What Really Controls Oil Prices?

Posted in The Petroleum Truth Report on February 29, 2016
Cushing-oklahoma-tank-farm

Source: http://www.castagra.com/

World oil prices are controlled by the amount of crude oil stored at Cushing, Oklahoma. That’s because Cushing is the pricing point for WTI (West Texas Intermediate) oil prices, the most-traded oil futures contract in the world.

Cushing Storage Rules World Oil Prices

WTI (and Brent) oil prices have good negative correlation with the volume of crude oil stored at Cushing. Comparative inventory, the present volume of oil compared with the 5-year average, and oil-price volatility, the rate at which the price of oil moves up and down, are shown in Figure 1.

Oil Price, Price Volatility and Cushing Stocks_FEB 2016

Figure 1. Cushing comparative inventory, oil price and oil-price volatility. Source: EIA & Labyrinth Consulting Services, Inc. (click image to enlarge)

From the beginning of 2014 until the end of July, comparative inventory fell and world oil prices were high averaging more than $100 per barrel. From August to the time of the November 28 OPEC meeting, Cushing inventories rose and oil fell below $70. OPEC’s decision not to cut production caused a spike in volatility and prices dropped to $46 per barrel by the end of January 2015.

Prices rose in February based on hope that falling rig counts would bring declining U.S. production. Rising Cushing inventories brought markets back to reality and they fell again in March (Figures 1 and 2).

WTI Oil-Price Volatility & World Event Timeline 2014-2016_FEB 2016

Figure 2. Cushing comparative inventory, WTI price and oil-price volatility. Source: EIA & Labryinth Consulting Services, Inc. (click image to enlarge)

Cushing storage fell from mid-April to mid-June 2015 and oil prices rallied to $60 per barrel. Concerns about China’s economic growth and the lifting of sanctions on Iran added to flattening Cushing inventories and oil fell to near $38 per barrel by mid-August.

When inventories fell again in late August, prices increased to almost $50 per barrel and then plateaued until the end of October. Storage had flattened but the outlook for Chinese growth had improved as the People’s Bank of China announced stimulus measures.

From the beginning of November to the end of 2015, comparative inventories increased again and oil prices plunged below $30 per barrel with the near-collapse of China’s stock markets.

Flattening comparative inventories in early 2016 and rumors of an OPEC production cut and then, a partial OPEC production freeze moved oil prices back above $30 per barrel where they have remained through February.

Expectation and reality both influence oil prices but Figures 1 and 2 show that the reality of Cushing comparative inventory change is the dominant factor. World economic and political events have the power to affect oil prices but without support from Cushing storage levels, these changes are relatively short-lived.

What Must Happen For Oil Prices to Increase

Cushing, Oklahoma is the largest oil-storage tank farm in the world. It has 73 million barrels of working capacity, about 13% of total U.S. storage. Several important oil pipelines converge there as oil moves from production sites to refineries on the Gulf Coast (Figure 3).

IEA Cushing Terminal Map

Figure 3. Cushing Oklahoma pipeline terminal map. Source: International Energy Agency. (click image to enlarge)

Cushing is the delivery and pricing point for West Texas Intermediate crude oil futures contracts. More than 3 billion barrels of WTI oil futures contracts are traded weekly. For the week ending February 26, 2016, the volume of WTI trades (3.1 million contracts) was nearly three times the volume of Brent ICE trades (1.2 million contracts). Each contract is for 1000 barrels of oil.

Few of these contracts result in delivery of physical oil. Instead, most contracts are sold forward to take advantage of the higher contango prices on later-dated contracts.

Limited refining capacity for the light, sweet crude oil from tight oil fields has resulted in the stock-piling of oil at Cushing. Since oil prices collapsed in 2014, it makes more sense to pay storage fees than to sell oil at a loss.

Storage volumes at Cushing have increased since the crude oil export ban was lifted in December. Since then, additions at Cushing have averaged more than 500,000 barrels per week and total U.S. storage has increased about 1.5 million barrels per week. Current storage capacity at Cushing is 89% full. As long as Cushing and Gulf Coast storage remain above 80% of capacity, oil prices will be low.

For oil prices to increase, Cushing inventories must fall. That means that both U.S. tight oil production, chiefly from the Bakken play, and Canadian light oil production brought by pipeline to Cushing must decline.

Bakken production was consistent in 2015 at about 1.2 million barrels per day. Canadian oil imports to the U.S. decreased from April through July 2015 and may have contributed to the fall in Cushing inventories that lead to a $15 per barrel increase in WTI prices. At the same time, decreased production from the Eagle Ford and Permian basin tight oil plays would free up storage in the Gulf Coast that might allow more oil to flow out of Cushing.

Although world events are important, Cushing comparative inventories dominate world oil prices. This does not mean that decreased production and inventories elsewhere in the world would not affect prices. It acknowledges, however, that increased North American unconventional oil production created the global over-supply that caused oil prices to collapse.

Given the history of the past 2 years, oil prices are unlikely to increase until U.S. and Canadian oil production decline enough to reduce Cushing storage. Recent flat comparative inventories suggest that near-term prices could go either way depending on flows in and out of Cushing.

A relatively small decrease of 3 to 5 million barrels in Cushing stocks could result in a $10 to $15 increase in WTI prices, similar to what happened from April through June of 2015. Conversely, an increase in stocks of a few million barrels may push oil prices into the low $20 range. It mostly depends on U.S. and Canadian unconventional oil production.


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12 comments on this entry


  1. Art,

    From what EIA reported we had another build of 10.1 mm bbls Wednesday (3/2/16). Cushing increased by 1.2 mm bbls to reach an all time record as per EIA. Cushing was at 89% full as per your article, so I was assuming that WTI crude prices would drop to the low 20’s, but that did not happen. I believe your comment “Normal Is Over” is absolutely correct. Regards.

    PS – In your article ‘Natural Gas Price Increase Inevitable in 2016’. If/when natural gas prices increase I assume this would help Exxons and Chesapeakes bottom line even in a low crude price environment since they are the top 2 gas producers in the US. Do you agree with that? If it does help Exxon, maybe Rex Tillerson will feel better about the XTO purchase. Regards, and thanks for your reports.


  2. Daniel,

    Crude oil prices are increasing because traders are testing the sentiment about a possible OPEC freeze/cut and inventories are lower than they were at the beginning of the year. Also short covering at the end of February.

    All the best,

    Art


  3. Art, it would appear that oil exports from the US would then drive up the price of oil. Maybe the US should consider selling oil to the world market at a further subsidized rate to get storage at Cushing down and thus increase prices (quickly able to recover costs to get that oil out). With the amount of investor manipulation that is already occurring why not follow through and generate one’s own price by pushing out the oil to foreign markets so one can set the price of oil in the world. If it is so that Cushing storage numbers sets world oil prices, it would seem possible to manipulate prices by manipulating storage. Of course, it could be the other way round, and storage goes up when prices are down.


  4. […] correlation between U.S. crude oil stocks and world oil prices is strong. Tank farms at Cushing, Oklahoma (PADD […]


  5. […] The correlation between U.S. crude oil stocks and world oil prices is strong. Tank farms at Cushing, Oklahoma (PADD 2) and storage facilities in the Gulf Coast region (PADD 3) account for almost 70 percent of total U.S. storage and are critical in WTI price formation. When storage exceeds about 80 percent of capacity, oil prices generally fall hard. Current Cushing storage is at 91 percent of capacity, the Gulf Coast is at 87 percent and combined, they are at a whopping 88 percent of capacity (Figure 3). […]


  6. Do you have any data for storage levels in countries outside of the USA? I imagine that will have a large effect on the price too.


  7. rgz,

    Both EIA and IEA publish data on OECD storage of liquids. About half is U.S. and total OECD tracks U.S. I do not know of any credible public source for the world. Matt Mushalik has published an excellent summary of OECD inventories.

    As I said in my post, the WTI casino pretty much sets world price and Cushing inventory is the best measure.

    All the best,

    Art


  8. […] correlation between U.S. crude oil stocks and world oil prices is strong. Tank farms at Cushing, Oklahoma (PADD […]


  9. […] correlation between U.S. crude oil stocks and world oil prices is strong. Tank farms at Cushing, Oklahoma (PADD […]


  10. Art,
    Thanks for your very interesting blog.
    In this particular post, I was surprised by the number of contracts of WTI and Brent that traded in the week ending on Feb 26: it seems that for WTI, aggregated volume is around 6.2 million contracts, and for Brent, around 5.1 million.
    You have to take into account contracts traded down the curve, and on the main exchanges (CME/Nymex and ICE).
    Moreover, if I agree with you that WTI price is largely influenced by inventory levels in Cushing, I am more skeptical regarding the world benchmark, which is the Brent. I think that Cushing levels might reflect global inventory levels, which will partly drive crude prices. In this case, correlation is not causality, even if it seems to work quite well.
    Brent and WTI have somehow decorrelated one to another and the recent lift of the export ban did not change that fact yet.
    The global glut is affecting Cushing levels as well, so both WTI and Brent are tanking.
    My sentiment at least 😉


  11. Thierry,

    Thanks for the information and for your comments. I did a simple comparison of prompt-month volumes traded on ICE and CME. For May, I find 118,652 for Brent ICE and 247,053 for CME WTI (plus 8210 for WTI ICE and 7,205 for CME Brent) as the two major exchanges, so roughly twice as many WTI contracts as Brent. That is a lower ratio than the February 4 data that I cited in my post but it still shows that there is much more volume on WTI than Brent which was my point.

    Perhaps I should not have said that Cushing inventories control world oil prices but, instead, correlate with world prices.

    All the best,

    Art


  12. […] The correlation between U.S. crude oil stocks and world oil prices is strong. Tank farms at Cushing, Oklahoma (PADD 2) and storage facilities in the Gulf Coast region (PADD 3) account for almost 70 percent of total U.S. storage and are critical in WTI price formation. When storage exceeds about 80 percent of capacity, oil prices generally fall hard. Current Cushing storage is at 91 percent of capacity, the Gulf Coast is at 87 percent and combined, they are at a whopping 88 percent of capacity (Figure 3). […]