Oil prices set to drop due to insufficient storage space | The Triangle

Oil prices set to drop due to insufficient storage space

There is more than one reason to store oil as producers turn out more oil than the world demands, which is the case now. Stored oil can be used in times of emergency, or to make a profit when prices go up. Oil can be stored in: underground salt caverns, over-ground storage facilities and oil tankers floating over the oceans.

The most popular storage facility is in Cushing, Oklahoma, due to two reasons. First, the West Texas Intermediate oil is priced in Cushing. Second, Cushing is connected with an impressive pipeline system that delivers oil to many refineries in the
United States.

These different storage depots have different costs. It costs 25 cents per barrel each month if oil is stored in salt caverns, while the cost is 50 cents to one dollar for oil stored above ground
in Cushing.

The most expensive storage form is storing oil in leased tankers over the oceans. This cost there is $1.25 per barrel each month. The storage will be cost effective and even profitable if oil prices move up significantly within months.

Greater oil in storage could move the oil price from contango to backwardation, which means the spot price will be lower than the futures prices, which is the case now. The extent of the fullness of these storage facilities means there is no place to store oil any more, and the newly extracted oil should go directly to the market sold at the
prevailing prices.

Additionally, since oil companies especially those that extract shale oil are burdened with debt, they must continue producing and sell all their oil on the market despite storage depot scarcity to pay off their debts.

Oil inventories in the United States are at an 80-year high, as oil storage is currently standing at 70 percent of full capacity, near 80 percent in Cushing and is expected to reach the maximum in April. Moreover, it is believed to be more than 90 percent in Europe, and 70 percent in China, Japan, Korea and South Africa.

Since the storage facilities are near full capacity, we should expect that in few weeks all oil produced should be sold on the market as production is continuing unabated This means spot oil prices should drop considerably in the coming weeks or months until new storage hubs are built.

The question now is: How much can oil prices drop?

My guess, it should try again to hug $40 a barrel or lower. According to the Wall Street Journal, the time the oil storage reached close to this level was 1998, when the oil price collapsed to $13.38 a barrel. If you factor in inflation since then, this price would be $19.18.

The base case scenario could be that oil would stay in storage for many months or few years with no new buyers in sight, which means the storage cost will mount and the speculators who stored the oil will panic, ending up dumping all stored oil on the market at the same time.

You could call this scenario a “run” on storage. Consequently, oil prices would collapse. Many small shale oil producers will
go bankrupt.

Major oil companies will however survive as more money will pour into their stocks. The “run on storage” scenario may also have implication for the current ban on crude oil exports.

Who will benefit from this fullness of oil storage? In addition to the consumers, oil refineries that are now undergoing maintenance will benefit big since cheaper oil means lower feed-stock costs.

Ladies and gentlemen, the oil price saga is not over yet. Do not listen to OPEC, people.

Shawkat Hammoudeh is an economics professor at Drexel University. He can be contacted at [email protected]