Little Guys Lose Out On Oil Bonanza

Oil storage capacity in the U.S. is more than half full as commodities traders and some midstream firms take advantage of an inversion in the price of crude.

Nymex futures contracts for U.S. benchmark West Texas Intermediate crude on Friday priced oil for delivery in January 2016 about 19% above the current spot price. That situation, called contango, is the opposite of normal pricing, which decreases in more distant, or forward, months.

Contango spurs energy traders to buy now and sell later at a profit. In the meantime, they must store the purchased oil.

“Buy oil, put it in storage, save it and you can forward sale it and deliver it in the future at a higher price and lock in some money,” said Phil Flynn, senior market analyst for the Price Group.

The practice turns an almost bullet-proof profit. It also inflates standing oil inventories and has analysts watching for oil and gasoline prices to tumble even further.

U.S. crude shifted into contango in January, as prices dragged more than 50% below their June highs.

The previous contango occurred during the 2009 financial crisis, as shale oil production ramped up just as demand from Europe and China slumped.

Citi sees the oil supply glut lasting through the first half of the year, with oil prices possibly falling to $20 per barrel. Simmons & Co. analysts expect crude supplies will peak in the spring.

“Low prices are going to cure low prices,” Flynn said. He noted that every time oil prices have fallen, the bigger the fall the larger the rebound in price.

Production Keeps Climbing

Global demand remains weak. Europe is struggling to rekindle its economies. Japan continues to grasp for a recovery.

China on Thursday officially ratcheted down its 2015 GDP growth target to 7%. That is still more than double the U.S. growth pace, but well below the Chinese growth that had underscored global energy markets. In addition, China itself became a net exporter of oil in 2014.

In the U.S., low prices have coaxed shale and other producers to slash billions of dollars from capital spending budgets. Some 600 oil rigs have stopped boring new wells since October. But production continues to rise as companies focus on their most efficient wells. Any significant slowdown may be months in the making.

Where Will All That Oil Go?

The Energy Information Administration said Wednesday that weekly crude inventories rose by 10.3 million barrels. That was nearly three times the increase expected by analysts polled by Platts.

The EIA also reported nearly 60% of the 82 million barrels of U.S. crude storage capacity had been tapped. That was up from 48% a year ago. In Cushing, Okla., the pipeline hub where West Texas Intermediate is priced, 67% of capacity was being used, vs. 50% a year ago and up from an August low.

Cushing is a storage site of choice due to its advantages as a delivery hub. Oil investors pay little or no transport fees to get the crude to the trading hub, where the transaction occurs and buyers take possession.

As Cushing’s tanks fill, oil storage is spilling over to other sites like the Louisiana Offshore Oil Port (LOOP), which has 67 million barrels of operational capacity, not including refineries. In Houston, crude oil storage capacity is near 36 million barrels. Beaumont, Texas and St. James, La. each have 30 million barrels of capacity, according to Genscape, a provider of energy market data.

Among the biggest traders of crude oil are international commodity trading firms like Vitol and Mercuria, as well as a number of large hedge funds, according to Reuters. Midstream players like Plains All American Pipeline (PAA) are also buyers, leveraging their spare storage capacity.

Traditionally, banks were among the largest energy traders. Goldman Sachs (GS) has stood its energy trading ground. But the Dodd-Frank reform bill of 2010 led other leading energy bankers, including Morgan Stanley (MS), JP Morgan (JPM) and Barclays (BCS) to offload their energy trading arms.

Refiners, who own vast shares of oil storage capacity, are constant oil buyers.

Plains has the largest amount of storage space in Cushing, closely followed by Enbridge Energy Partners (EEP) and Magellan Midstream Partners (MMP). Magellan bought BP’s (BP) storage facilities there in July 2010. Each has more than 10 million barrels of tank storage.

Plains also has the largest storage capacity in west Texas, where it operates a pipeline from the Permian Basin production region into Cushing. In Houston, Oiltanking Partners and Enterprise Products (EPD) are the leading storage companies.

All of the stocks are part of IBD’s Oil & Gas – Transport/Pipeline industry group. The group on Friday ranked a weak No. 154 out of 197 industries, fallen from a No. 4 ranking in September.

Storage leasing at Cushing typically costs 30 cents to 50 cents per barrel each month. Operators could increase rates as space fills.

The Little Guy Gets Left Out

Options are limited for individual investors wanting to take advantage of the contango situation.

“If you’re a trading shop and have a spare billion, you can invest in physical storage and do all right,” said Jason Stevens, an equity strategist at Morningstar. “But it’s not going to help stock investors.

Stevens said he wasn’t changing his ratings or earnings estimates on any midstream company over increasing oil storage.

As U.S. storage fills, WTI prices are likely to feel downward pressure vs. Europe’s Brent crude benchmark, said Hillary Stevenson, manager at Genscape’s Supply Chain Network.

The prices were nearly equal last summer. On Friday, WTI traded just below $50 per barrel, with Brent just below $60. That spread could increase, analysts say, as stored oil inflates the regional U.S. oversupply, further pressuring WTI.