WSG Article: A New Commodity: Storage Capacity

A New Commodity: Storage Capacity

March, 2015 - Kirsten Polyansky, Deborah P. Low

This coming Sunday, March 29, CME Group plans to launch the first ever physically-delivered crude oil storage futures contract. CME Group is able to make this contract available having teamed up with LOOP LLC (“LOOP”) (LOOP owns and operates the deepwater port and associated onshore terminal with significant crude oil handling, storage and re-distribution capabilities located in Clovelly, Louisiana, sometimes called the “Clovelly Hub”) and NEO Markets Inc. (“NEO”). Each contract will give the purchaser the right to physically store 1,000 barrels of LOOP Sour crude oil at the LOOP Clovelly Hub in South Louisiana for a specific calendar month. The hope is that this new contract will offer increased options to manage deliveries into the U.S. Gulf Coast market, as well as providing flexibility and transparency with respect to crude oil storage prices.

Record Lows and Highs

With crude oil prices having dipped to record lows and with a steep contango spread, the utilization of storage capacity in the United States is at its highest level for this time of year in at least 80 years according to the U.S. Energy Information Administration (“EIA”). During the week ended March 13, 2015 crude oil inventories rose 9.6 million barrels to a total of 458.5 million barrels, the highest weekly increase to occur since the EIA began keeping records. As of March 25, crude oil inventories reported by the EIA are at 466.7 million barrels. Some analysts estimate that if the current rate of inventory growth continues, the limits of available storage in the United States may be reached this year, and storage facilities like Cushing, Oklahoma (a major U.S. oil trading and storage hub) might top out in the next several months.

The Mysteries of Storage

While it is clear there is a surge in demand for storage capacity, what is not transparent to the marketplace is the cost for storage. Storage contracts are generally negotiated bilaterally between storage operator and storage lessee. These agreements typically contain confidentiality provisions and so there is little hard market data regarding these contracts. So far industry gossip has been perhaps the best way to determine an average rate charged for storage capacity in the United States. Furthermore, all storage contracts are not created equal as they vary greatly and differ depending upon the operator, type of oil, additional services offered, and term of the contract, among other variables. So with storage now being offered through a standardized, exchange traded contract will we start to see more relevant storage data not only involving the Gulf Coast, but also for extrapolation at other locations around the country?

Storage Futures Contract: Here’s How it is Expected to Work

At the beginning of each calendar month, LOOP will sell 7,000 storage contracts through a 30-minute online auction held through NEO, as broker. Each contract represents the right to store 1,000 barrels of LOOP Sour crude oil at LOOP’s Clovelly Hub. Following the auction, the contracts can be bought and sold freely on the open market electronically via CME Globex, as well as via submission for clearing through CME ClearPort and listed by NYMEX. Trading will halt on the third business day prior to the twenty-fifth calendar day of the month preceding the delivery month (with provisions for holidays). Whoever holds the contract at the end of the calendar month is entitled to store 1,000 barrels of crude oil at LOOP in the designated month. Seller is to provide buyer with a Capacity Allocation Contract (“CAC”), which will allow for the legal right to store the crude oil. Storage will either be above ground in a storage tank or in an underground cavern within LOOP’s crude oil storage facilities in South Louisiana. The crude to be stored must be of a sour crude type that is expected to be Poseidon, Mars or Loop Seg 17; but the form of CAC, which would presumably provide the exact specifications, has not yet been publicly circulated. The initial auction is scheduled to take place on Sunday, March 29, 2015 for a trade date of Monday, March 30, 2015, pending regulatory approval. May 2015 is intended to be the first listed month in which deliveries will be accepted. LOOP is said to have set aside approximately 7 million barrels of storage capacity in relation to the futures contract from CME Group.

Is the Future of Oil Storage Here?

As the planned initial auction represents the first ever oil storage futures contract, it is unclear if a robust market for the new contract will develop, and, if so, who the participants might be in such a market. In announcing the new contract, CME and NEO expressed hope that this new contract would create more transparency, greater ease of access and liquidity to the storage market. Additionally, CME expressed hope that the new contract will provide a boost to its LOOP Gulf Coast Sour Crude Oil contract and possibly develop a new benchmark (Gulf Coast) for delivery of crude oil contracts in the United States. The current benchmark for delivery of crude oil contracts in Cushing, Oklahoma has long been criticized by traders for being too remote from the Gulf Coast. The new futures storage contract could increase the overall volume of futures contracts for delivery at LOOP to the point that a new benchmark can be established in the Gulf Coast.

About CME, LOOP and NEO

LOOP, operator of the largest privately-owned crude oil terminal in the United States, is owned by Marathon Pipe Line LLC, Shell Oil Company and Valero Terminaling and Distribution Company. The total capacity at LOOP’s Clovelly Hub facility is approximately 70 million barrels. As a result, LOOP’s hub in South Louisiana is key to LOOP’s oil distribution network, with the Clovelly Hub providing storage to crudes from all over the world and allowing for easy access to many of the largest U.S. refineries along with numerous pipelines.

Chicago-based CME Group offers a diverse derivatives marketplace, with its exchanges offering products across major asset classes, including futures and options based on interest rates, equity indexes, foreign exchange, energy, agricultural commodities, metals, weather and real estate. CME Group brings buyers and sellers together through its electronic trading platform, its trading facilities located in Chicago and New York and its London-based derivatives exchange. CME Group also operates counterparty clearing operations. CME Group is a trademark of CME Group Inc.

With roots in Houston Street Exchange, NEO was formed in 2012 to offer an advanced technology platform and brokering system for access to the global physical and financial crude markets. NEO is considered a leading online marketplace for U.S. physical oil transactions.

Haynes and Boone will continue to monitor developments regarding this new futures contract (including any details released regarding the CAC) and provide updates as necessary. The Commodities Trading and Finance Group at Haynes and Boone regularly works with clients regarding all aspects of physical storage and transportation, as well as the purchase and sale of oil and exchange related activity.

To view prior articles in our series, click on the links below.