Oil Hits Critical Choke Point: Why "The Market Faces A Round Of Rapid Stockbuilds"

One month ago, just as Cushing storage was rapidly approaching its operational capacity, we warned that Cushing (and increasingly all parts of PADD 2) is denying storage requests. We also said that overall PADD 2 inventories had risen to a new record high 155 million barrels...

... hinting that it was just a matter of time before excess production would be shifted to other regions, most notably the Gulf Coast, or PADD 3.

In the intervening month, this is precisely the dynamic we have observed, which culminated with today's weekly DOE announcement which saw not only a massive inventory build, one which surpassed the estimate threefold (surpassing yesterday's gargantuan API build in the process), but also has confirmed that oil storage is now shifting away from Cushing and PADD 2 to PADD 3 just as we expected, to wit:

  • PADD 1: East Coast +1.8
  • PADD 2: Midwest -0.1
  • PADD 3: Gulf Coast +9.0
  • PADD 4: Rocky Mount +0.1
  • PADD 5: West Coast -1.4  

This confirms that the shift away from Midwestern storage to the Gulf Coast has begun in earnest, which was to be expected for a region that is already at operational capacity, even when netting out the excess oil that is being "exported" out of the US to Europe, Asia or Latin America. In fact, as shown in the chart below, with over 533 million barrels in storage, it is only a matter of time before oil overflows into swimming pools and household buckets.


Unfortunately, while most of this was as expected and suggests  that the excess supply situation in the US is getting worse by the day, not even we expected the dour picture painted by some key industry participants.

According to Reuters, trading houses such as Vitol, Glencore, Gunvor and Trafigura whose most profitable business line in recent months has been oil transit and offshore storage, are betting on oil markets remaining oversupplied for at least two more years even as crude prices stage a recovery driven by early signs of falling production.

These traders are looking to extend or lock in new leases on storage tanks for crude oil and refined products in key hubs as far out as the end of 2018, sources at storage firms and trading houses say.

As we have shown repeatedly in the past by demonstrating surging contangos, storing oil in a heavily oversupplied market has been a cash cow for traders and oil companies in recent years as markets bet that future oil prices will be significantly higher than current ones.

Or, looked another way, that current prices will remain very low. Indeed, "lower for longer."

Ian Taylor, chief executive of top oil trader Vitol, said on Tuesday that "stocks of crude and products continue to build and these will weigh upon the market."  Like other traders, Vitol has invested in recent years in storage, and last August acquired the other half of its VTTI storage subsidiary for $830 million.

As we also showed two weeks ago, with oil prices rising substantially since mid-February to around $40 per barrel, this has led to a significant narrowing of the crude contango despite a stock overhang of 300 million barrels, which means storage plays such as Vitols are suddenly far less lucrative.

Indeed, crude oil has found more of a balance in recent weeks through supply disruptions in Iraq, Libya and Nigeria (all of which are transitory).

However, while upstream, or crude, supply may have artificially stabilized modestly, downstream products have continued to build, something we also noted one month ago in "There’s A Feeling Of Bits Of Ice Cracking All At Once" - This Is The 'Big New Threat' To Oil Prices" in which we showed the dramatic buildup of gasoline and distillate products. 

Reuters today also touches on this and cautions that "refined oil products have not followed suit" the broader oil rebalancing. In fact "gasoline and blending components have been quietly building, squeezing the amount of storage left in Europe. U.S. gasoline stocks, when adjusted for current consumption, are just at the top of their 10-year range."

Krien van Beek, head of sales at RVB Tank Storage Solutions, a tank storage broker in the Netherlands, said traders are seeking storage on 12-month leases for products such as gasoline and naphtha outside key hubs in northern Europe, Singapore and the United States. "They are prepared to look at storage for the longer term because of the contango in the market but everyone is cautious about costs because we are at the top of the storage market,” van Beek said. "Since the standard storage options are taken, traders are considering less conventional and less attractive locations."

According to RVB, global commercial tank capacity is around 900 million cubic meters across 4,400 facilities – not including "captive tanks" in refineries that are not open to commercial buyers.

In short: because the US is already on the verge of operational capacity for most liquidity commodities, soon the entire world will likewise be full to the brim with excess oil, distillates and gasoline as oil production continues to ooze into what the Saudis recently characterized as a 3MM b/d oversupplied market.

Which brings us to what Reuters describes as a key production "choke point", one which is "forming in middle distillates – the diesel used to power trucks and generators, and the heating oil that warms homes around the world in winter."

Typically, these stocks fall over the winter. But warm weather this year kept this from happening – all while refineries worldwide ran full steam to feed seemingly insatiable demand for gasoline in the United States, China and India.

Global distillate stocks in the developed world are close to a record high, in the thick of refinery maintenance season, and in the run-up to the time when gasoline use hits its summer high point, but interest in diesel typically fades.

"Absent run cuts, the market faces another round of rapid stockbuilds once refineries return from maintenance," Robert Campbell of Energy Aspects said in a note.

At that point, the oversupply becomes self-fulfilling as the supply curve inverts that much more while producers scramble to find any marginal buyer in a world drowning with product, and unless some dramatic solution is found to stem the supply of the most upstream product, namely oil, whose dynamics we explained one month ago as follows...

As Paul Horsnell, global head of commodities research at Standard Chartered puts it, "There’s a feeling of various bits of ice cracking all at once" in the oil market, with both crude-oil and gasoline inventories at extremely high levels... People are worried about a short-term issue, particularly in the U.S., particularly at Cushing."


The good news is that we are likely very close to the worst case scenario playing out: refiners are unlikely to start buying more crude in the coming weeks. Instead, many will begin seasonal maintenance ahead of the busy summer-driving season. That could leave some oil producers scrambling to find places to store their output. Prices in some regions might have to drop sharply to justify the cost of shipping the oil to where it can be stored.

... with every passing week in which nothing changes in the fundamental supply/demand picture, the most likely outcome will be a violent inventory liquidation over the next few weeks, one which will be accompanied by a substantial plunge in oil prices resulting from wholesale dumping as producers rush to sell product to anyone who will buy it.