Commodities Story of the Year: Floating Oil Storage

The most incredible commodities story of the year (and that's saying something this year) may be this one from the Financial Times ...

Supertankers store 50m barrels of oil

The story is a simple one, and largely conveyed in the title: Oil prices are so low, and shipping costs are so low, that traders are currently pumping oil into oil tankers and using them for storage. One estimate says that at least 25 tankers holding 2 million barrels of oil apiece are figuratively adrift at sea.

The FT story, however, misses the point as to why this is really happening. Part of it, to be sure, is because oil prices are so low, as the story points out, and oil companies are trying to slow the supply of new oil to the market. But mostly, the floating storage phenomenon is happening because storing oil has become a very profitable business. In fact, storing oil—as measured by contango—may be at its most profitable level ever.

The price for the February oil contract on the NYMEX as of midday December 29 was $37.95/barrel. The March contract, in contrast, fetched $41.00/barrel. Let's say the average tanker holds 2 million barrels of crude. If you can lock in the $3.05/barrel difference between the two months' contracts, you can net $6.1 million in monthly income for a tanker-full of oil. At current rates, it costs about $50,000/day to rent a tanker, or $1.6 million a month. Whammo presto, instant profits.

Of course, it's more complicated than that. But the point is that there is massive contango in the near-month oil contracts right now: about 8% at current levels; that's off the charts on a historical basis.

All this suggests to me that investors who are looking for a quick rebound in the price of oil may be waiting a while. The biggest change in the oil market over the past year has been the switch from a market with zero excess supply to one that's drowning in excess oil.

Back in early 2008, oil shot to $146/barrel because there was zero excess supply in the system. As a result, any slight disruption in the flow of oil (say, a flare-up of fighting in Nigeria) would send prices rocketing higher. The marginal barrel of oil was critical to the global economy, and users were willing to pay big bucks to ensure that they had adequate supply.

Right now, there is so much excess supply that traders are using expensive supertankers as floating storage. This means that supply shocks in the market—such as the current flare-up in the Middle East—matter a whole lot less.

Until that excess supply is absorbed—until they stop using supertankers as Tupperware—the oil price isn't going up anytime soon.

Comments

[bsharvy:]

What's the evidence for this: "Back in early 2008, oil shot to $146/barrel because there was zero excess supply in the system".?

2008 Dec 30 07:57 PM

[John Polomny:]

Fifty million barrels stored on tankers is not even one days world demand. Meanwhile the recent IEA report is talking about 9% annual depletion without significant spending on exploration and development. I agree a contango usually means short term weakness in price but long term we are going to have serious oil supply issues. the offshore drillers and stocks like Suncor (SU) are being given away at these levels.

2008 Dec 30 08:08 PM

[Kashyap_Swamy:]

John,
Your observation about 50m bls being less than one day demand is right, but this is indicative of a larger phenomenon. Oil inventories in OECD are at very comfortable levels (e.g. Cushing storage at 28 mn bls - highest since 2004). Recent OPEC production cuts serve to increase spare capacity, which is in effect in-ground storage.
In the long-term (5 yr horizon), I agree that decline rates will provide strong support to oil prices but I am not so sure about 2009.

2008 Dec 31 09:13 AM

[john s. gordon:]

don't store oil @ sea unless you want to attract terrorists bearing RPG's
> jack

2008 Dec 31 09:35 AM