Record-high North American crude inventories are set to surge even further in the coming months, putting downward pressure on global oil prices even as OPEC leaders muse about a possible production deal that would buttress the market.
As traders return from the U.S. Presidents' Day holiday on Tuesday, they can find reason for pessimism or optimism: Fundamentals in the crude market remain grim, but there is increasing talk among the members of the Organization of Petroleum Exporting Countries that the cartel needs to reassert itself to impose production discipline.
Despite more than a year of sub-$60 (U.S.) crude prices – and two months below $40 – global producers are still pumping out an estimated 1.5 million barrels to two million barrels more supply than is being consumed. As a result, prices have been flirting with 12-year lows, buoyed occasionally – as they were last Friday – by profit-taking and reports of OPEC discussions.
Meanwhile, commercial storage facilities in the United States hold record amounts of crude – with inventories sitting at more than 500 million barrels, up 20 per cent from already elevated levels in February, 2015. Stocks at Cushing, Okla. – the key hub where the price of West Texas intermediate is set – hit 65 million barrels this month, 50 per cent higher than last year and rapidly approaching the 73-million-barrel capacity.
The glut comes as U.S. refiners prepare to scale back operations to perform required maintenance so they can produce summer-grade gasoline. With refined product inventories also high, refiners are expected to extend their maintenance operations, temporarily reducing North American demand for crude.
"The threat is: As storage tanks approach capacity, you don't have anywhere to put the ongoing production," said Gene McGillian, analyst with Tradition Energy brokerage in Stamford, Conn. "Then you start getting distressed pricing in the spot market."
He noted that the futures market is providing incentive for storage. Near-month price for West Texas intermediate shot up Friday by $2.81 to $29.02 on speculation about an OPEC move. But WTI for June delivery closed at $34.63, meaning someone who bought March crude and sold June delivery could lock in profit at current storage prices. That arbitrage provides some near-term support for crude prices, but will weigh on the market down the road.
Still, there is plenty of storage capacity to absorb the excess production, says Dylan White, an analyst with Genscape, a market intelligence firm. Companies have added 10 million barrels of capacity in Cushing, while additional pipeline connection to the U.S. Gulf Coast provides a "release valve" when the Oklahoma hub approaches capacity, Mr. White said.
U.S. production has declined to 9.2 million barrels a day from its peak of 9.6 million last summer, but that was still equal to what it was this time last year and one million barrels a day higher than it was two years ago. Analyst expect U.S. production to fall further over the coming months, though many companies are determined to produce at a loss in order to generate revenue and meet debt obligations.
Still companies on both sides of the border are slashing capital expenditures and laying off staff. The number of rigs in operation continue to fall, dropping 30 to 541 last week in the United States, down from 1,358 a year ago, according to Bakers Hughes. In Canada, the number of rigs in operation fell to 222 from 380 at this time last year.
Inventories are also growing in Canada, said Beth Lau, manager for crude-oil markets at the Canadian Association of Petroleum Producers. Ms. Lau said Canadian exporters are facing a squeeze on pipeline space. Low prices, meanwhile, are undermining the commercial viability of transporting crude by rail.
Producers' best hope in the near term is the growing buzz from OPEC that some agreement to cut or freeze production is desirable. Last week, the oil minister from the United Arab Emirates, Suhail Al Mazroui, was quoted saying the cartel was willing to co-operate with non-OPEC members to curb production. On the weekend, Nigeria's oil minister, Emmanuel Ibe Kachikwu, told Reuters there is an emerging consensus within OPEC that an agreement must be reached to end the oil-price rout.
Still, there is reason to be skeptical of OPEC's ability to act.
Saudi Arabia has been determined to drive out high-cost producers to reclaim its share of the market – a significant price increase now could defeat that purpose. At the same time, the Saudis worry about arch-rival Iran, which is determined to take advantage of the easing of sanctions to increase oil exports.