Venezuela’s Crisis Isn’t All Bullish For Oil

(Bloomberg Opinion) -- Attempted coups and alternative governments in petrostates like Venezuela are typically the stuff of oil price rallies. Thus far, the political crisis in Caracas — really just the latest escalation of the long-standing crisis engulfing the country — has prompted a twitch in crude oil prices rather than a full-on spasm of fear.

In part, that reflects a market that priced in Venezuela’s slumping oil output ages ago. But it also reflects apparent weakness in one of oil’s most important markets: gasoline. And further turmoil in Venezuela may actually exacerbate this.

The latest oil inventory numbers from the Energy Information Administration, released Thursday, showed weakening U.S. gasoline demand and stocks of the fuel hitting record levels. Little wonder gasoline cracks — a simple proxy for the profit on refining crude oil into the fuel — have hit their lowest level since late 2010:

Venezuela’s Crisis Isn’t All Bullish For Oil

As I wrote here a couple of months ago, one reason for the gasoline glut is rising production of lighter grades of crude oil from U.S. shale basins. These yield a higher proportion of gasoline even as refiners try to maximize output of diesel, for which demand and margins — currently about $26 a barrel — are stronger. In other words, gasoline is becoming something of a byproduct.

Refiners on the Gulf Coast are configured to be able to process heavier grades of crude oil. These have the double benefit of usually being cheaper and yielding a higher quantity of diesel vis-a-vis gasoline.

That’s where Venezuela comes in. Its production is very heavy and, along with its proximity, this has made those barrels popular with Gulf Coast refineries. If a deepening crisis, perhaps twinned with U.S. sanctions, cuts off some or all of those barrels, it will present refiners with a quandary. They can bid up the price of alternative heavier barrels. Indeed, that has happened already, especially as production caps in Canada’s oil sands have also limited another source of heavier barrels.

Venezuela’s Crisis Isn’t All Bullish For Oil

That narrowing spread is effectively money coming out of refiners’ pockets. And as Paul Sankey, oil analyst at Mizuho Securities writes:

Take another 500 [thousand barrels a day] of heavy [oil] out of the mix, and those [spreads] will narrow even further, and many GC [Gulf Coast] refiners will simply have to shift towards lighter grades and/or cut runs.

Cut runs, and that will put downward pressure on oil prices even if geopolitical fears are pushing the other way (remember, refiners, not you and me, are the ones who buy crude oil). On the other hand, if refiners resort to lighter grades, they will continue to add to that gasoline glut, also a drag on crude oil prices.

If Nymex crude oil prices offer a handy way to take the market’s temperature on Venezuela, the two margins above tell the story beneath the story.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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