The Impact of Oil Shortages in a Key U.S. Oil Town

3 Mins read

The dwindling oil reserves in Cushing, Oklahoma, a prominent oil town in the U.S., are causing significant ripples in energy markets. This shortage of oil has propelled U.S. oil prices to soar above $94 per barrel, reaching levels not seen since August 2022 and possibly inching closer to the $100 mark.

The Intricate Factors at Play

The reason behind this scarcity lies in a combination of geographical, chemical, and trading dynamics. Although Cushing is home to only 8,000 residents, it has become a vital trading hub due to its extensive network of oil pipelines. Moreover, Cushing is where West Texas Intermediate (WTI) crude oil is priced, making it the focal point of the energy market. The WTI futures contract serves as the benchmark for determining the U.S. oil price. As each month reaches its end, individuals who possess expiring futures contracts receive their oil supplies from the storage tanks located in Cushing. Consequently, this contract holds immense significance in supporting major financial products such as the United States Oil ETF (USO).

However, over the past month, the storage tanks have experienced a steady decline in their oil reserves. As per the latest government statistics released on Wednesday, Cushing currently holds just under 22 million barrels of oil. With the exception of brief periods in July 2022 and August 2018, storage levels have not been this critically low since 2014.

An Imminent Crisis

According to Robert Yawger, the director of energy futures at Mizuho Securities, the current state of storage is highly precarious, stating that “we are at really beaten-down levels.” He further remarks that this situation has been unfolding gradually over recent weeks but has now escalated dramatically.

The primary cause for this oil shortage can be attributed to refineries utilizing almost their entire capacity to process crude oil into gasoline and diesel, thereby generating substantial profits. Additionally, a pipeline outage in Cushing has forced the diversion of oil to other locations. As a result, gasoline prices have surged to $3.83 per gallon.

Considering Cushing’s total oil holding capacity of approximately 100 million barrels, it is disconcerting to note that just a few months ago, in June, the town managed to store around 40 million barrels. It’s worth mentioning that in April 2020, when the world was grappling with Covid-19 lockdown measures, an excess supply of oil led to tanks reaching their maximum storage capacity. Consequently, when the WTI contract expired that month, traders found themselves with no available storage options for the purchased oil, resulting in a historic situation where oil prices plummeted below zero for the first time ever.

The Current Situation with WTI: Too Little Oil in the Tanks

The current situation regarding WTI (West Texas Intermediate) is a complete turnaround from what we saw in 2020. Instead of an oversupply of oil, we are now facing a scarcity, and this scarcity is leading to its own set of problems. As the oil levels in the tanks continue to drop, the pressure decreases as well, making it more challenging to transport the oil, according to Yawger, an expert in the field. In some cases, the oil could even fall below the level of the nozzles that facilitate its flow into pipelines from the tanks.

The Impact on the Oil Futures Market

The shortage of oil is also wreaking havoc in the oil futures market. Speculators are placing bets on oil prices continuing to rise due to the diminishing oil supplies. This surge in prices for the November futures contract has resulted in a unique situation known as “backwardation.” Backwardation occurs when near-term prices are higher than future prices. Consequently, traders now have a strong incentive to sell their oil quickly rather than holding onto it for later sale. This has led to a significant price disparity between the November and December contracts, with the latter trading at a $2 discount compared to the former, which is wider than usual.

The Attraction and Risks of Spreads

These spreads between futures prices can be incredibly attractive to traders; however, they also come with significant risks. Spreads can change rapidly, and what might initially be paper gains can quickly turn into real losses. Individuals who hold November contracts that are set to expire on October 20 will either need to sell them before expiration or roll them over to avoid taking possession of the actual oil. It is important to remember that each WTI contract represents 1,000 barrels of oil, meaning that losses can accumulate swiftly.

An Uncertain Future

While Yawger does not anticipate the kind of excitement we witnessed during the 2020 oil plunge, he does foresee potentially turbulent trading in the coming weeks. The upcoming expiration presents a unique situation, and there is no clear precedent to rely on. The outcome is still uncertain, and only time will reveal what lies ahead.

Corrections & Amplifications

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