4 Myths About The Market Meltdown & Energy Pricing

1. Demand in China is Weak

The Chinese stock market may be down to 2007 levels and the government may be devaluing the yuan, but there is no indication that this “economic slowdown” is extending to commodities. China is one of the largest consumers of commodities in the world. A decline in commodity imports should foreshadow an economic downturn, but Chinese crude oil imports were up 27% in June and went up another 1.7 million barrels a day in July. In the beginning of August, the Chinese Ministry of Commerce granted licenses to two independent refineries in China to import crude oil directly, a move designed to further open their commodities market to private interests. Most of China’s domestic independent oil refineries have never received sufficient crude oil feedstock from the government and have been relying on imports of low quality fuel oil to refine into gasoline and diesel. Freeing these refineries to arrange their own imports should increase demand for crude oil imports in China in the coming months, and if China continues on this path, crude oil imports may rise even more. The bottom line is that if Chinese refineries have the ability to import more crude oil, they surely will, especially at the low $40/barrel prices seen in today’s market.

2. Low Prices are Bad for the U.S. Energy Industry

Not everyone is losing money in the U.S. oil market today. Refineries, petrochemical processing plants, and other manufacturers that use crude oil as feedstock are seeing huge profit margins. Gasoline demand is up 4.1% in the U.S. this year and refineries in the Chicago area saw profit margins of $50.48 in August – the highest since September 2008. In New York, the spread between gasoline and crude oil has been in the $30 range. Crude oil in the United States is artificially depressed because of a lack of refining capacity that is particularly acute due to a mismatch in the type of oil available in the U.S. and the type most efficiently refined by North American refineries, and because of several mechanical issues at major refineries that have taken hundreds of thousands of barrels of oil a day out of production. All signs indicate that the U.S. would process more crude oil if it could—which would push crude oil prices higher and gasoline prices lower. But since there is not enough refining capacity for all of the available crude, refineries and gasoline distributors are raking in the profits. This is why you cannot find $1.50 gas at the pump.

3. The Oil Price Slide Will Break Up OPEC

Low oil prices have been hurting small oil producing nations for the better part of the year, and every few months Venezuela, Iran, Nigeria, Algeria, and Libya call for OPEC to reassess its current production policies. The fact that half of OPEC is unhappy with the cartel’s decisions to keep pumping oil, whereas the big producers – Saudi Arabia, the UAE, Qatar, and Kuwait – are committed to staying the course, is no indication that OPEC is breaking apart. None of the smaller, poorer producers have even threatened to leave OPEC. After all, without OPEC their productive capacity means even less than it does now. Relatively small producers only have a voice in the global oil market today because of their OPEC membership. Dissention in the ranks of OPEC is nothing new. Saudi Arabia and Iran fought tooth and nail over where to set the price of oil in 1974, and Iraq invaded Kuwait in 1990, in part because Kuwait’s illicit overproduction drove down oil prices. A little bickering is par for the course, and Saudi Arabia will handle the smaller OPEC producers, because those smaller players have nowhere else to go.

4. All Oil Players are Suffering

Low oil prices hurt some players more than others. Public companies are all taking hits in the stock market, but those with diversified upstream and downstream operations can make up for it. When large companies, like ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), Royal Dutch Shell (NYSE:RDSa) and BP (NYSE:BP) cannot make a profit in oil production, they rely on their downstream refining operations to even out the difference. National oil companies that are similarly diversified, like Saudi Aramco, are also better situated to handle low oil prices by relying on refining operations, and they do not have to deal with the whims of shareholders. On the other hand, companies like Continental Resources (NYSE:CLR) and Whiting Petroleum (NYSE:WLL) do not own stakes in refineries, leaving them at the mercy of sub $40/barrel oil prices. ConocoPhillips (NYSE:COP), on the other hand, spun off its downstream operations into a separate company, Phillips66 (NYSE:PSX), which is positioned to do quite well in this period of low oil prices. Players who diversified during the period when high crude oil prices helped them reap profits are better positioned to ride out these lean times. The big and diversified firms will also ultimately best position themselves to purchase their competitors, who, come October, will certainly find themselves in even worse situations.

(This post also appears on investing.com)