Demand for storage is reaching a fever pitch with tank capacity and utilization at all-time highs, but the storage market is volatile and at the same time could be barreling toward oversupply.
The US crude market is in contango, meaning crude is worth less for delivery now than later. That dynamic encourages storage, but it could reverse as the contango narrows and production shrinks while tank capacity continues to expand.
There is an easy comparison between the take-or-pay contracts on pipelines and storage tanks, which might give a hint of things to come if the market structure reverses. Under both kinds of contracts, the counterparty has to either use the committed space on the asset or pay a penalty, often as much as the price to use the space in the first place.
In the case of pipelines, that pushed Midland WTI into a premium over its counterpart in Cushing as demand for crude to meet shipping commitments stacked up at the pipelines’ origin terminals. Not only that, but the existence of the contracts helped drive investment in infrastructure, which contributed to the explosive growth in pipeline capacity since the turn of the decade.
If the contracts have a similar effect on the storage market, it would likely manifest in stronger prompt prices, with weaker prices further down the curve — especially if production declines, leaving marketers who expected growth holding contracts to store barrels that don’t exist. For now, at least, imports have been able to keep driving storage demand, but how long might that last as the contango flattens out?
A capacity oversupply would lend strength to the crude prompt market by creating demand simply to meet the contractual commitments that underpin current and upcoming projects’ volume agreements. It could also apply downward pressure to the back end of the contango structure, because cheaper storage lets marketers work slimmer time spreads, Bentek Energy Analysis Manager Anthony Starkey said.
“It doesn’t really ‘solve’ anything, but [an overbuild] could provide that kind of support for oil,” Starkey said.
Though March and April so far have seen a relatively wide contango, with the front-month WTI contract in Midland averaging $1.48/b less than the second-month contract, it is still lower than February, which averaged $1.94/b.
The sustained contango has buoyed crude stocks in the US to an unusually-high 529.9 million barrels.
Those stocks are especially concentrated in Cushing, Oklahoma, with 66.32 million barrels and the Gulf Coast, which holds 277.54 million barrels.
What happens when contango becomes backwardation?
“If the market is in contango, there’s never enough storage, and if it’s in backwardation, there’s too much,” said Andy Lipow, president of Lipow Oil Associates.
The issue of having too much or too little storage capacity ultimately boils down to market structure at any given time, Lipow said.
This principle plays out in the available storage capacity versus crude oil inventory levels at Cushing terminals over the last couple of years. With crude stocks are roughly 89% of working capacity utilized, demand is high at the Oklahoma storage hub.
While the current contango structure has lent support to demand for storage, it probably hasn’t been particularly influential in the decision to build new infrastructure, CEO Ernie Barsamian of The Tank Tiger said.
Especially now that the contango is far from a fresh dynamic on the market, building new infrastructure on that basis is “fool’s gold,” Barsamian said.
“We’re kind of moving to the end of that period,” Barsamian said. “It’s kind of like building a new hotel in Vegas.”
In fact, the rate of greenfield expansions, wherein a company builds a completely new facility, haven’t accelerated at all, Barsamian said. Most of the growth is coming in the form of expansions to existing facilities.
Right now, for instance, Phillips 66 is planning incremental expansions to its 7.1 million-barrel crude and refined product storage facility in Nederland, Texas. The company plans to add 2.3 million barrels over the next two or three years, with an eventual maximum potential of more than 16 million barrels, spokeswoman Lara Burhenn said.
If supply overshoots demand, the older storage terminals will likely lose business to their better-connected, fresher counterparts, Barsamian said.
“That’s always going to happen,” he said. “You get these new facilities built, but they’re not going to end up empty.”
Author: Joshua Mann, Reporter (Platts)
Mary Hogan, a Platts reporter in Houston, also contributed to the research and writing in this post.
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It was shaping up to yet another dull OPEC+ meeting. Cut and dry. Copy and paste. Rubber-stamping yet another monthly increase in production quotas by 432,000 b/d. Month after month of resisting pressure from the largest economies in the world to accelerate supply easing had inured markets to expectations of swift action by OPEC and its wider brethren in OPEC+.
And then, just two days before the meeting, chatter began that suggested something big was brewing. Whispers that Russia could be suspended made the rounds, an about-face for a group that has steadfastly avoided reference to the war in Ukraine, calling it a matter of politics not markets. If Russia was indeed removed from the production quotas, that would allow other OPEC+ producers to fill in the gap in volumes constrained internationally due to sanctions.
That didn’t happen. In fact, OPEC+ Joint Technical Committee commented that suspension of Russia’s quota was not discussed at all and not on the table. Instead, the JTC reduced its global oil demand forecast for 2022 by 200,000 b/d, expecting global oil demand to grow by 3.4 mmb/d this year instead with the downside being volatility linked to ‘geopolitical situations and Covid developments.’ Ordinarily, that would be a sign for OPEC+ to hold to its usual supply easing schedule. After all, the group has been claiming that oil markets have ‘been in balance’ for much of the first five months of 2022. Instead, the group surprised traders by announcing an increase in its monthly oil supply hike for July and August, adding 648,000 b/d each month for a 50% rise from the previous baseline.
The increase will be divided proportionally across OPEC+, as has been since the landmark supply deal in spring 2020. Crucially this includes Russia, where the new quota will be a paper one, since Western sanctions means that any additional Russian crude is unlikely to make it to the market. And that too goes for other members that haven’t even met their previous lower quotas, including Iraq, Angola and Nigeria. The oil ministers know this and the market knows this. Which is why the surprise announcement didn’t budge crude prices by very much at all.
In fact, there are only two countries within OPEC+ that have enough spare capacity to be ramped up quickly. The United Arab Emirates, which was responsible for recent turmoil within the group by arguing for higher quotas should be happy. But it will be a measure of backtracking for the only other country in that position, Saudi Arabia. After publicly stating that it had ‘done all it can for the oil market’ and blaming a lack of refining capacity for high fuel prices, the Kingdom’s change of heart seems to be linked to some external pressure. But it could seemingly resist no more. But that spotlight on the UAE and Saudi Arabia will allow both to wrench some market share, as both countries have been long preparing to increase their production. Abu Dhabi recently made three sizable onshore oil discoveries at Bu Hasa, Onshore Block 3 and the Al Dhafra Petroleum Concession, that adds some 650 million barrels to its reserves, which would help lift the ceiling for oil production from 4 to 5 mmb/d by 2030. Meanwhile, Saudi Aramco is expected to contract over 30 offshore rigs in 2022 alone, targeting the Marjan and Zuluf fields to increase production from 12 to 13 mmb/d by 2027.
The UAE wants to ramp up, certainly. But does Saudi Arabia too? As the dominant power of OPEC, what Saudi Arabia wants it usually gets. The signals all along were that the Kingdom wanted to remain prudent. It is not that it cannot, there is about a million barrels per day of extra production capacity that Saudi Arabia can open up immediately but that it does not want to. Bringing those extra volume on means that spare capacity drops down to critical levels, eliminating options if extra crises emerge. One is already starting up again in Libya, where internal political discord for years has led to an on-off, stop-start rhythm in Libyan crude. If Saudi Arabia uses up all its spare capacity, oil prices could jump even higher if new emergencies emerge with no avenue to tackle them. That the Saudis have given in (slightly) must mean that political pressure is heating up. That the announcement was made at the OPEC+ meeting and not a summit between US and Saudi leaders must mean that a façade of independence must be maintained around the crucial decisions to raise supply quotas.
But that increase is not going to be enough, especially with Russia’s absence. Markets largely shrugged off the announcement, keeping Brent crude at US$120/b levels. Consumption is booming, as the world rushes to enjoy its first summer with a high degree of freedom since Covid-19 hit. Which is why global leaders are looking at other ways to tackle high energy prices and mitigate soaring inflation. In Germany, low-priced monthly public transport are intended to wean drivers off cars. In the UK, a windfall tax on energy companies should yield US$6 billion to be used for insulating consumers. And in the US, Joe Biden has been busy.
With the Permian Basin focusing on fiscal prudence instead of wanton drilling, US shale output has not responded to lucrative oil prices that way it used to. American rig counts are only inching up, with some shale basins even losing rigs. So the White House is trying more creative ways. Though the suggestion of an ‘oil consumer cartel’ as an analogue to OPEC by Italian Prime Minister Mario Draghi is likely dead on arrival, the US is looking to unlock supply and tame fuel prices through other ways. Regular releases from the US Strategic Petroleum Reserve has so far done little to bring prices down, but easing sanctions on Venezuelan crude that could be exported to the US and Europe, as well as working with the refining industry to restart recently idled refineries could. Inflation levels above 8% and gasoline prices at all-time highs could lead to a bloody outcome in this year’s midterm elections, and Joe Biden knows that.
But oil (and natural gas) supply/demand dynamics cannot truly start returning to normal as long as the war in Ukraine rages on. And the far-ranging sanctions impacting Russian energy exports will take even longer to be lifted depending on how the war goes. Yes, some Russian crude is making it to the market. China, for example, has been quietly refilling its petroleum reserves with Russian crude (at a discount, of course). India continues to buy from Moscow, as are smaller nations like Sri Lanka where an economic crisis limits options. Selling the crude is one thing, transporting it is another. With most international insurers blacklisting Russian shippers, Russian oil producers can still turn to local insurance and tankers from the once-derided state tanker firm Sovcomflot PJSC to deliver crude to the few customers they still have.
A 50% hike in OPEC’s monthly supply easing targets might seem like a lot. But it isn’t enough. Especially since actual production will fall short of that quota. The entire OPEC system, and the illusion of control it provides has broken down. Russian oil is still trickling out to global buyers but even if it returned in full, there is still not enough refining capacity to absorb those volumes. Doctors speak of long Covid symptoms in patients, and the world energy complex is experiencing long Covid, now with a touch with geopolitical germs as well. It’ll take a long time to recover, so brace yourselves.
End of Article