Friday, December 5, 2014

Markets - Is floating storage feasible?

Floating storage is not economically feasible based on the current contangos in Brent and West Texas Intermediate (WTI), a leading US consultancy said.
However, it may occur if one-year VLCC timecharter rates remain at current levels and Brent strengthens, which could happen as a result of perceived future demand growth, or supply constraints.
But, it is unlikely that the WTI contango will support floating storage, due to the isolationist nature of the US crude oil supply market, McQuilling Services said in a report released this week.

McQuilling took a look at the situation today following its last note published in September, when both crude oil benchmarks stood at much higher levels.

Following the collapse of the global financial system in 2008, a super-contango materialised on both the Brent and WTI forward curves. Bullish sentiment developed as the price bottom was established and the contango steepened. Both onshore and offshore storage plays were profitable during 2009, as the depth of the curve left plenty of profit potential.

During September, 2014, the Brent curve had moved into contango producing a flurry of speculation about the formation’s bullish effect, which led crude oil stakeholders to scrutinise the market for storage opportunities. However, since then, both Brent and WTI have been in steep decline.

The September 2014 contango did not provide enough future premiums to hedge the exposure at a profit, unlike in 2009 when the forward curve was steep enough to cover associated storage and carrying costs. Another consideration was that the September 2014 contango formed towards the top of a multi-year price range amid a period of oversupply and decreasing demand.

As global crude oil production outpaced demand, crude oil surpluses amassed and Brent and WTI prices fell. An unhedged storage play implemented in September would have yielded extremely poor results.

Both Brent and WTI have continued to weaken since September, as a result of the global oversupply of crude oil. On 27th November, 2014, OPEC decided to maintain its production ceiling for 2015 forcing Brent and WTI to the lowest price levels since July 2009.

Currently, neither Brent nor WTI are showing enough of a future premium to front month prices to justify implementing a floating storage play, assuming the average blended cost per VLCC on a one-year timecharter at $31,500 per day. The cost of carry per barrel per month utilising a one-year timecharter amounts to $0.58 per barrel/month.

Even though Brent provides a steeper premium to the front month than WTI, the economics still do not justify floating storage plays. At $0.58 per barrel/month, floating storage is in profit in April and August, 2015. However, there is likely not enough profit available to get into the arbitrage.

WTI has been trading at a sharp discount to Brent this year because of increased North American production and decreasing foreign imports. Less US reliance on foreign crudes has created a price polarity between the two benchmarks.

McQuilling has monitored the Brent/WTI spread since the beginning of the price decline in July and has identified a strong correlation between falling prices and a tightening Brent/WTI benchmark spread. From a high near $11 in July, the spread traded down to $3.11 on 11th November, 2014. Regression analysis on the price data yielded an 80% correlation between falling prices and a tightening spread.

It is likely that Brent forward premiums will increase at a faster rate than WTI futures, which may yield the potential for storage plays.

The relative price level at which these current contangos exist does fit the criteria for considering storage plays, McQuilling said.

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