Could three oil supplies dry up and create an arbitrage opportunity?

On 6 October, the Organisation of Petroleum Exporting Countries Plus (OPEC+) announced that it would cut oil production by two million barrels a day – over 2% of global production.

This cut may have little impact on its own: OPEC+ members have a long history of exceeding production quotas. However, other factors are at play.

SPR sales end in October/November

On 31 March, President Biden directed the Secretary of Energy to sell oil from the SPR at an average of a million barrels a day for the next six months – up to 180 million barrels in total.

These sales kicked off about two weeks after Biden signed the order and will end in October. The final 15 million barrels will be delivered in December, taking a million barrels a day off the market.

For perspective, Australia used slightly less than a million barrels a day in 2021. This is a significant amount of oil.

The SPR is the largest oil reserve of its type in the world and can store up to 714 million barrels of oil (its authorised capacity). Moreover, the SPR will need to be replenished, which leaves an unmet demand overhang on the future market.

Key Russian oil pipelines may be closed

Russia exported 8.2 million barrels of oil per day in 2021, making it the second-largest exporter after Saudi Arabia. The bulk of this oil went to Europe. As of June, OECD countries in Europe imported 22% of their oil from Russia, down slightly from 29% in June 2021.

Around 750,000 barrels per day were exported by pipeline, largely through the Druzhba pipeline, which transports oil from Siberia to as far as Germany.

On 11 October, the pipeline operator PERN discovered a leak in the main northern Druzhba pipeline in Poland. According to PERN, the leak wasn’t an act of sabotage. The southern Druzhba pipeline transits war-torn Ukraine. So far, there haven’t been any leaks reported.

Nevertheless, given that the two Nordstream gas pipelines were damaged in an apparent act of sabotage, the Druzhba oil pipeline could also be at risk of more accidental or deliberate damage.

Where next for oil prices?

Despite the ongoing instability in the Middle East, the war in Ukraine and sanctions against Russia, oil prices remain comparatively low. In nominal terms, oil at $85 a barrel (WTI Crude) or even $92 a barrel (Brent Crude) as of 25 October is below where it was ten years ago. Adjusting for inflation, oil prices are below the historical trendline.

One reason is, of course, the sales from the SPR.

However, there’s been a drawdown in inventories across the board in the US. Total crude oil stocks have fallen from 1,195 million barrels in July 2020 to 846 million on 30 September 2022 – a level not seen since 2002. Less than half of this is due to sales from the SPR.

This across-the-board selling is clearly unsustainable.

Right now, the global economy is slowing down and oil prices do tend to soften during periods of economic downturn. However, the combination of the end of the SPR sales, a possible slowing in the sales of other crude stocks, and reduced output from OPEC+ could send oil prices higher. Any disruptions to European pipelines could hike prices even more.

Do WTI and Brent offer an arbitrage opportunity?

The West Texas Intermediate (WTI) Crude price could be influenced by the drawdown in US stocks, including the SPR. The current $6 discount to the benchmark Brent Crude price could be explained by the apparent glut of oil in the US market. However, once the SPR sales end, there may be less downwards pressure on the WTI Crude price compared to Brent Crude.

According to the BP Statistical Review of World Energy, the WTI discount to Brent averaged $3.98 over the past five years and averaged $2.82 in 2021.

If the above analysis and assumptions are correct, a narrowing of the spread could create a profitable arbitrage opportunity by going short Brent and long WTI.