Aggregate US oil inventory rose by 8.9m barrels last week, amongst the largest weekly aggregate increases ever. Gasoline stocks are now at levels not seen in two years, some 10m barrels higher than they were last year. Until now the product overhang has mostly focused on distillates which made sense since they’re a key feedstock for industry, and demand has slumped because of the US recession. Gasoline demand by comparison had remained stable, but not any longer. Crude refined in the US through November and December averaged 637m barrels or 4.4% below a year earlier on DOE data. In total, upwards of 1.7m b/d of demand for crude oil disappeared in Q4 2009 because refiners could not pass on the cost of crude oil to consumers in Europe and North America and had to mothball plants. Meantime, there is no more space for crude to move into the Strategic Reserve (remember George Bush frantically filling those SPR tanks at $130 in mid 2008?)  The SPR is out of the market and the implications are bearish of crude as long as OECD demand remains depressed (and those full tanks should also cushion any Iran related price spike).

Chevron's recent profit warning was instructive on the scale of the crisis in the downstream oil business. The second largest US oil company could not make money refining oil averaging $70. If Chevron can't pass on the cost of $70 oil to struggling US consumers via profitable crack spreads, then why do Goldman Sachs think  that a $90 average this year is rational? Their bull case is based on emerging market demand, but a significant portion of China's record 5m b/d December imports will be re-exported in Q1 as refined products, but to whom exactly?  Over the next 6 months, either crude oil has to correct back towards $60 or US average gasoline prices have to surge well over $3 (from a current $2.75) assuming crude oil stays around current levels. If crude oil heads to $90 or beyond, gasoline has to rise pro-rata. Is that credible with an unprecedented supply glut? Speculators currently own more than twice the storage capacity at the NYMEX Cushing delivery hub for WTI crude. What are they going to do with all this oil, which at some point needs to be physically delivered?

On the supply side, according to IEA data just reported, in October non-OPEC crude oil On the supply side, non-OPEC production soared by over 500,000b/d, to 42.1 m b/d in October on IEA numbers. This is the first time since Q1 2007 that non-OPEC hit this production level, at a time when OPEC itself has 3-4m b/d of spare capacity.  The auto fleet in the United States shrank by an estimated 2% in 2009, as 14 million cars were scrapped and only 10 million new cars were sold, which is without precedent in peacetime.  Not only did the car fleet shrink, but average fuel efficiency rose, as many of the most wasteful 'clunkers' were put beyond use, while the price shock of 2008 has encouraged consumers to start driving the compact and sub-compact cars common in Europe and Asia. The idea of Ford launching the Fiesta in the US would have been laughable a decade ago, but looks inspired now.

Southern California is a good test bed for my theory that we are seeing a structural shift in US oil consumption, driven by a changing vehicle fleet and chronic unemployment. Yet gasoline prices are now higher than one year ago as refineries shutter production because of crack spreads at levels that guarantee losses. While the $4-5 dollar gas of late Winter and Spring 2008 was painful, this recent gasoline move to post-financial crisis highs is occurring amid extremely high unemployment. Indeed, California’s U-6 broad unemployment measure is over 19%. Gasoline at over $3 now is probably as economically destructive in terms of aggregate consumer spending power as the $4 plus prices of late Spring 2008 given the doubling of unemployment over that short period. There is always a risk in oil of a geopolitical upset, notably in Iran, but it seems likely the both the US and Israel will let domestic political events run their course over the next few months at least. The rising supply overhang explains why despite a positive view on a global rebound in 2010, I'd expect oil to face a significant correction toward $60 in H1 as fundamentals overwhelm speculative interest, which at a near 3 month high in open long interest makes crude a dangerously crowded trade.