Storage tends to be a ho-hum business until it isn’t. With oil demand diving, plentiful production, and the oil futures curve in steep contango, storage has become a hot topic. Of course, many midstream companies own and operate storage capacity. Today, we will briefly discuss the implications of storage filling up and what it means for MLPs and midstream corporations. For more context around storage, midstream, and the relationship to the oil curve, please read this article, which has been one of our most read pieces in recent years.
Combining the current demand shock with expectations for incremental supply, the stage is set for oil inventories to balloon. Reports are already indicating that available storage is becoming more and more scarce overseas. In the US, pipeline owners are sending letters to producers asking them to curb production and are requiring documentation that shippers have an outlet for the crude volumes they are moving, according to a Bloomberg article over the weekend. To the extent storage is constrained on a global or domestic basis, that would further pressure oil prices and likely cause production shut-ins. In other words, more crude can’t come to the market if there is nowhere to put it or no refiners (or traders) wanting to buy it, so producers would be forced to limit production.
In the US, crude inventories as of March 20 were at 455 million barrels (MMBbls), well below the relative peak of 534 MMBbls from March 2017 and total US working storage capacity of ~650 MMBbls, which includes crude storage capacity at refineries (~140 MMBbls). While there is clearly some running room, these numbers likely overstate the cushion. For example, capacity in one part of the country isn’t helpful if the glut is mostly in Texas. Similarly, the availability of heavy crude tankage isn’t helpful if light crude is what is oversupplied. Whether storage capacity limits are reached in the US and how quickly depends on demand. Refiners are lowering utilization in response to declining demand for gasoline and other fuels as people work from home. Refiner Phillips 66 (PSX) indicated on a March 24 call that they were nearing minimum crude rates at many of their refineries, and this is likely the case for refineries across the US. Wednesday’s Weekly Petroleum Status Report from the Energy Information Administration will be even more scrutinized than normal as market observers look for updated data points on inventories, refinery utilization, and demand.
The steep contango in the oil curve is certainly incentivizing storage, with a nearly $7/bbl difference between the prompt contract (May) and the July contract. Storage rates at Cushing have reportedly jumped from $0.20 per barrel (bbl) per month up to $0.50/bbl per month and could be headed higher. For midstream, this is beneficial for those companies with storage capacity available. However, storage is largely used to support operational functions (pipeline movements, exports) and is typically leased under long-term contracts. Magellan Midstream Partners (MMP) indicated last week that the incremental uplift from the contango environment was expected to be $7-10 million in 2020 reflecting additional leases that were not in place previously. MMP noted that most of its crude storage was already leased, limiting the upside. This is likely true for other midstream names as well. When the oil curve was backwardated at the time of its 4Q17 earnings call, the management of Plains All American (PAA) talked about the operational nature of their tankage at Cushing as reason for rates not being pressured by the structure of the curve at the time. PAA is the biggest provider of oil terminalling at the hub.
In short, the contango in the oil curve and rising storage rates may be incremental positives for midstream companies with available capacity or for those looking to renew storage contracts in the near-term, as they may be able to increase their rates. However, the impact is not expected to be needle moving, just as storage was not a drag on profitability when the curve was backwardated. More broadly, if the US and the globe start to run up against storage constraints, the benefits of higher rates would be negligible relative to the impact on oil prices in terms of sentiment and the implications for midstream’s producer customers.