Crude inventories still a problem

At the beginning of March there was a lot of talk in the crude market about an end to the contango coming soon, mostly due to some destocking of floating inventory. FT Alphaville was not convinced. In fact we reminded:

As WTI returns to a premium at the front end, the effect is support for the overall front-end oil price (as people return to purchase WTI over Brent). Restocking of floating storage meanwhile sees further selling into the curve (or the buying of time spreads), flattening the curve out of contango at first — but potentially seeing it revert as storage once again becomes full.

This has certainly been the case. Not only has the contango steepened once again, but Brent has returned to a premium over WTI again too.

WTI vs Brent

The latest EIA stock data out on Wednesday, meanwhile, confirmed storage is once again piling up, piling up in fact to its highest level since September 1990.

Here’s Reuters on the stats:

NEW YORK, April 15 (Reuters) – U.S. crude oil inventories rose to their highest level since September 1990 last week, as oil demand remained weak and refiners slowed production, the government said Wednesday. The Energy Information Administration said commercial stockpiles of crude rose 5.6 million barrels to 366.7 million barrels in the week ended April 10, the sixth consecutive weekly rise in stocks. Analysts had expected a build of 1.9 million barrels. The EIA data followed the weekly American Petroleum Institute report on Tuesday afternoon, which reported a 6.5 million barrel rise in crude stockpiles.

It’s also important to stress that the return of the Brent premium comes despite the easing of the Cushing delivery problem — which propelled WTI to extreme lows versus Brent earlier in the year. The latest stats data shows stockpiles in Cushing, Oklahoma — where Nymex WTI must be delivered — fell by 742,000 barrels to 29.2m, the lowest since December 26th. Although arguably at 29.2m the levels are still very elevated versus historical norms, which suggests there’s no end in sight to the contango any time soon.

Meanwhile, as Harry Tchilinguirian of BNP Paribas points out in his latest note following the figures, OECD countries are the ones specifically sinking in over-supply:

While OPEC is achieved respectable compliance with announced production cuts in March but the inventory hurdle the cartel needs to overcome is still sizeable. In the OECD at large, days of forward demand cover by the end of February was as high as it has ever been, approaching 62 days.

So what can we expect? As Tschilinguirian notes, Opec has already cut admirably. Would more Opec cuts actually make sense? Is it really Opec crude that’s plaguing the system? Here’s our logic, if there are more light sweet blends hitting the US market as Opec sour supplies fall (because ultimately Saudi Arabian sour crude contributes the most to Opec cuts or hikes) — refineries become more efficient at optimising gasoline production. This means cutting back more Opec crude would increase the chances of a gasoline supply glut in the US.

It seems, as Stephen Schork points out, the market is already prepared for that eventuality:

As we can see in today’s Chart of the Day, a year ago when gasoline supplies were trending sharply lower, the NYMEX summer-strip was is a well defined backwardation. That made sense, after all, crude oil was spiking over $100 and as result, gasoline margins were in the toilet. Thus, without an incentive to maximize output, gasoline traders were rightfully pricing in the potential of a supply crunch over the summer.

Obviously, the concern for this summer is not of a supply crunch, but rather of a supply glut, regardless of the current pace of turnarounds.

Rbob curve - The Schork Report

He goes on (our emphasis):

In this vein, refinery utilization for the first quarter of 2009 was 82.8%, drastically lower than the 90.7% utilization rate over the 2003-07 timestep. Crude oil inputs were 14.2 MMbbl/d, 7% lower than the seasonal average. But despite fewer refineries working with less crude, gasoline production is actually up 1% this year compared to the 03-07 timestep. Simply put, we’re watching more clowns climb out of an even smaller car, so what gives?

Increased refining efficiency will have something to do with increased gasoline production, but one also has to consider the turnaround in the type of crude being pumped into refineries now versus a year ago when Opec (or specifically Saudi Arabia) was producing at nearly full whack. Certainly, light sweet grades do appear to be over dominating the market. As JBC Energy pointed out last week:

The primary factor pressuring light-sweet grades is ample supply. Competing West African grades recently plunged to multiyear-lows relative to Dated Brent. Nigerian Escravos was last seen at -10 cents per barrel to Dated Brent while Bonny Light was even seen at just 45 cents per barrel to the benchmark. Furthermore the oversupply is not likely to disappear anytime soon as European demand remains low and additional volumes are being built up in floating storage off the coast of Nigeria. The further development of light-sweet grades will be strongly influenced by gasoline’s demand development, especially in the US, as the peak summer driving season approaches.

Either way, it is Schork’s opinon the market should expect gasoline supplies to continue rising relative to historic value due to more efficient use of refineries and a larger than normal crack spread (which encourages refineries to process crudes into gasoline). As he says:

In the coming weeks, we can’t expect weak utilization figures to hold back the surge in production of gasoline products.

But if the gasoline supply glut is yet to come, in a massive reverse of the situation last year, distillate inventories are already becoming a burden. As Tchilinguirian writes:

The overhang in diesel supplies remains and is unlikely to be brought down by US demand alone given weakness in economic activity. US industrial production was down 1.5% m/m in March, leaving capacity utilisation at 69.3%, the lowest level since records began in 1967. Exports can help to dispose of the surplus, and a number of wire reports indicate increased US product loadings to this effect. But the US would probably need to look towards Latin America for an outlet rather than Europe. Distillate storage in Europe has itself been building recently. By April 9, a number of newswires reported that some 24 mb of gasoil and jet fuel were being stored on more than 30 floating long-range tankers in Europe.

Onshore Independent storage facilities in Northwest Europe were also reported to be running out of “unreserved” space for distillates.

Of course, the above ironically makes a case for more Opec cuts (as Opec crudes optimise distillate production). But it is a balance, and it’s important to remember that we are at the critical winter/summer turnaround period which saw an increase in distillate consumption last year. So perhaps it is non-Opec and light-sweet Opec producers that should after all be the ones to cut next. As Tchilinguirian states:

Yet, even with lower retail prices, (the EIA sees an average of $2.23/Bbl for the summer driving season) current conditions (poor labour markets & depressed consumer confidence) do not suggest a strong seasonal increase in demand.

After all, if gasoline demand isn’t what it usually is, what’s more if distillate demand actually picks up instead, it will only be sweet light crudes that suffer.

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