- Blog Post
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In recent days, the Donald J. Trump administration appears to have been sending mixed messages about oil. Typically, low oil prices can be a stimulus to the U.S. economy, but that is in situations where American consumers can benefit from reducing the burden of the costs of their gasoline use. In what is increasingly moving towards a national lock down to stem the severity of COVID-19, falling gasoline prices pack little punch to the many Americans, who are sitting in their homes out of work and to the rest of working Americans whose pocketbook is focused not on car travel, but on necessary home goods: food, medicine, cleaning supplies, and home maintenance. To keep the logistics of vital goods moving, an army of brave Americans – truck drivers, postal workers, warehouse workers, cargo pilots, and others, are serving our nation. The U.S. oil industry needs to make sure that these valiant workers have the fuel they need. In the case of goods movement, that is diesel fuel for trucks and natural gas for local delivery vehicles.
Right now, there are roughly 140 million barrels of diesel fuel accumulating in storage tanks inside the United States. That is sufficient to support the vial goods industries of the United States for a few months. But storage for other petroleum products such as jet fuel and crude oil is filling rapidly and can become a larger logistics problem, even inside the United States, if it is not managed eventually. Total U.S. on-land inventories of jet fuel are at about 40 million barrels, with only about 10 million barrels left in tankage. As a result, companies are starting to investigate storing jet fuel on ships until demand picks up again. Globally, jet fuel tanks are also closing in on physical limitations, but air travel and refiner flexibility in some locations will be higher than in others. This burgeoning problem of oil storage is yet another reason why the Trump administration is correctly focused on diplomacy to end the oil price war. Time is of the essence since running out of oil storage globally is in no one’s national interest.
The Trump administration has tried to focus G-20 members like Saudi Arabia and Russia on the problem for sovereign credits markets if low oil prices persist. Now, policy makers have to concern themselves with a second order problem. Lack of access to oil storage is going to force shut-in a portion of oil operations around the globe, both refineries and wellhead crude oil production, in some cases potentially with dire consequences. Saudi Arabia has cleverly positioned itself to maximize its access to oil storage, as opposed to Russia which is more disadvantaged in the flexibility of storage in its oil operations. China still has 200 million barrels plus of strategic storage it can offer to desperate oil exporters. The United States has opted to reserve the remaining 77 million barrels of space in its strategic petroleum reserve for U.S. domestic oil producers.
Late last week, Citi analysts calculated an immediate 10 million b/d reduction in global oil production is needed to prevent global oil inventories from reaching maximum capacity. Over the weekend, Saudi Arabia and Russia let it be known that they are making progress towards a deal that would accomplish this. Early proposals included a 2 million b/d cut from both Moscow and Riyadh with another 4 million b/d from other producers. A group including the Organization of Petroleum Exporting Countries (OPEC) was seeking a 2 million b/d reduction from the United States. The Trump administration is pushing for at least a 10 million b/d reduction from the OPEC plus group, which includes Russia, and has suggested that Saudi Arabia contribute more than 2 million b/d to reduction efforts. The United States could need time to work out how it would participate in any Plaza Accord style oil stability program that would come under the auspices of the G-20. Canada has already stated it is open to participation. The Trump administration has already committed to taking U.S. oil off the market by leasing storage in the strategic petroleum reserve and possibly elsewhere. Legal, political, and other technical hurdles to a federal intervention in ongoing private oil company decision making means any additional cutbacks would take time to organize. There is virtually no federally-owned oil production in the United States since the U.S. Naval Petroleum Reserve was sold in the mid-1990s.
If OPEC does not act, lack of storage will force shut-in of crude oil production in any case, since oil demand will be unlikely to recover substantially in the coming weeks. The distribution of remaining storage for crude oil is not equally distributed around the world. According to Cornerstone Macro, most of the available large-scale storage capacity for crude oil is located in just five places: the United States, China, Europe, Japan, and South Korea. The United States and Canada still have a combined, 380 million barrels of tanks available for oil storage.
Some oil producers have already announced production shut-in based on low oil prices, including Brazil (200,000 b/d), Chad, and Canadian oil sands producer Suncor, which has already shuttered a portion of its oil sand mining operations at Fort Hills. Russia’s lower natural gas sales to a struggling European economy almost certainly means a drop in its high condensate production, which was the focus of concern at the December OPEC meeting. Limitation of storage along some of Russia’s export routes are also likely to curtail oil production soon if it cannot gain access to storage from other places. Certain Texas oil pipeline operators are already warning smaller U.S. fracking firms that they may have to turn away their oil by the end of May for companies that do not have existing long-range contracts.
All of the above developments mean that, soon, the determinant of whose production gets curtailed could become a function of access to storage, not oil prices or the cost of production, if a market stability deal fails to materialize. That raises some tricky questions because not all oil fields are geologically alike, and some are easier to close and restore later than others. The nature of how naturally-derived or manufactured pressure drives the oil out of the ground is key to whether turning off an oil field means permanent damage that could result in a loss of productive reserves or not. Saudi Arabia has decades of experience in mothballing and restoring oil field capacity, though occasionally with some difficulties. U.S. shale is uniquely resilient as the pressure for production comes from the artificial means of hydraulic fracturing which can be turned off and on easily. It is impossible to destroy U.S. shale reserves since there is no natural pressure that has to carefully be maintained. Any time the capital, equipment, and workers are there to produce it, it can be restored quickly in a matter of days or months.
The ongoing crisis in Venezuela has already resulted in some of its smaller oil fields being damaged in ways that the remaining reserves are likely lost forever. This type of permanent damage and loss of reserves could also happen in other places. Several of Iran’s largest oil fields require natural gas injection to produce oil and would be at risk if it cannot maintain a certain minimum production level across the country. Even some deep-water offshore oil platforms could be tricky to restart if they had to be fully shuttered for a long period of time. The technical difficulties of halting offshore production means suggestions that the Trump administration use its authority to close offshore oil production on federal lands could essentially be proposing the U.S. government destroy some percentage of that resource for all time. Finding a legal way to mandate limited, prorated cutbacks from multiple producers, while extremely difficult, could be the best manner for the United States to participate in a G-20 oil stability effort with an eye to sustaining U.S. companies’ ability to restore production capacity at a later date.
The looming shortage of remaining storage means the stakes are high for a major agreement among the world’s largest oil producers to throttle back in order to prevent global storage from filling to excess. It also means that oil production reductions are inevitable, if only because some producers will be thwarted by lack of places to store their oil.
Some U.S. politicians are calling on the United States to impose tariffs on imported oil. Implementation of this suggestion would be ineffective since the shortage of storage means any foreign oil producer who has concerns that shutting-in production would damage their reservoirs, will sell their oil at a loss just to get rid of it. That means they would still dump oil into the U.S. market to get access to buyers and/or buyer’s storage even with tariffs that lowered the profitability of doing so. Some oil is already trading around the world at negative value, that is, at prices where it costs more to produce the oil and ship it, leaving no percentage of funds received for the oil netting back to its seller.
There is disagreement on how long it would take the global oil industry to work off a historic buildup of inventories, were the surplus to reach the 900 million to one billion barrels analysts are calculating in the worst-case scenario. In 2015, when oil prices were cratering, surplus inventories ended the year at 593 million barrels and took two years of concerted producer cutbacks, led by Saudi Arabia, to run down. But that was when the global economy was humming at a 3.5 percent increase per year in Gross Domestic Product (GDP). Presumably, this time around, it could take longer.
Finally, just as some crude oil exporters will have an easier time adjusting to storage problems than others, localized constraints on jet fuel storage could produce varying degrees of operational flexibility for refiners. That could be a serious problem if the pandemic’s negative influence on air travel is long lasting, given the configuration of the refining industry where it is difficult to produce needed diesel fuel for goods movement and industrial use without also amassing a certain amount of unwanted jet fuel that could not be disposed of. That could be the refining sector’s next big headache, once it recovers from the shock of abrupt loss of demand for its products overall.