Oil Down Again In Early Friday Trade; Pumps Not Feeling It Yet

If the price of ultra-low sulfur diesel on the CME commodity exchange settles Friday where it was trading at about 10:45 a.m., it will mean that the building block for all diesel prices will have plummeted more than 26 cents in just three weeks of trading.

ULSD on CME kicked off August by settling at $2.1994 a gallon, the highest price since November 2018. But the decline since then has been steady for most of the month. The settlement for ULSD on CME has been down 11 trading days; it has risen only three. A decline on Friday would make it 12 days versus three increases, with a streak of declines to close the week that would stand at eight consecutive days.

At roughly 10:45, the price of ULSD was $1.9371 a gallon, down 26.23 cents from that Aug. 2 settlement. 

But at the pump, those declines are not showing up as the gallons pour into truckers' tanks. The DTS.USA data stream in SONAR, which tracks the national average retail diesel price, opened the month at $3.288 on Aug. 2. On Friday, after all the declines racked up in the commodity market, that retail price in DTS.USA stood at $3.297, actually having moved up slightly.

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Don't blame oil companies for those moves. The fact is, oil companies own few retail outlets anymore so they are rarely setting the price at the pump. Where they do set the price is at the wholesale level, known in the industry as the "rack." Rack prices need to move with commodity prices for a company to stay competitive, as buyers of wholesale fuels can construct their purchasing price formulas on the commodity price, which is tied to a number from a price-reporting agency like S&P Global Platts, or can buy on the basis of the actual wholesale price. 

Given that, it is imperative that the wholesale price stay tied to broad swings in the commodity market. And that's happened: The national average wholesale diesel price as reflected in the ULSDR.USA data stream has declined to $2.146 a gallon on Friday from $2.373 on Aug. 2, a decline that doesn't totally match the decline in the ULSD price on CME but comes close.

Given that, it's no surprise that the retail-to-wholesale spread reflected in the FUELS.USA data stream is soaring. On Aug. 2, it stood at 91.6 cents a gallon. Friday, it was up to $1.151 a gallon, the highest level since April. 

Explaining the pace of retail following markets down and up is close to impossible. But there does appear to be a trend where when prices fall hard and do so quickly, retail is slow to follow. It's been referred to as "rockets and feathers," with retail prices going up like a rocket when commodity prices rise, but falling at the rate of a feather when commodity prices fall. 

As noted, this is not an oil company decision; they set the price at the wholesale level and those prices move with the overall trends in commodity markets. But retail pricing decisions are taken by everybody from a mom-and-pop retail outlet with one station to a large independent retailer with thousands of outlets. And there's a natural reluctance there to drop prices at the same rate as the decline in the wholesale prices they are paying for supply.

As to what is causing the current slide in oil prices, the general consensus is the two D's: delta (as in variant) and the dollar.

The continuing rampage of the delta variant through the world led the International Energy Agency, in its most recent monthly report, to trim its forecast for demand growth this year. In July, the IEA estimated that world oil demand this year would come in at 96.45 million barrels per day. But in the August report, it cut that back to 96.15 million, a 300,000-barrel-per-day reduction. (Note that regardless of where the numbers come in, it's well above the IEA estimate that global oil demand last year was about 90.8 million barrels a day.)

The dollar's impact can be overlooked by nontrader types, but shouldn't be. Since oil is priced in dollars, a stronger dollar works to push down prices while a weaker dollar does the opposite.

The DXY dollar index on the Intercontinental Exchange, the most widely traded dollar contract, has moved up to roughly 93.6 from just over 92 at the start of the month.

That may not seem like a big move on the surface, but it's in just three weeks. The rise in the dollar overall has been going on for several months,  trading at less than 90 in late May before rising to its current level.

The drop in the IEA demand estimate coincided with a decision by OPEC+ — which includes OPEC members and non-OPEC oil exporters — to continue to increase production through the year. Those two things are coming together to create what IEA now sees as the possibility of a market that has excess oil supplies relative to demand.

The amount of oil needed from OPEC to balance world supply and demand is currently more than OPEC output of 26.83 million barrels a day, the current estimate of S&P Global Platts. But when the rise in OPEC+ output runs into the weakening demand growth created by the delta variant, "the scale could tilt back to surplus in 2022 if OPEC+ continues to undo its cuts and producers not taking part in the deal ramp up in response to higher prices," the IEA wrote in its latest report.

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