During the Depression, desperate producers would dump barrels of oil into pits to get rid of excess inventory and bump up prices.
Modern environmental regulations makes this an unlikely solution to today's high inventory levels, but University of Calgary professor Philip Verleger says if growing stockpiles aren't dealt with soon, the world will see $20 (U.S.) a barrel oil by year's end.
“This isn't complicated – we are running out of storage space and the economic situation is not getting any better,” said Prof. Verleger, who also runs PKVerleger LLC. “By winter we'll have this stuff coming out of our ears.”
Philip Verleger
Prof. Verleger, a former energy adviser to the U.S. government, said supply is outpacing demand by about two million barrels a day. Still, prices have increased almost 90 per cent from December lows as speculators fill reserve tanks in hopes of an economic recovery.
China alone has stashed more than 100 million barrels this year, after completing the first stage of an energy storage program. It will soon build a second facility to hold another 170 million barrels, with a third expected in the future. Its goal is to build a 90-day reserve, similar to that of the United States.
While Prof. Verleger said it's impossible to know how much global storage capacity exists, global crude and product inventory levels are near highs set in 1997, even after adjusting for demand growth.
“The inventory build must stop soon,” he said in an interview. “It will cease because global consumption increases or global supply declines. My guess is it will be production that falls.”
Crude oil was last at $20 a barrel in February, 2002. Yesterday, crude for August delivery closed at $62.02 on the New York Mercantile Exchange. And while the Organization of Petroleum Exporting Countries has been cutting production, Mr. Verleger said further cuts of about two million barrels a day would be needed to keep prices at current levels.
Lower oil prices have also driven down profits at refineries, which process crude into products such as gasoline and diesel. The lower that prices creep, the more likely it becomes that refineries will reduce their output – putting further strains on an already stressed storage market.
Petro-Canada's Edmonton refinery
Yesterday, European refiner Total SA said margins at its European facilities fell by 69 per cent in the last quarter as it announced a plan to lower its gasoline output by 60 per cent. Royal Dutch Shell PLC said last week that it might close or sell its Montreal refinery, which can process 130,000 barrels of oil a day.
“Oil producers will find themselves in the same predicament as natural gas producers,” Prof. Verleger said. “In the case of gas, output is shut in because there are no buyers. Some oil producers will be forced to cut production because they simply cannot find buyers.”
Despite the high inventories, the median of analyst forecasts compiled by Bloomberg has oil averaging $63.91 in the fourth quarter. Goldman Sachs recently raised its year-end target to $85, and CIBC World Markets expects oil will have averaged $60 a barrel through 2009.
“Yes, there is a downside risk from high inventories but I still think OPEC has proven its ability to take supply off the market to deal with that situation if needed,” said Avery Shenfeld, chief economist at CIBC World Markets. He expects oil to end the year with an average price of $60 a barrel.
