This week I am attending and speaking at the Platts North American Refining and Trading conference. This is without a doubt one of the most dynamic and confusing times in the refining business, with huge opportunities coming from shale and tight oil production colliding with regulatory uncertainty, declining demand and rapidly changing economic conditions in the refining sector.
Through today’s twelve presentations by refiners, midstreamers, regulators, lobbyists and consultants I listened for common themes. One of the most interesting of these themes was storage. In both crude oil and petroleum products, the industry is changing in ways that will require significant investments in operational storage. There is a lot of legacy storage capacity that was in the right place for historical market flow/trading patterns, but this is the wrong time for it now. That’s a problem for those that need the new capacity, because forward market prices don’t support storage capacity additions. It is a classic case of operating needs versus project economics.
Let’s first look at crude oil. Today the growth in crude oil production is coming from the Bakken, Permian, Anadarko, Niobrara, Eagle Ford and other plays that have increased supplies in the middle section of the country, requiring new transportation capacity to get volumes to the large refining complex along the U.S. Gulf. Significant new capacity is needed on the receipt end of the new pipelines for operating purposes.
When those barrels get south they will find huge facilities at the delivery end which were built to handle the unloading of VLCC (very large crude carrier) vessels that historically have supplied those refineries. As domestic and Canadian pipeline barrels make it to the Gulf, those giant storage facilities needed for the big ships will see their utilization decline accordingly. The time for those big ship unloading storage facilities is past.
And then there is Cushing. There has been a huge boom in the development of new storage capacity at that central hub location. In the past two years, Cushing storage capacity has increased from about 56 MMbbls to 78 MMbls. (These numbers are from Andy Lipow, President, Lipow Oil Associates. We had slightly different numbers when we looked at this issue in detail last month in Bad Moon Rising but the differences are not material to the issue we are considering here.) More capacity is being built to handle all of the new pipes coming in and out of Cushing. But a problem with Cushing storage is that a lot of the existing capacity is there to take advantage of the contango in the crude oil forward curve. In a contango market, the price for each future month is higher than the previous month. So it makes sense to put oil in storage today and sell the barrels in the forward markets. That doesn’t work so well when futures prices in the forward curve are backwardated – lower in future months. In the graph below, the blue line is the forward curve for crude oil. Except for the bump between now and year end 2012, that curve is definitely backward. Again, operating needs seem to be in conflict with price signals.