Stocks

This section looks at stocks, another critical component in getting oil from producer to consumer and in balancing oil markets globally, regionally, and locally.

Why Stocks Are Important

According to the Energy Intelligence Group's 1997 report, "How Much Oil Inventory is Enough?," there are 7-8 billion barrels of oil tied up worldwide in industry and government stocks (inventories) at any given time.  (The estimate excludes consumer stocks.)  Why so much?  Mostly, because stocks are needed to keep the global supply system operating.  They can be thought of as a huge pipeline stretching from the wellhead to the consumer, filling the tankers, the pipelines, the railcars, and the road tankers, and linking all the markets and all the segments of the industry together.  They are thus the key to the oil industry’s proven ability to deliver the right product to the right location at the right time.

Only around 10 percent of this vast stockpile is typically available to the industry to use as and when it pleases.  Although minor in volume terms, these stocks -- sometimes described as "discretionary" -- can affect the industry in major ways, because this subset of total stocks indicates whether markets have too little, too much, or just the right amount of oil.  Thus, when stocks are low in a particular market, prices there are likely to be relatively high, encouraging extra supply or reducing demand (whether through fuel switching or other means).  Vice versa, when a region's stocks are high, prices are likely to be relatively low in that market.  For example, if distillate is in short supply on the U.S. East Coast so that distillate stocks there are low, then the price for East Coast distillate rises relative to distillate prices in other markets, like Europe; relative to other products, like gasoline; and also relative to crude oil.   Stocks, particularly projected stocks, are thus viewed as a leading indicator of prices and are one of the most closely watched aspects of the oil market.

It is hard for the industry to follow global stocks as closely as it would like, because the data have large gaps.  The United States is the only country to publish comprehensive weekly stock data.  The data’s uniqueness and timeliness make them market movers, albeit temporary ones, nearly every week, in spite of the fact that they provide only a snapshot, based on preliminary information.

The United States, with its huge and widely dispersed oil market, has by far the largest commercial stocks, some one billion barrels.  The Gulf Coast holds the greatest part of the crude oil stocks, as shown in the accompanying graph, but the East Coast, with its high consumption and limited local supply, has the greatest finished product inventories.

Most of the world’s storage capacity is owned by the companies that produce, refine, or market the oil.  There is also a small but important proportion that is owned by independent operators, who make their living by renting it to third parties. These facilities are located predominantly at the world’s main trading hubs, like Rotterdam, Singapore, New York Harbor, and the Caribbean, and are an important element in making those hubs successful and viable.  The volumes in independent storage can be a key indicator of what is happening to discretionary stocks.  These data are, therefore, also greatly sought after by the industry but if they are outside the United States often lie outside the more formal data collection systems. 

Stocks Are Seasonal

World oil stocks follow a seasonal pattern in which they are typically drawn down rapidly in the middle of the winter and re-built rapidly in the spring, creating a tendency for world oil prices to be strongest in the fall and weakest in the spring.  This stock seasonality stems from world oil demand being much more seasonal than world production.  Stock swings are most pronounced in those Northern Hemisphere heating fuels -- heating oil, propane, and kerosene -- that drive world oil demand seasonality.  Crude stocks are also seasonal, being drawn when refiners push their runs up to peak levels and built when refiners schedule maintenance at their plants.   But, since Asia’s refining system has its peak output in the winter, with maintenance scheduled for the summer, while North America’s system is summer-peaking, with maintenance scheduled for late winter or early fall, much of the regional seasonality in crude oil stocks cancels out at the world level.  (The pattern for the United States is illustrated in the Energy Information Administration's weekly graphs for crude oil and petroleum products, gasoline, and distillate fuel oil.  Use your browser's "back" button to return to this page.)  Thus, global product stocks tend to be much more variable than crude oil stocks.  With refineries growing more flexible and demand becoming less seasonal, stocks are becoming less seasonal too. 

Strategic Stocks

The Arab Oil Embargo of 1973 initiated efforts among oil import-dependent nations to build government-controlled stocks of oil –- known as strategic stocks -- as a buffer against severe supply interruptions.  These strategic stockpiles, the largest of which is the U.S. Strategic Petroleum Reserve, or SPR (use your browser's "back" button to return to this page), now account for a significant fraction of the world’s inventories.   There has been only one strictly emergency use of strategic stocks, and it was small: during the 1991 Gulf Conflict, the United States sold 4 percent of its SPR stocks.

The International Energy Agency's oil-sharing rules, designed to share the burden of an oil supply shortage, require that each participating nation hold stocks equal to 90 days of imports.  Most of the participants meet the requirement with industry-owned stocks that can be commandeered in an emergency.  Only the United States, Japan, and a few other nations also hold government-owned stockpiles, stored separately.

Costs and Profits

Holding inventory costs money.  How much it costs varies, depending on the type of oil being stored, how much storage is available, whether the storage is owned or has to be rented, the price of the oil, and the cost of borrowing money.  In all cases, the cost of holding inventory can rapidly become significant compared to the average margins achieved by refiners, marketers, distributors, and other oil industry participants that might need or want to hold inventory.   Based on average prices in the first half of the 1990’s, holding crude oil for a year would cost a company about $1.50/barrel if it had its own storage and $4/barrel if it had to rent storage tank space.  For gasoline, the corresponding costs would be $2 and $6/barrel.   Thus, storing gasoline in rented tank space costs roughly 1 cent per gallon per month.  Companies, therefore, try to operate their supply and distribution systems in ways that keep their inventories as efficient as possible.

The trend in the more mature economies, like that of the United States, toward consolidation of the industry through mergers and acquisitions has helped in this regard.   Every gas station, terminal, refinery, etc., must have some oil in inventory.   As consolidation has led to facilities being closed, the minimum amount of oil needed to keep the system operating has fallen.

But stocks should not be viewed just as a cost of doing business. Stocks can also be a way to make money; they represent a profitable investment. Such stocks are truly discretionary stocks. They are built or drawn in response to prices, and particularly in response to the difference between today’s prices and expectations about where prices will be in the future -- the forward price curve. The widespread availability of financial instruments, like futures contracts, has greatly encouraged discretionary stock movements, partly by making the economic signals inherent in the forward price curve easy to see, but especially by reducing the risk of building stocks in a surplus market.

When prices for oil today are lower than prices for oil in the future –- a sign of oversupply -- the market is said to be in contango. If the contango is wide enough to cover the costs of holding stocks, namely storage and working capital, then a company can lock in a profit on the stocks if it, first, sells oil in the futures market while simultaneously putting the same volume of oil into storage in the futures contract’s delivery area, and then, subsequently either delivers the stored oil against the contract or sells the stored oil and buys an offsetting futures contract.   Discretionary stockbuilding occurs disproportionately in the U.S. Northeast, particularly around New York, and in Northwest Europe, especially in the Antwerp-Rotterdam-Amsterdam (ARA) area. That is because the world’s two active families of product futures contracts are based on these delivery areas: the NYMEX on New York Harbor and the International Petroleum Exchange on the ARA area.

The opposite of a contango is backwardation. A backwardated market has prices for oil today that are higher than prices for oil in the future –- a sign that supplies are tight.  Backwardation implies that oil in storage will be worth less later, even if holding it were cost-free.  The situation, therefore, creates an incentive for companies to reduce their stocks, which adds supply to the market and helps to correct the indicated shortfall.

There are many other situations that also cause companies to adjust their discretionary stocks because the risk, although not as low as it can be with building on a contango, is judged to be much lower than the potential reward. Three examples: when prices are at unusual levels by historical standards; when prices are moving fast; and when governments’ oil-related fiscal policies are expected to change. In all three case, stocks can be viewed as a buffer that enables a company to change the timing of its purchases, with the high probability that this will lower its costs and, therefore, improve its bottom line. Consumers sometimes do the same thing. For example, if the tax on gasoline at the pump is expected to increase on January 1^st, motorists rush in on December 31^st and buy early.