Oil prices have been on a tear over the past week, but this rally may not be entirely driven by fundamentals, sorry Andy Hall.
The all-in cost of tanker vessels chartering has once again intersected with the slope the oil forward curve, making for conditions which have previously initiated a process of floating storage inventory build.
According to research from Deutsche Bank, over the last two years alternating phases of inventory build and draw have ranged in magnitude from 30 million barrels of oil to 70 mmbbl as offshore storage has become one of the most profitable markets for oil traders around the world.
Floating storage is profitable when the market reaches a condition traders call a “super-contango.” In a contango market, prices of oil for delivery today are lower than those in future months. Current futures indicate that this is the case today (see chart below). However, when storing oil offshore, traders also have to take into account the daily charter rates for oil tankers, which is the most unpredictable cost traders face. As Deutsche Bank explains:
“The charter cost accounts for the most volatile portion of the offshore storage cost structure, ranging from 50% of the total when charter costs are low, to 87% of the total in December 2015, for example, when charter costs are higher [see chart below]. The other components we consider our financing at an assumed 5% cost of capital, insurance at a rate of 0.02% per month, transit and transfer losses of cargo, and bunker fuel for the vessel.”
Oil traders offshore storage will drive prices higher
Overall, the figures seem to support the conclusion that oil traders should be making the most of the current market environment to profit from offshore storage trades. And if traders are getting back into the market then the price of oil will reflect that. Going back to Deutsche’s research once again, the bank claims that the month-over-month change in floating storage inventory has explained 25% of the variability in month-over-month oil price changes since January 2015. Before this date, (back to 2010) Deutsche finds that the change in floating storage inventory only explained 4% of the variability in oil price changes. However, there are some fundamental differences about the state of the oil market between January 2010 to 2015 and from January 2015 to today. For a start, in the earlier period oil markets were still in deficit and investor positioning wasn’t overly skewed in one direction.
Today, oil markets are oversupplied, and most investors believe the price of oil is going lower before it moves higher. Simply put, today oil prices are likely to be a lot more responsive to a sudden surge in buying by traders looking to make a profit from offshore storage.
What impact is this likely to have on the price of oil? Well, by using a global floating storage regression, Deutsche’s analysts predict that base storage build of 50 mmbbl would result in a price upside of $8.5/bbl for Brent. A 30 mmbbl build would likely give an upside of 5.1/bbl and a 70 mmbbl build could lead to $12/bbl of upside.