http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/one-key-reason-why-oil-prices-may-have-further-to-fall/article23468251/
[If the Canadian Finance Minister is using 'forecasters' to figure out
oil is stabilizing at US$50 a barrel (last week's news, lower this
week), perhaps that explains why the Canadian economy continues to tank
in response to using failed strategies from the past. When Alberta
Premier Prentice - a former federal cabinet minister - told Albertans to
look in the mirror, he wasn't talking about figuring out which direction
to go in the future.]
One key reason why oil prices may have further to fall
JEFF RUBIN
Special to The Globe and Mail
Published Monday, Mar. 16 2015, 7:49 AM EDT
Finance Minister Joe Oliver, who is delaying the release of the federal
budget until at least April due to uncertainty over falling oil prices,
will have to put something on the table soon. In a survey of private
sector forecasters last week, he was told that oil prices look to be
stabilizing around the current level of $50 (U.S.) a barrel. Whether
uncertainty over oil prices (or any economic variable for that matter)
is a legitimate reason to delay a budget is worth discussing, but as far
as oil goes the minister might not want to get too comfortable with the
idea that prices have bottomed out.
Crude prices may be in a holding pattern for the time being, but the
conditions under which they appear to have stabilized are anything but
reassuring. Despite a saturated world market, North American production,
whether it’s bitumen from Alberta’s oil sands or light oil from North
Dakota or Texas, continues to increase. So why haven’t prices, in the
face of all this supply, continued to fall?
The answer is storage or, more precisely, the record amount of oil
that’s being poured into U.S. storage tanks and salt caverns, despite
inventory levels that are already at all-time highs. Putting oil into
storage is attractive to oil companies right now for two reasons. First,
it effectively takes excess oil out of an already glutted market, which
alleviates downward pressure on spot prices. Next, since oil for future
delivery is currently trading for more than the spot price, a situation
traders call “contango,” selling into the futures market is a financial
win for producers.
Like all hedging manoeuvres, however, the storage play is a stopgap
measure and not a sustainable strategy. Storage is only possible as long
as there is physical space to park the excess supply. By encouraging
production growth when market conditions dictate the opposite, pumping
barrels into storage is only leading to a day of reckoning down the
road. Mr. Oliver would do well to ask what happens to oil markets when
the storage tanks are full. Traders also know that record inventories
must be unwound at some point. With that in mind, how much longer will
they be willing to pay more for tomorrow’s oil than today’s?
Unfortunately for the oil industry, the tank tops are already in sight.
Storage at Cushing, Okla., a crossroads for much of North America’s oil
production, is now 70 per cent full. Look back only seven months and
those same tanks were three-quarters empty. In order to accommodate
North American oil production that continues to increase, producers have
been putting millions of barrels a week into storage. Such significant
inflows mean the amount of oil stashed at Cushing has nearly tripled to
more than 50 million barrels. Elsewhere, storage levels are even
tighter, running as high as 85 per cent of capacity.
If oil continues to go into storage at its current pace, Cushing’s tanks
will be full within a couple of months. That would push more oil to the
spot market, which will send North American prices sliding once again.
Goldman Sachs president Gary Cohn said recently that prices could fall
as low as $30 a barrel if the U.S. runs out of storage space. Ed Morse,
the global head of commodities research at Citibank, predicted oil could
go as low as $20. Of course, for Canada that’s even worse than it
sounds. When Goldman Sachs and Citibank talk about oil prices, they’re
referring to the price of West Texas Intermediate, the benchmark prices
of U.S. oil. The price of Canada’s oil sands crude, Western Canadian
Select, trades at a discount to WTI.
The failure of high-cost North American producers to cut production in
an oversupplied world oil market is setting the stage for another leg
down in oil prices. When Mr. Oliver finally does decide to deliver a
budget, he may have more than a few fiscal aftershocks from falling oil
prices to manage. If oil drops into the $20-to-$30 range, he may soon be
dealing with the consequences of an oil sands industry, his government’s
anointed engine of economic growth, suddenly becoming a commercial
disaster on a scale that could be unrivalled in Canada’s history.
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