From Your Advisor’s Desk – May 2016

The U.S. has so much crude oil that it is running out of places to put it, and that could drive oil and gasoline prices even lower in the coming months.

For the past two months, the United States has been producing an average of 1 million more barrels of oil every day than it is consuming. That extra crude is flowing into storage tanks at the country’s main trading facilities in Cushing, Oklahoma, pushing U.S. supplies to their highest levels in 80 years, the Energy Department reported in March.

Storage tanks could approach their operational limits, known in the industry as “tank tops”, by mid-April and possibly send the price of crude and gasoline lower. Many analysts believe oil prices will fall through the spring, before summer drivers start to relieve the glut with anticipated travel plans.

Other factors affecting a growing supply of oil include a rising production of oil by U.S. drillers. The newly extracted oil is light, sweet crude, which is the type U.S. refineries are not designed to process. Oil companies can’t just get rid of it by sending it abroad because crude exports are restricted by a decades-old federal law.

So in essence, foreign oil continues to be imported into the U.S. because of economic weakness in other countries and the need to feed U.S. refineries designed to process the heavier grade crude from other countries.

At the root of the precipitous decline in oil prices has been the development of techniques for extracting tight oil in the U.S., mostly from shale deposits, by horizontal drilling and hydraulic fracturing. This reversed the decline in U.S. oil production, adding 3 million barrels a day since 2012. As a result, the gap between global production and consumption has widened, precipitating a dramatic rise in U.S. and world inventories and a fall in prices.

After the oil embargo of the 1970s, OPEC wrested oil pricing power from the U.S. But the shale technology breakthrough is likely to be a far more effective stabilizer of oil prices than the cartel of oil producing countries. OPEC is now relinquishing its pricing power, which many believe may never be regained.

The reasoning is that shale technology is far more flexible, thus shale oil output can expand and contract more rapidly than conventional wells. Fluctuations in market prices will automatically guide shale expansion and contraction.

So far, the heavy build-up of inventories of crude and petroleum products and the decline in the number of active drilling rigs has not subdued the growth in U.S. crude output.

Sources: U.S. Energy Department, Oil & Gas Journal Macro Overview – May 2016