Patrick Kulsen, of PJK International, examines if the current contango market will last and the implications for German tank terminal operators
Players active in the German tank terminal market have noticed a sharp change in market fundamentals in the last two years. At the beginning of 2014 the outlook for mineral oil and petrochemical markets was cloudy. High oil and energy prices were taking their toll on European producers and consumers leading to depressed activity. In the second half of 2014 oil prices began increasing until January 2015 when it lost around 60% of its initial value.
Afterwards prices stabilised around these low levels. This slide in prices marked the start of a switch to a brighter period for many players in the oil and petrochemical sector.
Low oil prices and contango
The switch from a high oil price to a low oil price regime has benefited the European oil and petrochemical sectors. Before this happened European players were at a competitive disadvantage compared to global peers because of the high cost structure. US competitors had lower energy and feedstock prices because of the US shale gas and LTO production revolution. In Asia new state-of-the-art refineries and petrochemical plants also had better economics.
Especially in the Atlantic basin, the oil glut altered this situation by lowering feed and energy costs. Furthermore the low oil prices stimulated global demand, especially for petrol, and supported refining margins. Also margins for petrochemical crackers recovered and as a result European refineries and petrochemical plants ramped up production rates.
The price forward curve also changed from backwardation into contango. If the contango is large enough traders may even profit from filling up tanks, locking in prices by selling lots on the futures market and letting the product sit and wait until futures contracts expire. A secondary effect of the contango is that traders will replenish stock in larger quantities when possible because transport costs are lower and storage costs are less relevant in this market situation.
These developments are applicable to the German liquid bulk sector. The decreased prices levels have resulted in more demand for oil products from consumers and increased production rates at refineries and petrochemical plants. The contango stimulates traders to fill up tanks, first in the ARA region but when these tanks are full also in inland terminals and at terminals located in German sea-harbours. The increased supply of liquid bulk from production plants and refineries, the additional demand from consumers and traders filling up tanks results in more demand for storage capacity. The additional demand for capacity supports storage and occupancy rates and improves profitability of the sector.
When will the party be over?
The question is how long will this ‘fest’ last? The answer can never be an absolute truth but based on current expectations for global crude oil supply and demand one can make a ‘most-likely’ estimate. There are a few indicators that will help understand what the market is counting on:
1. Till what future date is the crude oil forward curve in contango?
2. What do various institutions say about global supply and demand?
3. Do calendar spreads show a narrowing, stable of widening pattern?
4. Have oil futures prices shown a significant increase in prices?
At the date of publication the Brent crude forward curve was fully in contango, so eight years into the future. The back-end of the curve stabilized around a price level of around $65/bbl (see figure 1). The conclusion is that the contango and low oil prices will be around for a while.
Institutions that forecast global oil supply and demand on a regular basis are the International Energy Agency and the US Energy Information Administration (EIA). According to their latest monthly forecast the oversupply will persist until the end of 2016 (see figure 2).
The last two indicators are interconnected and act as an early warning for changing views on future fundamentals. A narrowing of calendar spreads and rising oil prices might signal a shift in expectations about the balance between supply and demand. Therefore these indicators should be watched carefully. So if all indicators point in to the same direction than this is a strong indication that market fundamentals might change.
Currently fundamentals are not expected to change in the medium term. However please note that these forecasts are based upon today’s expectations and that’s sudden and unexpected events can alter such expectations very rapidly as it did in the second half of 2014! So beware that an end to the party will come sooner or later.
- Kulsen will be speaking on the first day of the conference about the current contango as well as the implications of the drop in oil prices and refinery closures