The Fuse

Oil Storage Brimming as Supply Glut Continues 

by Nick Cunningham | February 12, 2016

One of the most glaring metrics of the current state of oversupply in the oil market is rising storage levels. The industry is producing more oil than the world is consuming, and the extra crude is going into storage. Since the onset of the current market downturn in mid-2014, storage tanks around the world have been mopping up the excess oil. The high amount of inventories has not only put downward pressure on prices; it has also widened the spreads at the front of the curve, further providing economic incentive to store. In other words, the commercial inventory has been self-perpetuating—and could continue. That development would be, of course, bearish for oil.

By early 2015, the rate at which storage levels were increasing kicked into high gear. By April 2015, the U.S. hit a high watermark: at 490 million barrels, the U.S. had the largest volume of oil sitting in storage in at least 80 years.

After drawing down through the summer of 2015, storage levels rose again in the fourth quarter. In January, U.S. inventories spiked, jumping above 500 million barrels for the first time.

uscrudestocks

Globally, the story is similar. Crude oil stocks continued to build through 2015 as supply outstripped demand. In OECD countries, oil storage levels topped 3 billion barrels by the end of the year (see IEA graphic below).

ieastocks

Supply cutbacks

 If the elevated storage levels do not come down anytime soon and instead continue to mount, inventories will put deeper pressure on oil prices.

If the elevated storage levels do not come down anytime soon and instead continue to mount, inventories will put deeper pressure on oil prices. It was no coincidence that West Texas Intermediate (WTI) plunged to $26 per barrel in January at the same time that inventory levels in the U.S. surged above 500 million barrels. Stocks remain above 500 million bbl, and WTI is back down near $26, as of Thursday’s close.

The head of commodities research at Goldman Sachs, Jeffrey Currie, told Bloomberg that oil storage capacity could actually become precariously tight in certain regions, which would force immediate oil production cuts. “Once you breach storage capacity, prices have to spike below cash costs because you have to shut in production almost immediately,” Currie said on February 9. With no storage capacity left, oil prices would crash lower than they already are. Currie said he “wouldn’t be surprised if this market goes into the teens.”

It is important to differentiate between storage hubs that are landlocked and those that are located in coastal areas. At the global level, total storage capacity won’t reach its limits, but on a local basis, certain storage areas could soon see constraints.

For example, the storage hub at Cushing, Oklahoma, which is pricing point for the WTI benchmark, is reporting storage levels not seen in EIA data dating back to 2004. For the week ending on February 5, Cushing’s storage levels reached 64 million barrels, or about 88 percent of the facility’s working capacity.

cushing

Enterprise Products Partners, an oil and gas pipeline company, recently had difficulties in transporting oil at Cushing because the storage levels there are too high. The company reported “terminalling and pump” issues as congestion at the storage hub interrupted deliveries. When oil tanks are nearly full, it becomes difficult to find space to drain and blend oil to specific requirements. “It’s hard to move barrels around right now because there’s so much oil (in Cushing),” an oil trader told Reuters.

As storage capacity runs low, crude oil prices can experience sudden and severe declines. Without room for more product, and with prices responding with sharp losses, production can be negatively affected. When oil plunged to $26 per barrel in January, production started to finally feel the impact, with volumes being shut in. “When we got into that $26-$28 dollar range, we started to see action. We started to see price volatility turn into fundamental volatility for the first time,” Goldman’s Jeffrey Currie said, referring to production shut ins. “And I think the most striking feature of this market relative to past cycles is the lack of a supply response…in this pull back in prices. But now we are beginning to see fundamental movements.”

Supercontango

A dearth of storage and too much supply have contributed to a steep contango in the oil futures market, a situation in which oil deliveries in the near-term are cheaper than oil for delivery at some point in the future. The contango, which is now labeled by some as a “supercontango” because it’s currently so wide, occurs because today’s oil gets sold at a discount as a result of oversupply. If the difference in front-month contracts to deferred contracts is wide enough, it can become profitable to store oil at sea and sell at a later date.

“Primary and secondary storage is pretty much full,” Chris Bake, senior executive at oil-trader Vitol Group, said in London on February 10. “It’s probably a good time to be a vessel owner.”

 The contango structure may seem like a bizarre financial quirk, but put simply, the shape of the forward curve and high onshore storage levels are symptoms of an oil market that is still immensely oversupplied.

The contango between front month and year-ahead contracts for WTI widened to $11.74 per barrel on February 11, its largest since the first quarter of 2015. That is roughly the level needed to turn a profit—floating storage requires a contango of around $10 to $12 per barrel. Glencore, the multinational commodity trader and mining company, said in late January that it was storing oil on four very large crude carriers (VLCCs), which hold 2 million barrels each, off the coast of Singapore.

The contango structure may seem like a bizarre financial quirk, but put simply, the shape of the forward curve and high onshore storage levels are symptoms of an oil market that is still immensely oversupplied. Storage levels are rising because too much oil is being produced and there is not enough demand to soak it up.

“Since 2014 we’ve accumulated 450 million barrels of stocks. That number we think will go up in the next six months by another 360 million barrels,” Vitol’s Chris Bake said, according to Bloomberg.

Low oil prices could persist

Record levels of oil sitting in storage illustrate the fact that the oil glut continues. The International Energy Agency (IEA), in its February Oil Market Report, estimated that global storage levels will build by 2 million barrels per day (mbd) through the first quarter of this year.

In the second quarter, the stock build slows a bit to 1.5 mbd, and only toward the end of 2016 will the inventory increases begin to come to an end. The IEA says that if its projections are accurate, “it is very hard to see how oil price can rise significantly in the short term.”

By the same token, since oil prices will only rebound when supply is curtailed, brimming storage levels could force painful cutbacks if prices crash below $20 per barrel. Though painful for the industry, it may be necessary to force more supply cuts. There is still a great deal of uncertainty. When asked if $30 oil was cheap, Jeffrey Currie of Goldman Sachs demurred. “The one thing that we do think is cheap is oil volatility. We think it’s going higher.”