Will the world run out of storage to place unwanted barrels of oil?
The reduction in oil demand caused by coronavirus-related turmoil and Saudi Arabia’s record-high production have combined to create a massive oversupply. Where will it all go?
Oil prices have collapsed over the last few weeks, with NYMEX crude and ICE Brent hitting lows Wednesday last seen 2002-03.
If storage tanks are near capacity, further price declines will certainly occur to force producers to stop pumping.
Refiners are slashing runs because even though crude is cheap, weak product demand has undermined margins, turning negative in some cases.
Another source of demand has emerged from traders who buy physical barrels, sell oil futures for later delivery and place the oil into storage.
As long as the price spread between the spot market and futures market is more than the storage costs, then the trader can make a profit.
This situation -- in which oil prices are more expensive for deferred delivery than immediate delivery -- is known as contango.
Source: CME Group, ICE Europe
In times like this, when a huge glut is forming, the contango is necessary to remove the supply above and beyond refinery demand.
There will likely be two stages in the process.
First, storage rises in locations where refinery demand has been most adversely impacted.
It’s not surprising, therefore, the inventory builds were pronounced in China where the coronavirus began and refinery demand suffered.
Ursa data shows China’s crude inventories rising sharply since February, reaching all-time highs.
In this sample, China’s crude inventories have increased by 60.5 million barrels (8.6%) since the start of 2020.
The same trend is visible when countries outside the OECD are lumped together, mostly on account of China.
But China isn’t the only reason why non-OECD inventories are rising. Even if we remove China, there’s still an upward trend.
The second stage involves the cash-and-carry trade described above. Traders search for empty storage in optimal places both onshore and offshore.
Glencore chartered a supertanker capable of holding 3 million barrels, while Shell hired a tanker to store 2 million barrels, aiming to capitalize on the contango storage play, according to media reports.
One region that attracts attention when storage is profitable is the Caribbean. Close proximity to US markets, deepwater ports and merchant-owned tanks make the Caribbean an ideal destination.
The collapse of Venezuela reduced the flow of oil into the Caribbean, which meant tanks were relatively empty for a long stretch, but have begun to fill recently.
Of course, the US will also attract barrels, with the obvious candidate Cushing, Oklahoma, a major storage hub and delivery point for the NYMEX crude contract.
Source: US Energy Information Administration
NYMEX crude has narrowed its discount to Brent since the collapse began. The spread has halved since the start of March.
The severity of the outbreak across Europe likely drove Brent down relative to NYMEX crude.
One factor supporting NYMEX crude was the decision by President Trump to fill the US strategic petroleum reserve (SPR) over the next few weeks.
Here's a recap of where inventory levels are today versus four weeks ago:
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