Friday, January 23, 2009

Oil Ready to Crash?

The following adds a little more color to last week's post Oil Tankers are a Banks Best Friend. For those that missed it, factors have appeared in the oil market that make it attractive for investors to buy oil in the spot market, store it, and sell through the (higher priced) oil futures market. Now that storage is reaching capacity, there is a significant possibility the spot price of crude will "tank" as a source of demand (storage) is no longer available. This is especially true for WTI crude, which is delivered in Cushing, OK and HAS reached its limits according to Marketwatch:

Inventory levels at Cushing, Okla. -- the delivery point for Nymex oil futures -- rose by 0.2 million barrels to a record 33.2 million barrels, the EIA reported. Platts estimates that maximum storage capacity at Cushing is about 42.4 million barrels, but only 80% of that is considered operable.
This suggests that maximum operating capacity is about 34 million barrels, meaning there is little room to add to storage tanks out in Cushing, according to Linda Rafield, senior oil analyst at Platts.

Assuming that 34 million barrels is an accurate level of the maximum capacity in Cushing (i.e. 98% of the capacity is filled) this explain why the price of WTI crude has fallen so much relative to Brent and makes the case for a potential crash in the WTI crude spot market.

Source: EIA


  1. Another great post, and you're right, the lack of storage at Cushings probably is contributing to WTIC trading at a discount to Brent.

    But it doesn't explain the supercontango in the futures for crude.

    This contango has been dropping this past week, and crude looks like it is putting in a bottom. Yes, the storage situation at Cushings suggests that price should fall, but something else is going on. I'm not quite sure what, but crude's above $45.

  2. Could you include the tickers/CUSIP/ etc with these when you post them? I know I could expend the effort myself on the Bloomberg, but you post some great ones that I would like to keep updated on a regular basis. Thanks in advance.

  3. kosta- contango should be dropping because it can be arb'd out until there is no more storage, but I do agree that for contango to occur in the first place there has to be a demand for those futures contracts. so the big question becomes, why is there demand for oil six months out? my guess (purely a guess) is investors who see this as a buying opportunity and hedgers who got burned in the last run up to $140...

    alex- i'll try to do that, but there were no cusips for this post, only the data from EIA, which I did link to.

  4. Thanks for the reply Jake, I still don't understand why there's contango in the prices.

    But how about this alternate interpretation of the rise in inventories in crude. Rather than viewing it as too much supply/not enough demand, it can be interpreted as investors taking advantage of the low price in oil to stockpile. Inventories went up because there are some forward looking people who bought crude to store because prices are so cheap.

    In this interpretation, a rise in inventories can actually be bullish for crude prices because it can indicate that the market finds the price cheap and is stockpiling.

    I saw this argument made last Spring, but in reverse, regarding drops in inventories and the price being too high.

  5. the buildup in inventory might also be some front-running of the Strategic Petroleum Reserve refilling. There was a small news article 2 days back that the government authorized two energy firms (I think Shell was one of them) to go out and purchase oil for the SPR. The price that came out was roughly $51/barrel, so anyone who bought some physical at in the 30's and sells at $46 now in relation to the SPR is makes a very nice return.

  6. Whoops. Thanks for that.

  7. Here is an explanation for a part of that contango...

  8. I am Tejas Seth and will endorse Kosta's intrepretation. We need to look things which are in a diffrent way rather than the most common ways. Crude stocks are not only stored into the exchnge warehouses but they are also stored in quantity into big sea tankers and special warehouses in the gulf countires. The smart money know that Oil production will be continuously reduced by the producing nations and these prices are not gonna stay here for long time. Crude storage cost would be very less than its returns in its prices escalations say in later 2009 or 2010. Even if crude trades above $60 in 2010, then also there is a impressive gains.