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As the year 2020 wears on, it seems that every month brings a new surprise. In August, in addition to the ongoing pandemic and protests, a major hurricane was added to the mix. What comes next is anybody’s guess. A zombie apocalypse? An alien invasion? At this point, the possibilities seem boundless. And the energy industry has been no stranger to this year’s turmoil, what with COVID-related demand destruction, an oil-price collapse, and production shut-ins. Amidst the chaos, the Department of Energy (DOE) announced that for the first time, private-sector energy companies would be allowed to store crude oil in the U.S.’s Strategic Petroleum Reserve (SPR), which resulted in the leasing of 23 MMbbl of capacity. Recently, those volumes have begun to be drawn back out. Today, we examine the factors influencing movements of crude oil into and out of the U.S. SPR. RBN is pleased to announce that today’s blog is the winning submission in our first-ever blog writing competition held for students in Texas A&M’s Trading Risk & Investment Program (TRIP). For more about the contest and links to other top entries, click here.
April was quite a month for crude oil, complete with the price of WTI dropping to unprecedented levels — even going negative for a day, as we discussed in One Way Out. Even before the bottom fell out though, in early April, the DOE was scrambling to cope with the fallout of the OPEC+ price war and rapidly deteriorating global crude demand due to COVID (see Things That Matter). In an attempt to stymie further price shocks and stabilize the market by absorbing some of the oil glut, the Trump administration directed the Secretary of Energy, Dan Brouilette, to fill up the SPR. To comply, the DOE announced on April 2 that it would lease up to 30 MMbbl of crude storage space in the SPR to private energy companies for the first time. It was a stunning decision to many in the industry; however, given the abundance of unceasing surprises which have occurred this year, this action was quite fitting with the what’s-next uncertainty that has ensued in 2020. The U.S. SPR is the largest emergency stockpile of crude oil in the world, with an authorized capacity of 714 MMbbl. It was established in the mid-1970s in response to the 1973 oil crisis to mitigate domestic supply disruptions. In the past few decades, it has been used to store crude for a rainy day — that is, to help deal with unpredictable events such as embargoes or devastating hurricanes that interrupt supply. There are currently four storage sites in operation. Moving from west to east in the map in Figure 1 below, they are:
Figure 1. Strategic Petroleum Reserves by Location as of June 30. Source. DOE Previously, the powers that be have stocked away millions of barrels of crude in the SPR in times of supply gluts to reduce the negative impacts of oversupply and to prevent the further downfall in prices. Alternatively, the government has released oil from this emergency stockpile to increase supply in times of major shortage events, such as wars and hurricanes. This includes the 2005 release of 20.8 MMbbl of crude after Hurricane Katrina, as well as the 1991 release of 33.75 MMbbl around the time of Operation Desert Storm. And in mid-March of this year, as pandemic-induced demand destruction precipitated a huge supply glut, falling prices, and dire market sentiment, the Trump administration proposed purchasing and storing 77 MMbbl of U.S. crude oil in the SPR. In addition to the 635 MMbbl that was already stored at the time, the stated goal was to fill 'er up “to the very top” of the 714 MMbbl of authorized capacity. However, Congress was not in favor of this proposal, and declined to provide financial support for it, so the administration and DOE conjured up a different plan to help prevent the plunge in prices from continuing any longer than was unavoidable. On April 2, the DOE announced its plan to allow private energy companies to lease and store up to 30 MMbbl of crude — 22.8 MMbbl of sweet and 7.2 MMbbl of sour oil (see Heavy Fuel for an explanation of sweet and sour crudes) — in some of the remaining available storage space in the SPR. Under the plan, companies could store their crude in the SPR starting as early as late April. Delivery of crude to the SPR sites had to be completed by June 30, 2020. Companies could then withdraw their crude as early as August 1 or October 1, depending on the storage site. Any oil stored in the Bryan Mound, Big Hill, and West Hackberry sites (maroon-, orange-, and blue-labeled sites, respectively, in Figure 1 above) could be withdrawn starting August 1, 2020; any oil stored in the Bayou Choctaw location (purple label) can be withdrawn starting October 1, 2020. Withdrawals from any location must be completed by March 31, 2021. Figure 2. Weekly SPR Volume. Sources: DOE, EIA Weekly Petroleum Status Report The leasing process went like this. First, companies placed a bid and finalized their proposals by April 9. These bids were sent off to the DOE to determine which contracts would be approved, and which companies could store their crude as part of this historic agreement. Nine companies’ contracts were approved, finalized, and executed around April 16 and were announced on April 29. In the end, out of the 30 MMbbl of storage space offered by the DOE, 23.2 MMbbl of storage space was leased out to these nine companies, and 21 MMbbl (green bracket in figure 2) of that had been utilized by the June 30 deadline for injections. The winning contracts were provided to the following companies: ExxonMobil, Sunoco (Energy Transfer), Vitol, Mercuria, Alon USA LP, Chevron, Equinor Marketing & Trading, Atlantic Trading, and MVP Holdings LLC. It was not made public whether any companies’ proposals were rejected. In bidding for storage contracts, individual companies’ proposals were made in terms of “exchange transactions.” In other words, the storage fee for these contracts is paid via a portion of oil that each company must leave at the SPR when they withdraw their oil; this is known as an “exchange ratio.” The contracted ratios awarded to companies are as low as 0.1% but average 1.9%. So, instead of paying, say $0.50/bbl/month for storage, a company with an exchange ratio of 2% must leave 2% of their oil per month of storage at the SPR at the time of withdrawal, as a form of payment. So, the amount of oil returned to the companies is the amount of oil injected in the SPR less the exchange oil. The longer companies leave their oil in storage, the higher their exchange oil and storage cost. Through the filing of a personal request with the DOE under the Freedom of Information Act, we were able to determine the specific volume of storage leased to each company, the specs of this oil, the specific SPR site chosen for the storage, and the appropriate method of return and pipeline being used for withdrawal. Distribution of barrels awarded to each specific SPR site can be found in the chart below. (Click here for a table showing the details of capacity awarded by company.) Figure 3. Distribution of Barrels. Source. DOE FOIA response You might be asking, if these contracts were signed and finalized way back in April, why should we care about it now? Well, these barrels, collectively accounting for more than 21 MMbbl of crude, are now coming back onto the market. By June 30 of this year, the oil was locked and loaded in the SPR sites, ready to be returned to their prospective companies. And it could flood the markets with crude more profoundly than the storm surge of Hurricane Laura. The 21 MMbbl of oil injected in the Bryan Mound, Big Hill, and West Hackberry SPR sites began coming back onto the market (less the storage fee associated with the exchange transaction) last month. Every Monday (unless there’s a federal holiday like Labor Day), the current inventory of crude oil in the SPR is published by the DOE, alongside any movements in the reserve from that week (example in Figure 4 below). The importance and relevance of checking the SPR’s stocks has been discussed in a number of blogs, including in Save The Last Barrel For Me. Just yesterday (September 8), we learned from the DOE that in August, a net 8.3 MMbbl of oil stored in the SPR was withdrawn (blue dashed oval) but no meaningful volume was drawn in the first four days of September (dashed orange oval). So, of the 21 MMbbl that was stored, 8 MMbbl has already been withdrawn (red bracket in Figure 2), leaving a total inventory of 647.9 MMbbl as of the week ending September 4 (dashed green oval). This means that around 13 MMbbl is still expected to be released within the next few months (less the exchange oil for storage cost); 10 MMbbl of this may be released before October 1 (those barrels stored at Bryan Mound, Big Hill, and West Hackberry). Starting October 1, barrels stored at the Bayou Choctaw site can begin to be released, so we can expect an additional 2.8 MMbbl to be pulled from the SPR and brought back to the market at a maximum drawdown rate of 550 Mb/d (subject to available pipeline capacity). Figure 4. SPR Current Inventory. Source. DOE The question now is, when will the remaining privately owned crude be released? Well, historically, when millions of barrels of oil have been released from the SPR, the administration announces the time of the planned release, and the volume of oil being released. So, we would know a specific time when the oil will be released, allowing for timely and accurate projections of the supply impact, thus giving some indication of the pressure on prices. However, with these new, private lease agreements, those specific dates are considered proprietary information and are not public. We can, however, make an educated guess as to how companies might think about timing their draws.  Back on April 9, when companies were submitting their proposals, the forward curve for crude futures was in steep contango and even super-contango (Figure 5), meaning that the market expected prices to be sharply higher in the months ahead. As we explained in our blog, Save it for Later, that contango play made short-term storage extremely attractive and allowed for massive potential profitability (for those that could get it), before the curve flattened out somewhat beginning around the August contract. As an example, a company wanting to capitalize on the contango play could have bought a contract on April 9 to take delivery of crude in May — that barrel would have been bought at $22.76/bbl (red dot in Figure 5). Since the August contract was trading at $33.12/bbl (blue dot), the company could sell that contract and lock in a spread of $10.36/bbl, minus the cost of storage. As far as those companies with SPR storage are concerned, however, after the August contract month, the forward curve flattened out, yielding diminishing returns. In addition to shrinking returns, the monthly storage exchange volumes continue to accumulate, meaning the longer companies store their oil in the SPR, the larger their storage costs will be, and the smaller their returns. Figure 5. WTI Forward Curve as of April 9, 2020. Source: EIA Given that financial justification, it would be reasonable to expect that the remainder of the leased storage space would be cleared sooner rather than later, meaning that the remaining 13 MMbbl of privately owned crude still in storage at the SPR may come back onto the market within the next few months. But nothing is that simple in 2020. In anticipation of Hurricane Laura, the West Hackberry site in Louisiana and the Big Hill site were closed. Big Hill was back up and running by August 31, but West Hackberry sustained considerable damage and recovery efforts are still underway, according to situation reports from the DOE. Authorities have said that the SPR can facilitate emergency exchange requests from refineries due to Laura through its Big Hill, Bryan Mound, and Bayou Choctaw sites, but that there hadn’t been any requests. Of course, hurricanes and offline facilities complicate any potential drawdown of SPR inventories. Regardless, especially in a year like this one, folks in the oil patch can take some small solace in the fact that the SPR is achieving its mission, namely, helping to absorb major shocks in the oil market. Over the next few months, companies that gratefully took on the opportunity to store over 21 MMbbl of oil in the SPR will discharge the remaining 13 MMbbl, and then we shall see what the effects truly are on price when their crude breaks free from the SPR.  "I Want to Break Free" was written by Queen’s bassist, John Deacon. It appears as the second song on side two of Queen's 11th studio album, The Works. Released as the second single from the album in April 1984, the song went to #45 on the Billboard Hot 100 Singles chart. Four different versions of the single were released. The video for "I Want to Break Free" was a parody of the long-running British television soap opera, Coronation Street, featuring the members of Queen dressed as women. MTV banned the video as they considered it too controversial. Personnel on the record were: Freddie Mercury (lead and backing vocals), Brian May (electric guitar), John Deacon (bass, acoustic guitar, synthesizer), Roger Taylor (drums), and Fred Mandel (synthesizer solo). The Works was recorded between August 1983 and January 1984 at the Record Plant in Los Angeles and Musicland in Munich, Germany. The title of the album comes from a comment Roger Taylor made as they started recording it. Referring to the fact that the record would be a combination of old-style Queen hard rockers and newer-style Queen electronic synth-pop, he said, "Let's give them the works." The Works was produced by Queen and Reinhold Mack, and it was released in February 1984. It went to #23 on the Billboard Top 200 Albums chart. Four singles were released from the album. It has been certified Gold by the Recording Industry Association of America. Queen is a British rock band formed in London in 1970 with Freddie Mercury, Brian May, Roger Taylor, and John Deacon; May and Taylor had previously played together in a band called Smile. Queen has sold over 170 million records worldwide, and has released 15 studio albums, 10 live albums, 15 compilation albums, two soundtrack albums, seven EPs, and 72 singles. The band has won four Brit Awards, four Ivor Novello Awards, and one Grammy Award, as well as a Grammy Lifetime Achievement Award. They are members of the Rock and Roll Hall of Fame, Songwriters Hall of Fame, and UK Music Hall of Fame. Brian May and Roger Taylor have continued to tour with supporting musicians as Queen. The band has featured both Paul Rodgers and Adam Lambert as their lead vocalist since the death of Freddie Mercury in 1991. Founding member John Deacon retired from the band in 1997. Queen plans on releasing a live album with Adam Lambert as vocalist in October of this year. |
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