Five months ago, Goldman Sachs forecasted that crude prices could drop to $20 per barrel if the Organization of the Petroleum Exporting Countries (OPEC) did not take action to limit global crude production. At the time of that prediction, crude was running just below $50 per barrel.
Many scoffed at the prediction as being overly pessimistic. There was speculation that increased demand was going to soak up excess crude supplies and that crude prices would be on the rebound by the end of 2015.
At that time, many were willing to bet that the Aug. 24, 2015, close of $38.24 marked the floor for crude prices. Prices had rallied in late August following that low, and the seemingly smart play was to buy into the rally. Traders did just that through September and October.
So far, Goldman Sachs’ prediction has been more right than wrong. More and more crude traders are buying $25 put options for Brent crude. This put option would not benefit its holder unless crude prices fell below $25 per barrel. The fact that traders are buying options at that price shows the level of pessimism they have for the immediate future of crude prices. Crude fundamentals around the globe consistently show high inventory levels and less improvement in demand than expected.
Perhaps the most critical location in the United States for crude inventory is Cushing, Okla. Cushing is a massive storage facility and it is the settlement location for West Texas Intermediate (WTI) crude, the U.S. benchmark crude. Inventory in Cushing can have a disproportionate impact on crude prices.
The first data point for 2016 showed Cushing crude inventory at a record high of 63.910 million barrels. Inventory was only at 32.098 million barrels during the same week last year, and the five-year average for the first week of the year has been 37.877 million barrels.
Historically, inventory in Cushing has increased during the first four months of the year. Some are fearful that, over that period, storage capacity in Cushing could reach its max, which would almost certainly be a bearish development. Because of this, more traders are willing to bet that crude will fall below $25 per barrel.
Let’s consider how likely it is that Cushing will reach its storage limits. According to the Energy Information Administration (EIA), there are 472.636 million barrels of crude storage capacity in the United States, excluding the Strategic Petroleum Reserve. At 87.685 million barrels, Cushing holds just over 18.5 percent of that capacity.
However, actual working storage at Cushing is considered far less. EIA reports that as of Sept. 30, 2015, actual working storage capacity at Cushing is 73.014 million barrels. If that number were accurate, it would mean current inventory is within 10 million barrels of the working storage capacity.
Over the last five years, from now until Cushing inventory peaks in mid-April, the average increase has been 6.01 million barrels. An average build in inventory would place Cushing inventory at about 3 million barrels below working capacity.
However, inventories in Cushing over the last quarter of 2015 increased 9.921 million barrels, or 3.311 million barrels over the five-year average build during the final quarter of the year. If that rate of inventory increase continues through mid-April, one could conclude that it is possible for Cushing inventory to reach its working capacity.
This possibility certainly makes the recent lifting of the U.S. crude export ban more important for producers than many realize. While the export economics might not look too good for crude right now, they could improve dramatically if Cushing begins to approach its capacity.
Also, EIA is expecting U.S. crude production to average 570,000 barrels per day less this year than it did last year. That could slow down the rate at which barrels arrive in Cushing for storage.
All the potential drama for Cushing crude inventory will take place when most propane retailers are trying to make decisions about next winter’s supply. The buying environment for propane is very good, and we won’t let the potential developments in Cushing drive us away from locking down prices for next winter. However, we might let it temper the enthusiasm we have in locking down that supply.
It will likely be prudent to leg into our supply position over the first six months of the year rather than get overly aggressive early. Changes in propane fundamentals, such as a sharp reduction in inventory during the rest of this winter, would trump our worries about crude. However, we need to be aware that the bearish conditions for crude are far from resolved. Unless there is a dramatic change in propane fundamentals, a slower, more deliberate and prolonged period of supply accumulation for next winter might be the safest approach.
In other words, we like the odds that an average price of supply locked down ratably over the next six months has less risk than going all in with one or two purchases somewhere during that period, especially early in that period. It is difficult to believe, but there is still some downside risk to crude, which would influence propane prices.
Again, we want to reiterate that a change in propane fundamentals, such as sharp reductions in inventory due to increased propane exports or a drop in propane production, would make us more aggressive early during that six-month accumulation period.
For more Cost Management Solutions analysis of the energy market that helps propane retailers manage their supply sources and make informed purchasing decisions, visit www.lpgasmagazine.com/propane-price-insider/archives/.