Two weeks ago in Don’t Drink the Oil Storage Shortage Kool-Aid I discussed the tightening crude oil storage picture in the U.S. The bottom line from that article was that while it is true that crude oil inventories in the U.S. are high and continuing to rise, the situation isn’t as dire as many in the media have made it out to be. But pundits continue to predict that crude oil prices have nowhere to go but down, because we are simply going to run out of crude oil storage.

Since I wrote that article, there have been two more weeks of storage builds, and even more buzz that something has to give. Well, something is about to give.

There are many moving parts in this storage picture. One of those, as I explained previously, is refinery demand. This piece of the picture seems to be largely lost in the storage discussion, so I created a graphic to emphasize its importance. Below is the average refinery utilization percentage for each month of the year since 2010.   

Note that the lowest utilization month—in other words the month in which crude oil demand from refineries is the lowest—is March. The reason for this is that this is an ideal time—weather  wise and demand wise—for refineries to do maintenance ahead of the summer driving season. In the South the weather may be favorable enough to begin maintenance in February, which is the second lowest utilization month, or even January—the third lowest. Refineries in the North may schedule their maintenance for April, when the risk of ice and snow (which creates additional hazards) is lower, or they may take fall turnaround—which you can see in the utilization dip in October.

So we are presently nearing the end of the lowest one-month refinery utilization period, which also ends the lowest three-month refinery utilization period. This has been a big factor in the crude oil build, but one that is about to start swinging the other direction. And while the crude oil build this year has been higher than normal, we do see a build in inventories at this time of year just about every year.

To put all of this in perspective, so far this year commercial crude oil inventories have increased by 76 million barrels—an average of 7.6 million barrels per week. But the difference in refinery demand in March and in the highest utilization month in July is about 9 million barrels per week. As we ramp up to that level over the next few months, the crude oil storage build will slow and likely reverse.    

This week the Energy Information Administration also offered up a bit of information in a new feature called “Today in Energy” that is relevant to inventory levels in the storage hub in Cushing, Oklahoma. While much attention has been given to the fact that Cushing is at a record high volume, the EIA noted that capacity there has increased by more than 20 million barrels since 2011. So even though Cushing is presently at 77% of capacity, in March 2011 (there’s March again) the volumes peaked at 91% of capacity before starting a decline that would last the rest of 2011:

Source: U.S. Energy Information Administration, Weekly Petroleum Status Report and Working and Net Available Shell Storage Capacity

To be clear, I am not suggesting that there is zero cause for concern. Any time inventories are approaching historical highs or lows, there is the potential to disproportionately affect prices (although I would gauge that to be a greater risk when inventories are very low). Plus, it will take a while to work these inventories down, and that’s likely to keep a lid on oil prices for a while.

But in my view, this is all already built into the price of crude. That’s the reason oil prices keep dipping into the mid $40’s. If we only looked at the first three months of this year, projected that possibility out for the next 3 months, and then concluded that oil could fall to $20, we are really missing just how dynamic this entire picture actually is.

You can’t extrapolate what happened in the past three months and project that into the next three months and conclude we are going to be out of inventory space. The inventory build over the next three months will not be comparable to the build over the past three months. In fact, if history is any guide, inventories are close to peaking, and will start to decline soon.

What that means is that oil isn’t falling to $20, but it also isn’t likely to run back to $70 this year as these high inventory levels will take some time to work down. I do think we are likely to find support back above $50/bbl for WTI as it becomes clear that inventories are coming down (and as the shorts predicting $20 oil are shaken out of their positions).

However if the crude oil export ban is repealed—something I deem as unlikely this year—all bets are off. A flood of crude oil would be sent to the Gulf Coast for export (we have excess light crude oil, and our refineries are more equipped to process heavier oils). Inventories in that case would probably come down rapidly, and crude oil prices would move into a higher trading range. Until that happens, and as long as crude oil prices remain in the current range, the crude oil refiners will see the biggest benefits.

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