Using very large crude carriers (VLCCs) as floating storage tanks is usually expensive and, therefore, only occasionally used. There are exceptions to that generalization, but no trader wants to pay the day rate for a VLCC if there is any other option available.
In its latest Oil Market Report, the International Energy Agency notes that short-term floating oil storage fell during the month of July, from 54.4 million barrels in June to 50.5 million barrels. Each VLCC holds about 2 million barrels.
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In early 2009, with crude prices below $40/barrel, crude traders held more than 90 million barrels of oil offshore in floating storage waiting for crude prices to rise. By May of that year, prices were back above $50/barrel.
At that time, day rates for a VLCC were about $75,000/day, or about $1.12/barrel/month of storage. In a backwardated market, where the current spot price is higher than the forward price, this tactic doesn’t work, and the backwardated crude market didn’t end until the fall of 2009. Crude oil shipping companies made a bundle.
Now, though the situation is reversed. WTI crude is trading this morning around $89.40/barrel for October delivery. The price for January 2012 delivery is about $89.70/barrel. While technically not backwardated, it’s about as close as it can get.
That means that fewer cargoes are going into floating storage waiting for prices to improve, even with VLCC day rates below $10,000/day, or about $0.15/barrel/month. The weak global economy could turn the arbitrage negative in a heartbeat.
Of the 50.5 million barrels in floating storage, the IEA estimates that 55% of that amount is Iranian crude. Iran has denied this, but the country’s ongoing dispute over payments from India and the international sanctions on Iran are clearly having an impact on the country’s shipments. Iran does admit that it has six VLCCs in use as temporary storage, not out of line for the country, which has very little onshore crude storage.
In the US, crude production is at its highest level in more than six years and imports are at their lowest level in more than a decade. There are — or at least there should be — no VLCCs cruising in circles around the Gulf coast or NY harbor, waiting for crude prices to rise. The price differential between WTI and Brent has closed by about $2/barrel in just the last two days, but that reflects a rising price for WTI, not a drop in the Brent price.
In any event, oil bound for the US from West Africa or the Middle East is no doubt headed straight for onshore storage tanks. US crude stocks fell by 6.7 million barrels last week although total stocks are still solidly above the top of the five-year average.
We can offer a couple of observations about the drop in floating storage even as day rates for VLCCs is virtually free. First, as always, the weak global economy is limiting the demand for crude and there is no advantage to holding crude in a VLCC as opposed to leaving it in the ground.
Second, the switch of the world benchmark price from WTI to Brent is over in fact if not in law. The differential is closing from the bottom up, which means that US drivers will continue to pay more at the pump. How quickly Libyan oil can come back on the market and in what quantity could push prices down, but that isn’t likely to happen for a few more months.
Third, shipping companies are going to get hammered until at least 2013, as the current oversupply of tankers gets even worse. The current fleet of 570 VLCCs is oversupplied by as much as 50 vessels, including 42 new ships so far this year.
One last observation about floating crude storage is that when it is at relatively high levels traders expect prices to rise and are willing to pay the storage costs as they wait. That’s not the case currently, as the weak economic outlook is keeping a rein on crude prices.