April 06, 2020 [The Edge Markets – Published on April 6, 2020] – It has been a month since Russia and Saudi Arabia parted ways in an oil meeting and decided to go for an oil attrition war, with huge repercussions across the energy sector.

 
This comes as human movements are limited to an unprecedented level amid efforts to contain the Covid-19 pandemic. Almost half of oil usage is related to mobilities. An oil glut coupled with diminished consumption could only mean one thing: The world will soon be overflowing with excess oil.

Last Thursday, the US Energy Information Administration (EIA) said commercial crude oil inventories jumped almost nine times to a build of 13.8 million barrels compared to a surplus of 1.6 million barrels in the previous week.

It must be noted that the one thing that separates energy from other commodities is that it must be contained within its production infrastructure, which for oil includes pipelines, ships, terminals, storage facilities, refineries and distribution networks. All of these have limited spare capacities.

A Bloomberg news report said analysts at S&P Global Platts estimate worldwide storage capacity at 1.4 billion barrels, including 400 million of floating storage. So far, 50% of that has been used. The figure is expected to rise to 90% by the end of April if the situation persists.

Scrambling for Storage

Just as all these are happening, the oil market price structure has fallen into a so-called super contango, which means it is now profitable for traders to buy oil today, store it and reap the profits by selling it at a higher price later.

As of last Friday, MarketWatch data showed the arbitrage profit — the spread between June 2020 futures contract and February 2021 contract — for an oil trader to earn was as steep as US$9 (RM39) for a barrel of oil.

This further motivates traders to hoard crude, which in turn push up demand for oil storage facilities — both onshore and offshore.

When limited spare capacity meets soaring demand, how would oil storage players fare? Back home, Dialog Group Bhd which currently anchors its footing in building a major oil storage hub in Pengerang, Johor is seen to benefit slightly.

An analyst of an investment bank, who wished to stay anonymous, told The Edge Financial Daily in a phone interview that the latest ground checks showed storage rates had surged 20% amid the overwhelming demand.

However, he highlighted that of the three phases in Dialog’s Pengerang Deepwater Terminals (PDT), only storage tanks in phase 1 – which translates to about 30% of the total capacity – follows market-driven pricing, and the rest are mainly for the purpose of locking in long-term contracts.

“Dialog’s business model is defensive in nature; [it is] poised towards delivering stable results in good times and bad times,” he added.

RHB Research Institute, in a research note in mid-March, noted that Dialog’s independent tank terminal facilities — Pengerang Independent Terminals Sdn Bhd (Phase 1) — were running at 80% to 90% utilisation rate as of last year-end, corroborating the view that limited upside is seen amid the fiery storage demand.

When contacted, Dialog’s representatives said the company could not comment on the current situation.

However, based on the group’s latest filings, it is still in the early stages of developing PDT into the largest petroleum and petrochemical hub in Asia Pacific, and there is approximately another 500 acres (202ha) of the total 1,200 acres available for development.
 

Turning to Vessels for Storage

As land-based storage is filling up, oil traders have resorted to storing oil offshore in very large crude carriers (VLCC), and smaller vessels such as Aframax and Suezmax. The oil storage capacity for these vessels could range from one million to two million barrels.

Interestingly, the spot charter rate for VLCC from the Arab Gulf to Singapore (see figure), has more than doubled to US$230,000 (RM1 million) per day, from a two-week low of US$90,000 per day.

With China, the world’s largest oil consumer, taking advantage of the current environment to buy up oil for its emergency reserves, the prospects for oil transportation tankers may improve further.

For MISC Bhd, whose petroleum tanker segment contributes 48% of its overall revenue, analysts said its time charter rates — whereby vessels are hired for a specific period of time — could rise in tandem with spot tanker rates but by a smaller magnitude.

MIDF analyst Adam Mohd Rahim pointed out that 72% of MISC’s petroleum tankers (as compared to 100% for VLCC, 74% for Aframax and 44% for Suezmax) are tied to time-charter contracts.

This means that the VLCCs will not be able to benefit from the surge in spot tanker rates while the smaller scale Suezmaxes and Aframaxes will still be able to benefit, albeit on a lower scale.

“The weakness in oil prices amidst the Covid-19 pandemic and Saudi Arabia turning on the oil taps has prompted traders to purchase oil and store [it in] tankers due to the flexibility to transport crude around the globe and store it in any part of the world where it has the highest value,” Adam said.

However, he added there is no guarantee that these current spot rates will persist like what happened in October 2019. He opined that if the Covid-19 pandemic has a very long-term detrimental impact on oil demand, the rates will trend downwards.

Nevertheless, if the pandemic recovers within the next few months, then prospects are bright for oil tankers provided that there is no halt to high levels of crude output by Saudi Arabia.

MISC’s large exposure to time-charter contracts will also shield it from any volatility in the oil market. Adam, therefore, believes that any potential earnings disruption to the petroleum and liquefied natural gas vessel freight rates either from geopolitical conflicts or the Covid-19 pandemic are manageable.

In terms of share price action, both Dialog and MISC have been holding up pretty strong. Year to date (YTD), Dialog retraced 11.3% whereas MISC has fallen 8.84%, while other Malaysian oil and gas related counters have dropped by between 23% and 82%.

Over the week, US President Donald Trump tweeted that he has brokered a deal for both Saudi Arabia and Russia to cut back on production, immediately prompting a massive rebound in oil prices.

The US WTI crude price jumped 31% to US$28.34 per barrel, from US$21.51, while Brent crude jumped 36% to US$34.11 from US$24.93 in the previous week.

While this has severely narrowed down the oil contango situation, which could put off some of the storage demand by traders, if the production cut talks break apart, there is a need to figure out how to store the excess oil when the world is facing a global oil demand destruction amid plateaued economic activity.

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