Oil Storage Continues to Weigh on Rally

Friday, March 18, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Oil prices rise in conjunction with speculative activity

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- A sharp rally in oil prices since the beginning of February has corresponded with a surge in speculative bets on rising oil prices.
- By the end of February, hedge funds and major money managers had the equivalent of 430 million barrels in net-long positions in WTI and Brent.
- But the bullishness tilts much more in favor of Brent rather than WTI. WTI only held 110 million barrels in net-long positions. Contracts for net-long positions on Brent doubled from 157,617 to 320,289 in February.
- The differences are likely a reflection of the record high levels of storage in the U.S., which will act as a near-term drag on WTI.

2. Oil stocks rising around the world

- Oil traders may be gaining confidence in a rebound, but crude oil storage levels should give them pause.
- In the U.S., storage levels continue to rise even though production is declining. For the week ending on March 11, storage levels hit a new record high of 523.2 million barrels.
- The story is similar across the world. In the OECD, storage levels increased by another 20.2 million barrels in January, the month for which the latest data is available.
- Floating storage stood at 72 million barrels at the end of February, 17 million barrels above the same level a year ago.
- There are glimmers of hope, however. The January OECD stock build was less than the five-year average for that time of year, which is 32.2 million barrels. Also, the IEA says that preliminary February data shows a smaller crude oil build in the OECD of 10.8 million barrels.
- Overall, storage levels are at or near record highs, and until they are drawn down, oil prices won't be able to sustain a rally.

3. Brazil suffering worst recession in over 100 years

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- Brazil has fallen into a deep recession. Its export-dependent and commodity-dependent economy has been hit hard by the collapse in commodity prices. GDP contracted by 3.8 percent in 2015, and could fall by nearly as much in 2016. The economy shrank by 5.9 percent in the fourth quarter year-on-year.
- The problem for Brazil is multifaceted. Inflation stands at 11.3 percent. The central bank has already hiked interest rates to 14.25 percent, so there is little room for more increases to stop inflation. The currency has plunged since commodity prices started falling, and the government is suffering from a huge fiscal crisis.
- On top of all of these problems, Brazil is reeling from a political crisis not seen in years. The President's position looks more precarious than ever.
- These problems are spilling over into the oil market, in terms of both supply and demand. Brazil's oil demand fell by 0.3 million barrels per day so far in 2016, year-on-year.
- On the supply side, Brazil's investment in maintenance and new supply is taking a hit as state-owned Petrobras runs low on available capital. Brazil's output plunged by 180,000 barrels per day in January.
- A few new fields are expected to come online in 2016, which could help production rise. But the long-term picture looks a lot less ambitious than it did just a year or two ago.

4. Crack spreads narrow

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- Crack spreads - the difference between the price for WTI and refined products - have narrowed since the middle of last year, despite the fact that gasoline demand in the U.S. is 600,000 barrels per day higher in February than the same month a year ago.
- While crude oil inventories are at record highs, the supply of refined products is also elevated. Gasoline storage levels hit record highs in February at 255 million barrels.
- 2015 was a banner year for refiners, as they took advantage of cheap crude and sold refined products at higher prices.
- Refiners are in for a tougher 2016 with spreads narrowing. Downstream investors should keep this in mind.

5. Contango shrinking

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- The "contango" that opened up earlier this year in the oil markets is starting to shrink, as depicted in the Reuters chart, which shows the spread between May 2016 oil contracts and those delivered in 2017.
- A contango situation occurs when front-month oil deliveries are selling at a lower price than delivery at some point in the future.
- But the spread is narrowing. As Reuters points out, Brent delivered in May 2016 jumped $10 per barrel in February, while Brent delivered in 2017 only increased by $7 per barrel. In other words, the futures curve flattened a bit.
- With a wave of bullish sentiment sweeping over the oil market in March, short-term contracts are rising faster than longer-term oil futures.
- The discount between the two time periods fell from $9 to $6 per barrel, leading to a weaker contango. Contango tends to indicate a near-term glut in supply. The shrinking contango suggests that oil traders are less concerned than they previously were about the near-term glut in oil supplies.

6. Oil tanker rates set to fall on growing vessel fleet

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- Just as refiners enjoyed a strong 2015, so too did oil tanker companies. Tanker rates hit multiyear highs for periods of time, as active oil trading, a shortage of vessels, and rising floating storage all pushed up daily tanker rates. Cheap fuel also reduced the cost to move tankers around.
- However, the rates for very large crude carriers (VLCCs) have fallen back since the start of the year. Oil demand is not growing as quickly as it once was. In February, tanker rates traveling from the Middle East to Asia fell by 24 percent, and from the Middle East to the West by 39 percent.
- The outlook for the tanker market doesn't look good either. That has less to do with oil demand than it does with the coming wave of new tanker supply.
- By 2017, another 200 tankers could hit the market as construction finishes up, 40 percent of which will be VLCCs. That is the fastest build out in at least four years.

7. Fracking almost entirely responsible for surge in U.S. oil production

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- Before the shale revolution, U.S. oil production suffered from several decades of steady decline.
- Even today, conventional fields are in decline.
- In 2000, only 102,000 barrels per day of oil came from hydraulically fractured ("fracked") wells, or less than 2 percent of production. But then the shale revolution took off - fracking and horizontal drilling unlocked vast new reserves.
- In 2015, oil from fracked wells amounted to 4.3 million barrels per day. Fracked oil overtook non-fracked wells in terms of overall production, accounting for 51 percent of total output.
- As everyone knows, most of this new oil came from the Eagle Ford (South Texas), the Permian (West Texas), and the Bakken (North Dakota), along with an array of other shale regions.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.