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Cushing faces oil shortage crisis

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2023-09-28

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A critical US oil town, Cushing, Oklahoma, is grappling with a dire oil shortage that is sending shockwaves through energy markets, pushing US oil prices above $94 per barrel for the first time since August 2022 and raising the specter of breaching the $100 mark in the near future.

The crisis hinges on a complex interplay of geography, chemistry, and the mechanics of oil trading. Despite its modest population of just 8,000 residents, Cushing has emerged as a vital trading hub due to the extensive oil pipelines converging in the area, making it the epicenter for pricing West Texas Intermediate (WTI) crude, the benchmark US oil price. Each month, holders of expiring WTI futures contracts receive oil from Cushing's storage tanks. These contracts underpin major financial products such as the United States Oil ETF (ticker: USO).

In the past month, alarmingly, these storage tanks have started to run critically low. Government statistics, as of Wednesday, reveal that Cushing currently houses slightly under 22 million barrels of oil. With the exception of brief periods in July 2022 and August 2018, storage levels haven't plunged this low since 2014.

Robert Yawger, the director of energy futures at Mizuho Securities, noted, "We are at really beaten-down levels of storage. It's been a slow-motion train wreck for weeks, and today it got supersized."

The primary driver of this oil shortage is the fact that refiners are operating at nearly full capacity to process crude into gasoline and diesel, both of which are commanding robust profit margins. Moreover, a pipeline outage in Cushing has diverted the flow of oil elsewhere, exacerbating the situation. Gasoline prices have surged to $3.83 per gallon in response.

Cushing has a total capacity of approximately 100 million barrels of oil, and as recently as June, it held about 40 million barrels. In April 2020, during the initial stages of the COVID-19 pandemic, a massive surplus of oil led to storage tanks reaching capacity, causing the infamous moment when oil prices turned negative as traders struggled to find places to store their excess crude.

The current WTI situation stands in stark contrast to 2020, with Cushing now facing a dearth of oil in its tanks. As oil levels plummet, pressure within the tanks decreases, making it increasingly difficult to transport oil. Some tanks risk reaching levels where oil falls below the nozzles necessary for it to flow out of the tanks and into pipelines.

This predicament is also wreaking havoc in the oil futures market. Speculators are betting on further oil price increases as supplies dwindle. The surge in prices for November futures contracts has led to a form of "backwardation," where near-term prices surpass future prices, incentivising traders to sell oil quickly instead of holding onto it for later sales. The December contract is now trading at a significant $2 discount compared to the November contract, a much wider spread than usual.

While these spreads may attract traders, they carry inherent risks. Individuals holding November contracts when they expire on October 20 will be compelled to roll over their contracts to the December contract if they wish to avoid taking physical possession of the oil. If December contracts continue to trade at substantial discounts, significant financial losses could ensue, as each WTI contract represents 1,000 barrels of oil, potentially resulting in a $2,000 paper loss per contract.

Yawger anticipates that this month's expiration may not generate the same level of turmoil as the 2020 oil plunge, but he does foresee a potentially turbulent trading environment ahead. "It's going to be an interesting expiration. We don't have any precedent. It's not certain what's going to happen," he remarked, highlighting the uncertainty that looms over Cushing's oil crisis and its impact on the energy market.

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