U.S. oil inventories are at record levels, but there are a few glimmers of
hope that the glut could be starting to subside.
Storing crude oil for sale at a later date is no longer profitable, as the
futures curve has flattened out in recent weeks, depriving traders of a strategy
that has served them well over the past few years. The market "contango," in
which front-month oil contracts trade at a discount to oil futures six months
or a year out, has all but vanished. The differential must be large enough
to cover the cost of storage, and for many time spreads that is no longer the
case. After three years of a steep contango, storing oil simply to take advantage
of the time spreads is increasingly uneconomical.
One of the more expensive forms of storage is floating on tankers at sea,
and because of the narrowing contango, floating storage is unprofitable today.
Reuters reports that traders are beginning to unload crude from floating storage
along the Gulf Coast. "Right now, traders aren't incentivized (to store)," Sandy
Fielden, director of oil and products research at Morningstar, told Reuters in
an interview. "It won't all stampede out of the gate, but inventory levels
will come down. What will happen is that some of it will go to refineries,
but a fair amount will be exported too."
Just as the rapid rise of floating storage in 2015 and 2016 was a sign of
the deepening global supply imbalance, draining tankers of stored oil is an
early sign that the supply glut is receding.
So far, it is only the most expensive storage facilities that are seeing drawdowns
- the U.S. on the whole has seen crude stocks swell to record
highs. But oil analysts argue that the surge in crude inventories is a
symptom of stepped up imports booked at the end of 2016, when OPEC members
pumped out huge volumes of crude just ahead of implementation of their deal
to cut production. After a few weeks of transit time, the extra supply started
showing up in U.S. storage data in January and February. In other words, the
stock builds could be a temporary anomaly.
More recently, the time spreads for Brent futures also indicate increasing
tightness in the market. John Kemp of Reuters notes that
the spread between futures between April and May has sharply narrowed this
month, meaning that the market is betting on a supply deficit as we move into
the second quarter. The spreads for May-June and June-July are even smaller,
trading at a few cents per barrel. This is a complicated way of saying that
there isn’t a way to make money by buying oil, paying for storage, and selling
it at a later date.
In a separate report, Reuters notes that inventories are also starting to drawdown in
Asia, adding further evidence that the glut is not as bad as feared. As OPEC
has throttled back on production, Asia is starting to see the impact. Reuters
says that unusually large drawdowns took place across key oil hubs in Asia
- 6.8 million barrels of oil were withdrawn from tanker storage off of Malaysia’s
coast while Singapore saw a 4.1 million barrel decline and Indonesia’s storage
fell by 1.2 million barrels.
"Dancing contango is now not a profitable thing to do, so we've sold out," an
oil trading manager told Reuters. The trader no longer stores oil on tankers
because of the disappearing contango.
The details of the contango and the oil futures market may seem complex and
arcane, but the shift in time spreads is exactly what OPEC has been targeting
with its supply cut. By cutting near-term supply, OPEC has succeeded in changing
the economics of oil trading, forcing inventories to draw down. That could
cause a short-term supply problem as oil is unloaded from storage, but in the
long run OPEC needs to drain that excess supply from storage tanks around the
world in order to spark higher prices.
Traders are more and more confident that the oil market will experience tighter
conditions as we move into the second quarter, a bet that is reflected in both
the time spreads and the exceptional buildup in bullish
positions on crude oil. The oil price rally is not without its risks
- very notable risks that have been covered in previous articles -
but for now, the futures market is offering investors and traders some reasons
for bullishness.
By Nick Cunningham of Oilprice.com
