A common investor strategy is to buy low and sell high i.e. to buy assets at low prices and sell them at high prices. Of course, this requires contago conditions wherein asset prices are appreciating or are expected to rise. With the slight rise from mid-March 2015 after the slump from mid-2014, precisely such conditions exist in the global oil market.
Falling oil prices have caused over 51,000 layoffs, plummeting stock prices, and major spending cuts. Plus the oil tanker industry was thrown into the doldrums. Already under pressure since the 2008 slowdown, it struggled to make enough to cover daily operating expenses of $20,000.
Things are changing now. With oil prices in contago and the onshore facilities in the U.S. already 60% full in March this year, investors are turning to offshore storage, particularly very large crude carriers (VLCC). Oil traders have already booked space for 40million barrels of crude onboard 20 tankers.
Tanker freight rates are rising, shipping operators are raising money from stock markets, the crude tanker order book is expanding, prices of old tankers are increasing, customers are switching orders from other types of vessels to tankers, and owners are delaying the decommissioning of old tankers.
Experts caution against the current hysteria transforming into overcapacity and playing spoilsport. The fundamentals for oil demand remain strong despite the recent discoveries of oil in the U.S. – the main reason for the price slump. It is these fundamentals that will drive oil prices upward. And with prices will rise the tanker industry.
Oil: A Strategic Asset
Asset classes include stocks, bonds, real, estate, commodities, cash / deposits, and other possessions. Oil is a strategic asset because it supplies more energy than any other resource. 31.4% of the total primary energy supply of the world in 2012 came from oil.
In 2013, the global tanker fleet comprised of 11,000 tankers with a total deadweight tonnage of 490million. Reuters reported $83,000 earnings a day by supertankers in January 2015, close to the peak of $120,000 before the slump in 2008.
It is this strategic significance of oil that makes nations around the world hold 4.1billion barrels or 650,000,000m3 of oil (Source: United States Energy Information Administration) as strategic reserves. Of these, 1.4billion barrels are government controlled the rest being under private control.
With 727million barrels capacity, the U.S. Strategic Petroleum Reserve is the world’s largest. Most of the rest is held by 26 member nations of the International Energy Agency (IEA).
Shipping operators are raising money via stock issues to cash in on the optimistic prospects. If crude oil prices continue to be weak, the demand for storage will rise because investors can make better profits from higher prices in the future. Major oil companies have signed contracts with oil tanker companies.
Presently, the crude tanker order book, a crucial indicator of the health of this segment, has expanded to 66.3million deadweight tons and 747 vessels on order or under-construction. Then again, the January-2015 price for a 5-year-old VLCC has jumped to $80.7million, the highest since August 2011.
Fundamental Drivers & the Long-Term Scenario
Five fundamental drivers of oil demand include:
- population growth
- economic growth
- consumption patterns
- efficiency of in-use technology
Oil prices have fallen mainly because the U.S., the largest global oil consumer, produces most of its oil. And, because OPEC refuses to cut production despite falling prices. OPEC produced 31.02million barrels-per-day (bpd) in March 2015 and will not cut supply because supplying oil is the source of its power.
In 2014, the U.S. produced 3.2billion barrels of crude. The U.S. now imports only 5.4million barrels a day, 52% less than in 2008 and currently produces 9.65million bpd. Oil exports from Africa and the Middle East now find its way to China and India, not the U.S. as earlier. This means the demand for oil will soon recover.
With falling crude prices, China too is building strategic reserves. It imported 6million barrels a day in January-November 2014 compared to 500,000 a day in the same period in 2013. Of course, the 7billion plus global population with its increasingly high-demand lifestyles will continue to propel demand for oil.
Interestingly, oil markets have always looked ahead, an indication that the market expects correction of present anomalies. Expectation is after all the lifeblood of markets for price movements are based on expectation.
While oil markets expect prices to rise in the current environment of sluggish prices, they have expected falling prices whenever current (spot) prices have soared due to supply shocks.
This has been the case during the 1973-74 Oil Shock, the onset of the decade long Iran-Iraq war in 1979-80, the start of Gulf War I in 1991, and in the immediate aftermath of the 9/11 bombings. Guess the contago is very real then.