In my previous column – Is the U.S. Running Out of Crude Oil Storage? – I discussed the tightening crude oil storage picture in the U.S. That column has already generated the highest level of feedback and inquiries from readers and the media of any I have written in quite some time. So I want to follow up and drill down a little more, and show why this situation is more dynamic than is typically conveyed.
Since I wrote that article, there have been 2 more weeks of crude oil storage builds. Pundits continue to predict that crude oil prices have nowhere to go but down, because something has to give. Well, something is about to give.
There are many moving parts in this storage picture. One of those, as I explained in the previous article, is refinery demand. This piece of the picture seems to be largely lost in the storage discussion, so I created a graphic to emphasize its importance. Below is the average refinery utilization percentage in the U.S. for each month of the year since 2010.
Thus, we are presently nearing the end of the lowest one-month refinery utilization period, which also ends the lowest three-month refinery utilization period. This has been a big factor in the crude oil build, but one that is about to start swinging the other direction. And while the crude oil build this year has been higher than normal, we do see a build in crude oil inventories at this time of year just about every year.
To put all of this in perspective, so far this year commercial crude oil inventories have increased by 76 million barrels — an average of 7.6 million barrels per week. But the difference in refinery demand in March and in the highest utilization month in July over the past 5 years has been about 9 million barrels per week. As we ramp up to that level over the next few months, the crude oil storage build will slow and likely reverse. I will note that refinery utilization this past week has already reached 89%, but it’s also true that in times of high demand or high refinery margins the monthly utilization rate has gone above 95%. So we have a lot of room to increase refinery utilization, and that’s what we are going to see in the months ahead.
This week the Energy Information Administration also offered up a relevant piece of information in a new feature called “Today in Energy.” While much attention has been given to the fact that the key storage hub in Cushing, Oklahoma is at a record high volume, the EIA noted that capacity there has increased by more than 20 million barrels since 2011. So even though Cushing is presently at 77% of capacity, in March 2011 (there’s March again) the volumes peaked at 91% of capacity before starting a decline that would last the rest of 2011:
Source: U.S. Energy Information Administration, Weekly Petroleum Status Report and Working and Net Available Shell Storage Capacity
Just to be clear, I am not suggesting that there is zero cause for concern. Any time inventories are approaching historical highs or lows, there is the potential to disproportionately impact prices (although I would gauge that to be a greater risk when inventories are very low). Plus, it will take time to work these inventories down, and that’s likely to keep a lid on oil prices for a while.
In my view, this is already built into the price of crude. That’s the reason oil prices keep dipping into the mid-$40’s. But if we only looked at the first 3 months of this year, projected that possibility out for the next 3 months, and then concluded that oil may fall to $20, we are really missing just how dynamic this entire picture actually is. It’s almost like saying “If this summer is as cold as this winter was…”
You can’t extrapolate what happened in the past 3 months and project that into the next 3 months and conclude we are going to run out of crude storage space. The inventory build over the next 3 months will not be comparable to the build over the past 3 months. In fact, if we look at past history then inventories will probably peak and start to decline soon.
What that means is that oil isn’t likely to fall to $20/bbl, but it also isn’t likely to run back to $70/bbl this year as these high inventory levels will take some time to work down. I do think we are likely to find support back above $50/bbl for WTI when it becomes clear that inventories are coming down (and as the shorts who are predicting $20 oil are shaken out of their positions).
One other factor impacting crude oil inventories is the crude oil export ban in place in the U.S. Most of the new shale oil production over the past 6 years has been light, sweet oil just as U.S. refineries had spent years configuring themselves for heavier crudes. That means that what is being produced now isn’t the best feedstock match for our refineries. They are literally limited by how much light oil they can feed the refineries, and without spending a lot of money over the next few years that situation will remain much the same.
However if the crude oil export ban is repealed — something I deem as unlikely this year — all bets are off. A flood of crude oil would be sent to the Gulf Coast for export while we continued to import heavier oils from places like Canada and Venezuela. Crude oil inventories in that case would probably come down rapidly, and crude oil prices would move into a higher trading range. The share prices for refiners would probably sell off pretty sharply too.
But until that day, and as long as crude oil prices remain in the current range, the crude oil refiners will be the biggest beneficiaries, at the expense of U.S. crude oil producers.