Writing for ASPO, Tom Whipple reports:

Oil prices opened and closed the week around $68 a barrel. At one point they fell below $65 on news of a build in US crude stocks and later touched a high of over $70 on hopes that US unemployment was bottoming out. Oil's connection to the dollar, equity markets, and hopes for an economic recovery remains strong.

Demand for oil remains weak, with US consumption of petroleum products falling to 17.7 million b/d, the lowest since May 1999. While gasoline demand this year has been relatively strong, distillate consumption, which is largely used for industrial purposes in the summer months, is down by nearly nine percent. Distillate stocks continue to grow and are now 34 percent higher than last year. In the meantime, OPEC production continues to creep back up as exporters take advantage of higher prices to ease their recent financial problems.

An oversupply of distillates in the US can be reduced through exports, provided world demand holds up, or they can be stored provided there is enough space. In the last two months, oil stored on tankers has jumped by 71 percent. Some distillate is now being held aboard newly built tankers that have not yet been used for crude.

As the article notes, demand for oil is weak, while demand for gasoline is strong. So why doesn't strong demand for gasoline create just as strong a demand for oil?

Because in normal refining, a given ratio of several products must come out of a barrel of oil: gasoline and perhaps diesel, heating oil, kerosene, aviation fuel, lpg or even asphalt are produced. Gasoline is a blend of distillates and non-distillates, so oil guys tend to say "distillates" to mean heating oil and diesel. If demand for the distillates is low, then refiners must either refine less oil or find storage for heating oil and diesel they can't sell. Cutting back on refining will make gasoline scarcer, hence more expensive.

Update 1: Matt Savinar raised an interesting point on LATOC:

Also, many of your friends ... are probably asking "if the oil inventories are high then why are the prices soaring." Keep in mind there is a bottleneck in many of the refineries ... An increasing amount of the oil in "inventory" is heavy oil. Most of the currently operating refineries were built to handle the light sweet varieties and retrofitting them to handle the heavier varieties of oil is extremely capital intensive. With the credit markets locked up at a time when oil prices have plunged in the last year, companies can't get the loans needed to overhaul their refineries to handle the heavy stuff.

Hard to believe oil refiners can't get credit.

Update 2: Wall Street Journal June 10 2009

Although gasoline demand may be rising, refiners cut back on production of other fuels last week, operating at 85.9% of capacity, down 0.4 percentage point. Gasoline inventories fell by 1.6 million barrels, compared with a forecast for an 800,000-barrel increase. Distillate stocks, including heating oil and diesel, fell 300,000 barrels, where analysts had expected a 1.5-million-barrel gain.