NEW YORK (Reuters) - U.S. oil traders braced for an unprecedented test of the nation’s most critical storage tanks three months ago, as global markets were awash in surplus crude and the tanks were filling up at a record pace. The moment never arrived.
Record demand from refiners reversed the flow of oil into Cushing, Oklahoma, just 9 million barrels before the oil tanks there reached their estimated limits.
Now, that test may be approaching again this autumn as inventories are rising anew, far earlier than expected, and refinery maintenance is around the corner.
Cushing stands just 15 million barrels shy of its working limit, so physical traders are asking one fundamental question: has the market priced in the pain ahead considering how close the hub is to maximum capacity?
“We’re two-thirds of the way through July now and the idea that we were supposed to draw substantially didn’t happen,” said Eric Lee, an oil market strategist at Citigroup. “Looking at OPEC, shale production, imports... now that to me spells trouble.”
Reaching tank limits would mean unprecedented shock to the oil markets, as an overflow of crude would set off the next sell off in benchmark prices. U.S. crude has already lost 50 percent of its value in a year-long rout. It has knocked $2.76 per barrel off the price in the last week alone.
When traders were alarmed earlier this year, the front to second-month WTI calendar spread widened to as much as $2.49 a barrel. On Monday, that spread was only 46 cents.
Traders have also rushed large sums of money into bearish options, betting that the spread between calendar trading months could blow out on quickly rising tanks later this week.
Still, others argue that Cushing’s avoiding capacity earlier this year is a testament to how flexible the infrastructure is nationwide, with arbitrage opportunities in the cash market capable of rebalancing oil volumes quickly around the country.
They add the build in Cushing stocks over the past four weeks will not last. The physical WTI Aug/Sept cash “roll”, a measure of how healthy Cushing balances look, traded from negative 30 cents up to negative 15 cents a barrel during cash trading last week, indicating strong draws in August.
Those who expect a short-lived build add that strong prices for Permian crude in the U.S. Gulf Coast and the start up of new pipelines will divert more crude from Cushing in the near term.
But bears are quick to say that August is simply a momentary reprieve before more pain. Despite refineries running the most crude ever on record, it has hardly made a dent to Cushing. There is just too much production, they say, and lagging government data has continued to record upwards revisions.
Higher production from surprisingly resilient U.S. shale fields is keeping volumes at Cushing higher, while refineries are winding down ahead of autumn maintenance season, making it difficult to keep up.
The U.S. Energy Information Administration revised upward its 2015 quarterly forecasts in July from its January estimates. Meanwhile, April production hit 9.7 million barrels, the highest monthly since 1970 when production pushed past 10 million barrels.
The draw down at Cushing is lower than recent years, which is crucial to ready tanks for excess seasonal volumes.
According to data from the EIA, Cushing stocks have whittled on average over 8 percent between May and August, the peak of summer driving season, in the last five years. From April through the third week of July this year, though, stocks at the NYMEX delivery point have only fallen by 6 percent.
Cushing stocks are also 39 million barrels higher than last year, the highest year over year on record.
Even more, traders say they are not able to find affordable monthly tank leases anymore to take advantage of the contango, meaning that they will not be able to buy and hold excess crude.
Traders with a high-risk appetite can buy calendar-spread options, a typically illiquid financial contract based on the price of two calendar months.
Trading last week poured into large volumes of bearish puts, including over 6,000 lots for the fourth quarter at a strike price of negative $1.50 a barrel, the CME Group’s daily price bulletin showed, reflecting an increasingly bearish sentiment.
Traders even traded 100 lots of Nov/Dec puts with a negative $3.50 strike, and another 200 lots at a negative $2.00 strike.
On Monday, Nov/Dec spread traded at negative 70 cents.
Market structure is reflecting some of the bearish pressure. The front to second month calendar spread was priced at a discount to the second to third, third to fourth and fourth to fifth month until late June, when it flipped to a premium, indicating the worst may be yet to come.
“People are starting to focus on structure,” said John Saucer, vice president of research and analysis at Mobius Risk Group. “I think Cushing hasn’t bent (on the curve) in the way it should. That phenomenon will likely play out in the next few months.”
Reporting by Catherine Ngai; Editing by Jessica Resnick-Ault and Lisa Shumaker