curve implies traders have a strong incentive now to take profits on stored tanker cargoes and release them into the greater energy market

TO BE NOTED: From Alphaville:

"The big floating storage debate Posted by Izabella Kaminska on Jun 05 19:10.

The issue of floating storage is causing a spirited debate within the energy trading community.

You see, time-spreads are improving — in energy speak that means the curve is flattening, and the contango is abating. On a theoretical level that implies it is no longer economical to store crude oil for the purpose of profiting from the ‘contango trade‘. This is especially so for crude being held in more expensive floating storage.

Simply speaking, the curve implies traders have a strong incentive now to take profits on stored tanker cargoes and release them into the greater energy market.

And yes, the incentive is definitely there. The only problem is, executing that incentive, even in a rising price environment, isn’t as easy as it sounds.

Nevertheless, it appears traders are attempting to take profits. A recent report from Dow Jones suggests the number of crude carriers chartered for oil storage has been dropping. As the report states (our emphasis):

LONDON -(Dow Jones)- June 4, 2009-The number of supertankers used to store crude oil worldwide dropped last month after a rally in crude oil prices lured barrels onshore, shipping data suggested Thursday. A total of 34 very large crude carriers were in use for storage purposes at the end of May, down from 53 a month earlier, according to preliminary data from shipbroker Simpson Spence & Young Ltd.

The number of very large crude carriers - which typically hold about 2 million barrels of crude each - employed in U.S. Gulf of Mexico crude oil storage dropped to 16 from 24 over that period, said analysts at SSY, the world’s largest independent shipbroking group.

U.S. government data Wednesday revealed an 868,000 barrel a day rise in crude imports boosted U.S. onshore inventories last week. The climb was partly attributed to crude being brought ashore as traders sought to cash in on a rally that has seen prices rise to seven month highs near $70 a barrel this week.

A narrowing contango structure in crude oil futures during May also likely contributed to the release of crude from floating storage. A wide contango - a structure where near-term contracts are priced cheaper than those further into the future - offers potential profits from buying crude at current prices and selling it at a future, higher price. With global crude storage levels reported to have stood in excess of 100 million barrels at their height earlier this year, current prices and a change in the oil futures curve could bring even more crude back onto the market in the coming weeks.

But as they also caution:
However, with freight rates still at historic lows - and spreads between monthly contracts starting to widen again - it remains to be seen how long any destocking will persist. “I think it will take quite a while [to clear the overhang of floating storage] and if the contango fluctuates it could increase again before it decreases substantially - cheaper charter rates obviously help,” said Simon Chattrabhuti, head of tanker research at ICAP Shipping in London. He estimated 33 very large crude carriers are currently being used worldwide for floating storage purposes.

At FT Alphaville we’ve heard from industry sources that as much as 135m barrels of stored petroleum products are being stored at sea over the current cycle. To compare, the current crude inventory stock in the US amounts to some 364m barrels. That’s a lot of floating oil to cash in on.

Here’s a chart showing comparatively just how much inventory oil there is in the US.

Fundamentally speaking, it’s still hard to understand how there is enough demand on the physical side to make that floating oil easy to sell. Just imagine how hard it would be to sell a 30 per cent stake in a FTSE 100 company without moving the market, and that doesn’t even involve demurring charges, capacity and spec issues.

As Harry Tchilingruian, senior oil analyst at BNP Paribas, points out:

SSY estimate that the daily cost for a 12 month time charter of a 300 Dwt VLCC is currently USD 41,500, down from USD 50,000 at the end of March. Assuming about 2.2 mb per 300kt VLCC, a back of the envelope arithmetic, if all the VLCCs were 300 kt ships, would imply that over 48 mb of crude oil is sitting on the water beside US shores. Add that amount to onshore industry crude stocks of 366 mb and that is a lot of crude.

So dumping the oil into the front-end would presumably have the effect of pushing prices lower. However, this is not happening. Yet, all evidence points to VLCCs and crude carriers being emptied.

A floating Catch-22?
There are two explanations here. Traders might just be transferring charters into smaller vessels to capitalise on lower rates. The other is that prices have completely broken away from the fundamentals — which in the physical market seems an oddity.

But there is yet one other thing to consider. As prices rage higher alongside inflation hedging and new fund inflows, the fear of escalating prices is undoubtedly set to attract the hedging community back into the market at a significant rate: the airlines, the power companies and all those exposed to high oil prices. These players will seek to hedge exposure at the back end, something that should put renewed upward pressure on long-dated futures; something that may end up seeing the contango revert, once again seeing storage dynamics become economical.

But if there really is a glut on the market, one would expect it to reveal itself in the US cash crude differentials (the difference between the paper market price and the physical). Again, no symptoms here of any glut. Differentials are strong on a historical basis, as can be seen from the story below:
HOUSTON, June 4 (Reuters) - Key U.S. cash crude differentials gained as futures rebounded sharply and calendar spreads waffled back and forth Thursday, traders said. Light Louisiana Sweet sold for $1.90 a barrel over West Texas Intermediate, up 15 cents.

Mars sour gained 5 cents to $1.65 under WTI. “Spreads moved in 10 cents and out 7 or 8 and then back in again,” a broker said. A stronger front-month WTI future contract versus back months usually weakens cash crudes. A weaker front-month usually strengthens them.

Both happened Thursday. A trader said grades also benefited from crack spreads being on the upswing above $13 a barrel. On futures markets, July WTI gained $2.69 to $68.81. July Brent rose $2.83 to $68.71. The front-month WTI spread ended 9 cents narrower at -88 cents. WTI’s advantage over Brent also was diminishing, ending at +10 cents Thursday.

Stronger Brent tends to support cash crude differentials. Among other cash grades, Bonito light sour traded up 30 cents at +10 cents. Heavy Louisiana Sweet lost 25 cents to sell for +70 cents. West Texas Sour changed hands for -$1.55, stronger by 15 cents. WTI at Midland sold for -50 cents, up 5 cents. Poseidon sour shed 5 cents to -$1.70. On the West Coast, Alaskan North Slope crude last sold Wednesday for August delivery at 35 cents under WTI. The last July deal was done Monday at 25 cents under. Buyers raised posted prices for California crude by $2.70 a barrel.

According to energy analyst Morgan Downey, author of industry must-read “Oil 101“, there is only really one market where floating storage still makes sense and that is distillates. Reports suggest this practice is indeed gathering pace across the industry, which in itself is historically unusual due to the complications and costs involved.

Nevertheless, one can presume there is so much of an overhang in distillates it currently makes sense while tanker rates are low.

But that is largely another story, and doesn’t help to explain the crude scenario.

Import alert
With regard to crude, there are two last points to consider. First, it is possible there is so much crude in floating storage traders are caught in somewhat of a catch-22. If they try to dump their oil in one go on fears of backwardation reverting into the market ( making their positions very unprofitable), the move could have a depressing effect on the front-end of the curve. This would, needless to say, potentially resuscitate the contango encouraging traders to restock their floating storage once again. In short, whatever crude was disposed of this month, it may very well be in the process of being restocked.

We will only know for sure next month. What we do know in the meantime is that DOE data on Wednesday showed a large increase in US imports for the first time in a month last week. If you assume constant Opec production rates (a tall order we know, but please do presume), then a lot of that crude would obviously have had to come from floating volumes. What’s more, the unexpected nature of the build itself supports the notion traders felt incentivised to destock.

As Olivier Jakob at Petromatrix points out:

According to SSY, at the end of May there were 34 VLCC used as crude floating storage compared to 53 a month ago. That is a stockdraw of about 38 myn bbls, including a draw of 16 myn bbls in the stocks afloat in the US Gulf. During the same period crude oil onshore in the US have been reduced by 10 myn bbls (including a 6 myn bbls draw in Padd3).

Hence the sharp reduction in offshore stocks has not even been able to prevent a reduction in onshore stocks and this then means that the real import flows are much lower than the face-value number shown in the DOE.

Of course, unless US refinery utilisation continues to go up this week, those constant Opec volumes may have to be taken up elsewhere.

What this might imply is that floating storage is essentially being churned through the system, the floating phenomenon itself resulting from a need for a buffer to compensate for oversupply during the lower demand period of the crisis. In that case — as we are not out of the catch-22 scenario described above just yet — some level of restocking should be expected in the weeks to come.

However, it is also entirely possible the world is simply becoming used to a new norm in forward-cover periods as it adjusts to protect itself from upcoming supply shocks.

This could be an attempt to echo the EU’s own inventory guidelines which aim for at least 90 days of forward cover, versus the OECD average of 60. In that case it doesn’t matter how much extra inventory there is out there, we’re setting a new paradigm and the price of oil can happily disregard the current inventory builds, especially while tanker rates are cheap.

Related links:
‘Demand is in the toilet’ - FT Alphaville
Distillate hangover - FT Alphaville

This entry was posted by Izabella Kaminska on Friday, June 5th, 2009 at 19:10 and is filed under Capital markets, Commodities. Tagged with distillates, floating storage, oil, WTI."

"the overhang of excessive debt accumulated in the boom years remains the biggest problem for the UK economy and for the world."

Robert Peston on BBC with another lucid contribution to arcane machinations:

"As I said boringly and monotonously on Monday, before during and after the pre-Budget report, the overhang of excessive debt accumulated in the boom years remains the biggest problem for the UK economy and for the world.

The past, current and future write-offs of trillions of dollars of imprudent loans is - as you know - the main reason why there is so little new credit being made available."

Bad Loans. That was it.

"Which doesn't mean to say that Alistair Darling's attempt to stimulate economic activity is irrelevant."

Of course not.

"But as Mervyn King said yesterday, in a classic case of creating news by stating the bloomin' obvious, it's the massive retrenchment of lending by banks and other private-sector financial institutions that's doing us the most damage.'

Correct. The banks won't lend. That's why I wanted TARP to be a Credit Stimulus Plan.

"In response to this failure of the credit-creation system, what we're seeing - particularly in the US and the UK but also in other parts of the world - is a transfer of the risk of lending on a colossal scale from the private sector to the public sector, from commercial investors to the taxpayer."

We need a better adjective than "colossal". Something that includes a sense of mind-numbing.

"That's happening because, after the collapse of Lehman, there's been a massive increase in the perception of the dangers of lending to the private sector and to emerging economies perceived to have borrowed too much."

More like a perception that without government help there's no way out.

"So pension funds, money managers and sovereign wealth funds are demanding punitive returns for investing in pure private-sector entities. Their preference is to lend to countries like the US perceived as too impossibly large to fail."

The Massive Flight To Safety, and even more Massive Flight From Risk, any risk.

"And because the US state is still perceived to be a good credit risk, the US authorities can borrow to fill the lending gap created by the disappearance of private-sector funding."

Well, for now, yes.

"Only hours ago, we saw the US Federal Reserve providing $800bn of credit - in effect from taxpayers - to breathe life into the markets for residential mortgages, credit card finance, small-business loans, car loans and student finance."

I thought only God could do that. The Fed's more powerful than I thought.

"That brings to more than $8000bn the aggregate amount of loans, guarantees and investments committed by US taxpayers in the past few months - whether they like it or not - to bailing out failing banks and insurers and also unfreezing credit markets."

Could someone find me the dumb bastard who likes it? I want him/her to pay my share.

"It's a mindboggling sum, equivalent to around half of the annual economic output of the US."

I said mind-numbing.

"Some analysts see this as the start of the money printing-presses being turned on with a vengeance, a deliberate attempt to stoke up inflation to reduce the real value of all those excess debts."

I've said to turn them on and keep them printing day and night, and no breaks for tea.

"I'm not sure we are there yet - though it's probably only a matter of time."

I'm pushing us there as fast as I can. But I'm only one man, battling the odds, staring down naysayers, etc.

"The biggest chunk of the Federal Reserve's recent financial support has been allocated to the commercial paper market - which in effect means that US taxpayers are providing short term loans to the biggest US companies."

The Mom and Pop outfits can kiss our bloody arse.

"There's no reason to assume that we've seen the end of this process of the nationalisation of credit."

Um. Um. Um. No. He's right. No reason.

"The head of one of our largest banks has told me there'll probably have to be sovereign guarantees provided at some point to the corporate bond market, because big companies are increasingly finding it both expensive and difficult to raise longer-term loans in the form of bonds sold to investors."

By "probably", he meant "assuredly", but he wants us all to get used to it first.

"Here in the UK, the chancellor has signalled that British taxpayers will be called on to underwrite a revival of lending to small businesses and to home buyers - probably to the tune of well over £100bn."

He signaled the bagpipes to start playing "Well Over 100 Billion Pounds" while walking through the city.

"And remember that taxpayers in Britain have already provided £600bn of loans, guarantees and capital for battered British banks."

Even amnesiacs haven't forgotten that.

"To reiterate, the credit-creation process has already been nationalised to a great extent - and this process of taxpayers standing in for commercial lenders isn't over."

Hold on old boy, you're beginning to run out of breath.

"How far will it go?"

In parsecs?

"Funnily enough, to a large extent that depends not on what happens to credit markets but on what happens to share prices."

Highly comical those share prices, are they?

"As George Magnus of UBS points out, part of the problem for most banks is that they are not perceived to have enough capital, even after the recent injections they've received from governments all over the world.'

What's got into you, Peston? Are you an epistemologist? You've used "perceived" more in this column than H.H. Price did in "Perception". I said that was one of my fears about TARP in, let's see, early October. Damned good perception on my part.

"With recession taking hold in most of the developed world, and with financial crises gripping many emerging markets, investors fear that we've only seen the tip of an iceberg of losses to be incurred by banks from their ill-advised lending splurge of the previous few years"

Let's catalogue these:
Recession "taking hold"
Financial Crises "gripping"
Investors "fear"
Only The Tip Of The Iceberg "seen"
Losses "Incurred"
Ill-Advised Lending "splurged"

"The big simple point is that banks can only lend what they can borrow. And when money managers provide funds to banks and financial institutions, and when banks lend to each other, they look at how strong the borrowers are: they assess whether the borrowing banks have sufficient capital to weather the storms ahead."

Weather words. Bad sign.

"Right now, providers of funds to banks want them to have far more capital than they could ever possibly erode through the write-offs of the loans provided when the banks were infected by an epidemic of blindness about the risks of lending."

Absolutely correct.

"the loans provided when the banks were infected by an epidemic of blindness about the risks of lending."

Bingo!

"For some reason, the Treasury doesn't seem to understand this simple point. It yesterday issued a statement telling banks that they had more capital than they need for the long term - in the hope that this will provide our banks to lend more and take on greater risks."

We'll decide that for ourselves, if you don't mind. Oh, and thanks for the cash. Jolly decent of you to lend it to us with no strings attached. Foolish, but decent.

"However, it's almost irrelevant whether the Treasury thinks our banks have enough capital. It's the private-sector holders of trillions of pounds of potential funding for banks who'll determine whether the banks are appropriately capitalised. And at the moment, they'd like the banks to have more capital."

Let me know when it actually is irrelevant. Come up with some capital first, if you don't mind. Your recent track record is piss poor.

"With stock markets on their knees, there only one source of new capital for most banks: us, taxpayers."

Are they praying? Bowing?

"So here's the Catch-22 to end all Catch-22s. If we want our banks to lend more, they're going to have to be able to borrow more. And to do that, they're going to need to raise more capital."

I hereby declare, from this point on, Catch-22 's to be null and void.

"Raising more capital, for many banks, means huge further cash injections from taxpayers."

How appropriate. They're junkies.

"That's why, as the governor of the Bank of England implied yesterday, we may yet see most of the banking system formally nationalised, so that it can do what it's supposed to do - which is to provide the credit that's absolutely vital if we're to avoid a prolonged and very painful slump."

I'm for nationalisation. But is this the same buffoon who praised Buiter's blog and forgot to mention the commenters? His credibilty is tripe.