Supply and Demand

May 8, 1999

Supply & Demand

Analysts look at the market for jet-A, avgas

BY John Boyce, Contributing Editor

June 1999

Many oil industry veterans will tell you that oil is one of the few commodities left whose price is as close to pure dependence on supply and demand forces as you can get in today's global marketplace.

As one oil company executive puts it, "Simply put, as the cost of crude oil goes up, the finished product (price) goes up. As the supply of crude oil becomes abundant the price goes down and the price of finished product goes down. It's a direct relationship. True supply and demand."

Says another veteran, "The oil industry is probably one of the purest supply and demand markets in the world because you have one common product that is being sold."

In point of fact, only in the very early stages of the oil business did the marketplace operate completely unfettered as envisioned by Scottish philosopher/economist Adam Smith. And it certainly doesn't now with government oversight and alliances such as OPEC manipulating the amount of crude available on the world market.

But with all that, basically, if there is abundant supply of crude oil, as there has been over the past year or two, the wholesale prices fall, and that fall is reflected in the price to the consumer. When that supply constricts or is perceived to constrict, the price all along the pipeline increases.

"Crude prices have been extremely low for the past year or two," one executive says. "Because of that everybody has been enjoying a pretty low product price. You've been able to buy motor gasoline at a low level, aviation fuel at a pretty low level.... What was happening was that the price was so low that their (oil companies) cost base was getting eaten into, and they have been suffering."

With OPEC's recent announcement that it would cut back on crude production, the price of crude has slowly increased, based on the perception that supply would tighten. That has forced the price of the refined product to rise.

"Physically," says one oilman, "there is no change in the amount of oil in the world right now; it's just the perception that there is going to be less oil and that will increase the price.... Now, if it turns out in the next month or two that there isn't, indeed, significantly less product to sell, then the price of that crude is going to be bid lower and lower. In the long run, what will determine this, is if there is less crude being chased by the same number of buyers." The price will go up or down based on that factor.

Of course, nothing is that simple.

There are many factors weighing on oil supply and price. All oil producers have the option of capping some wells until the price begins to rise, for instance. Among other current factors, in addition to the presumed cutback in crude oil production by OPEC, are the the Asian and South American financial crises, which have stunted consumer purchasing generally and aviation fuel purchasing, specifically; refinery shutdowns on the West Coast, which have shortened supply and forced prices up; world affairs crises that call for greater consumption of military aviation jet fuel; mild winters that reduce the consumption of heating oil; and, the seasonal nature of driving and flying.

Consolidation among oil companies also will have a significant impact on fuel prices in the long term, according to many analysts. "I think it's like anything else out there," says one industry insider. "I think it has to make the price go up. I don't see any way around it. We've seen it in the airline business — consolidation and de-regulation. Any time you start pulling players out of the market, prices usually go up...."

Consolidation, analysts say, is a function of the low crude oil prices of recent years. Companies have to get their unit cost down to keep margins up.

"If the prices are going to be holding in this $12 to $15 a barrel range," one says, "what the companies are forced to do is get their cost down to a level where they can make money at those kind of prices. If prices were $20 to $30 a barrel there wouldn't be a significant effort to consolidate. When people are comfortable, there's no pressure to change."

Greater efficiency leads to less cost and, eventually, reduced cost to the consumer. However, one industry veteran says, quoting a union official, "cost reduction is a nice way of saying ’laying off people'" and it translates to increased margins, never price reduction.

The seasonal nature of driving and flying is particularly important to the avgas market. Along with the normal economic pressure on refiners to use more of the octane pool to meet the ever increasing demand for motor gasoline and thus increase revenue, as motor travel increases during the spring and summer, refiners will feel added pressure to shorten the supply of avgas in favor of motor gas.

Although nobody says that avgas will be in extremely short supply in the near future, it could get that way long term if refiners shut down or cut back their avgas production in favor of motor gasoline. Consolidation in the industry and many small refiners going out of business also will have an impact on avgas supply and the price for it.

"As we know," says an insider, "avgas has continued to compete for the same components that they use to make regular gasoline.... As a result of that, as there become fewer and fewer players, there could be increased pressure to attract a little more profit out of the avgas. To what extent and how much that happens is really tough to say. That's purely speculation. Practically speaking, there are very few players other than the major oil companies supplying avgas. On the West Coast there is no independent avgas, it's all supplied by the major oil companies."

With so few refiners, a decision by one or two of them to cut back on or completely eliminate avgas production could have a major impact on the availability of avgas, according to a major oil company source. "That (avgas) is tightening up quite a bit. I won't name names, but there are some producers who are now critically looking at whether they want to continue producing avgas. This changes in terms of what's needed for motor (gasoline) and some of the new emission requirements.

"What's happening (is), refineries are needing to put more of the octane pool into motor (gasoline) which is putting a lot of pressure on the avgas business, and it's going to severely cut back on their ability to produce avgas. So much so, (that) I've heard strong rumors that some refiners — one in particular has three refineries that produce avgas — are seriously modeling the scenarios of not producing it any more. If that happens, that will really tighten up avgas (supply)."

While some refiners are, apparently, considering eliminating avgas, there is some indication that another major producer is considering increasing its avgas production. However, even that, if it happens, won't be for another one or two years.

"In that time," says one industry analyst, "avgas could get very, very tight. Very tight, based on the assumption that some refineries will decide that they will not make avgas."

Nobody expects the availability of jet fuel to be shortened, at least not for the foreseeable future. Producers will meet their commitments, and nobody is expecting a huge price increase.

But the price will rise. How much depends to a large degree on whether or not OPEC (and a few allied non-OPEC producers) carries through with it's proposed reduction in crude production and, of course, whether or not military jet fuel consumption increases dramatically.

There have been some stiff increases over the past month or two on the West Coast, says one oil industry analyst, because of the refinery problems. "I don't expect significant increases beyond where we are now on the West Coast," he says.

"You actually have to separate the country into two marketplaces: One is the West Coast and the other is the rest of the U.S.... The West Coast, I don't expect to have a substantial increase now, and I expect it to actually start to come down over the next couple of months — not to where it was but some decrease because right now it's being impacted by a lot of refinery problems.

"In the rest of the U.S., I think there could be a little more increase but primarily it's going to be determined by what happens over the next couple of months in crude. If the production of crude is actually not reduced, there'll be plenty of volume out there, and the bidding is going to start pushing prices back down, and that'll impact the refined product side."

The reverse will be true, he concludes, if production of crude is, indeed, cut.

If jet is in short supply for the private sector, those retailers who get their fuel from spot buyers could see a considerable increase in price, according to most analysts. Those buyers with regular contractual agreements with a supplier will get first option on available product. The spot buyer who buys at the best price day to day might experience some difficulty getting product, and then at a premium price.