Analyzing the Decline in Oil Prices with ZEMA – Part 1
The global oversupply of crude oil, partly caused by the US shale boom, has already pushed the prices of Brent and Western Texas Intermediate (WTI) to their lowest in three years. Undoubtedly, the decline of both benchmarks by more than 20% in the past three months will have a prominent effect on the refining industry, along with all other dependent industries, for months to come.
Two of the most important and closely observed derivatives of crude oil are gasoline and heating oil. Figure 1 indicates the relationship among all three by showing the prices of WTI (blue line), New York Harbor ULSD also known as “heating oil” (orange line), and RBOB gasoline (green line) for the last three months.
The light orange area represents a 3:2:1 crack spread, a differential between the price of crude oil and its derivatives, which may be explained as a theoretical profit margin expected for refining crude oil. The 3:2:1 crack spread estimates a product yield where refineries make two barrels of gasoline and one barrel of distillate fuel from every three barrels of crude oil they process. It would be fair to assume that the derivatives react to the price of crude oil with a small delay; therefore, a slight increase in crack spread should occur after each oil price drop. However, the graph shows the opposite picture—crack spread declines sharply upon the drop in gasoline prices at the end of September. If we compare the relative change for this whole period, we will notice that RBOB Gasoline price decreased by 23%, having outstripped heating oil (15% drop) and WTI (21% drop) and pushed the crack spread down by 16% compared to the beginning of August.
According to American Automobile Association, such behavior of gas price in autumn of 2014 is not solely the consequence of its oversensitivity to oil prices. In fact, the excessive supply of the crude oil coincided with a seasonal pattern of gasoline demand, as it usually declines in September due to the ending of the busy driving season and the switching of gas stations to a less costly winter blend. The absence of Atlantic hurricanes, typical for September, also prevented spikes in gas prices, pleasing drivers with the lowest September gas prices since 2010, as RBOB steadily keeps moving towards the $2 mark.
Now let’s compare the prices of gasoline and heating oil during the same period for the last three years. Figure 2 represents RBOB and ULSD prices in 2014 (green and orange dotted lines, respectively) compared to their 2011-2013 averages (green and orange solid lines, respectively) for the months of September, October, and November.
Both contracts are being traded below their three-year averages, and the difference becomes more notable in the month of October.
Let’s also take a look at a similar graph (Figure 3) comparing current prices of WTI and Brent with their three-year averages; red and black solid lines represent 2014 prices of Brent and WTI respectively, and corresponding dotted lines show 2011-2013 averages of Brent and WTI for the same months.
Despite the fact that ULSD and RBOB share a mutual region with WTI, the pattern of their curves looks more similar to the North Sea benchmark. The correlation analysis of the last three months carried out in ZEMA supports this conjecture with the following results: correlation coefficients “ULSD vs. Brent” and “RBOB vs. Brent” are 0.893 and 0.732 respectively, while “ULSD vs. WTI” and “RBOB vs. WTI” are only 0.728 and 0.601 respectively. This gives us basis to presume that Brent crude oil plays a more important role in determining prices of US petrochemicals than its North American counterpart.
Meanwhile the price of distillates is not the final link in the chain of “crude aftereffects.” In the next blog I will analyze whether there is any dependency between the sharp decline in oil prices and the stock prices of major transportation companies.
 “AAA Monthly Gas Price Report: Gas Prices to Keep Dropping in October,” Daily Fuel Gauge Report, September 30, 2014, accessed November 13, 2014, http://fuelgaugereport.aaa.com/aaa-monthly-gas-price-report-gas-prices-to-keep-dropping-in-october/.