Supply and Demand Fundamentals to Drive Asphalt Prices for 1996 Paving Season

Dec. 28, 2000
Asphalt is a unique product. Although it represents a small yield, only 3%, of the U.S. refinery system, it is not a simple product to understand. No other petroleum product is affected by so many variables. The resultant supply/demand fundamentals in turn affect the prices of asphalt that materialize in a particular season.

Some of the key variables affecting asphalt include the following:

  • The government is the largest customer of asphalt in the paving sector and affects asphalt through the release of highway funds.
  • The U.S.
Asphalt is a unique product. Although it represents a small yield, only 3%, of the U.S. refinery system, it is not a simple product to understand. No other petroleum product is affected by so many variables. The resultant supply/demand fundamentals in turn affect the prices of asphalt that materialize in a particular season.

Some of the key variables affecting asphalt include the following:

  • The government is the largest customer of asphalt in the paving sector and affects asphalt through the release of highway funds.
  • The U.S. economy affects private sector growth and influences both the paving and the industrial sectors.
  • Pricing of products, such as high sulfur fuel oil, which if strong, could divert vacuum-tower blend stocks from the asphalt market.
  • Economics. Whether or not asphalt is produced depends on the economics at the individual refinery.
  • Transportation. Is there an economical means to move asphalt volumes from areas of surplus to areas of deficit?
  • Crude-oil spreads. Whether the differential between light and heavy crudes makes it economical or uneconomical for a refiner to process heavy crudes that produce asphalt.
  • Specifications, such as the new SHRP specs affecting AC grades, and whether refiners can meet them with ease, and
  • lNatural disasters can affect asphalt in different ways: storms disrupt paving, blizzards deplete transportation budgets, earthquakes can result in redirection away from asphalt and hurricanes encourage increased roofing flux sales.
These and other variables can influence the supply or demand for asphalt and affect prices.

This article will highlight some of the changes in fundamentals over the past few years that will affect the asphalt scenario in the future. It will discuss the 1995 asphalt picture with resultant prices in key consumption regions. Finally, it will outline some of the key variables that can be expected to influence asphalt supply/demand fundamentals in 1996.

Asphalt consumption in the U.S. averaged approximately 31.7 million short tons in 1995. To put this in perspective with other petroleum products, asphalt consumption is about 6.2% of gasoline consumption and 15% of No. 2 oil consumption in the U.S.

Asphalt consumption consists of two key sectors: the paving and the industrial sector, or roofing sector. Paving asphalt demand was close to 85% of total asphalt demand in 1995, and averaged 26.7 million tons in 1995.

Paving demand is dependent mainly on the following factors: the level of federal highway funding, matching fund availability at the state level, the ability of the states to put out projects in a timely fashion, and private-sector asphalt-demand growth for the state. Industrial demand is mostly influenced by construction in the residential and commercial sectors, which also is dependent on the state of the economy. This 15% of the total asphalt market in the U.S. amounts to around 4.8 million short tons. Private-demand growth is a very important part of the demand picture for paving and industrial demand in some states, particularly in the last few years when interest rates were low and the economy improved.

The various regions of the U.S. consume different amounts of asphalt. The Midwest region, with the largest number of states, has the highest consumption level and is estimated to have consumed around 40.4% of the total asphalt pie in 1995. The East Coast region is second, its rate is 27.9%, with the Gulf Coast following at 14%. The other two regions, the West Coast and the Rockies, had asphalt consumption of less than 13% each in 1995.

On the supply side, asphalt comes mostly from domestic refineries, with imports covering the balance. U.S. refiners are estimated to have produced roughly 29.6 million tons of asphalt in 1995, or 91% of the total supply. Today, the supply of asphalt is an important fundamental, much more important than in the past. Before 1993, demand was the key market fundamental in the asphalt business. There was little doubt that there would be enough asphalt to meet the requirements of demand, mainly from local refiners in the vicinity of the projects.

Even though demand continues to be an important fundamental, supply appears to carry more weight. This is partially due to the continuing shutdowns that have been occurring in the refining industry, partially due to environmental legislation affecting other refined products.

Asphalt-capacity reduction in the U.S. has become a trend over the last few years. It is important to note that even though the actual capacity has been declining, the production levels of asphalt have remained roughly in the 29 million ton band over the last few years. This has been possible mainly due to existing U.S. asphalt refiners running at higher utilization rates. Unfortunately, it makes the market more vulnerable to short-term price fluctuations should there be any supply disruptions at these refineries.

Just as in the case of consumption, asphalt production is not uniform in all U.S. regions (see Chart No. 1). The Midwest region has the highest production of 39.8%, followed by the Gulf Coast at 24.9%. The East Coast-region production is estimated to be at 17.2%, with the West Coast and the Rocky Mountain region trailing at 10.6% and 7.5%, respectively.

In regions where asphalt production exceeds consumption, there is a net flow "out" of the region in the form of inter-regional transfers out and sometimes exports. This can be said for the Gulf Coast region and the Rocky Mountain region.

All other regions, the East Coast, Midwest and the West Coast, have production levels lower than consumption levels of asphalt. These regions have net flows "in" of inter-regional transfers and imports. It is important to note that supply logistics sometimes make it difficult for asphalt volumes to reach areas of need with ease.

In 1995, it is estimated there were over five million tons of asphalt moving from one U.S. region to another (see Graph No. 1). The asphalt moved by barge, truck and rail. This graph shows an interesting change occurring in the asphalt market over the years, namely the movement of asphalt over longer and longer distances within the U.S. Formerly, asphalt buyers/ resellers would typically obtain supply mainly from one or two marketers who were nearby and with whom they had long-term relationships. Today, volumes move great distances, giving asphalt some of the mobility that its sister petroleum products have enjoyed for years. As you can see from the graph, in 1995, about 80,000 tons moved from the Midwest to the West Coast by rail.

Asphalt imports into the U.S. were estimated to be at 3.1 million short tons in 1995. Historically, asphalt imports have come mainly into the East Coast, as this region has the most acute shortage of asphalt production facilities in the U.S. In 1995, the East Coast is estimated to have imported around 2.5 million tons of asphalt which represents approximately 82% of the total asphalt imports. These imports came mainly from Venezuela, Canada, Spain, and Mexico. Imports to the Gulf Coast came primarily from Venezuela and Mexico, as did imports into the West Coast. The Midwest and Rockies imported asphalt from Canada.

Although every year is different in the asphalt business, even asphalt industry veterans will agree that the 1995 asphalt season was one for the history books. What made the 1995 asphalt season particularly different from some of the prior years was that prices rose in spring and stayed high in most markets, well into the summer months. This was due to continuing supply tightness, which necessitated supply allocations by a few key marketers, particularly in the Midwest, Rocky Mountains and East Coast regions.

Looking at the fundamentals that affected asphalt in 1995, asphalt consumption was nothing to brag about for the combined paving and industrial sectors. Consumption was about 0.6% nationwide. This fairly flat consumption was due to paving markets being limited by state-budgetary constraints. Industrial markets did better with booming housing and development in some regions. A look at consumption numbers on a region-by-region basis shows that the smaller consumption regions, the Rockies and the West Coast, had higher growth rates of 2.9% and 2.7%, respectively. The Midwest and the Gulf Coast were lower with 2.5% and 2% growth rates, respectively. The Midwest and the Gulf Coast were at 2.5% and 2.0%, respectively, while the East Coast showed a decline in consumption of 4.1% over 1994.

When we look at only the paving sector, demand was even weaker with only 0.4% growth rate. On a region-by- region basis, the strongest growth of 3% was in the Rockies, while the poorest performance was observed in the East Coast, which had a decline of 4.8%.

On the industrial side, nationwide growth was 1.4%. The best performance on a regional basis, was the 5.7% increase seen in the West Coast region. The lowest performance was in the East Coast with flat consumption. Other regions were between 2.0% to 2.8% in growth.

The reduced supply of asphalt played an important role in the higher prices seen in the 1995 season. Rising costs for heavy-crude oils and weak refinery margins caused many refiners to reduce runs or switch to lighter-crude slates even before the season started. Additionally, the strength in the fuel-oil market kept some refiners away from asphalt production in the winter months. The result was limited asphalt inventory build-up in refiners' tanks during the winter. The situation was particularly severe as marketers were already down to tank bottoms due to the relatively warm winter last year, which extended the 1994 paving season well into the traditionally dormant months.

The tight supply situation eased somewhat in the second half of the year due to higher production from local refiners and an increase in imports. The East Coast, however, saw more asphalt supply than could be absorbed by the weak demand.

Asphalt rack prices in 1995 were generally higher than in 1994 in most markets. This is due to the cost push from higher crude-oil prices. Some regions of the U.S. had price softening in the second half of the year. In the Midwest, for example, asphalt prices rose in spring and only showed some softening in the second half of the year.

A look at the East Coast market shows the same trend, however, it is much more dramatic because the supply situation had wider swings than in other regions. Prices increased rapidly in the spring by $25-35/short ton, stayed up for several months and then started dropping fast in July. This was observed in all East Coast regions: the New England area, the Mid-Atlantic, and the South-Atlantic.

It is at this time of year that suppliers and buyers attempt to understand what asphalt supply/demand fundamentals will be like for the upcoming season (see graphic above). Due to the myriad of variables that influence asphalt, this can be a complex task. A preliminary look at the fundamentals shows a very different year from 1995.

Asphalt consumption in 1996 is expected to decline overall by around 1.2%. This is mainly the result of declines anticipated for the East Coast and the Midwest sections. East Coast consumption is expected to decline by 2.5%, while the Midwest region is expected to decline by about 1.6%. Other regions are expected to show positive growth rates. The Gulf Coast and the West Coast are projected to have growth of less than 1%, while the Rocky Mountain region is projected at around 1.5%.

Part of this less-than-optimistic forecast for demand comes from the delays releasing federal highway funding. Additionally, some of the states have had budgetary constraints. The bottom line then becomes less money going towards the transportation sector or the movement of state funds originally ear-marked for transportation being used for more pressing needs. Additionally, the industrial sector or the roofing market, has been growing at a slower pace than in prior years.

On the supply side, the picture is less clear. The asphalt could be affected by additional coking capacity that is scheduled to come on stream by the end of the first quarter of 1996. Assuming that the capacity comes on line as scheduled and operates properly, it could strengthen the fuel-oil market, which in turn could provide a price floor for asphalt. On the other hand, crude-oil prices are expected to soften on average, but only slightly, compared to last year. This is partially due to additional supplies by OPEC and more North Sea production. Asphalt inventories are high in some markets, and a few new participants are entering the asphalt market, though their participation may not affect the long-term supply picture.

These are some of the key supply/demand factors that could shape the 1996 asphalt prices. The past cannot be used to predict what will happen in the future.

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