Oil prices dropped to 10-month lows this week amid growing concerns that the oil market will remain oversupplied for quite some time. One indicator that suggests the glut will persist, or even become sloppier, is the recent uptick in the volume of oil stored on tankers at sea.
Floating storage is a revealing sign of a market dealing with too many barrels of oil. In multiple market downturns over the past several years, oil traders stored millions of barrels on tankers because onshore storage facilities were brimming. Buyers became scarce or market players could make a profitable trade by holding the crude at sea and selling it at a later date.
Floating storage is another sign that the market is still suffering from a supply glut, reinforcing that the problem may not go away anytime soon.
Market sources emphasize how overwhelmingly bearish sentiment is right now, and rising volumes at sea will only add to this mindset. The recent increase in floating storage is an ominous sign that the OPEC cuts may not balance the market, and it also poses a threat to the ambitious drilling campaigns by U.S. shale companies that are still recovering from the price crash to below $30 in early 2016.
Floating storage increases
The floating storage situation appears to have changed dramatically this month.
The IEA and OPEC both reported declines in floating storage in their latest monthly oil market reports, but the situation appears to have changed dramatically this month. According to Bloomberg, citing data from Kpler SAS, the volume of oil stored at sea reached its highest point so far this year in June at 111.9 million barrels. That is up from 74 million barrels versus early May. Morgan Stanley says that floating storage has been increasing at a rate of 800,000 b/d in the past month and a half.
Other reports confirm this trend. Reuters said that old crude oil tankers are being leased in Southeast Asia for storage. At least 10 very large crude carriers (VLCCs) have been chartered since the end of May. Floating storage is rising not only in and around Singapore, but also in the North Sea, which recently saw an uptick in floating storage by 7 to 9 million barrels, according to JBC Energy. The Vienna-based consultancy noted that the storage “does not appear to be entirely voluntary as it comes amid slackening demand from Asia” due to refinery maintenance.
The futures market is also making it profitable to store oil at sea. In order for floating storage to economical, traders need to be able to buy oil, pay for leasing storage space, and sell the cargo at later date at a higher price. As such, spot or front-month prices need to be lower than prices further along the curve. Traders lose money if the future price does not cover the cost of storage.
Recent changes in the futures market have near-term prices dropping to a sharper discount than contracts dated six months or a year out, a structure known as contango. JBC Energy says that the contango is wide enough that floating storage has become at least a breakeven proposition, assuming the cost of tanker storage at a daily rate of $16,500. Other analysts agree. “It makes a lot of sense for a trader to pay $16,000-$19,000 per day to take an older VLCC for 30-90 days to store oil,” an unidentified Singapore-based supertanker broker told Reuters.
“If the Brent contango widens further, we may see interest in floating storage take off,” JBC analysts wrote.
Too much supply
Ultimately, the circumstances in the futures market reflect real world realities. In other words, the oil market is suffering from too much supply, which depresses near-term prices and opens up a wider contango in the futures market.
Libya has managed to ratchet up production to 900,000 barrels per day (b/d), the highest level in four years and more than double its average production level from 2016. Libya’s National Oil Corporation said that it is aiming to boost output to 1 million barrels per day (mbd) by the end of July. Nigeria restored some of its disrupted oil production in recent weeks, adding 174,000 b/d in May from a month earlier. Royal Dutch Shell lifted the force majeure on the Forcados export terminal, which could lead to the restoration of 250,000 b/d.
The rising output from these two countries, combined with production gains from U.S. shale, is putting more barrels onto the market at the worst possible time. Some of that is heading into floating storage.
Challenge to OPEC and U.S. shale
The rise in floating storage is an indication that the OPEC production cuts are not taking enough barrels off the market to bring fundamentals back into balance. It is no coincidence that the uptick in floating storage has occurred at the same time that oil prices have dropped to their lowest level so far this year.
The rise in floating storage is an indication that the OPEC production cuts are not taking enough barrels to bring the market back into balance.
But the problem is even more complex for OPEC because its effort at balancing the market not only hinges on taking barrels off of the market, but also in trying to flatten out the futures curve and flip it from contango into a state of backwardation, in an effort to keep inventories from growing, whether onshore or at sea.
Backwardation would have knock-on effects. Lower futures prices along the curve would make hedging less profitable, which could curb drilling because of the lack of certainty. Backwardation may also scare away Wall Street from showering shale companies with abundant credit over fears that drillers might not be able to pay back their debt. In short, backwardation would drain inventories this year while at the same time preventing the shale industry from ramping up production. As of now, OPEC is failing to achieve this objective.
The situation is not rosy for U.S. shale producers either. Floating storage is another sign that the market is still suffering from a supply glut, reinforcing that the problem may not go away anytime soon. Ultimately, the mantra “lower for longer” has returned to trouble the industry once again.
A temporary problem?
As was the case in past market downturns, the rise of floating storage corresponds with a slide in oil prices. But the problem is typically temporary. As demand picks up or the contango narrows, barrels are unloaded from floating storage and sent to buyers.
While the recent uptick in floating storage is a sign of a rising supply in the Atlantic basin, it is also the result of lower demand due to refinery maintenance in Asia. That is a temporary problem that should dissipate as Chinese refiners come back online. As they buy up crude from the Atlantic basin, floating storage should decline.
While the recent uptick in floating storage is a sign of a rising supply in the Atlantic basin, it is also the result of lower demand due to refinery maintenance in Asia. That is a temporary problem that should dissipate as Chinese refiners come back online.
Moreover, the contango has to deepen if floating storage is to become lucrative for some market players. David Martin of JP Morgan Chase disputes the fact that floating storage is profitable, noting that the timespreads for crude futures at three, six, and 12 months are still not wide enough to justify floating storage in many parts of the world. Regardless, floating storage is a symptom, not a cause, of too much supply. It will become less of a factor when the oil market starts to return to balance. When that occurs, however, is up for debate.