the last time gasoline traded at a discount to diesel was in 2013. If diesel’s premium does return, refiners will likely make a switch, said Mark Broadbent, Wood Mackenzie’s senior research analyst for refining and oil product markets.
Delta Air Lines (dal) is currently considering pulling back the reins on gasoline output to boost diesel production, according to a source familiar with the plant’s operations.
Others think it might not be the easiest or the best strategy to switch just yet. Gasoline is still the marquee product for the summer, said Tom Kloza, global head of energy analysis at OPIS.
“If I were in a refinery meeting in the next 60 days, there’s no question I would say, ‘Let’s make as much gasoline as possible,'” said Kloza.