Tuesday, March 24, 2015

Oil Prices and Oil Storage: Why a Price Rally is Difficult

On Tuesday, I read a story titled "10 Charts That Point to an Oil Rebound." At first, I was willing to dismiss the story, especially because it contradicts itself from one paragraph to the next, saying: "The sudden downdraft in oil pricing was caused mainly by Saudi Arabia and the Gulf States" followed by "The U.S. shale boom has been the only real global source of recent supply growth."

Well, which is it?

Hint: He was right the second time. Sort of. Iraq is growing production a lot, too, and until recently, so was Canada. Still, the U.S. is by far top dog in oil production growth.

There's also an older chart from Rystad Energy that confuses oil production costs with oil development costs. And so on.

That's not to say everything in the article is wrong. Some decent points are made. But the bad points ruin the overall analysis.

However, this isn't the only article calling for a rebound -- even a big rebound -- in oil prices. (example 1, example 2) When we start to see a lot of opinion that is contrary to our own, we need to investigate it.

After all, they might be right, and we might wrong. 

First of all, we should separate U.S. crude oil prices from international crude oil prices (Brent, but also other oil benchmarks around the world).

It is true that the global oil glut is only about 1.5 to 2 million barrels per day. A calamity in any of the troubled oil producing nations (Venezuela, Iraq, Iran, Libya, Nigeria, etc) could remove the global glut.

How about the U.S. glut?

US crude oil stocks are soaring. 

The blue line is current stocks at Cushing; the gray zone is the five-year range. Obviously, stocks of crude oil in this country are soaring. Crude oil storage at Cushing, Oklahoma, are up 15 weeks in a row, and reached 54.4 million barrels on March 13, according to EIA's Weekly Petroleum Status Report. This volume (measured in barrels) is the highest on record.

Capacity utilization at Cushing is now 77%, a large increase from a recent low of 27% in October 2014.

But it's not the first time oil in storage has surged. In fact, Cushing reached 91% of capacity back in in March 2011.

There was less storage at the time, so the total number of barrels was lower.

So what happened to oil prices back in 2011? Let's look at a chart ...

(Updated chart)

In fact, 91% storage utilization did not immediately impact prices. Oil prices went up for nearly a month after storage peaked.
Then, however, starting on May 2nd, prices started rolling down the slippery slope. In the space of a few months, they fell by a third. Ouch.

So maybe the lesson here is that oil storage isn't the main driver of prices. Maybe -- or even probably -- the U.S. dollar and speculation are more important.

By the way, look at the bottom of that oil chart, and you can see that RSI, a momentum indicator, is improving. This is why many technical analysts are calling a bottom in the price of the U.S. oil benchmark, West Texas Intermediate crude oil.

Meanwhile, there's the other factor in oil prices: The fact, that, even though the U.S. rig count has fallen for 14 weeks in a row, U.S. crude oil production keeps rising, recently hitting 9.42 million barrels per day.

(chart source)

In fact, production is still way up year over year.

You saw my previous chart on the US dollar and crude. Watch that one closely.

Finally, there's one more important thing we must take into consideration. And that's just how fast Cushing storage is filling up. And that's fast.

The EIA reports: "Cushing inventory levels in the previous two months have changed by about 2.2 million barrels (on a net basis). In previous years, the net weekly changes were more often in the range of 0.5 to 1.0 million barrels either in or out of Cushing."

So, IF storage is a part of the equation, then another big build this week would likely send oil prices lower.

But back to the point, "could oil prices rally and rally big?" Unless the U.S. dollar collapses or production starts falling/storage starts emptying, a real rally in U.S. oil prices is difficult.

New storage numbers come out tomorrow. We'll see. So, up or down? You can place your bets. Or maybe we're entering an "undulating plateau" of oil production.

Wednesday update: Crude Oil Inventories rose by 8.2 million barrels for the week, versus expectations of 5 million. That was down from the previous week's build of 9.6 million barrels, giving bulls a straw to grasp at.

Also, the build at Cushing was 1.9 million barrels -- below the average previous build (at least recently).

 Obviously, with Cushing near its limit, producers are looking to store elsewhere.

One more thing: When oil storage tanks are "full", they aren't full to the tippy-top. The company that builds those tanks says there's another 3% to 5% left at the top to prevent spillage. If that comes into play, that would be potentially more profit for the companies doing the storage, don't you think?

1 comment:

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