On Sunday, we noted that the economics of the floating storage play [8] could spell further declines for crude prices. With a global stock increase that’s some 3 times larger than that which occurred during the last period of oversupply, expect cheap, on-land storage to prove inadequate necessitating the use of VLCCs. According to Soc Gen, determining how far the front end of the curve would have to fall in order for traders to arbitrage the difference between buying and storing physical oil and selling paper forward is a good indicator for where prices may find a floor:
...the bank is looking for the front end of the curve to fall until the contango is wide enough to make the floating storage play enticing.
The example Soc Gen uses shows that Brent needs to see ~$49 before the trade is sufficiently profitable.
The takeaway, we noted, is that storage availability and contango should be taken into account when considering the future direction of oil prices. With production still climbing despite the decline in rig count, it seems supply may, in short order, outstrip storage capacity for as the following two charts show, crude storage capacity in the US is now at 60% and is set to be completely exhausted by June:
[9]
[10]
From the EIA:
Crude oil inventory data for the week ending February 20 show that total utilization of crude oil storage capacity in the United States stands at approximately 60%, compared with 48% at the same time last year. Most U.S. crude oil stocks are held in the Midwest and Gulf Coast, where storage tanks were at 69% and 56% of capacity, respectively, as of February 20.
Capacity is about 67% full in Cushing, Oklahoma (the delivery point for West Texas Intermediate futures contracts), compared with 50% at this point last year.
What this means is that over the next few months, the contango breakeven trade will become increasingly more unprofitable as the cost of remaining storage goes through the roof (i.e. prices would need to fall even farther for the the floating storage play to be economically viable).
Here's FT [11]:
Demand for facilities where it is easy to move crude and refined products in and out has increased: from European and US hubs, to South Africa, South Korea and Japan. In Europe, it is understood traders are in talks about the construction of new tanks, which is a characteristic of the 2008-09 “supercontango”.
US storage levels are being closely watched as commercial crude stock piles rise rapidly. They hit 444.4m barrels last week, the highest level for this time of year since the 1930s, according to government data.
Come June, when all available on-land storage is exhausted, each incremental barrel will have to be dumped on the market forcing prices lower and inflicting further pain on the entire US shale complex (just as Q1 results are released which will invariably show huge writedowns as companies will no longer be able to hide behind the SEC-mandated accounting trick that made Q4 results appear respectable). Here's Soc Gen:
...oil markets can be impatient and prices could drop considerably lower. As we have written previously, we are currently more concerned about downside risk than upside risk.
Meanwhile, investors (who never, ever learn and who piled into oil ETFs [12] ahead of the widest contango in four years) are diving in head first:
From WSJ [13]:
Investors are snapping up new stock and bonds from energy producers as they search for bargains amid the tumult caused by the plunge in oil prices.
Some investors are lured by cheap prices, while others are hoping to prop up companies in which they have already invested and keep creditors at bay. High interest rates on the new bonds—12% annually on some—are also attracting buyers at a time when rates on safe government debt are low.
“If you like a company, you can get something at half-price,” said John Groton, a senior equity research analyst at Thrivent Asset Management, an investment-management firm that oversees roughly $96 billion.
What's that old saying about falling knives again?
