Children’s Guide to Understanding Oil Storage Situation

During normal times, the world produces 100 million barrels of oil per day and it also consumes about the same. The supply and demand are in balance. If there are any short term imbalances, the land storage serves as a buffer. Oil tankers are used to transport the oil to the customers.

When demand collapsed 30 percent because of the Coronavirus and producers did not cut production, imbalances were created. Producers did not cut production because doing so is very expensive and oil contango encouraged production to continue. As a result, land storage filled up.

After land storage was filled and the producers kept producing, the oil tankers were given another job. Instead of just transporting oil, they started storing oil and thus getting taken out of the fleet.

Because such situation continues, more and more ships are being taken out of the fleet to store oil. This is happening even after some producers are reducing their output because the cuts are not enough to offset the demand destruction.

At some point, the quarantines will end increasing oil demand while the vessel fleet will stay reduced. Some vessels will keep storing oil for months.

At first, the production of oil will continue being higher than demand and therefore more ships will be needed for storage.

Once the balance between supply and demand is reached, no more ships will be needed for storage, but this will not be the time for them to be released from storage either. There will have to be a deficit – demand > supply. Only, then can the ships start returning back to the fleet.

However, this process will not be immediate. This will take months. Eventually, the ships will return back to their fleet.

At that point, the industry will be able to start working off the excess from the land storage. Day by day, the amount of oil in the land storage will keep decreasing assuming the deficit persists.

This process, too, will take time. It will probably take years instead of months to get back to normal levels.

About Mariusz Skonieczny 333 Articles
Mariusz Skonieczny is the founder of Classic Value Investors.