INSIGHT: Saudi, Russia oil deal may delay storage crisis

HOUSTON (ICIS)–A possible oil deal between Russia and Saudi Arabia could delay when the world runs out of crude storage.

US President Donald Trump said he spoke with Crown Prince of Saudi Arabia Mohammed Bin Salman, and he expects the kingdom will reach a new production cut agreement with Russia. The deal would cut 10m-15m bbl of oil, although Trump did not specify the rate the two countries would cut production.

That’s a key piece of information, because one analyst estimates that the world will need to cut 8m bbl/day to avoid running out of crude storage.

Saudi Arabia and Russia produced a combined 23.82m bbl/day of crude in 2019, according to the Energy Information Administration (EIA).

It is hard to imagine that the countries agreed to reduce production rates by up to 63%.

Trump did not say there could be any production limits adopted in the US.

Still, Brent futures for June delivery rose by $5.20/bbl to close at $29.94/bbl.

TIME IS RUNNING OUT
Oil producers are running out of time to prevent the world from running out of storage, something that would bring oil prices crashing.

Citi Group expects Brent oil prices to reach an average of $17/bbl in the second quarter, said Ed Morse, global head of commodity research. He provided the forecast during a webinar hosted by the National Association for Business Economics (NABE).

One Citi Group scenario shows it falling as low as $5/bbl.

Citi’s forecast is so grim because OPEC and Russia have abandoned their earlier production-cut agreement while the coronavirus (Covid-19) is causing significant declines in oil demand.

In China, the disease caused demand for transportation fuels to fall by as much as 80% during the worst of the epidemic in that country, Morse said.

If that magnitude of decline hits the other countries stricken by the disease, then that amounts to an average drop of 16m bbl/day during the second quarter, Morse said.

When falling demand is combined with production from OPEC and Russia, then global inventories could grow by 1bn bbl in the next four to six weeks, Morse said.

Such a large inventory build is unprecedented in the history of the oil industry, he said.

The world cannot store that much oil in such a short period of time.

Morse estimates that the gap between storage needs and storage capacity will reach 8m bbl/day during the second quarter.

If that estimate holds true, then any likely deal between Saudi Arabia and Russia will only buy the world time to find a way to store all of the excess oil.

OIL MARKETS APPROACH BREAKING POINT
Something needs to happen soon, because there are already signs that oil markets are reaching a breaking point.

Sources say US oil refiner Flint Hills Resources declared force majeure on its April crude deliveries because it is running out of storage and has no way to ship material.

The company was not immediately available for comment.

There are anecdotes of pipeline operators wanting to review their customers’ storage contracts, out of concern that they will use the lines as a cheap, short-term way to store crude.

Oil prices are pointing to further distress. Earlier this week, the price difference between May 2020 and June 2021 Brent prices was more than $16/bbl.

Futures contracts enter contango when prices for more distant months exceed those for more recent ones. Contango encourages markets to store a product because the material can fetch a higher price in the future.

The steep contango earlier this week illustrates the premium being placed on storage.

For some grades of oil, prices could get low enough to shut in production.

In Canada and Mexico, some grades of crudes are trading at a $16/bbl discount to West Texas Intermediate (WTI), Morse said. With WTI at $20/bbl, that comes to $4/bbl at the well head.

In Canada, it costs $6-9/bbl to ship oil from Alberta to the Gulf Coast, he said.

In Wyoming, oil reached negative levels, Morse said. “Wyoming sour crude is pricing at below zero dollars per barrel. The producer has to pay somebody to take it away.”

Whiting Petroleum, an oil and gas producer, filed for bankruptcy protection under Chapter 11.

STEPS THAT COULD HAPPEN IN THE US
States in the US could take their own steps to limit oil production.

The Texas Railroad Commission (TRC) regulates the oil industry in the state of Texas, the largest producer in the US.

TRC Commissioner Ryan Sitton said the regulator is working towards an open meeting on 14 April to hear from experts about the implications of imposing production restraints.

One way Texas could limit production is by restricting licenses to flare gas, said Ken Medlock, senior director of energy studies at Rice University’s Baker Institute for Public Policy. He spoke in an earlier interview with ICIS.

CNBC reported that Trump will meet with oil executives on Friday, although it is unclear what specific topics they will discuss.

EFFECTS ON THE US CHEMICAL INDUSTRY
Oil prices are important to the chemical industry because prices for chemicals and plastics tend to follow them with a six-month lag, according to the ICIS Petrochemical Index (IPEX). The index tracks 12 major petrochemicals and polymers.

For US chemical producers, lower oil prices can shrink their margins because they rely overwhelmingly on ethane and other natural gas liquids (NGLs) as feedstock. Much of the world relies on oil-based naphtha.

US producers lose their cost advantage when naphtha prices fall in relation to ethane.

FURTHER HIT TO GDP
A collapse in the oil industry would also affect US chemical producers by slowing down economic growth.

The US was the world’s largest oil producer in 2019, producing 19.51m bbl/day, well ahead of Saudi Arabia, the second largest producer with 11.81m bbl/day, according to the EIA.

The oil and gas industry is now a significant contributor to the US economy. Its collapse could more than offset any benefits from lower fuel prices.

At the least, refiners cannot take advantage of the low oil prices by producing more fuel. The coronavirus has obliterated demand.

During such difficult times, energy companies first reduce capital spending, Medlock said. The next step is to furlough workers, which initially takes place in the oil-services sector. After that comes layoffs.

“This is unprecedented,” Medlock said. “The nature of this demand shock, the fear-driven nature of it, there is nothing that has happened like this post World War II in commodity markets.”

The fallout from the crash in the oil markets will compound the damage the coronavirus is doing to the US economy.

By Al Greenwood

Adds oil prices, paragraph 7

Additional reporting by Alex Snodgrass, Andrew Putwain and Michael Sims

Thumbnail image by Shutterstock

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