Owners of US oil storage stay cautious despite bumper volumes

by Brian Baskin

Tank operators at the most prominent oil storage hub in the US aren't seeing much additional profit from record demand for their services.
Because the city of Cushing, Oklahoma, acts as a delivery point for the physical barrels that underpin crude oil futures on the New York Mercantile Exchange, it's one of the world's most closely watched terminals. More oil is stored at Cushing than anywhere else in the US outside the Strategic Petroleum Reserve. The city is hooked into pipeline networks stretching from Western Canada to the Gulf Coast's oil ports.

For the first time in years, Cushing's tanks are almost full, and are likely to remain so for months. Yet, for the most part, their owners are taking a pass on what is shaping up to be one of the best markets in a generation for storage. Those companies accumulated tanks over the years under the assumption that they would earn a steady stream of income by signing long-term leases with producers and refiners.
The storage companies are being tempted away from that conservative business model by the emergence of highly profitable trading strategies that exploit differences between the price of crude now and the price of crude in the future. Currently, the beneficiaries are the holders of the long-term leases, mainly large oil companies, refiners and trading firms.

As long-term storage contracts come up for renewal, terminal operators will have a strong incentive to charge higher rates for shorter leases, or even to build new tanks. Far more oil is being produced than refiners in weak economies want to process. The supply overhang invariably ends up in storage.
Low demand also drives down the price of near-term oil futures, creating an incentive to hold crude in storage. Earlier, a record 33 mm barrels were held in tanks at Cushing, brushing up against usable storage.

The vast majority of those tanks are owned by just four companies: BP; Enbridge Energy Partners, a unit of Enbridge; Plains All-American Pipeline; and SemGroup Energy Partners. All but BP have added significantly to their storage capacity in recent years, with an eye on holding Canadian crude on its way to the Gulf Coast. Most tanks are leased out for two years, with the newest contracted for up to 10 years. Chasing profits in the oil market is seen as their customers' concern.
"Quite frankly, the... market is so difficult to follow and predict," said Bruce MacPhail, who oversees contract storage for Enbridge, which owns the most capacity at Cushing. "We're not experts; we're infrastructure players. Our preference is to contract out space to parties who have that expertise." Even so, Enbridge is considering shorter leases for tanks whose long-term contracts end this year, MacPhail said.

Running out of room
As the world's extra oil fills up storage terminals, both the physical and futures markets are contorting to compensate. February futures traded at a $ 8.65 discount to March. The spread between the two front months was 56 cents in mid-November. Light, sweet crude oil for February delivery settled $ 1.11, or 3.1 %, higher at $ 36.51 a barrel on the Nymex.
Until recently, companies with long-term leases at Cushing could arrange to buy and sell oil in the futures market, locking in a price increase far bigger than the cost of their storage fees. The price of oil in the physical market has jumped as cheap storage filled up, erasing that gap. Oil companies and trading firms have even taken to using tankers as "floating storage."

"If you didn't put that (storage) play on in November and December, your opportunity is over with," said Jeffrey Currie, head of commodity research at Goldman Sachs Group. Some of the tank owners at Cushing hold onto storage in order to take advantage of the futures spreads, but rarely set aside more than a quarter of their capacity.
"That's really not their business," said Mark Easterbrook, an analyst with RBC Capital Markets. "They want to sell that capacity out... and get paid no matter what. They're not there to hit home runs when an environment like this arises."

Here to stay
It's becoming more difficult to use physical barrels of oil to profit off of the giant Nymex futures spreads. But analysts see the unusual market structure as an indication that a large amount of unwanted oil is still looking for a home in storage. Inventories are likely to remain high through 2010, the US Energy Information Administration said, as it will take at least until the end of next year for global demand to approach pre-downturn levels.
"Unless we see something change dramatically... I think the market is perfectly comfortable with a $ 7 (spread)," said Darin Newsom, a senior analyst at DTN, a market-information service.

No storage terminal operator has announced plans to build new tanks at Cushing, but the temptation will grow the longer the supply overhang persists, said Easterbrook, the RBC Capital analyst.
"I wouldn't be surprised if this does continue," Easterbrook said. "They're probably outlooking right now to see how to go about building some more storage."

Plains and Enbridge both own land near existing facilities that could house additional storage tanks, Easterbrook said. Enbridge's MacPhail said the company would build tanks only if approached by a potential customer looking to sign a long-term lease.
"If parties came to us... we may consider an expansion, but we are being somewhat cautious because of the sheer volume of storage now in the Cushing market," MacPhail said.