December 8, 2008 / 9:40 PM / 9 years ago

Refiners rush to store cheap crude

4 Min Read

NEW YORK (Reuters) - A big discount in oil prices for prompt delivery is leading U.S. energy companies to fill up their storage tanks at a time of the year they normally run down stockpiles for tax purposes.

The trend could spell bloating inventories in the world's largest energy consumer into the new year, keeping pressure on prices that have already slumped more than $100 a barrel since July as economic turmoil hits consumer demand.

It could also be a boon for some of the nation's top oil storage companies, like Enbridge, Plains All American and TEPPCO, all of whom have been expanding at the key futures delivery point in Cushing, Oklahoma.

"Tax considerations that normally discourage stock building around year end may not be a big deal this time around due to the recent price drops," said Antoine Halff, analyst at Newedge Group in New York.

Front-month oil futures were running at roughly $44 a barrel on Monday -- down from record highs over $147 a barrel hit in July -- creating a relative bargain for buyers.

But more importantly, the front-month price is also trading at levels far below contracts for delivery farther in the future, meaning companies can make money simply by holding the oil in storage.

For example, front-month oil futures are running about $7 a barrel below oil futures for delivery in May, and some $35 a barrel below oil futures for delivery in five years.

Dealers said the market structure, called a contango, is due partly to expectations that U.S. President-elect Barack Obama's plans to shore up the economy will help brake the freefall in fuel demand.

The exceptional circumstances of a steep slump in oil prices and an unusually high contango market structure have reversed the normal year-end run down in commercial crude inventories related to LIFO, or "last in, first out," tax considerations.

Twenty Month Inventories

Refiners are eyeing all space available to ramp up their crude storage, including ships, sources said. Brokers estimate about 10 VLCCs, or very large crude carriers, are holding about 20 million barrels offshore in the U.S. Gulf.

"We also expect inventories to continue to build as the entire energy complex remains in a strong contango resulting in very favorable economics to buy and store just about any of the major energy commodities," said Dominick Chirichella, of Energy Market Analysis.

U.S. crude oil stocks have climbed around 30 million barrels, or more than 10 percent, since September, putting them near the top of the five-year range, according to U.S. government data. (For an interactive graphic, click here:here )

Meanwhile, stocks at Cushing, Oklahoma, the delivery point for NYMEX crude futures, hit an 18-month high of 22.9 million barrels in late November, according to the data.

"Over the last two-and-a-half months the contango in the NYMEX forward curve has continued to grow," said Stephen Schork, editor of the Schork Report. "Given that tankage will likely cost you anywhere from 70 to 75 cents a barrel, that is enough of a discount to carry inventory for the next twenty months," said Schork.

The buying spree could be cut short, however, if OPEC cuts output dramatically enough to trigger a supply shock, raising front-month prices relative to back-month prices.

OPEC has already agreed to cut some 2 million barrels per day from the market and members meeting December 17 in Algeria are leaning toward deeper cuts to staunch the market freefall.

"To wit, there are a lot of barrels on the market, we thus expect OPEC to act accordingly when the group meets next week in Oran, Algeria," said Schork.

Saudi Arabia, the world's largest oil producer, has already told Asian refiners it will cut January supplies by 10 percent from normal contracted volumes, and also told some European refiners of cuts.

Editing by Christian Wiessner

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