An excerpt from the Quarterly Report of Petroleum Pricing in Canada, Quarter 2, 2020:
We are living in unprecedented times. The COVID-19 pandemic has had extraordinary effects on petroleum markets in Canada and worldwide. With restrictions in place to control outbreaks, thus reducing travel by vehicle and air, there have been drastic reductions in demand for petroleum products. Petroleum product demand decreases have not been equivalent among different products, and this has presented some challenges to refiners. In this section of the newsletter, we will examine how Canadian refineries have reacted and the effect this has had on Canadian petroleum prices. Is the Canadian market on the road to recovery?
Attempts to control the outbreak and “flatten the curve” after the virus entered Canada in January led provinces to enact various states of emergency. By March 22, all Canadian provinces were in some form of lockdown. The effects on petroleum demand were drastic. In April, the first full month of lockdown efforts, gasoline consumption in Canada fell nearly 45 percent from the same month last year (Figure 4). Diesel fuel demand fell less steeply in April, down 21 percent, while jet fuel demand fell dramatically, down 84 percent. May data, the most recent month available, shows demand for all three types of fuel remaining well below levels from a year ago. While diesel and jet fuel demand had fallen further (31 and 87 percent respectively), there was a slight recovery in gasoline demand in May.
The COVID-19 virus affected many countries before becoming problematic in Canada. Consequently, global fuel demand decreased worldwide before impacting Canadian markets. Globally, as refineries reduced outputs in response to low product demand, the need for crude oil inputs into refineries also declined, leading to a glut of crude oil. Additionally, in March, the Organization of the Petroleum Exporting Countries (OPEC) and a group of oil producing countries (collectively referred to as OPEC+) began a crude price war in a bid to increase market share. Low oil prices led to lower refined product prices, abroad and in Canada.
Canadian refineries similarly reduced refining activity in response to low product demand (Figure 5). This included the closure of Newfoundland’s sole plant, the North Atlantic refinery. Refining output in Canada fell to an average of 58.5 percent of capacity in April, far below the previous five-year range. May and June utilization rates remain well below seasonal norms, running at just two-thirds of capacity. Not only have refiners been challenged with reduced operations, but they also face balancing product yields with unpredictable demand patterns.
Sustained trucking demand from consumer stock-piling and increased online shopping maintained diesel demand in March and April. As Canadian gasoline wholesale prices fell at a faster rate than falling crude prices, those refining margins were squeezed, reaching as low as 6.4 cents per litre in late March. In contrast, with wholesale diesel prices falling less dramatically, diesel refining margins expanded to as high as 36.9 cents per litre by the end of March. Consequently, Canadian refineries adjusted production yields, reducing gasoline production by 39 percent year-over-year in April, while diesel production was adjusted downward by only 11 percent. With extremely low jet fuel demand, refiners produced additional diesel fuel by converting jet fuel production to diesel fuel production due to the two product’s similar nature (Figure 6).
Adjustments to product yields in April likely matched product demand trends. But as many provinces in Canada moved towards various stages of re-opening in May and June, demand among different products changed. People began driving more, increasing gasoline demand, while the economic effects of shutdowns began affecting diesel demand, which is closely linked to gross domestic product. As refiners increased gasoline production in response to increased demand, diesel fuel production also increased as a technical necessity, and particularly as jet fuel production was diverted to diesel production. Consequently, diesel inventories expanded, and wholesale diesel prices fell below wholesale gasoline prices in May and June.
Additionally, crude prices have been climbing since April. After reaching extreme lows by the end of March, crude prices remained low in April as inventories remained high. By late April, crude storage capacity became critical. The main storage hub and pricing point for the key North American benchmark, West Texas Intermediate (WTI), reached 83% capacity near the end of April, nearly double the inventory levels at the onset of the pandemic. WTI futures prices reached negative values, a previously unheard of event, on the last day of trading in April as there were few storage options. Many futures contract holders paid other buyers to close contracts. By this time, OPEC+, agreed to undertake extreme crude production cuts, beginning in May. This has lent support to crude prices and brought stability in May and June. Figure 7 shows a timeline of the effect of COVID-19 in 2020 on Canadian petroleum prices.
So what can be expected for Canadian petroleum prices going forward? Planned crude production limits by OPEC+ and lower North American crude production (due to lower crude prices) will likely moderate any steep increases to crude prices for the remainder of 2020 and well into the next year. However, some lifestyle changes experienced during COVID-19, such as working from home and higher online shopping, may become permanent for some. Combined with ever-increasing environmental fuel standards, it is difficult to predict whether fuel demand will ever return to pre-pandemic levels. Evidence of a second wave of COVID-19 in the U.S. (and uncertainty on when a second wave will hit Canada) will continue to have profound effects on product inventories and wholesale prices. Additionally, the economic impact of the shutdowns experienced will likely have long-lasting outcomes on petroleum product demand for the foreseeable future.
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