Tightening US storage capacity could quickly become a glut: Fuel for Thought

Demand for storage is reaching a fever pitch with tank capacity and utilization at all-time highs, but the storage market is volatile and at the same time could be barreling toward oversupply.

The US crude market is in contango, meaning crude is worth less for delivery now than later. That dynamic encourages storage, but it could reverse as the contango narrows and production shrinks while tank capacity continues to expand.

There is an easy comparison between the take-or-pay contracts on pipelines and storage tanks, which might give a hint of things to come if the market structure reverses. Under both kinds of contracts, the counterparty has to either use the committed space on the asset or pay a penalty, often as much as the price to use the space in the first place.

In the case of pipelines, that pushed Midland WTI into a premium over its counterpart in Cushing as demand for crude to meet shipping commitments stacked up at the pipelines’ origin terminals. Not only that, but the existence of the contracts helped drive investment in infrastructure, which contributed to the explosive growth in pipeline capacity since the turn of the decade.

If the contracts have a similar effect on the storage market, it would likely manifest in stronger prompt prices, with weaker prices further down the curve — especially if production declines, leaving marketers who expected growth holding contracts to store barrels that don’t exist. For now, at least, imports have been able to keep driving storage demand, but how long might that last as the contango flattens out?

A capacity oversupply would lend strength to the crude prompt market by creating demand simply to meet the contractual commitments that underpin current and upcoming projects’ volume agreements. It could also apply downward pressure to the back end of the contango structure, because cheaper storage lets marketers work slimmer time spreads, Bentek Energy Analysis Manager Anthony Starkey said.

“It doesn’t really ‘solve’ anything, but [an overbuild] could provide that kind of support for oil,” Starkey said.

Though March and April so far have seen a relatively wide contango, with the front-month WTI contract in Midland averaging $1.48/b less than the second-month contract, it is still lower than February, which averaged $1.94/b.

The sustained contango has buoyed crude stocks in the US to an unusually-high 529.9 million barrels. Those stocks are especially concentrated in Cushing, Oklahoma, with 66.32 million barrels and the Gulf Coast, which holds 277.54 million barrels.

What happens when contango becomes backwardation?

“If the market is in contango, there’s never enough storage, and if it’s in backwardation, there’s too much,” said Andy Lipow, president of Lipow Oil Associates.

The issue of having too much or too little storage capacity ultimately boils down to market structure at any given time, Lipow said.

This principle plays out in the available storage capacity versus crude oil inventory levels at Cushing terminals over the last couple of years. With crude stocks are roughly 89% of working capacity utilized, demand is high at the Oklahoma storage hub.

While the current contango structure has lent support to demand for storage, it probably hasn’t been particularly influential in the decision to build new infrastructure, CEO Ernie Barsamian of The Tank Tiger said.

Especially now that the contango is far from a fresh dynamic on the market, building new infrastructure on that basis is “fool’s gold,” Barsamian said.

“We’re kind of moving to the end of that period,” Barsamian said. “It’s kind of like building a new hotel in Vegas.”

In fact, the rate of greenfield expansions, wherein a company builds a completely new facility, haven’t accelerated at all, Barsamian said. Most of the growth is coming in the form of expansions to existing facilities.

Right now, for instance, Phillips 66 is planning incremental expansions to its 7.1 million-barrel crude and refined product storage facility in Nederland, Texas. The company plans to add 2.3 million barrels over the next two or three years, with an eventual maximum potential of more than 16 million barrels, spokeswoman Lara Burhenn said.

If supply overshoots demand, the older storage terminals will likely lose business to their better-connected, fresher counterparts, Barsamian said.

“That’s always going to happen,” he said. “You get these new facilities built, but they’re not going to end up empty.” — Joshua Mann in Houston

Mary Hogan, a Platts reporter in Houston, also contributed to the research and writing in this post.