Oil prices began their collapse almost a year ago, yet the impact to the industry and speculators has been light. There have been no major hedge fund failures. Large energy companies have taken advantage of the opportunity to conduct some layoffs, but there have been no high-profile business bankruptcies. Most important of all, the price decline has not yet triggered cascading CDO/CDS calls of the type that brought down the mortgage industry in the ‘aughts.
There is a chance that the industry may avoid a reckoning, but only if producers and traders can navigate an ugly challenge over the next few months. It appears that the US is running out of cheap oil storage. At the current production pace we will run out of capacity at the main “contango” facility at Cushing, Oklahoma in June. Avoiding a price crash will depend on finding new places to store the stuff until production finally declines and demand recovers – whenever that might be.
Energy traders have benefited so far from one of the unique characteristics of oil – it is relatively easy to store. For more than a decade as production has consistently outpaced demand, steadily expanding capacity at the main storage facility in Cushing has allowed traders to cheaply store unsold oil contracts, waiting for better conditions. A lot of people made serious money from this “contango” strategy in the last crash, storing cheap oil until prices recovered.
Get caught in a long position on oil? Monthly storage might cost as little as 33 cents a barrel. At those prices there is no reason to dump oil on the market. Until you run out of places to put the stuff.
Storage at the cheapest location, the Cushing facility, is running out. Having surpassed its previous all-time high last year, Cushing is expected to reach 80% of its overall capacity in April. Unless production slows it could fill by June, trigging much higher storage prices. There is capacity available in Midland, Houston, and Nederland at modestly higher prices, but it is unclear how much storage they have available. New capacity is being added, but owners are waffling, unsure how long this party might continue.
The next cheapest option for oil storage is on tankers at sea, but that capacity is being rented out quickly as well. Prices for seaborne storage have doubled on some providers since last fall.
With the Saudis continuing to pump oil at a fantastic rate while drilling new wells, there is no supply relief in sight. US production is unlikely to drop much until some companies go out of business. Once a well goes online, it costs money to shut it down. Better to bring in some money than no money.
Ultimately it seems that we are in an oil storage race. As long as new storage capacity can be brought online at a somewhat reasonable price, traders will continue to hedge their losses in the hope that demand and prices will recover. This is a game that traders and producers have been playing and winning for well over a decade as the financialization of commodities markets have pushed prices out ahead of market forces. The music hasn’t stopped yet. If storage can be built or found in time, the band might keep playing a bit longer.