By Alex Kimani
It’s more than a month since the oil markets sunk to a nadir in the mother-of-all market routs. Since then, oil prices have staged an impressive recovery, especially from WTI’s negative trade zone visited on April 20. There’s real optimism in the air with the formidable headwinds of a massive supply glut and limited storage nearly in the back mirror while the markets even recently dodged a big bullet.
Yet, resting uncomfortably in the back of trading minds is this: Oil storage remains painfully squeezed, raising the specter of another April-esque selloff.
Ships full of crude are still anchored in the high seas off the coasts of the U.S., China, Europe, and elsewhere with onshore storage sold out and refinery run rates across the globe still a long way off their usual clips.
But this time, there’s a different method to the ongoing madness.
High Stakes for Oil Traders
The obvious reason for the ongoing shortage of space to store oil is that global oil consumption remains depressed despite economies gradually emerging from lockdown.
A new report by the International Energy Agency (IEA) has projected that global oil demand in May is set to decline ~25 mb/d compared to a year ago with June demand clocking in at ~15 mb/d below last year’s corresponding period. In fact, the organization expects December demand to still fall short by ~3 mb/d.
However, looking at refinery margins tells a different story.
Gasoline crack spreads have improved quite dramatically over the past eight weeks with the NYMEX front-month RBOB vs. front-month NYMEX crack clocking in at $11.92/barrel on Monday. Crack spreads represent the economics of refining a barrel of crude oil into its various constituent products. The metric is viewed as a useful proxy for gauging real-time demand for crude and various distillates, and right now, it’s saying that oil demand might not be as poor as previously feared.
The refinery trajectory looks promising and suggests that there might be something else to blame for the gridlock.
You can chalk up the unfolding situation to smart traders who have been eyeing the oil contango profits.
Bloomberg has reported that some of the oil supertankers off the South African coast have been chartered by leading oil-trading companies, including Vitol Group, Mercuria Energy Group Ltd. and Glencore Plc, through its ST Shipping subsidiary. The traders are ostensibly looking to either purchase the cheap crude and sell the more expensive forward contracts to lock in profits or simply hold the oil and wait for crude prices to rise before selling.
By placing large bets on physical crude, oil traders have been directly contributing to the dearth of oil storage while also exacerbating the volatility in the markets. Bloomberg has estimated that the flotilla of tankers is carrying enough oil to meet about 20% of the world’s daily oil demand, more than enough to keep a lid on prices while also keeping prices volatile.
Thriving on Chaos
That said, it’s this kind of situation that oil traders actually thrive on.
Bloomberg reported in January that dozens of large oil traders made billions of dollars in profits in 2019 thanks in large part to choppy markets. Independent traders such as Vitol Group, Mercuria, and Trafigura all posted record profits with some like Mercuria declaring it their best trading year ever.
But it’s not just independent traders that made a killing.
In-house trading units of oil giants such as BP Plc, Royal Dutch Shell Plc, and Total Plc made even bigger profits considering that a company like Shell trades the equivalent of 13 million barrels of oil per day, nearly double the 7.5Mb/d by Vitol.
Much of last year’s volatility was triggered by a stream of supply disruptions.
Oil markets have been a lot more volatile this year, which could set the stage for another bumper year for oil traders as we predicted here.
Unfortunately, it could also mean that the smooth recovery in oil prices that many investors have been hoping for just won’t happen.