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What Really Controls Oil Prices?

What Really Controls Oil Prices? thumbnail

World oil prices are controlled by the amount of crude oil stored at Cushing, Oklahoma. That’s because Cushing is the pricing point for WTI (West Texas Intermediate) oil prices, the most-traded oil futures contract in the world.

Cushing Storage Rules World Oil Prices

WTI and Brent oil prices have good negative correlation with the volume of crude oil stored at Cushing. Comparative inventory, the present volume of oil compared with the 5-year average, and oil-price volatility, the rate at which the price of oil moves up and down, are shown in Figure 1.

Oil Price, Price Volatility and Cushing Stocks_FEB 2016

Figure 1. Oil price, weekly price volatility and Cushing stocks. Source: EIA & Labyrinth Consulting Services, Inc.

From the beginning of 2014 until the end of July, comparative inventory fell and world oil prices were high averaging more than $100 per barrel. From August to the time of the November 28 OPEC meeting, Cushing inventories rose and oil fell below $70. OPEC’s decision not to cut production caused a spike in volatility and prices dropped to $46 per barrel by the end of January 2015.

Prices rose in February based on hope that falling rig counts would bring declining U.S. production. Rising Cushing inventories brought markets back to reality and they fell again in March (Figures 1 and 2).

WTI Oil-Price Volatility & World Event Timeline 2014-2016_FEB 2016

Figure 2. WTI daily oil-price volatility, Cushing comparative inventory and world event time line, 2014-2016. Source: EIA & Labyrinth Consulting Services, Inc. (click image to enlarge)

Cushing storage fell from mid-April to mid-June 2015 and oil prices rallied to $60 per barrel. Concerns about China’s economic growth and the lifting of sanctions on Iran added to flattening Cushing inventories and oil fell to near $38 per barrel by mid-August.

When inventories fell again in late August, prices increased to almost $50 per barrel and then plateaued until the end of October. Storage had flattened but the outlook for Chinese growth had improved as the People’s Bank of China announced stimulus measures.

From the beginning of November to the end of 2015, comparative inventories increased again and oil prices plunged below $30 per barrel with the near-collapse of China’s stock markets.

Flattening comparative inventories in early 2016 and rumors of an OPEC production cut and then, a partial OPEC production freeze moved oil prices back above $30 per barrel where they have remained through February.

Expectation and reality both influence oil prices but Figures 1 and 2 show that the reality of Cushing comparative inventory change is the dominant factor. World economic and political events have the power to affect oil prices but without support from Cushing storage levels, these changes are relatively short-lived.

What Must Happen For Oil Prices to Increase

Cushing, Oklahoma is the largest oil-storage tank farm in the world. It has 73 million barrels of working capacity, about 13% of total U.S. storage. Several important oil pipelines converge there as oil moves from production sites to refineries on the Gulf Coast (Figure 3).

IEA Cushing Terminal Map

Figure 3. Cushing Oklahoma pipeline terminal map. Source: International Energy Agency. (click image to enlarge)

Cushing is the delivery and pricing point for West Texas Intermediate crude oil futures contracts. More than 3 billion barrels of WTI oil futures contracts are traded weekly. For the week ending February 26, 2016, the volume of WTI trades (3.1 million contracts) was nearly three times the volume of Brent ICE trades (1.2 million contracts). Each contract is for 1000 barrels of oil.

Few of these contracts result in delivery of physical oil. Instead, most contracts are sold forward to take advantage of the higher contango prices on later-dated contracts.

Limited refining capacity for the light, sweet crude oil from tight oil fields has resulted in the stock-piling of oil at Cushing. Since oil prices collapsed in 2014, it makes more sense to pay storage fees than to sell oil at a loss.

Storage volumes at Cushing have increased since the crude oil export ban was lifted in December. Since then, additions at Cushing have averaged more than 500,000 barrels per week and total U.S. storage has increased about 1.5 million barrels per week. Current storage capacity at Cushing is 89% full. As long as Cushing and Gulf Coast storage remain above 80% of capacity, oil prices will be low.

For oil prices to increase, Cushing inventories must fall. That means that both U.S. tight oil production, chiefly from the Bakken play, and Canadian light oil production brought by pipeline to Cushing must decline.

Bakken production was consistent in 2015 at about 1.2 million barrels per day. Canadian oil imports to the U.S. decreased from April through July 2015 and may have contributed to the fall in Cushing inventories that lead to a $15 per barrel increase in WTI prices. At the same time, decreased production from the Eagle Ford and Permian basin tight oil plays would free up storage in the Gulf Coast that might allow more oil to flow out of Cushing.

Although world events are important, Cushing comparative inventories dominate world oil prices. This does not mean that decreased production and inventories elsewhere in the world would not affect prices. It acknowledges, however, that increased North American unconventional oil production created the global over-supply that caused oil prices to collapse.

Given the history of the past 2 years, oil prices are unlikely to increase until U.S. and Canadian oil production decline enough to reduce Cushing storage. Recent flat comparative inventories suggest that near-term prices could go either way depending on flows in and out of Cushing.

A relatively small decrease of 3 to 5 million barrels in Cushing stocks could result in a $10 to $15 increase in WTI prices, similar to what happened from April through June of 2015. Conversely, an increase in stocks of a few million barrels may push oil prices into the low $20 range. It mostly depends on U.S. and Canadian unconventional oil production.


Art Berman
Petroleum Geologist and Professional Speaker


12 Comments on "What Really Controls Oil Prices?"

  1. rockman on Mon, 29th Feb 2016 7:48 pm 

    Once again Art and I view matters differently. First, I have no ideas what this “Canadian light oil production” shipped to Cushing. That oil is not “light”…it’s that very heavy oil sands production that has to be diluted with light oil to get it to flow. But the dilbit is still typically that heavy sludge.

    And then we have the chicken-egg problem: does the non-working storage (speculator oil) leaving the tank farm cause prices to increase or do higher prices motivate spec oil to be sold for a profit which is why those INVESTORS bought that oil and paid to have it stored at Cushing.

    And then there’s the basic question: exactly how are refineries forced to buy oil at a certain price when they know they’ll del products at a loss to consumers. Consumers who can’t pay more for products then they can afford. IOW if the refineries can’t FORCE buyers to pay more then they can afford how can the oil sellers force the refineries to pay more then they can afford.

    The Rockman certainly wishes he could tell the refineries what to pay him. But their response is rather simple: sell his oil for the price they offer (we all do understand that it’s the refineries that post the oil prices and not the producers, right?) or the Rockman can eat it. LOL.

  2. Nony on Mon, 29th Feb 2016 8:38 pm 

    I think the storage situations at Cushing is more a result of the contango (price strip) than a cause of it.

    If anything there is more transport out of Cushing than previously, given the slow drop in Bakken production and given the opening of Seaway or lower Keystone or whatever it was called pipe that reversed flow down from Cushing to the Gulf.

    There could be some strange flow pattern affecting basis differential a little–I am not a pipeline jock. But in any event storage in Cushing is not causing world prices to move. Tail, meet dog.

    Oh…and price is UP 7+ dollars since the 26 bottom. (People like the Rockman are getting a couple more bucks from Plains, now. Heck maybe in low 30s depending on grade.) So how is the recent price rise consistent with some looming problem? Along with the strip contango itself?

  3. DMyers on Mon, 29th Feb 2016 9:07 pm 

    Good points, Rockman.

    The relationship of oil price to Cushing storage is obscured by confusion over the cause and effect.

    There is another factor in the oil price which is not often addressed on this site. That is the affect of dollar strength on oil prices. A strong dollar causes oil to be more expensive to those who begin with not-dollar currencies. The dollar has been strong during the recent drop in prices.

    To the extent dollar strength is an oil price determinant, the “oil glut” and considerations of supply in general are misplaced and in error.

    I defer to Peter Schiff commentaries on this dollar effect for a more thorough and technically precise discussion.

  4. markisha on Mon, 29th Feb 2016 11:59 pm 

    Like lokustes . Drill there put it in the salt cavern here , PURE MADNESS

  5. rockman on Tue, 1st Mar 2016 6:59 am 

    Nony – Obviously I agree. There is no lack of pipeline capacity to move oil out of Cushing. Or that matter the rest of US storage facilities. I’ve tried in vain to find thru put number for Cushing. But consider how much Canadian oil is sent to that tank farm: a significant portion of the 3 mm bopd that is exported. So or grins let’s assume 2 mm bopd at a minimum. That means a minimum of 730 mm bbls of oil passes thru a facility that’s currently holding around 66 mm bbls. IOW when they report a gain of 500,000 bbls in one week that number represents about 3.6% of the oil that entered Cushing that week. And that estimate is probably a bit high so it’s likely that 97% of the oil entering Cushing in any one week is immediately sent on to the refineries.

    Or more simply during this terrible oil “glut” almost 100% of the oil entering Cushing (the canary in the mine warning about the oil glut) is being sent directly to the refineries which, in turn, crack it and sell the products to the consumers. And even though we can’t find the numbers we do know that much of the oil held at Cushing has been bought from producers by speculators betting on higher future prices. Likewise there has not been a single report of any producer being unable to sell its oil.

    There is no glut. But there are lower oil prices but those are not an indicator of oversupply but highlight the inability of the global economies to continue paying the higher prices we had not long ago. Just as there was no oil shortage when oil was $100+/bbl and the economies cold afford it. So again it’s really simple: no one can force the consuming economies to pay more for oil then those economies can afford. The Rockman certainly wishes that wasn’t true…it was difficult enough finding long term conventional oil reserves when the price was 4X tomes higher than it is today. LOL.

  6. shortonoil on Tue, 1st Mar 2016 7:17 am 

    “The price of oil depends on the strength of the economy, and the strength of the economy depends on oil’s ability to power it.”

    The price of oil is range bound; maximum affordability on top, and minimum lifting costs on the bottom:

    Its price has now fallen below its full life cycle production cost, and it will never again be high enough to cover the cost of the average barrel. Neither will its cost be low enough that the economy can afford to acquire all of the oil that is produced. Inventories certainly do control its price in the short term, they always have. Its ability to power the economy controls it over all, and continually excessive inventories are now the result of that decaying ability. They are not the cause, they are an effect.

    The result will be lower investment in production, increasing debt load for the industry, and the liquidation of sovereign wealth funds to feed now failing petro states. The outcome will not be pretty; it will shake our modern world to its core!

  7. dave thompson on Tue, 1st Mar 2016 9:14 am 

    What truly boggles my mind is that the world consumes about 93-96 million bbls per day. So on any given day, there is 93-96 million bbls being pumped at the well head, 93-96 million bbls being shipped/moved to refineries, 93-96 million bbls per day being refined, 93-96 million bbls of refined product shipped to consumers/users to replace the 93-96million bbls being consumed/used as we speak now. How much oil per day is the whole process for one day then? by my calculation there is 465-480 MILLION bbls per day to keep the whole shebang going, oil glut my ass.

  8. rockman on Tue, 1st Mar 2016 12:10 pm 

    Dave – An interesting perspective. But if you’re trying to estimate the total amount of oil/refinery products in play on any given day your number is very short. It can take severa weeks to several months for oil to make it from the well head to the refinery. On a slow producer (like the 25% of our production that comes from stripper wells) the oil might sit on the lease for several weeks before being hauled to an oil terminal. And then more weeks until it gets shipped to a refinery. Some of my Texas production sits in a terminal until enough oil from multiple producers accumulated to fill a barge that will take several days to be hauled to a La refinery.

    And that’s fast compared to the 3+ months it takes to move Alberta dilbit from blenders in Canada to Cushing. And then perhaps a couple of weeks to make it to a Texas refinery. An once there perhaps a week or three in its working storage. Then a few days cracking it.

    And now the product delivery system. As you say probably 100+ bbls (refinery expansion) of product consumption. Did you know there are pipelines that carry gasoline and fuel oil from Texas to New England? And that can take weeks.

    I’m not going to try to work detailed numbers. But there will be about 18 million bbls of oil cracked today. And the 18 mm bbls cracked tomorow is in transit. As is much of the oil that will be cracked 3+ months from today. That’s about 500 million bbls of just oil in transit for 1 month. So now we’re up to 1.5 BILLION BBLS. And that’s just the oil. Maybe that much product in transit for that long…or longer. So now were at 3+ BILLION BBLS of liquid fossil fuels in play every day. The actual number may be twice that for all I know: I was trying to be very conservative in my time lines.

    Now think of 20+ BILLION BBLS of oil/products in play during just one week and compare that to a 500,000 bbl of oil gain at Cushing in one week. So 500,000 bbls sounds like a lot…but that’s still just 0.003% of the oil/products in play during the same week. In reality I doubt the amount of oil being stored by price speculators has much impact on any part of the system. Except, of course, for the futures gamblers. LOL.

  9. Dredd on Tue, 1st Mar 2016 1:25 pm 

    What Really Controls Oil Prices?

    Doomer Tuesday

  10. dave thompson on Tue, 1st Mar 2016 5:50 pm 

    Rockman, thanks for the in sight,I had no idea it was that much, so I still say oil glut my ass.

  11. rockman on Tue, 1st Mar 2016 8:36 pm 

    Dave – Neither did I until you got me thinking about it so I started estimating time lines for the entire dynamic. Surprised me to. It does make some of the hype over daily/weekly/monthly swings in the various inventory stats a tad too much IMHO.

  12. antaris on Tue, 1st Mar 2016 10:47 pm 

    Energy east pipeline was just on the news. If it goes ahead it will be a 42 in line x 4600 km long.
    If I didn’t screw up my calculations it will hold 22.5 million barrels of oil. That’s a very large tank, but just one of many hidden beneath our feet.

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