A Cushing Bloodbath Is Overhyped

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Daniel Jones

Summary

With oil prices trading low and storage levels at Cushing extremely high, investors fear that the region could cause a firesale in prices soon.

Certainly, this would be a major negative for oil investors but I believe the fears are being overplayed by the bears.

Cushing inventories are very high right now but they aren't at the highest they've been and overall inventories in the U.S. are nowhere near full.

A regional pricing difference could come into effect but it's unlikely that this would be long-lasting, especially as companies divert the flow elsewhere.

One fear that has left many investors worried regarding oil relates to the fact that capacity in Cushing, Oklahoma, is nearing its brink. The overall fear is that, if tanks in the region fill up, it could spark a downward spiral in oil prices as companies operating there are forced to unload inventories at firesale prices in order to bring on additional crude that's flowing in that direction. While this may make sense, the fact of the matter is that a "bloodbath" in Cushing is improbable and, even if one does take place, it's likely to have a regional, not national, impact on finished products.

A look at Cushing over time

In order to get a good understanding of what is typical in Cushing, I had to look at the historical inventory data of the region and compare that to its capacity over time. Today, using the most recent data available, oil inventories in the region stand at roughly 64.70 million barrels. Given data provided by the EIA (Energy Information Administration), which came from September of 2015, storage capacity in the region stood at 73.01 million barrels. What this means is that, if storage capacity hasn't increased over the past five months and if the EIA's inventory data is accurate, tanks in Cushing are roughly 88.6% full right now.

Whenever tanks fill up, there arises a risk that commercial storage space may not be great enough to handle additional inflows. The reality that some companies are cutting back on production while demand has never been higher is evidence that they are trying to reduce finished product inventory levels due to profitability concerns and/or that they believe that by restricting how much additional finished product is added to the market, they can ensure higher prices near-term. This could make the situation worse because it allows tanks to fill up quicker and could, if commercial storage capacity hits its max, justify selling crude at firesale prices.

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However, the market is acting like these high storage levels at Cushing are something new. They are not. If you look at the graph above, you will see that storage levels in the region, while extremely volatile, have been here before. Back in March of 2011, for instance, crude storage levels peaked at the highest on record (relative to storage capacity), leaving tanks at over 91% full. Certainly, if this were trouble, you would expect for prices to take a beating during this period but that wasn't the case. In the 10 weeks leading up to this, inventories at Cushing soared nearly 32% from just 69.1% full. Prices over this same timeframe shot up by 22.9% from $84.93 per barrel to $104.41 per barrel and continued to rise for weeks after as Cushing stocks fell but still remained high.

One argument investors could make regarding filling tanks is that oil inventories are high elsewhere too, making today different than it was in 2011. They would have a point in saying that oil production in the U.S. is higher today (indeed it is, with levels standing 65% higher at 9.186 million barrels per day vs. 5.568 million per day back then) and they would also have a point in saying that the world is experiencing an oil glut (something nobody will deny). However, despite how awash the world is in oil, the U.S. storage picture isn't all that bad.

While storage at Cushing is extremely high and needs to drop down at some point in the future, the overall oil storage situation in the U.S. is far from bad. In the graph below, you can see just how full different categories of petroleum products are according to the EIA right now. As a note, the crude number factors out 120 million barrels of oil from the inventory levels because they are in transit, mostly via pipeline. My approach is the same one the EIA uses in its analysis.

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What we see from all of this is that we aren't really anywhere near storage capacity across the U.S. Yes, crude levels are at about 69.3% storage capacity but that's a far cry from 100%. Motor gasoline is at 68.6% capacity and total crude plus petroleum products stands even lower, with storage tanks just 58% full. Although tanks in Cushing may fill up, there are plenty of places to store crude for the meantime and it's highly unlikely that the supply/demand imbalance will last long enough to fill tanks up across the U.S.

On top of this, it is possible that tanks may not be as full as we believe them to be. In the table below, you can see the historical buildup of storage capacity between September of 2010 (the furthest back that data is available for) and September of 2015. If you look between 2012 and 2015, we've averaged added capacity of 1.58 million barrels every six months. At a time when capacity seems to be nearing its peak, it wouldn't be a surprise to see firms adding more space in the five months that we haven't seen data. If this matches the historical average increase, we should expect for tanks to be about 86.7% full now, which allows a bit more wiggle room.

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Now, it should be mentioned that this doesn't mean WTI prices won't drop if tanks reach their peak sometime soon. Back in 2011, when tanks nearly peaked, the price of WTI fell in relation to the price of Brent, with the spread between the two climbing significantly and staying that way for years. However, in June of 2012, in response to this arbitrage opportunity, the Seaway Pipeline elected to reverse the flow of crude toward the Gulf region so that it could benefit from this disparity. Given the large pipeline network that exists today within the U.S., it wouldn't be unthinkable for operators to also reverse flow, which would help to alleviate these concerns.

Takeaway

At this moment, the fears regarding Cushing are meaningful but, in my opinion, overblown. There is a big psychological impact that could hit, causing prices to crater for a very short period of time if capacity at Cushing is reached, but the likelihood of this having anything beyond a short-term impact on the price of crude appears, to me, minimal.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.