Analysis: Dubai crude sinks to new lows to find space in a storage tanker

Singapore — Middle East sour crude benchmark Dubai crude fell to its steepest discount Wednesday, as the rising cost of leasing ships forces prices of physical barrels to sink deep below the futures contract to create a contango that would lure companies looking to buy oil for storage.

With the coronavirus pandemic cutting oil consumption across the world, the boom in demand for storing oil has been key in absorbing excess barrels from the market in recent weeks.

Millions of barrels of oil are being pushed into storage globally, from market participants looking buy cheap oil today in the hope of selling it at higher prices in the future -- enabled by one of the steepest contango structures in the oil markets.

According to Affinity Research, an estimated 40 VLCCs and 25 Suezmaxes were fixed globally in recent weeks to be floating storage -- for periods ranging from one month to a year -- for crude and condensate products.

But companies leasing more ships for storage is driving up chartering costs, which in turn is adding more pressure on physical oil prices to fall low enough to make storage economics profitable.

Owners have been able to put vessels on subjects at rates from $40,000-$85,000/day, with offers reaching $95,000/day, according to Euronav CEO Hugo De Stoop, who spoke at Capital Link's online panel Tuesday, S&P Global Platts reported earlier.

The cascading effects have led to a steeper fall in prices of physical barrels of oil than the headline-grabbing decline in oil futures contracts that trade on exchanges such as the Intercontinental Exchange or NYMEX.

Between March 2 and April 1, front-month Dubai crude futures fell by about 43% to $29.16/b Wednesday. Over the same period, benchmark Cash Dubai -- that represents the price of physical Middle East oil -- fell by a whopping 58% to $21.20/b Wednesday.

STORAGE ECONOMICS

Front-month June Dubai futures at $29.16/b Wednesday was at a steep discount to prices a year out, with the May 2021 contract trading at $37.51/b, representing a contango of $8.35/b over the 12-month period. Over the same period, the contango in ICE Brent futures was even steeper at $13.38/b.

A company hoping to profit from high prices in the future may buy 2 million barrels of physical oil for June loading and sell May 2021 derivatives to lock in the profit from higher prices in the future. On a full VLCC containing 2 million barrels, the contango in the derivatives market points to a gain of about $16.7 million based on the Dubai market structure, or $26.76 million on the ICE Brent curve over the 12-month period.

But with offers for VLCCs approaching $95,000/day, that margin pales in comparison to the cost of leasing a ship, let alone other associated costs associated with storage, including insurance, financing, maintenance and logistics. At $95,000/day, just the cost of leasing a VLCC for a year would be $34.70 million.

To make the storage dynamics economical, the physical price of oil has to fall to steeper discounts versus futures. In the case of Dubai crude, the spread between front-month cash prices versus same-month futures has hit new record lows several times in the last few weeks to reach the widest ever discount of $7.96/b Wednesday.

At Wednesday's price for Cash Dubai, buying June Middle East oil at $21.20/b would yield a contango of $16.31/b versus May 2021 Dubai futures. On a VLCC filled with oil, that's worth some $32.62 million of potential gains in a year.

But that's still barely enough to cover more than $35 million-plus costs associated with storage, meaning that unless there's a dramatic shift in the oil demand-supply balance, or freight rates ease drastically, there may be more pain in store for physical barrels of oil.