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ENERGY & OFFSHORE | Contributed Content, Singapore
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Kim Iskyan

All you need to know about oil is just off Singapore's coast

BY KIM ISKYAN

In global financial markets that are drowning in information and data, we may have a huge advantage here in Singapore: We can glance out into the bay from the ECP and learn more about oil markets than any deskload of commodities traders sitting in London or New York.

Recent weeks have been sunny ones for the price of oil. Since a mid-February low of US$26 per barrel, the price of oil has nearly doubled. And in the last couple of months, prices have rallied by over 35%. Now, at just over US$50 per barrel, both WTI (West Texas Intermediate) and Brent prices are at levels not seen since last October.

Many analysts are now excited about the prospects of a further crude oil rally. They argue that the global supply glut, which has kept prices down for so long, is reversing course. This is apparently leading to a supply/demand rebalancing. And they are pointing to a handful of severe global supply disruptions to support their views.

First, wildfires have been raging in Canada's main oil region in northern Alberta, which has disrupted crude production. By late-May, about 1 million barrels per day (bpd) had been taken offline as a result of the wildfires. This amounts to 40% of the country’s total output, and just over 1% of total global supply. So Canada's supply reduction has been helping to prop up oil prices.

In the last few weeks, unrest in Nigeria, Africa's biggest oil-producing country and the sixth-biggest in the world, has also been roiling oil markets. Militants have been attacking major oil facilities in the country, which has cut overall output in half to 1.1 million bpd. What's more, they've promised that more attacks are coming.

The weekly number of operational oilrigs in the US fell during May to its lowest level in nearly seven years, indicating a decline in that country's oil production. US crude oil stockpiles have fallen three times in the last four weeks, which has also helped support recent oil prices.

But if you think oil prices will continue to rally, you might want to think again. And you might also want to take a look at what's going on in Southeast Asia's Straits of Malacca in particular.

The Straits of Malacca are just off the coastal waters of Singapore and Malaysia. They are a crucial waterway connecting the Indian Ocean to the Pacific Ocean and South China Sea. So, oil heading from the Middle East to China and Japan, for example, passes through these waters. The US Energy Information Administration (EIA) has estimated that over 15 million barrels of oil pass through the Straits every day – that's 16% of global supply.

Except not all of it is just passing through at the moment. There's been a huge build-up of tanker ships parked there, holding millions of barrels of oil between them.

In late May, Reuters reported that 47.7 million barrels of oil was in storage on tankers in the Straits of Malacca (which is about half of the world's global daily crude supply). This is the highest level in five years, and has been consistently rising in recent weeks. (And a glance off the ECP suggests that there do seem to be more tankers in the water than usual.)

Normally, the decision by oil traders to store oil offshore is driven by profit. To make money, the oil futures curve needs to be in contango. This means that the spot price of physical crude, or the price to buy a barrel of oil today for delivery today, is lower than the futures price – which is the price at which a barrel of oil can be purchased today, but only for delivery at a future date. And when the opposite is the case – when the spot price is higher than the futures contract price – the market is considered to be in backwardation.

So if the contango is strong enough – that is, the futures price is sufficiently higher than the spot price – then a trader can purchase physical barrels of crude oil; keep them in floating storage; and lock in a high futures price, at which the oil can be sold later on. Of course, the futures price would have to be higher than the spot price plus the cost of storage to make a profit.

But this is not what is happening in Asia's waters at the moment. The contango is nowhere near strong enough for traders to make money by buying, and selling, this much oil.

So why is so much crude in floating storage if no one is making money doing so? Simply put, it is because there aren't enough buyers for all the oil at these prices. Weak demand is forcing oil to be put into storage, and the market is now looking for new locations to store the unsold crude.

Floating storage would not normally be used if the oil could be stored somewhere else. But there is nowhere else to store all the extra oil right now. In fact, banks are now reporting that they are experiencing a spike in interest from oil traders who need to finance their floating storage requirements.

So it seems as if they have no choice but to keep all this oil on tankers. And it is also likely that the oil will only be sold at lower prices.

Singapore – the major Straits of Malacca port – seems to be the epicentre for this growing oil glut. But the rise in storage seems to be happening globally. Financial market analysts BMI Research has calculated that the world's total floating storage was up by just under 20% between the first quarters of 2015 and 2016. In the US Gulf coast region, for example, crude stocks have risen by 18% from the beginning of the year to May. This means that there is too much oil, and the global supply glut is likely far from over.

It is also worth mentioning that the supply disruptions in Nigeria and Canada are only temporary. Nigerian militancy has periodically affected the country's oil production for many years, with production returning to near-full capacity every time. And Canada's wildfires are also not going to disrupt production forever.

Once their production returns to normal, the global glut will return. And those who are saying oil will continue surging higher may have to adjust their forecasts.

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The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Singapore Business Review. The author was not remunerated for this article.

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Kim Iskyan

Kim Iskyan

Kim Iskyan is the publisher of Stansberry Churchouse Research, a Hong Kong and Singapore-based independent investment research company, and the editor of Asia Wealth Investment Daily, a free daily e-letter with actionable insight about Asian investment, finance, and economics. He has nearly 25 years of experience as a stock analyst, hedge fund manager, political risk consultant, and financial commentator in emerging and frontier markets.

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