Let’s take a look at the recent developments in the US energy markets and the seemingly contradictory reaction by equity investors.
First of all, while we continue to see significant declines in the US rig count (both oil and gas), …
… American crude oil production remains at record levels and still rising. It’s going to take time for this momentum to turn.
Part of the reason is the increasing productivity of new rigs in the US.
Moreover, outside the US some major oil producing nations such as Russia and Iraq – desperate for hard currency – will maximize production in the months to come. Global production will therefore continue to rise.
The second key development has been a relatively steep crude oil futures curve (contango).
This is encouraging crude investors to store oil. The arb involves buying spot crude, simultaneously selling forward, and storing for delivery at a future date (Profit = Forward Price – Spot Price – Storage Cost – Financing Cost). If the arb persists, the trade can be rolled. That’s why this past week we saw the largest spike in volume of crude in storage.
Moreover, the absolute levels of crude in storage are now at the highest level in some 80 years.
As a result, analysts expect Cushing, Okla. (the WTI crude delivery/storage hub) to run out of storage soon.
Crude in storage is on the rise outside the US as well. As an example, Iran just launched a huge floating oil storage unit in the Persian Gulf (built by Samsung). This facility stores 2.2 million barrels of crude.
