Oil Market Alarm: Cushing Inventories Fall to Pre-Fracking Levels

Oil prices soar again after last week’s relief. The growing rejection of Russian oil and the absence of alternatives in the very short term to replace it are generating some panic in the markets. The focus is once again on supply problems to meet the immediate demand for crude oil (spot or physical market), which is exacerbating the structure of backwardation of the market (a premium is paid for physical oil against futures). Meanwhile, crude oil inventories continue to fall and in Cushing, Oklahoma, have hit levels not seen since the oil industry fracking and the shale oil broke into the US.

The market is facing a difficult balance and the low level of reserves does not help at all. In the end, the reserves or inventories of crude oil are a kind of network that serves to compensate for excess demand for a certain time. When the world consumes more oil than is being produced, inventories fall to offset that imbalance, but inventories are not finite. Cwith inventories at minimum For several years, the protection network has lost resistance, so the premium at which crude oil is quoted is higher.

Cushing’s facility

Oil inventories at Cushing are the lowest since the fracking It made its big break in the US back in 2013 and 2014, according to Bank of America Merrill Lynch (BofAML).

The spread between the oil already extracted or spot and crude oil futures are reaching highs in recent decades ($11.70 difference between 1-month futures and 3-month futures). This is dangerous, according to BofA, since it creates a disincentive to keep oil in inventories. Traders are selling all their oil because they will get a higher return on it now than if they store it and sell futures.

Inventories at the Cushing facility have fallen to 24 million barrels (has capacity for 90 million barrels), the lowest level for this time of year in nearly a decade. “Right now, storage levels are likely to be close to minimum operating levels. Given current levels of backwardation In the market, we believe that a good part of these inventories are being used for combined operations and as support for pipeline flows. Therefore, these barrels may not be used for physical delivery of expiring West Texas Intermediate (WTI) crude futures,” BofA analysts said.

Cushing, Oklahoma, is a storage center which is used for the delivery of light sweet crude oil futures contracts from reference in the NYMEX. Cushing’s physical delivery mechanism uses a network of nearly two dozen pipelines and 15 storage terminals, several with major pipeline collectors.

From CME Group they explain that the Cushing facilities are relevant for the market, above all, because they serve as a thermometer to measure the temperature of the oil market (analyzing storage trends). This center has a maximum capacity of 90 million barrels, which is normally used as a physical delivery mechanism for West Texas oil futures, which requires that there be a sufficient amount of oil to compensate for the maturities in the futures market every year. months.

In April 2020, with the covid pandemic, the problem was that there was not enough space to store oil in Cushing (there was oil left over), so crude oil began to be sold at negative prices (traders took oil off the shelves). hands because there was no physical space to store it).

The risk of short squeeze

“Now, the market situation has reversed. With inventories at very low levels, the ability to deliver against the WTI contract is likely to be reduced. As a result of the poor growth in US crude oil production during the In the first half of 2022 and limited incentives to ship barrels to Cushing, inventories are likely to remain low With the market desperately short barrels, we see an increased risk of what is known as a short squeeze as WTI approaches a new expiration each month. In addition, we see the risk of WTI strengthening relative to other North American grades (other types of oil), “they warn from BofA.

WTI oil is at risk of what is known in financial jargon as a short squeeze (“short strangulation”), which occurs when the asset not only does not fall as expected but experiences a strong rebound, which causes those who bet on short positions to try to abandon them and cut their losses via purchases, resulting in an increase in demand that pushes prices even higher. Oil could experience sharp price increases and volatility as futures approach their expiration date.

Oil is trading virtually flat this day after restarting an upward rally that took a break last week. The reason for the latest push higher in oil “is the news that the EU appears to be considering a ban on oil imports from Russia. A high-level meeting with US President Biden will take place this week, at which new sanctions against Russia are likely to be discussed. The US already announced a ban on imports of crude oil and petroleum products two weeks ago. In view of the actions of the Russian armed forces in Ukraine, which are targeting civilians, there is growing pressure on Europe to follow the US example,” Commerzbank said.

The great dependence on Russia

However, the EU is much more dependent on Russian oil, which covers nearly 30% of its crude import needs. In the case of diesel, Russian oil even represents up to 80% of its net imports, according to Commerzbank data. This means that large quantities of this raw material would have to be sourced elsewhere, further restricting the market.

All of the above is also increasing pressure on OPEC+ to produce more ‘black gold’, since the cartel has countries like Saudi Arabia or the United Arab Emirates that have the capacity to increase oil pumping almost immediately.

According to two well-informed sources, production in February fell more than 1 million barrels per day below the agreed level. “The downward deviation is likely to increase significantly in the coming months given the expected decline in Russian oil production. In addition, Houthi rebels have attacked oil facilities in Saudi Arabia over the weekend. Although no serious damage was done This makes it clear that supply cuts are also a distinct possibility in that country, which would be practically impossible to compensate for in the current environment.