Tuesday, April 27, 2010

Oil Contango Soars as Oklahoma Brims With Crude: Energy Markets

By Grant Smith

April 26 (Bloomberg) -- Oil storage costs are soaring to the highest level in four months as tanks in Oklahoma brim with near-record crude inventories.

Oil for delivery in June cost $1.95 a barrel less than the July contract as of April 21, the biggest gap since Dec. 15 on the New York Mercantile Exchange. The premium for further-out delivery, or contango, mirrors the expense of stockpiling. It emerged after inventories jumped 5.8 percent in the week ended April 16 to 34.1 million barrels in Cushing, Oklahoma, where traders make deliveries for futures, government data show.

Inventories are near the record 35.7 million barrels on Jan. 1 as Canadian imports rise refineries shut for maintenance. Supplies are so plentiful that West Texas Intermediate, or WTI, oil costs less than Brent crude in Europe, a lower quality crude. Brent cost more than WTI three times in the past year.

“The problem is you cannot get a lot of crude out of the region, it’s landlocked,” said Lawrence Eagles, head of commodities research at JPMorgan Chase & Co. in New York. “It points to being a very local issue.”

New York crude oil for June delivery rose 22 cents to $85.34 a barrel today, $1.87 less than July. The June contract has traded in a range between $72 and $88 so far this year on the New York Mercantile Exchange.

While the oversupply weighs on the front-month contract for WTI, European benchmark Brent crude traded today near the highest price since Oct. 7, 2008 on London’s ICE Futures Europe exchange. Brent for June delivery increased as much as 0.6 percent to $87.75, and the contango against the July contract was at 72 cents.

About 16 million barrels of unused storage capacity remains around Cushing, Barclays Capital estimates. Should that site reach capacity, producers will need to halt operations because there will be no place to put it. A wider contango means traders can potentially earn more from storing crude, and in turn means tank terminal owners can charge them more for the service.

Gulf Coast Connection

Cushing was used to connect Gulf Coast companies with refiners in Chicago and the Midwest. Declining onshore production means the hub is now also being used to store additional barrels from Alberta, Canada, according to the Energy Department.

In other energy markets, gasoline prices last week reached their highest since October 2008 as refinery maintenance curbs production. Nymex gasoline dropped 0.1 percent to $2.352 a gallon today.

Refineries are running at 85.9 percent of capacity, below the 10-year average of about 88 percent for this time of year, according to the Energy Department.

The refinery restrictions are making existing operations more profitable. The gasoline crack spread, or the difference between fuel and crude oil based on June contracts, widened about 11 cents to $14.08 a barrel today. The June gasoline crack spread is up 26 percent in three months.

Handling Canadian Crude

Refiners in the Midwest have added equipment such as coking units to handle more Canadian crude, which is heavier and cheaper than WTI, according to BNP Paribas SA.

“In periods of weak refining activity, either due to maintenance or weak oil demand, you have greater chance for the more expensive, lighter crudes to back up in storage at Cushing,” said Harry Tchilinguirian, head of commodity derivatives research at BNP Paribas in London.

Total U.S. fuel demand, averaged over four weeks, fell 1.1 percent to 18.9 million barrels, the biggest decline since the week ended Jan. 8, the government reported April 21.

Storing at Sea

Vitol Group of Cos. is among companies that can profit from holding oil when the difference between near-term and future delivery exceeds the cost of storage. A record contango last year coupled with low freight rates made it possible for traders from Royal Dutch Shell Plc to BP Plc to store as many as 150 million barrels on ships anchored at sea.

Ed Morse, the head of commodities research at Credit Suisse Group AG, called WTI a poor indicator of global oil prices last year because of its link to stockpile levels in Oklahoma, rather than world supply and demand. In October, Saudi Arabia’s state oil company dropped WTI as its U.S. pricing benchmark in favor of another grade that is priced at the Gulf Coast.

The contango may unwind as U.S. refineries whittle down inventories at Cushing when they bolster operating rates to make gasoline in time for the peak summer driving season, David Greely, a New York-based commodity analyst at Goldman Sachs Group Inc., said in an April 20 report.

The bank, Wall Street’s biggest commodity broker, said growth in Cushing inventories is “likely temporary,” and recommended buying WTI and selling Brent contracts to profit when the difference between the two narrows.

--With assistance from Alexander Kwiatkowski in London and Mark Shenk in New York. Editors: Mike Anderson, Raj Rajendran.

To contact the reporter on this story: Grant Smith in London at gsmith52@bloomberg.net

To contact the editor responsible for this story: Stephen Voss at sev@bloomberg.net

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