By: Russell Karas and Dan Brusstar – OpenMarkets – The oil market has begun to adjust to the “new normal” in the global economy, with significantly lower fuel demand and decreased oil production.
In the wake of the demand collapse and lower refinery utilization rates, storage levels for crude oil have finally peaked and are starting to decline as the economic recovery from COVID-19 begins.
The Nexus of Oil Fundamentals
At the heart of the global pricing network is the Cushing, Oklahoma crude oil storage hub, which provides the physical delivery mechanism for the CME Group’s NYMEX WTI futures contract.
When the WTI futures contract was first listed in 1983, Cushing was a vibrant hub for cash market trading of crude oil with a network of pipelines, refineries and storage terminals. Today, Cushing is the key nexus of market fundamentals for the global crude oil market, with nearly two dozen pipelines and 20 storage terminals.
According to the U.S. Energy Information Administration (EIA), the working storage capacity in Cushing is 76 million barrels and 91 million barrels of total shell capacity as of September 2019.
The pipeline infrastructure in the Cushing market is expansive, with approximately 3.7 million barrels per day (bpd) of inflow pipeline capacity to Cushing and 3 million bpd of outflow capacity. The inbound pipelines deliver crude oil streams produced in Canada and the U.S. shale oil areas, including the Bakken, Niobrara and Permian producing areas. The outbound pipelines supply crude oil to the main refining centers in the gulf coast and Midwest.
Making and Taking Delivery
It is not just the storage or pipeline capacity that make Cushing the critical hub, but also the interconnectivity between a diverse mix of operators at Cushing. The WTI futures contract allows for delivery through Enterprise or Enbridge facilities in Cushing or at a facility that is connected to either.
The Enterprise terminal provides a key junction point in Cushing, capable of facilitating the transfer of tens of millions of barrels of crude oil every month. A commercial company that elects to take delivery after the termination of the WTI futures contract must have storage and/or pipeline capacity connected to one of the NYMEX delivery locations in Cushing. From there, the firm can elect to take the oil into storage or into a pipeline with connectivity to Midwest refineries and to the Gulf Coast market.
The unprecedented global market fundamentals put intense stress on the oil industry in the first half of 2020. The first indicator of the energy demand destruction from COVID-19 was seen in the New York Harbor RBOB gasoline futures contract (RBOB).
The futures market for RBOB gasoline forecasted demand concerns early when prices traded at a 20-year low of $0.376 on March 23, 2020. RBOB futures is an important indicator for global gasoline as it is the only gasoline futures contract to trade electronically around the clock. Historically, gasoline stocks build in the winter in anticipation of the peak summer driving demand.
As it became apparent that the summer driving season would be significantly curtailed, RBOB futures prices started to decline at a faster pace than crude oil prices. Meanwhile, the price of New York Harbor Ultra Low Sulfur Diesel (ULSD) futures held up relative to RBOB futures in March and April 2020 due to stronger demand from the transportation sector for delivery of essential goods during the pandemic, as reflected in the crack spread chart below.
Oil Storage Drawdown
In response to the sharp drop in gasoline and ULSD prices, the oil refining companies were quick to respond to the price signals, as is evident in the decline in the U.S. refinery utilization rate, which has been stuck below 75% utilization during the peak summer demand period when refinery utilization typically rises over 90%. As the refining sector ramped up production with the re-opening of global economies, the stocks in Cushing have been drawn down significantly since the peak level of 65.4 million barrels in storage on May 1, 2020.
As a result of the surging global oversupply, U.S. crude oil production dropped sharply to 10.5 million bpd in June 2020, down from a peak of 13 million bpd in December 2019. The oversupply coupled with demand collapse on a global scale created price arbitrage that was not favorable for U.S. crude oil exports.
Exports stood at 2.5 million bpd in June, down from the peak of 3.7 million recorded in December 2019. The growth in exports has been transformative for the U.S. crude oil market and has enabled U.S. crude to become the marginal barrel of supply in the global energy market.
WTI futures continue to reflect the fundamentals in the physical crude oil market driven by the unprecedented global impacts of the COVID-19 pandemic, including decreased demand for crude, global oversupply, and high levels of U.S. storage utilization.
These fundamentals intersect at the Cushing hub, and will continue to put intense stress on the oil industry in 2020, as companies respond to price signals and hedge the price risk associated with the “new normal” in the global economy.