If you want to know what is happening to all that surplus oil, look out to sea where huge ships laden with millions of barrels of crude are anchored, riding out the market storm. Since the beginning of 2015, big oil companies and commodity traders have been scrambling to charter vessels to store crude for periods of up to a year. Around the world, wells are estimated to be pumping between 1.5 million and 2.5 million barrels per day more than we can burn or turn into plastic. It has to go somewhere: storage tanks are rapidly filling and fleet- of-foot oil traders are snapping up Very Large Crude Carriers (VLCCs) while rates are still affordable.
You can make money hoarding stuff. Rock-bottom interest rates and the futures markets make it possible to keep a million barrels of crude in a tank for a year and still sell it for a profit. Oil futures are in contango which means that the price per barrel is lower today than in six or 12 months time. As long as the difference between the prompt barrel and the12-month future is bigger than the cost of storage, a trader can lock in a gain. Small wonder that shipping brokers report more VLCC time charter activity in January than in the whole of 2014.
Oil is also flooding into the storage tanks in Cushing, Okla., according to Argus, the oil price publisher, which reports nine weeks of consecutive increases. Cushing has capacity for about 85 million barrels and reports suggest that the tanks will be full within two months. Goldman Sachs suggests that the world has enough storage capacity to satisfy the equivalent of one million barrels in daily global demand. But it is filling up fast and that means more downward pressure on prices. When the oil threatens to slop over the tops of the tanks at Cushing we can expect the price of West Texas Intermediate, the U.S. benchmark, to tumble again and drag down with it the price of Western Canada Select.
Where else can we send the unwanted barrels of oil? Turn it into oil products is the other current fashion. Refineries are running at a frantic pace, turning dirt-cheap barrels of crude into diesel, jet fuel and gasoline. Product manufacturing has been a godsend for the big integrated oil companies, protecting them from financial Armageddon as the losses mount at the wellhead. Margins have soared as the cost of feedstocks falls faster than the product. According to Argus, in January refiners were selling diesel at prices 40 per cent higher than the cost of crude, a ratio not seen for six years. But oil product storage tank capacity is finite too, and the manufacturing profit boom will subside in due course.
What we need to understand is that cheap money and the sophistication of modern futures markets have not worsened this oil price crash, as some continue to believe. Oil storage and financial engineering has softened the blow and lengthened the decline, helping the shale oil producers to adapt to the new world by soaking up excess crude. We are now at a hiatus and sooner or later what is piled up in storage, speculative hoarding and in China's strategic petroleum reserve will have to come on to the market. That heralds another price slide.
The big question then is how durable and adaptable is the financial model of the hundreds of shale producers in the Bakken and Eagle Ford fields in the United States. Many skeptical and scornful commentators late last year suggested shale oil producers would collapse as the price fell below $80 (U.S.) a barrel. However, in cash flow terms, estimates of break-even for Bakken producers are now at $40 per barrel and some say as low as $23 per barrel.
But the real issue is not whether shale oil producers will cut back – that much is certain – but how quickly they will return when prices rise. At the Energy Institute annual conference in London this week, the view was widespread that the shale oil operators were now replacing Saudi Arabia as the swing producer of the oil world, quick to start up and quick to cut back; efficient, innovative and adaptable, the essence of an entrepreneurial revolution.
If that is true, expect the low prices to continue for some time to come with sudden sharp recoveries followed by downturns.
Carl Mortished is a Canadian financial journalist based in London.