Abstract
COVID-19’s impact on the aviation industry has been significant, but the decrease in demand for jet fuel is a only drop in the crude oil bucket. With the media focusing so much of their attention on jet fuel decimation, market participants are associating this fact to the overall global demand picture. Until the media’s portrayal of oversupply in processed aviation fuels is corrected, the negative demand outlook for the oil industry as a whole cannot be fixed.
Introduction
As reported on September 16th, 2020, a growing disconnect between oil prices and the actual availability of crude oil has arisen from the influence of market sentiment. A major influence causing this disconnect relates to refinery runs and consumption of associated refined crude products. The number one culprit manipulating prices more than it should: jet fuel. Jet fuel demand has tanked since borders have been shut down and travelers fear leaving their homes, but increased consumption in other sectors, like gasoline for personal vehicles, will offset the reduced demand in aviation. The problem is demand for jet fuel has fallen considerably with an unknown recovery date causing fear for the global demand picture. This fear is biasing overall sentiment and forcing the market to misbehave. It is misplaced since available data proves more oil is currently being demanded than supplied, regardless of the oversupply in processed fuels for the aviation industry. Until the media’s portrayal of oversupply in processed fuels for aviation is corrected, the negative demand outlook on the oil industry as a whole cannot be fixed. Attention must also be drawn to the other forms of transportation consuming processed fuels in order to see how the overall demand profile has shifted.
Transportation Fuels
The coronavirus pandemic decimated millions of barrels in crude oil demand as countries locked down to contain the spread of disease. This demand is now returning as lockdowns have ended, but not as quickly or strongly as some may have wished, prompting bleak forecasts like those from bp in mid-September. While these forecasts remain grim, the actual global demand picture is not so dreary. Demand will return, it will just take time – the precise prediction made in our Post-COVID Demand Series back in June which was further confirmed by all three of the world’s main oil forecasting agencies (the International Energy Agency, the U.S. Energy Information Administration and the Organization of Petroleum Exporting Countries) in August [1]. All three sources agree global demand will return to pre-pandemic levels, but it may not occur until 2022.
Luckily, global demand is already trending towards pre-pandemic levels in all areas of global consumption – petrochemicals, construction materials, freight transport, and personal transport. While there are still a few million barrels of global demand shy from pre-pandemic levels, demand is returning. As economies continue to recover they will need more oil. The key holdout: transportation fuels. Starting in mid-March 2020, transportation fuel demand in the United States decreased to record lows as a result of reduced economic activity and stay-at-home orders aimed at slowing the spread of the virus [1]. Demand for gasoline and jet fuel fell faster than demand for diesel, so refiners decreased runs in units associated with gasoline production like catalytic crackers more than they decreased runs in units focused on distillate production such as catalytic hydrocrackers [3]. Many agencies blame the delay in crude oil demand recovery on transport fuels, noting that “the aviation and road transport sectors, both essential components of oil consumption, are continuing to struggle” [1]. Figure 1 shows 68% of U.S. petroleum consumption resides in this sector, so it is no wonder transportation fuel consumption is causing the biggest holdup to global demand returning to its historic peak [2]. While freight and personal vehicle transport has rebounded, jet fuel appears to be the only subset within the transportation sector that is not nearing pre-pandemic levels.
Refinery Slates
To compensate for the record decline in jet fuel and gasoline demand, U.S. refineries shifted their yield slate away from gasoline and jet fuel to produce more distillate fuel. In 2019, U.S. refinery finished motor gasoline yield was 46.2%, and distillate fuel yield was 29.7% [3]. In April 2020, U.S. gasoline yield fell to 40.7%, a record low, while distillate yield rose to a record high of 38.1% [3]. A majority of the April uptick in distillate production outpacing gasoline yields in the U.S. Gulf Coast region for the first time on record was a result of the decline in jet fuel yield falling from over 10% to below 4% [3]. This dramatic rise in distillate yield compared to the loss in jet fuel can be seen in Figure 2.
In addition to adjusting their crude oil slates to account for the demand destruction, domestic refineries also reduced their operations to adjust to changing levels of overall demand. These operational changes resulted in proportionately less production of motor gasoline and jet fuel and more production of distillate fuel oil.
Jet Fuel
It is no secret that the aviation industry was among the hardest hit from the pandemic and is certainly the one taking the longest to recover. Although up from the April trough, the TSA screened around 75% fewer passengers in July compared to 2019 [4]. This is due to substantially reduced flight volumes and was passed through to jet fuel demand. Refineries knew they had to intervene to solve the problem before things got out of hand, and in March and April jet fuel stocks saw large inventory draws. As refineries continued to increase operations, stocks for the refined petroleum product have again begun to rise regardless of a reduced jet fuel yield.
With refineries running at 76% capacity in September, down approximately 10% from the seasonal average, they are producing less refined petroleum products [6]. In addition, refineries have significantly reduced the yield of jet fuel to half of what it was before the pandemic. Yet jet fuel stocks are still rising, proving beyond a shadow of a doubt that consumption is still down significantly. In fact the EIA estimates that as of August 16, 2020, consumption of jet fuel by U.S. commercial passenger flights was approximately 612,000 barrels per day (b/d), 43% of the estimated amount consumed on the same date one year earlier [7]. While bleak, demand for jet fuel in the U.S. is recovering faster than in many other markets. By comparison, jet fuel consumption compared with prior-year levels was down in Europe 36%, the rest of Africa 31%, the Middle East and North Africa 30%, the rest of Asia 28%, and in the rest of the Americas 24%, which makes the situation in the United States quite a bit more palatable [7]. Although not as high as relative demand in China, the outlook is for growth. Not only growth to pre-pandemic levels but growth to new heights. In a recent report on air travel subscriptions, forecasters predict the global market will grow at a compound annual growth rate of 3.4% by 2027 [8]. The data proves jet fuel demand is nowhere near where it was before the global pandemic but will return in the future.
Gasoline
Similar to airports, roadways around the world were nearly desolate at the peak of the pandemic as societies sheltered in place. With economies opening back up, adults returning to work, kids returning to school, and families fearing travel via airplanes; road traffic has resumed around the world. In fact, Bank of America analysts announced road traffic has nearly recovered from pre-pandemic levels and expects global oil demand from road use to go positive year-over-year within the next few months [9]. This comes as no surprise and was predicted in Post-COVID Global Oil Demand Series – Part 3: Personal Transportation when the RP Media Team highlighted the reduced ridership for public transportation and air travel will have a compounding effect on increased demand for gasoline to fuel personal vehicles. This, in addition to increased demand for goods to be delivered to society’s doorstep, is a recipe for a dramatic uptick in global gasoline consumption.
Even with refinery yields of gasoline shown in Figure 2 at or above the levels they were before the pandemic, Figure 4 shows domestic gasoline stocks falling at historic rates. The levels have dropped so fast that they are now well within the five year range, at nearly the same levels as 2019, and 3 million barrels lower than stocks two years ago [10]. Therefore, more gasoline is being consumed than can be produced which will continue to boost global oil demand. Within the next few months, the crude demand lost as a result of decreased jet fuel consumption will be overtaken by the increased demand for gasoline above pre-pandemic levels.
Distillate Fuels
In April, refinery yields for motor gasoline fell to 41%, and jet fuel yields fell to 4%. Both values are the lowest in the U.S. Energy Information Administration’s (EIA) monthly data series for refinery yields dating back to 1993 [11]. Since refinery yields are zero-sum, meaning a decline in one product’s yield will mean an increase in another product or group of products’ yields, where was the gap made up? Distillate fuels of course! Distillate fuels create diesel and heating oil, and U.S. distillate fuel oil yields increased to 38% in April, their highest value on record [11]. In the U.S. Gulf Coast region, distillate fuel oil yields managed to surpass those of gasoline for the first time, reaching 40% for distillate and 39% for gasoline. This means at the peak of the global pandemic more diesel fuel and heating oil was being proportionally created than any other time in history. As a result the domestic distillate stocks began to rise.
As seen in Figure 5, when yields dropped to 36% in May, the stock curve flattened to a nearly horizontal shape. This occurred because supply and demand created a balance for a yield 5% higher than the historical average. How is this possible? Sustained diesel demand for freight transportation combined with reduced refinery run rates. Since distillate fuel yields increased so much during lockdowns, distillate production increased dramatically and by association distillate inventories rose. But since there has been sustained freight traffic resulting from increased shipping needs, current distillate inventories have remained fairly flat after reaching the earlier peak. While inventories are still outside the 5 year range, they are not in danger of overflowing and appear to have struck a supply/demand balance at the higher refinery yield.
Conclusion
Demand is outpacing supply, yet the price of oil has remained depressed. This is all because a small portion of global consumption has remained offline since the start of the pandemic. Since the media has focused so much of their attention on jet fuel decimation, market participants are associating this fact with the overall global demand picture. The fact of the matter is, as travel increased in May, motor gasoline demand increased while jet fuel demand continued to fall. Now gasoline consumption has nearly reached pre-pandemic levels, and the new demand in this sector should be what market participants are focused on.
Utilizing Figure 2, it becomes clear that about 45% of a barrel of oil goes towards making gasoline. That means before the pandemic, 45% of oil demand came from gasoline alone. If gasoline consumption is quickly reaching record-high levels, this sector alone will dwarf the 5% reduction in yield that disappeared due to lower jet fuel demand. Additionally, distillate consumption, another sector dwarfing jet fuel, has reached a supply/demand balance with higher refinery yields than before the pandemic. This indicates distillate fuel consumption is also quickly approaching pre-pandemic levels.
COVID-19’s impact on the aviation industry has been significant, but the decrease in demand for jet fuel is only a drop in the crude oil bucket. The grim outlook for jet fuel demand is casting a shadow over the industry as a whole. While the oil industry has been battered in recent months and may continue to struggle for some time, the world is still reliant on what it produces. Jet fuel demand may truly take years to return but as consumer habits have changed to a post-COVID reality, the smaller footprint for one processed fuel cannot be an analogous representation for total demand. Demand is returning and to assume a small fraction of the pie is a representation of the whole is irresponsible. Just because a small slice of pie has become smaller does not mean the entire pie has shrunk in size.
References
[3] https://www.eia.gov/petroleum/weekly/archive/2020/200819/includes/analysis_print.php
[5] https://www.eia.gov/todayinenergy/detail.php?id=44936
[6] https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WPULEUS3&f=W
[7] https://www.eia.gov/todayinenergy/detail.php?id=44996
[8] https://www.reportlinker.com/p05961238/Global-Air-Travel-Industry.html?utm_source=GNW
[9] https://www.cnn.com/2020/09/08/investing/oil-prices-drop-saudi-arabia/index.html
[10] https://www.eia.gov/petroleum/weekly/gasoline.php#tabs-stocks-us
[11] https://www.eia.gov/todayinenergy/detail.php?id=44936
[12] https://www.eia.gov/petroleum/supply/weekly/pdf/figure3.pdf [13] https://www.eia.gov/petroleum/supply/weekly/pdf/figure4.pdf