The Covid-19 outbreak and consequent lockdowns in many parts of the world, including India, Germany, Italy, and parts of the United States have contributed to an oil slump.
With the demand taking a hit with planes being grounded, and cities and industries coming to a grinding halt, refiners turned to storage spaces to stock up cheap oil. However, they will be running out of space in less than three months.
As per an analysis by IHS Market, at the current rate of supply and consumption, the oil inventories will rise by 1.8 billion barrels by the the second quarter of 2020.
At present, only 1.6 billion barrels of storage capacity is available. Therefore, by June, producers will have to cut down on oil production as refineries run out of storage space.
The oil market, which was already hammered by the ongoing price war between member nations of the Organisation of Petroleum Exporting Countries (OPEC) and its allies, has been further impacted by the virus outbreak.
As of now, the market is in a ‘super contango’, a situation where it is profitable for traders to buy oil now, store it, and make a profit by selling it at higher prices in the future.
The analysis further added that the supply will exceed demand by 12.4 million barrels a day in the second quarter of 2020 as the price war deepens. However, the demand has fallen by as much as 20 million barrels a day from last year.
The last time the oil industry was staring at production cuts was in 1986 was when Saudi Arabia led the market in another war. The cuts were also witnessed in 1998-99 and 2015-16. However, they weren’t significant enough. With global consumption falling by 20 per cent, there is no incentive for producers here.
As ground storage spaces run out, the refiners are now turning to the seas.
As per a in Bloomberg, traders are now opting for tankers to store oil in the hope of selling it later and reaping profits. Over 100 million barrels of oil may eventually find space in floating tankers and ships with capacity as little as a few thousand barrels. There are also reports of traders opting for pipe networks to store oil.
The lack of storage space may further dampen the pricing prospects of the oil industry. Already, West Texas intermediate (WTI) traded at the lowest since December 2008. Brent futures are already in a contango.
The storage capacities do not inspire much confidence either. Russia has storage capacity worth 8 days, Saudi Arabia for 18 days, and the United States for 30 days. These three countries are the largest oil producers. Nigeria, Africa’s biggest producer, has a storage capacity of only 2 days, the analysis stated.
China, meanwhile, has had an oil party. Given the nation imports 70 per cent of its crude needs, it added 2.5 million barrels a day to its storage in the first two months of 2020.
In 2019, China imported 10.2 million barrels a day. The plunge of Brent crude from $67 to $25 saves China $428 million per day (or about 1 per cent of its GDP) in oil bills.
Yet, even China, with one of the largest storing capacities, is running out of space for oil. Including underground strategic storage and floating-roof storage, China can hold up to 1.2 billion barrels of oil.
Second to the United States (788 million barrels), China’s share of global commercial storage capacity stands at 16 per cent at 737 million barrels.
However, by the second of week March, more than two-thirds of China’s storage capacity was exhausted compared with 61 per cent of the entire world. By March 16, the above-ground storage amounted to 745 million barrels.
An analysis by Wood Mackenszie projects the total oil reserves to exceed 1.15 billion barrels by the end of 2020, at 300,000 barrels per day.
The consequences of exhausted storage space are now hurting the small producers in the United States as well.
Wyoming Asphalt Sour, a dense oil used to make paving bitumen, was being sold at negative prices in March. Thus, producers were actually paying the buyers to get rid of the oil.
This happens when the storage costs run high enough for producers to no longer make profit by merely stocking oil.
Another crude from North Dakota went as low as 50 cents to a barrel, before the price was revised to $1.50. Negative pricing has been witnessed in California, but for electricity, where the excess of renewable energy has driven down energy prices, resulting in power plants shutting down.
With no end to the pricing war in sight, and markets being flooded with cheap oil by Saudi Arabia and Russia, and an unprecedented demand shock in the wake of the Covid-19 outbreak, net importers like China and India would look to fill up their oil reserves.
However, at some point, they too will run out of space, pushing the oil market closer to historic lows and smaller producers towards negative pricing, or worse — bankruptcy.