The oil supply outages coming from recent militant attacks in Nigeria and wildfires in Canada gave many in the financial industry a reason to call for much higher oil prices, with Goldman Sachs going so far as saying it has resulted in a quick rebalancing of the oil market.
At first I was surprised by that statement from Goldman Sachs, as it's so riddled with dubious assertions it would in my view make the giant bank look foolish. But the market wants to hear this narrative now, so even while the so-called "rebalancing" isn't based in fact or reality, it did provide some temporary support for the price of oil.
Why I say it's not based in reality is because a true rebalancing can't justifiably be defined from a couple of events that will turn around very quickly. Even in the more volatile situation in Nigeria, it's not as if these types of things haven't happened in the past; the country has a history of sabotage and eventual recovery from it.
As for Canada, it's obvious this is going to be a very short-term event, one which will very quickly go back to normal. Even during the fires the lack of production didn't have an impact on U.S. inventories in the sense of driving it down, as it was up for the week, suggesting stockpiles would have been much higher with Canadian oil delivered to the U.S.
Not only that, but a recent report from Reuters noted the Asian floating storage hub around Singapore and Malaysia has added significant oil supply to the region, with overall storage now climbing to almost 48 million barrels of oil, an increase of 10% week-over-week, the highest level in at least 5 years. Over the last several months is has continued to increase "sharply," according to BMI.
For these reasons alone the idea of calling it a rebalancing is a joke. To assert a decline in supply from temporary outages has rebalanced the market is irresponsible in my view, especially when it's known it's going to quickly revert back to the production and supply norm in the near future.
Asian trading hub a benchmark for many traders
For some time the Asian trading hub off Singapore's and Malaysia's coasts have been considered a benchmark for the health of the oil industry by a large number of investors.
Data from Thomson Reuters concluded the oil in tankers in the Asian hub jumped 10% to 47.7 million barrels of oil, with the bulk of that being crude. It is stored in 40 supertankers as of this writing.
China in particular has given signals of difficulty in finding storage, with it entering into a recent deal with South Korea to store from 3 million to 5 million barrels of oil. It's likely some of the supertankers are holding Chinese oil. Part of this comes from the Chinese practice of buying up commodities in general when prices drop; this is also the case with oil.
With a lack of infrastructure in China in particular and Asia in general, there is a limit how much oil can be received. That is why floating storage levels continue to rise.
The problem is the Asian demand for oil isn't coming from consumer or industrial needs only, but also from the low price of oil. For that reason the glut in Asia will increase. The higher inventory goes the longer it'll take to work down. That is a negative catalyst for oil prices.
Global storage also a problem
While infrastructure is a major problem for Asia, oversupplying the market has tested oil storage capacity around the world. Floating storage on a global basis has jumped 19.5 percent from the first quarter of 2015 to the first quarter of 2016.
Investors need to understand why global storage is important. Because of exorbitant costs, it reinforces the thesis the storage crisis is a real one. Buyers wouldn't be using floating storage if they had alternative places to stockpile oil.
When I say this I mean under the existing term structure associated with crude futures. There are obviously times when investing in floating storage is a viable option. But at this time floating storage isn't an investment play, it's coming from traders looking for places to store their oil.
Why this reinforces the ongoing oil glut is it costs over $40,000 per day to charter a supertanker or Very Large Crude Carrier ("VLCC"). These giants tankers can hold 2 million barrels of oil. It would take a steep contango at that price to make it profitable. Future prices are simply too low to make money on at today's charter costs.
As of now the one-year contango for Brent crude futures stands at $4 per barrel. In January it was at $7.60, which was still significantly under the $10 needed to make investment in floating storage attractive. Again, this is why we should feel save in concluding storage is under real pressure; it's not a fiction created by those wanting to make money shorting crude.
Goldman Sachs is wrong
If all of this floating storage build-up was based upon traders taking advantage of contango, then Goldman Sachs would have a stronger case for a rebalancing of the oil market, even if it at best was temporary. But since floating storage demand is driven by the real struggle to find buyers for oil, the idea that oil has rebalanced makes no sense.
Not only is Goldman incorrect because of the temporary nature of the outages, but because even when Canada wasn't delivering oil, U.S. inventories still rose. Nothing but an excess of supply can explain that.
I think the reason Goldman missed on this is it was primarily focused on Canada and Africa, while neglecting to address the floating storage issue. It's also because it strangely drew the conclusion a temporary outage could be described as a rebalancing of the market. In other words, Canada was always going to quickly return to it recent supply level, which would almost immediately change the supply/demand equation. That never made sense to be from the first time I heard Goldman talk about a rebalancing.
When floating storage is bought for the sole purpose of storage, you know there is a problem finding places to put oil. That means the oil glut continues to grow, and there is no evidence inventories are being sustainably drawn down.
With the loss of a significant amount of Canadian supply during the wildfires, almost everyone, including myself, believed there would be a drop in U.S. inventory levels. It didn't happen.
Looking at all this, what seems to be the answer to this mystery is there may be more supply coming to market than is being officially reported by some competitors. Both Russia and OPEC members are notoriously secretive about what they're really doing. There have always been the official numbers and the actual numbers. It appears under the storage situations mentioned here, there is more supply than being reported.
There is of course the Iranian factor, with Iran ramping up production and exports far quicker than the market believed it could. That alone can't account for all of this though. Since supply can't appear from nowhere, I think producers are bringing more to market than we're being told.
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.