Column: Rally in U.S. oil futures fuelled by Cushing stock draws: Kemp

Crude oil storage tanks are seen in an aerial photograph at the Cushing oil hub in Cushing, Oklahoma, U.S. April 21, 2020. REUTERS/Drone Base

LONDON, Oct 28 (Reuters) - Rapidly dwindling crude inventories around the NYMEX delivery point at Cushing have helped push front-month futures prices to the highest level in seven years and drive the market into an exceptionally steep backwardation.

But the drain in stocks at Cushing may be overstating the shortage in the rest of the country, where inventories have been rising in recent weeks and appear comfortable - in which case, it is likely to reverse in the next few weeks.

Cushing crude stocks fell by 8 million barrels (23%) in the three weeks between Oct. 1 and Oct. 22, according to data from the U.S. Energy Information Administration (“Weekly petroleum status report”, EIA, Oct. 27).

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In barrels, the drawdown was the 9th fastest of any of the 913 overlapping three-week periods since 2004. In percentage terms, it was the 4th fastest and the most rapid since 2007.

Rapid inventory depletion helped propel the front-month WTI futures contract to an intra-day high of $85 per barrel on Oct. 25, its highest since October 2014 (https://tmsnrt.rs/3mlsOEw).

WTI’s six-month calendar spread surged into a backwardation of more than $7 per barrel - in the 99th percentile for all trading days since 1990 - up from just $2 at the end of August, in the 78th percentile.

By all indicators, physical availability of crude around Cushing has become extremely tight, which has spilled over into futures prices.

But across the rest of the United States, crude inventories rose by 15 million barrels (1.4%) over the same three-week period.

Inventories in the rest of the Midwest away from Cushing were essentially flat while stocks along the Gulf Coast rose by 20 million barrels.

Stocks at Cushing are 46% below the pre-pandemic five-year seasonal average for 2015-2019, but in the rest of the Midwest are only 7% below the average and on the Gulf Coast 9% above average.

DELIVERY POINT

Physical availability of crude and associated prices at Cushing are not always representative of the petroleum supply situation in the rest of the United States or internationally.

In the last two decades, inventories at Cushing have repeatedly but temporarily disconnected from broader trends in domestic and global oil markets.

Cushing lies at the heart of the pipeline network, linked to the West Texas oilfields as well as refining centres in the Midwest and on the Gulf Coast, which is why it was originally selected as the NYMEX delivery point.

Cushing also has a large volume of non-refinery storage, though most of the tank farm space is leased by a small number of companies.

But as a result of logistics bottlenecks, it has sometimes been difficult to make or take delivery at short notice, causing distortions in nearby futures prices.

In some instances, logistics problems have been made worse when traders have made large deliveries into or out of the tank farms.

The most recent and spectacular dislocation occurred in April 2020, when Cushing stocks surged suddenly during the first wave of the pandemic and lockdowns.

As inventories climbed at the fastest rate on record, storage threatened to run out, which would have made further deliveries and receipts impossible, and caused front-month futures prices to become negative briefly.

The opposite is now occurring, with inventories rapidly depleting, exerting intense upward pressure on prices, especially for the nearest-to-deliver futures contracts, and pushing the market into deep backwardation.

In most cases, dislocations in the availability and price of crude at Cushing have been reversed relatively rapidly, usually in a few weeks or months, especially when there is plenty of crude oil or storage space elsewhere.

In this instance, abnormally low stocks at Cushing compared with the rest of the country and the strong backwardation are likely to attract inflows over the next few weeks.

If that happens, it will eventually take some of the heat out of nearby futures prices and cause the backwardation to soften at little.

Related columns:

- OPEC+ comfortable with rising price trend (Reuters, Oct. 26) read more

- Global oil market is tight, despite what producers say (Reuters, Oct. 15) read more

- Hurricane Ida's lingering effects tighten global oil market (Reuters, Sept. 30) read more

- U.S. petroleum inventories are becoming tight (Reuters, July 9)

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Editing by Jan Harvey

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John Kemp is a senior market analyst specializing in oil and energy systems. Before joining Reuters in 2008, he was a trading analyst at Sempra Commodities, now part of JPMorgan, and an economic analyst at Oxford Analytica. His interests include all aspects of energy technology, history, diplomacy, derivative markets, risk management, policy and transitions.