Petroleum

The World Is Running Out of Places to Store Excess Oil

Fossil Fuel Industry Pain

Overloaded crude oil storage facilities are causing more pain for the fossil fuel industry. The global oil supply glut that began in mid-2014 sent a tremendous amount of new oil and gas supplies throughout the global market. Rapidly expanding technology related to hydraulic fracking and deep-water oil drilling opened up vast new reserves of oil and gas that were pumped out of the ground by fossil fuel companies. These new fossil fuel extraction technologies were developed in response to increasing global demand for oil and gas in developing countries like China, India, and Brazil. In recent decades, concerns mounted about easy-to-access oil and gas reserves becoming increasingly scarce. However, these concerns have largely subsided. Instead, a surge in technological breakthroughs has created a world that is drowning in oil.

Supply Exceeding Demand

Beginning in early 2020, global oil producers started to experience an unprecedented phenomenon, where oil and gas supplies vastly exceeded global demand. While oil price volatility has been a common side effect of a world that is dependent on petroleum products, massive new reserves of hydrocarbons have created enormous challenges for global leaders, fossil fuel companies, and the health of the world’s economy. As the spread of the coronavirus impacted fossil fuel demand beginning in February and March of 2020, global oil supplies started to outweigh global oil demand.

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The Law of Supply and Demand

According to the economic principle of the law of supply and demand, the relationship between the availability of a particular resource and the demand for that resource has an effect on price. Generally, low supply coupled with high demand increases the price of a resource. Conversely, high supply and low demand decreases the price of a resource. This economic theory can be seen in today’s oil market. Increasing supplies of oil and the lack of demand for gasoline, diesel, and other petroleum products have driven down the price of oil. Interestingly, there is one aspect of the law of supply and demand that is not being followed by today’s oil producers. The theory says that, at higher prices, sellers will seek to supply more of an economic good to capture more revenue. However, while oil prices hovered around record lows in early 2020, producers continued to supply more oil rather than cutting back. This continued supply of oil has crippled revenue projections for nations dependent on fossil fuels for economic growth.

Addressing the Problem

As oil supplies have continued to grow and demand has continued to drop, fossil fuel producers are running out of places to store excess oil. The glut of oil that has been experienced throughout the world has sent oil prices through the floor, towards unprecedented lows that threaten to wreak havoc on nations that depend on oil revenue. There are two possible solutions that could address this problem. The first solution that would ease the global oil supply glut would be for economic growth to take off once again. When economic growth is strong, fossil fuel consumption has also traditionally been robust. Since oil and gas powers the global economy, a strong economy fuels growth in the fossil fuel industry. However, as the coronavirus pandemic spread throughout the world, economic growth has been unable to regain momentum that was previously felt prior to 2020.

The second solution that could have been implemented to reduce anxiety related to oil supply storage would be to cut oil production. As the coronavirus dramatically stunted economic growth, world leaders turned to the Organization of the Petroleum Exporting Countries (OPEC) for signs of production cuts. After all, one of the main founding principles of the OPEC cartel was to safeguard against dramatic energy price fluctuations that would have an adverse impact on the economies of oil-producing countries, as well as countries that import oil (Chen, 2019). Moreover, a secondary objective for OPEC has been to provide a substantial return on capital investment for countries that choose to participate in financial ventures related to the oil and gas industry. To the demise of many struggling oil and gas producers, OPEC was unable to use its power to make necessary cuts to oil production that would stabilize oil prices. Instead, OPEC was part of the problem that ended up exacerbating production concerns.

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OPEC Failures

In addition to the founding members of Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela, OPEC membership in 2020 included Algeria, Angola, Equatorial Guinea, Gabon, Libya, Nigeria, the Republic of the Congo, and the United Arab Emirates. Because these nations are largely dependent on oil revenue to maintain economic stability, it is critical for them to maintain consistent global oil prices to avoid unnecessary geopolitical conflicts. However, in a dramatic attempt to weaken American influence over the global oil market, Russian oil producers announced in March 2020 that they would seek to drown the world in fossil fuels by pumping out more crude oil than they ever have in history. While Russia is not an official member of OPEC, Russian leaders had aligned with OPEC prior to 2020 in order to support global oil prices. Russian leaders felt that breaking away from the OPEC alliance would allow them to possibly regain the title of the world’s largest oil producer from the United States.

Shortly after Russia shocked the world’s oil producers by breaking away from the OPEC alliance, Saudi Arabia started to engage in a political counterattack against Russia’s plan to increase oil production. Thus, the oil price war between Russian and Saudi Arabia was initiated. Against the will of the rest of the OPEC nations, Saudi Arabia also started to pump up oil production to cut prices and weaken Russia’s ability to regain influence over the global oil market.

Source: Pixabay

A Recipe for Disaster

As the global economy collapsed and the oil price war waged onward, crude oil supplies reached levels that had not been seen in history. The coronavirus wiped out global oil demand as big producers continued to create more supply. This was a recipe for disaster that many world leaders didn’t expect to see in their lifetimes. The threat of overwhelming oil storage capacity has the ability to completely wipeout the oil and gas industry as a whole. As producers geared up to flight in the oil price war, smaller oil and gas companies have become pressed towards economic collapse.

When asked about the gravity of the situation, Rystad Energy’s Head of Oil Markets, Bjornar Tonhaguen, said, “We believe we have not seen the worst of the price rout yet, as the market will soon come to realize that it may be facing one of the largest supply surpluses in modern oil market history in April” (Sharafedin and Nasralla, 2020). The flood of oil from Russia and Saudi Arabia threatened to increase global oil inventories by more than 900 million barrels in as little as three months. Rising supplies and declining demand sent oil prices down by over 40 percent in March alone. Warren Russell, a prominent commodities strategist at Bank of America said that the wave of extra crude could create surpluses as large as 10 million barrels of oil per day between April and June of 2020 (Faucon and Said, 2020). Antoine Halff, the chief analyst of Paris-based economic research firm Kayrros, described the situation as, “a chess game played with a timer and each player has a very short time slot to make his moves” (Faucon and Said, 2020).

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Filled to the Brim

With dwindling demand and skyrocketing supplies, physical storage containers have become filled to the brim with excess oil. Some oil traders have turned to floating oil tankers to store excess supply. However, as of mid-March 2020, there were only two remaining ultra large crude oil carriers capable of storing up to three million barrels of oil. In comparison, traditional oil tankers typically can hold up to two million barrels of oil. In the 2014-2016 oil glut, some crude oil traders found success in buying up oil tankers to fill with cheap crude, with the goal of storing the oil until prices had risen enough to make a profit. Even with the cost of the oil tankers, traders were able to spin a profit when oil was purchased during the height of the supply glut and sold during 2018. However, with the significant demand for floating oil storage facilities and tankers, the price of that infrastructure has become cost-prohibitive for many traders.

Oil traders with access to existing storage facilities and capital funding may be able to achieve billion-dollar profits as a result of short-term supply gluts. Although, as Saudi Arabia and Russia increased oil production, these countries have scrambled to charter ultra large crude oil carriers to transport additional oil to the global market. As onshore oil storage facilities filled up, some analysts projected that even sea-based storage would eventually become maxed out as well. Unless new storage facilities and associated infrastructure is constructed, oil producers could be forced to cut production in the future.

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The Strategic Petroleum Reserve

In response to the excess oil flooding the global market, President Donald Trump vowed to purchase oil to fill the United States Strategic Petroleum Reserve (SPR). The U.S. SPR is already known as the largest supply of emergency crude oil in the world. However, as of March 2020, the SPR had the capacity to absorb an additional 77 million barrels of crude (Sharafedin and Nasralla, 2020). According to Energy Secretary Dan Brouillette, filling up the SPR when oil prices are low will save American taxpayers billions in the future when oil prices rebound.

The U.S. SPR was first established by President Gerald Ford in 1975, following the 1973-1974 Arab Oil Embargo that sent oil prices skyrocketing. The SPR was created to mitigate future supply shocks. Prior to President Trump’s announcement that the U.S. would be adding to the reserves, the SPR held 635 million barrels of oil. The total storage capacity of the SPR is 713.5 million barrels. According to economic reports, the average price paid for the oil reserves in the SPR has been approximately $29.70 a barrel (McNew, 2020). The SPR stockpile is stored throughout underground salt caverns in government complexes along the Gulf Coast in the states of Texas and Louisiana.

Throughout its existence, the SPR has been crucial for mitigating economic impacts related to high oil prices and general oil-related uncertainly. Following the September 11th attacks in 2001, President George W. Bush ordered the SPR to be filled completely, in the event that oil from the Middle East became inaccessible due to conflict. Since then, there have three events that have led U.S. presidents to tap into the SPR. For example, in 2011, 30 million barrels of oil were sold from the SPR to mitigate disruptions caused by geopolitical unrest in Libya. President Bill Clinton also released 30 million barrels of oil from the SPR to lower gasoline prices and increase home heating oil supplies. Overall, U.S. policymakers hope that refilling the SPR will help to ease some concerns related to the SPR.

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Bracing for Uncertainty

According to the International Energy Agency, the impact of the coronavirus eliminated 2.5 million barrels of oil per day in demand, which is representative of about a 2.5 percent decline in global consumption (Sharafedin and Nasralla, 2020). Following OPEC’s failure to cut oil production, coupled with Russia’s move to dramatically increase production, global oil producers are bracing for a future characterized by even lower oil prices and more stress on oil storage infrastructure.

Sources             

Chen, J. (2019). “Organization of the Petroleum Exporting Countries (OPEC).” Investopedia.

Dlouhy, J., et al. (2020). “U.S. to Start Buying Oil for Emergency Reserve Within Two Weeks.” Bloomberg.

Faucon, B., and Said, S. (2020). “Overloaded Storage Facilities Likely to Mean Even Lower Oil Prices.” The Wall Street Journal.

McNew, D. (2020). “Strategic Petroleum Reserve Fast Facts.” CNN Editorial Research.

Sharafedin, B., and Nasralla, S. (2020). “Filling up: The world has an oil storage problem.” The Sydney Morning Herald.

U.S. DOE. (2020). “About the SPR.” U.S. Department of Energy.

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