Oil Storage, China Credit Threaten Crude-Price Rally

Business, China, Economics, Europe, Naphtha & other feedstocks, Oil & Gas, US

Keeping count of floating storage

By John Richardson

MANAGE your naphtha and other raw material inventories incredibly carefully over the next few months, as you cannot afford to believe the hype that oil prices have definitively, without doubt, bottomed out.

This has to be the only sensible approach for petrochemicals companies, given that:

  • The hedge funds and pension funds poured into oil futures during Q1, as they once again switched to commodities in general as a store of value against a weaker US dollar. This was the result of strong Fed signalling that it had become much more lukewarm about further US interest rate rises.
  • So crude prices, of course, rose as short positions became long positions.

Sure, there are physical reasons to back up today’s price recovery, including disruptions in Canadian, Nigerian and Libyan production. But I am once again left with the feeling that this has merely added further momentum to a rally that had mainly been driven by the financial sector.

Meanwhile, you have to be alarmed by the fact that floating oil storage in Singapore appears to be at a record high.

“I’ve been coming to Singapore once a year for the last 15 years, and flying in I have never seen the waters so full of idle tankers,” a senior European oil trader told Reuters. 48m barrels of crude are now being stored off the coast of Singapore – enough to satisfy five days of working demand.

The US oil surplus is also so large that a futures market in storage opened last year, with 25m barrels now being traded in this market. Globally, 90m barrels are being stored on ships, according to the International Energy Agency. In Qingdao, China, oil tankers are waiting a month to discharge their cargoes.

And here’s another concern: Whilst oil markets are in contango – i.e. prices for future delivery are higher than today’s prices – the contango is insufficient to cover the cost of storage, according to Morgan Stanley. It estimates that the one-month Brent storage arbitrage currently produces a loss of $0.48 per barrel, while its six-month equivalent loses $6.11 per barrel.

Traders are thus taking a gamble on the contango widening as the price rally continues. If it doesn’t then they could cut their losses and sell-down a considerable slice of this floating inventory.

The supply disruptions in Canada, Nigeria and Libya might, of course, all prove temporary.

And we also know that following its announcement of its Vision 2030 strategy, Saudi Arabia remains firmly committed to maximising oil production, as it doesn’t want to risk being forced to leave its most valuable asset in the ground. Iran, too, will want to pursue the same strategy as it tries to make up for lost economic ground following the nuclear deal with the West.

Credit growth in China is another important part of this story. In Q1, the anti-reformers gained ground as the growth in new lending rose by as much as 58% year-on-year. In April, though, lending declined – a sign that the reformers have regained the upper hand. The surge in Q1 lending has been another factor behind the rise in oil and other commodity prices.

But what might well be the biggest single trigger for a retreat in oil prices are indications from the Fed that US interest rates could, after all, be raised in June. This risk further underlines my point about how genuine price discovery in oil markets, based on real supply and demand fundamentals, has been so badly distorted by central bank economic stimulus.

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