Crude oil inventories rose 2.15 million to reach 504.1 million barrels last week, according to the Energy Information Administration (EIA), reaching an 86-year high. While key members of OPEC reached an agreement to freeze production, near-record output and the lack of demand growth is likely to keep downward pressure on the troubled commodity. Crude oil prices briefly rallied from their all-time lows, but remain below $35 per barrel.
OPEC Strikes a Deal
Russia, Saudi Arabia, Venezuela and Qatar agreed to freeze crude oil production at January 2016 levels on February 18. Saudi Arabian Oil Minister Ali Al-Naimi hinted that the agreement was the beginning of a bigger deal after U.S. shale producers shut down.
Many U.S. shale producers, such as Apache Corporation (APA) and EOG Resources Inc. (EOG), have significantly higher breakeven and production costs relative to light crude oil production by OPEC members. While these shale producers may have taken market share when prices were high, Saudi Arabia’s move to oversupply the market has dropped prices to levels that may not be economical for these companies.
This doesn’t mean that OPEC members aren’t suffering from low prices. With crude oil at prices that haven’t been seen in decades, countries like Russia are struggling to balance their budgets. Saudi Arabia has ample cash reserves to weather the storm, but many OPEC members can ill-afford to have prices this low for a prolonged period of time. These dynamics have likely prompted the production freeze to stem the drop in prices moving forward.
The absence of significant demand growth has led to rapidly growing inventories that have reached 86-year highs. In fact, oil tanker operators, such as Teekay Tankers Ltd. (TNK) and Frontline Ltd. (FRO), have benefited from the fact that oil must be stored at sea because there’s so little storage space left on land. Cushing, which represents 13% of the U.S.’s oil storage, has a capacity of just 73 million barrels and is now 88% full.
Currently, the major crude oil terminal is running out of space to blend oils to meet WTI specifications. Building more storage tanks would take time and the cost of the enormous tanks would need to be spread throughout the supply chain. The problems are so bad that at least one refiner – Phillips 66 (PSX) – has reportedly dumped crude oil in a distressed sale at deep discounts to NYMEX futures prices.
The Bottom Line
Crude oil inventories have reached an 86-year high and OPEC has only indicated that it may freeze production at near-record levels. With inventories building, a growing number of companies are concerned about the limited amount of land and sea storage for crude oil, with Cushing reaching about 88% of its capacity. The lack of storage could lead to a growing number of fire sales at below-market prices, exacerbating the commodity’s decline. Finally, with demand slowing in the U.S. and refinery maintenance season in force, these problems could become even more severe over the coming months and put downward pressure on prices.