Last Contango in Cushing

  This week, there’s been a lot of talk about oil storage—or rather, the lack thereof. Experts are saying that U.S. crude oil storage capacity could be depleted by mid-April of this year, which could result in even larger discounts on U.S. crude oil prices. According to the Wall Street Journal, EIA estimates that U.S. crude oil stocks are at their highest levels in over 80 years, while Citigroup reports that European commercial crude storage could be more than 90 percent full, and inventories in South Korea, South Africa and Japan may surpass 80 percent of capacity. The U.S. currently sits at approximately 60 percent of net storage capacity, while storage in Cushing, Oklahoma (the delivery point for West Texas Intermediate futures contracts) is at 67 percent, up from 50 percent at this time last year. Make no mistake: U.S. commercial crude stocks are high—over 100 million barrels higher than any point in the last years, as data from EIA’s latest Weekly Petroleum Status report shows. According to Jonathan Fahey of the Associated Press, the price implications could be severe. Citing Citigroup’s Ed Morse, one of the world’s most prominent oil market forecasters (and "Bears”), he notes that running out of U.S. storage could push West Texas Intermediate and other U.S. based crude oil streams all the way down to $20 per barrel, as suppliers become desperate to alleviate the glut. There are a few reasons why inventories are building. First, there’s the mismatch of domestic supply and demand fundamentals right now—although producers are cutting back on new drilling and idling many of their less productive wells, the slowdown driven by low oil prices hasn’t materialized yet in production decline. We are also in the winter months when U.S. demand is typically lower and refineries reduce their runs to perform seasonal maintenance, reducing their oil consumption. Furthermore, U.S. shale producers are pumping light-sweet crude, even though many U.S. refineries are optimized to process heavy-sour crudes, which are still being imported from foreign producers. This causes buildup of light-sweet crude in storage facilities. But there’s another big reason why storage tanks are getting crowded: the current market condition: contango, in which the current price of oil is lower than the price for delivery in a few months. In short, contango means there’s a premium for deferring delivery of oil supplies, and money to be made by storing it. Investors are buying oil now for about $50 per barrel, and locking in a contract to sell it in December at $59 a barrel, turning a profit even though they’re paying for storage in the meantime. When enough investors take this approach, commercial inventories naturally build. So should we expect oil prices to “tank” again in April? There’s lots of headlines, but most experts (and the market) are not convinced. While commentators are pointing to the current contango as the reason for the supposed storage crisis, in truth the current contango is very mild. The premium for delivering oil in December rather than June is only $5, which translates to 75c per month, which is not a high enough level that it’s likely to drive an imminent storage crisis. This might be enough to cover costs for onshore storage, but while oil can also be stored in oil tankers offshore, this form of storage is more expensive, and current market conditions don’t make it appealing for traders looking to profit. Furthermore, if it appeared likely that we were going to run out of onshore storage (or in industry terminology, if we were near tank tops), the price of storing oil would increase immediately. This would mean it was no longer economical to pay for storage while delaying delivery to take advantage of the contango. It’s also worth noting that most of the rapid pace of buildup has occurred in Cushing, Oklahoma, a storage facility that is more prone to leasing for tactical purposes. As John Kemp notes in Reuters, Cushing is the first, rather than the last, place where excess oil piles up, since many traders use it for short-term storage. Furthermore, although stocks of crude oil are high, stocks of refined products (gasoline, diesel, etc) are behaving normally. Many have noted that refineries are operating at their lowest annual capacity right now, while undergoing their usual seasonal maintenance. Once full refinery operations return, they will likely begin drawing down crude oil stocks. Meanwhile, stocks of refined products are currently high and above their ten year range, but have actually been falling since the beginning of the year, suggesting that refiners have space to pick up some slack. The return of refineries to full operational capacity will also coincide with the beginnings of summer driving season, and we can expect U.S. fuel demand to remain at the high levels we have seen since oil prices began falling in October. The market is not yet reacting to the supposed storage crisis—after all, we are still far below the level reached in 2011 when Cushing was 88 percent full, and as mentioned, the current contango is small enough to constrain excessive storage. If push comes to shove, traders know there is still plenty of oil storage space still available onshore overseas, and in “floating storage” provided by oil tankers. Needless to say, look for oil producers to use the issue in their continued push for a relaxation of the crude oil export ban.