Brent spreads reflect expected evolution of supply-demand-stocks balance in coming months
By John Kemp
Brent futures prices indicate the crude market is expected to move into a deficit with a significant draw down in stocks from the middle of the year.
Brent futures are trading close to full contango or full carry through until June but thereafter the calendar spreads are no longer wide enough to cover the cost of storing and financing oil stocks.
Most stocks are held involuntarily because the oil is in transit from the well to the refinery or because the stocks are needed to meet the operational requirements of refiners.
But beyond these operational requirements, traders will hold inventories only if prices are expected to rise or they can cover their storage and financing costs by running a short position in the futures market.
The structure of futures prices therefore determines the profitability of storing oil beyond minimum operating needs, so called “cash and carry” trades.
On Feb. 9, the structure of Brent futures prices provided around 37 cents per barrel to hold stocks between April and May and around 33 cents to hold stocks from May to June.
If the cost of onshore storage is around 20-30 cents per barrel per month and the cost of borrowing is around 2 percent per year, storage is just about profitable in May and June (http://tmsnrt.rs/2kbiSiw).
But the spread from June to July is just 24 cents and it declines even further to just 15 cents from July to Aug. and 6 cents from Aug. to Sept. There is no way oil storage can be profitable at such low spreads.
The economics of storage is very sensitive to assumptions about the cost of leasing tank farm space and borrowing money.
The figures used above are purely illustrative. Some traders will have access to storage much cheaper (or more expensive) than these figures.
Both the cost of leasing space and the cost of borrowing is specific to the tank farm and the storage company so will vary.
Onshore storage is generally much cheaper than offshore storage, and some companies will have access to financing at lower costs than others.
Companies with access to cheap borrowing and cheap storage can make cash and carry trades work at a much smaller contango in the futures market.
Nonetheless, the inter-month spreads in Brent futures are so low it is hard to see how any traders will be able to recover their storage costs from June onwards.
The current structure of prices points to storage tanks starting to empty from the middle of the year as traders unwind storage plays.
Of course, spreads can change. The Brent spreads reflect the expected evolution of the supply-demand-stocks balance in the coming months.
If the crude market does not move into the expected deficit and stocks remain high, the inter-month futures spreads will have to widen again to pay for the necessary extra storage.
