Storage fundamentals turn
A shift in most oil markets from contango to backwardation is changing the outlook for the global storage business
World oil inventories are falling, and the two-year bonanza that handsomely rewarded oil-storage owners may well have run its course.
After building through 2014 and 2016, commercial oil inventories in rich countries ended 2016 unchanged from a year earlier, and have since begun to draw, according to the International Energy Agency (IEA). The agency estimates that the second quarter saw a commercial year-on-year stock withdrawal of 9m barrels, compared with average increases of 45m barrels over the previous five years. This left stocks only 219m barrels over their five-year average, compared with over 330m barrels a year earlier. In its most recent market report, from September, the IEA calculated that OECD commercial stocks were unchanged in August—but, as this month typically sees a build, this again lowered the surplus to the five-year average, to 190m barrels.
Meanwhile, forward pricing curves see the market shifting from contango into backwardation, with the shift most pronounced in refined products. This change is eliminating the longstanding incentive to store oil and is reflected in major traders' reported decisions to reduce their holdings of crude and products in inventory, as well as of physical storage assets. A key exception to the trend is the US, where hurricane damage to Gulf Coast oil installations and difficulties marketing tight oil grades look set to keep crude inventories high.
Storage firms' 2016 profitability and activity reflected the changing market. Vopak, the world's largest independent storage provider with nearly 34m cubic meters of capacity worldwide, reported operating profit before exceptional items of €326m ($387.9m) for 2016, nearly unchanged from the €325m it disclosed the previous year. Privately held competitor Marquard & Bals, owner of the world's second-largest storage company, Oiltanking, which doesn't publicly report financial results, registered storage throughput of 156.8m tonnes in 2016, up from 128.2m in 2015.
But company financial performance is a lagging indicator of the market, which now looks less likely to remunerate storage plays. Big traders appear already to have adapted their strategies to reflect the market changes. This year, Glencore sold a 51% stake in its storage business to China's HNA Innovation Finance Group, while Vitol reportedly offered to sell crude stored at South Africa's Saldanha Bay.
The current market structure isn't encouraging for the storage trade. While US crude forward curves continue in contango, substantially all other markets are in backwardation—making cargos to be delivered in a few months cheaper than spot deliveries. The backwardation is more pronounced in products than in crude, and affects even the quickly growing Asian markets.
For example, in Singapore gasoil price spreads between the front, second, and third months were at the time of writing negative by between $0.40-0.95 per tonne, making storage distinctly unattractive as a trading strategy. Meanwhile, the Brent and Dubai forward curves are showing backwardation of up to $0.02-0.20 per barrel. In the US, where recent crude demand has been limited by hurricane-related refinery damage and tight oil is difficult to sell, crude futures remain in contango, but gasoline and heating oil prices are backwardated.
"It's important to note that pretty much every curve is now in backwardation, with products the most, so tankage rates should start feeling the pressure globally", says a Singapore-based trader. He and others underscore the market's growing belief that the next major move in oil prices will be upwards. Last year's faith in the persistence of a market contango appears to be shifting in favour of a lasting market backwardation.
In the key Amsterdam-Rotterdam-Antwerp (ARA) trading hub, several structural factors are also dampening the lust for storage. Lacklustre demand is reflected in port statistics: Rotterdam alone saw total crude oil throughput of 26.629m tonnes in the first quarter of 2017, a slim 2.3% growth over the same period of 2016, while oil products throughput fell 11.1% to 21.735m tonnes. Incoming crude volumes were up 3.4%, but outgoing crude volumes plunged by 78% year-on-year, while incoming products volumes were down 9%, and outgoing products volumes dropped 13.5%. Vopak figures reflect these developments, as the company noted in its mid-year presentation to analysts that it sees occupancy rates at its Dutch terminals falling to 91% in 2017, down from 96% last year.
Modest European oil-demand growth has been one cause of a slump in storage volumes. Another has been a decline in US gasoline imports, which fell by 4.4m barrels in 2016 from 2015, affecting key European refiners. However, a more important factor appears to be the continued decline in Russian fuel oil exports as new hydrotreating and other conversion units come on stream in that country's refineries. Previously, small Russian fuel oil cargos were transhipped at Rotterdam to Very Large Crude Carriers (VLCCs) for long-haul export to the world's largest bunkering market in Singapore. The decline in Russian fuel oil exports has conversely increased the country's gasoil sales, leaving traders wondering where this product will find a home, and encouraging possible conversion of crude oil and dirty product storage to clean product storage in the ARA hub.
Across the Atlantic, continued forecasts of crude and natural gas liquids output increases are incentivising large additional North American storage investments, particularly around the oil futures delivery point of Cushing, Oklahoma. Some traders see new crude oil storage as necessary to handle additional production until the market finds a solution to the conundrum of where to place the increasing volumes of tight oil—which, because they are prevalently very light and sweet, are not finding a home either in the US refining system, or in export markets. Some analysts expect that this phenomenon will lead to US crude storage capacity seeing 60-70% occupancy rates through the next few years.
Like Europe, the US saw a consistent inventory draw on both products and crude through the first half of the year. According to the IEA, commercial oil stocks in the US ended July, at their lowest level since December 2015, after dropping counter-seasonally that month by 25m barrels. That said, the IEA thinks the forced shutdown of nearly 30% of US oil refining capacity, due to Hurricane Harvey in August, likely will lead to a short-term build-up of stocks. "Before Harvey, there's been a nice draw for these inventories", says Marcus Waldner, manager of oil storage for Genscape, an analysis firm.
Notwithstanding the inventory draw through most of this year, Genscape notes that considerable volumes of new crude storage capacity are under construction. The firm calculates that approximately 22.7m barrels worth of additional storage capacity is being built in Louisiana, Oklahoma, Texas, and western Canada. These are all areas that expect to see increased crude flows as US tight oil growth continues, confirming North America's status as the world's largest hydrocarbon liquids producing area.
Storage pricing worldwide appears to be weakening, with oil traders quoting onshore crude and dirty product storage at about $0.30 per barrel per month, and clean product storage at about $0.70 per barrel per month, excluding in-out fees, which may vary considerably. Compared with a year earlier, both dirty and clean storage rates appear to have fallen. Floating storage rates have also declined.
New storage frontiers
While market forward curves readjust and backwardation takes hold, independent international storage companies are expanding in the Asian, South American, and African markets, where demand is expected to continue to increase. According to the IEA, Chinese and Indian commercial inventories fell in the year to May, and Genscape notes a further decline in August. But industry expectations are that Asia will drive medium and long-term oil-demand growth and require new infrastructure to sustain it, including at the key oil entrepôt port of Singapore.
Consequently, international oil-tankage firms are consolidating investment in these regions. Vopak, for example, is concentrating major oil-product storage expansions and new development in Malaysia, South Africa, and Panama. Its expansion projects in Pengerang, Malaysia, across from Singapore, are the largest in its portfolio. Backwardation in the oil market may, however, inhibit additional expansions if storage fees come under too much pressure. The advantage in this sector will lie with companies able to contract capacity for the longer term.
One problem hanging over Singapore is the tankage necessary for its active bunkering market. In 2016, bunkering volumes rose 6.5% from 2015, but are up only 2% this year. An open question in today's oil market is the effect that new International Maritime Organisation regulations, which will limit shipping emissions to those equivalent to 0.5% sulphur content in fuel oil, will have on demand for the product. The new rules enter in force in 2020, and many in the market wonder which way these will drive product demand, and hence necessary infrastructure. It may be that Singapore will consider the European alternative of converting crude and/or dirty project tankage to clean tankage.
In Europe, away from the storage hub of ARA, Vitol affiliate VTTI is developing the second phase of its Adriatic Tank Terminal project at Ploce, in Croatia, by adding 200,000 cm of product and liquefied petroleum gas storage. The development should contribute to alleviating the Adriatic's long lack of significant storage capacity.
In the short term, US oil storage occupancy rates are expected to receive a boost from hurricane-related refinery shutdowns in the Houston area. According to the US Energy Information Administration, through May of this year occupancy rates at US crude oil storage facilities were approximately 68%, with Cushing occupancy at a near-capacity 88%. Occupancy rates for major product terminals were in the 53-60% range, depending on the product. In the wake of the hurricane closure of nearly a third of US refining capacity, crude storage occupancy is likely to rise, while product storage will be less affected as much of the US' product need will be met by imports. The final effect on the storage industry will depend on how long it takes to get US refineries back onstream.
Several storage projects and expansions are now underway in the US, being pushed by the increasing supply of tight oil and gas liquids. At Cushing, for example, Tallgrass Energy Partners is developing a new, 5.5m-barrel storage facility, while Transcanada is adding 2.1m barrels worth of storage in six tanks to its existing Cushing facility. With Cushing operating at nearly full capacity and the US shale boom apparently back on track, particularly in relatively low-cost, high-productivity areas such as the Permian and Eagle Ford prospects in Texas, additional such projects may be on the cards. "The storage guys could end up laughing all the way to the bank", if US tight oil output develops beyond the market's ability to accept the oil, says a market analyst with a leading oil company.
While US storage developments go forward, it may in the short term be difficult for additional major storage infrastructure investment to develop in other markets. Projects such as Vopak's Pengerang expansion are already under-way and likely won't be halted, but the market's shift into backwardation will likely delay additional major investment. The stark differences between key storage markets seen a year ago appears to have become even more pronounced: whereas in 2016 it paid to store products in both Europe and the US, now Europe has dropped out of the picture, and only inland US crude storage has maintained a bonanza.
Oil-market participants believe that, if the producers group led by Opec continues to limit output and force a draw on worldwide commercial stocks, the market backwardation likely will continue and perhaps become more acute over the next year. Storage operators may have to wait for another season in the sun.
Source: Petroleum Economist
From liquids to liquefied natural gas
Longstanding key participants in the oil market, leading independent oil-storage companies are now increasingly seeking to build a significant presence in the liquefied natural gas infrastructure sector.
Take storage company Vopak, with 34m cubic meters of liquid storage capacity worldwide in July. It recently received EU merger approval to proceed in a venture with Dutch gas infrastructure firm Gasunie and Vopak competitor-and second-largest global storage concern-Oiltanking, to build a "multiservice" LNG terminal in Northern Germany. Details of the project haven't been released, but the initiative appears set to participate in the development of the European downstream LNG market.
The project isn't Vopak's first in LNG. It's already a shareholder in the Gateway LNG terminal in Rotterdam and, with Spain's gas-transmission-system operator Enagás, in the Altamira terminal on Mexico's Pacific coast. It says its strategy is to participate in the developing LNG market by creating "hub" terminals, and breaking bulk LNG cargos for distribution to satellite terminals in local markets.
Concern over climate change and the carbon intensity of energy markets has dovetailed with a significant rise in LNG supply to increase its penetration in many markets, in particular shipping. Last year, LNG trade totalled 258m tonnes, and existing gas-liquefaction capacity is 340m tonnes, with significant increases in progress, according to the International Gas Union's 2017 World LNG report. The industry's challenge is to place its product, expanding the gas market as it does so.
While Vopak and now Oiltanking are beefing up their LNG presence in Europe, in the US leading energy-storage and pipeline concern Kinder Morgan is developing gas-liquefaction plants in Georgia and Mississippi to participate in the US gas export boom.
New fuel opportunities are cropping up in the trucking and especially shipping markets, where environmental regulations will enter vessels operating in Emissions Control Areas, where vessel emissions can't exceed the equivalent of 0.1% sulphur fuel. Already, the Baltic Sea and Norwegian coast have seen a proliferation of small-scale LNG reception terminals serving shipping and road-transport customers, as well as the larger full-scale LNG terminals developed in Lithuania and Poland. In Europe and the Americas, small LNG "satellite" plants have long been used for local gas storage and, more recently, to supply LNG to remote industrial sites or clients on islands.
The business model underlying all these developments-regulated or long-term contracted returns from a significant infrastructure asset-is familiar to all leading infrastructure players and may offer significant growth possibilities to all three companies. In the case of Vopak and Oiltanking, they are taking on activities which previously had largely been confined to designated state transmission operators.
Competition for the large storage firms will also in practice be limited. While conceptually popular and technologically proven, LNG-even on a small scale-remains a costly and technically demanding business and only creditworthy counterparties have typically taken on the industry risks.