As U.S. crude oil stockpiles soar, CME Group Inc. has come up with an innovative way for energy producers to reserve space in storage facilities.
The ability to trade oil futures contracts has been around since 1983, but on Monday, the first ever oil-storage futures contract goes live. One contract bestows upon its holder the right, but not the obligation, to store 1,000 barrels of crude oil in caverns or above-ground tanks in Louisiana.
Three grades of sour crude are eligible to be held at these facilities, which are connected to 50 per cent of the United States' refining capacity via pipelines.
The futures will be listed, traded and cleared through the CME Group.
The storage space is owned and operated by LOOP LLC, and the auction of these contracts will be done by NEO Markets Inc.
The rapid pace at which oil inventories in the United States are mounting is, no doubt, a key driver fuelling this development.
U.S. inventories rose by 8.2 million barrels during the week ended March 20 and, according to the Energy Information Administration, have reached 446.7 million barrels in total – the highest level year-to-date on record.
At the current pace at which stockpiles at the Cushing, Okla., hub have been growing in 2015, the tanks could be filled by May.
Storing oil has become attractive to producers because of the current structure of the futures curve, known as contango. While a barrel of oil sold today goes for less than $49 (U.S.), one sold 12 months from now generates more than $57 in revenue. This disparity allows producers to lock in profits by selling the year-out contract and keeping oil in storage until the time it has to be delivered.
Citigroup estimates that a month of on-land storage costs between 50 cents to 75 cents a barrel, while floating storage on idled tankers ranges from 75 cents to $1.40 a barrel.
"Citi expects that oversupply in the U.S. will persist through the second quarter, when storage may test capacity limits," said Richard Morse, a member of Citi's commodity strategy team. "As storage continues to fill and only more expensive types of storage remain, prompt prices would have to fall and the contango would have to steepen to continue moving barrels into storage."
These futures contracts will likely be utilized by firms with economic exposure to the cost of storage – such as producers, transporters and refiners.
Peter Keavey, executive director of energy products at CME Group, calls them "a unique way to be able to accept or transfer risk."
Oil storage futures should provide greater certainty and visibility into storage costs, which is becoming a more important element for companies to monitor and manage as inventories build.
However, it also could prove to be fertile ground for speculators, and encourage the build-out of more facilities to store oil.
"By creating a listed market, they're clearly trying to push the narrative that storage is at a premium and that is what's driving oil prices, and also anticipate that they're going to have some action from financial players," said Eagleview Capital chief market strategist Andrew Barber, who has a bullish intermediate and long-term view on oil.
"In theory, if demand for this product goes through the roof, it would create an incentive to expand storage capacity."
It is neither difficult nor unreasonable to see a scenario in which hedge funds might take advantage of this market to take a share of the "storage play" profits for themselves, especially if it were deployed at Cushing, a hub where there is much more visibility into the physical flows.
However, activity is expected to be fairly low in the early stages, with this contract being utilized primarily by physical players while financial ones shy away until they have more security on activity and knowledge of the dynamics on the ground at this location.
As such, this contract is unlikely to have any significant effect on producer behaviour.
An analyst who asked not to be named indicated that this might be a test case by which the CME Group will be able to gauge if there is enough interest in this type of product before exploring opportunities at other storage facilities.
However, Mr. Keavey said there is "no immediate plan" to do a similar contract, but that the firm will discuss these possibilities if it becomes something the industry wants more of.
"This is a very unique case where we had a partner that wanted to facilitate this [contract]," he said.
"We're focused on having a successful launch and product at that facility and we will take it from there."