Crude inventories have been rising in Alberta and Kharg Island for very different reasons.
In Canada, the main oil-producing province is struggling to find the right balance between output, pipeline capacity and crude-by-rail loadings.
Once again, the balance has tilted toward oversupply, causing storage tanks in Hardisty and Edmonton to fill up.
In Iran, tougher US sanctions have caused exports to drop at a faster rate than production.
Washington stopped granting waivers to eight buyers of Iranian crude in early May, causing inventories to build at the key export hub of Kharg Island in the Persian Gulf.
Both stories are significant because they highlight key drivers impacting the global oil market.
The growth in North American crude production (capping oil prices) and the reimposition of US sanctions against Iran (supporting oil prices).
But what if the logic underpinning the statement above is changing?
That seems like at least a possibility when you consider the reasons for the inventory builds in Canada and Iran.
Let’s begin in Western Canada.
A lack of pipeline capacity has bedeviled oil producers. How much more can production grow unless additional pipelines get built?
The same dilemma has been present in the Permian Basin throwing into question whether producers there can maintain staggering growth rates.
Yet the outlook is far worse north of the border where opposition to pipeline construction remains fierce (a topic we covered in an earlier blog).
A bottleneck caused prices for benchmark Western Canadian Select to trade at a massive discount relative to WTI (Cushing, OK delivery).
The WCS discount hit a record of more than $52/b in October 2018.
On December 2, the Alberta provincial government took the extraordinary step of mandating production cuts of 8.7% (325,000 barrels per day) to address the oversupply.
A day later, the WCS discount fell from $32/b to $25/b. The discount kept falling, hitting a low of $8/b mid-January and trading mostly in a range of $8/b-$14/b since then.
The Alberta government intended to narrow the WCS discount when it decided to issue the curtailment order.
On that basis, the decision could be considered a success. The problem was the WCS discount became so small there was an unintended consequence.
Crude-by-rail was no longer profitable.
As a rule-of-thumb, the WCS discount must be at least $15/b to incentivize train owners to load and deliver crude out of Alberta.
No surprise, the volume of crude-by-rail loadings dropped as a result.
Source: National Energy Board
This decrease has caused Alberta crude inventories to build since March, despite the production curtailment.
That sent a signal for prices to respond, which is exactly what has happened.
The WCS discount has been widening -- reaching $18.50/b last week -- its biggest amount in more than six months.
Reports indicate that crude-by-rail loadings are headed higher.
Will this be enough to stop Alberta’s crude inventories from building further?
The other component is production. The curtailment order expires at the end of 2019.
The monthly allotment began at 3.56 million bpd in January. It has been raised every month since, and is set for 3.71 million bpd in June.
Half-way around the world, Iran has also dealt with inventory builds and questions about future production.
The main impediment isn’t a lack of pipelines, but US sanctions in full effect since early May.
Washington’s stated desire to drive Iranian exports to zero have begun to bear fruit.
Iran’s crude exports fell to 400,000 bpd in May. Turkey, one of the eight countries no longer receiving a waiver, has stopped its purchases.
Those cargoes still leaving Iran are reportedly headed to Asia (Last week’s blog discussed China’s imports of Iranian crude).
An interesting trend to develop alongside the slowdown in exports has been the crude inventory build at Kharg Island.
This suggests production hasn’t fallen to the same extent that exports have. One reason why could be the costs and logistical difficulties involved in restarting production.
But this isn’t a sustainable path. The amount of crude that can be placed in storage -- on land or at sea -- will reach its limits.
Iran faces some hard choices.
What do you think? Will Tehran try and find buyers willing to risk US sanctions if caught?
Or could the unthinkable happen? Might the US lift sanctions in return for a new Iranian nuclear deal?
We’ll continue to follow these stories.
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