Why the world needs more oil storage

The oil 'contango' - an imbalance between the current and future price of oil - means the world is running out of storage facilities as oil is stockpiled. Eoin Gleeson examines the sector and picks one stock to profit from the phenomenon.

Along a seven-mile stretch of coastline in the west Indian state of Gujarat sits an armada of beached cargo ships in various states of disrepair. With global trade in retreat, the local town of Alang, which harbours the world's largest ship-breaking business, has been inundated in recent months and much of the town sets to work each day with blowtorches and hacksaws, reducing the ten-thousand-tonne vessels to scrap.

But while these ships are being condemned, in the port of Rotterdam they are crying out for tankers. It seems that one shipping trade is holding up even as global demand collapses: the trade in crude oil. The problem is that with the giant fuel storage tanks in Rotterdam now full, there has been a surge in demand for long-range vessels to sit offshore, full of oil. Across the world, record numbers of ocean-going tankers are being hired to store jet-fuel and gas oil as shore tanks fill up, reports Bloomberg's Alaric Nightingale. Few industries face such a large backlog as these tank storage firms do today.

Independent tank storage, where the owner of the tank doesn't own the product being stored, accounts for 12.7% of the world's tank storage capacity, according to the Global Storage Agency. You'll see them in any major port towering tanks designed to hold millions of litres of crude oil and chemicals. They play a vital role in the global oil trade. Oil continues to be sourced from the four corners of the world, so there is constant demand for oil storage in the ports of importing countries. Tank storage also plays a big role in allowing operators to build a series of small cargoes up to quantities suitable for inter-continental shipments, and then an equally large role in breaking down these big cargoes when they reach their destination.

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But the main reason ships are parked off the coast of Rotterdam just now is because of a market phenomenon called contango, whereby futures prices are higher than the price of shorter-term supplies. Right now, you can buy crude oil for $52 a barrel. But you can also lock in a contract to trade crude in December for $84. So with the onshore tanks full and the price of chartering ships plunging, canny traders have found that it's economical to buy up oil and hire the ships to use as floating storage while they wait for higher prices. Rotterdam has seen a 10%-15% rise in ships docked because of contango, says Minco Van Heezen of the port of Rotterdam.

Fears about disruption to oil production are another boon for the industry, says Josephine Moulds in CNBC European Business. Whenever geopolitical tensions surface, you see stockpiling of oil and gas at ports. Those tensions are not about to disappear. In fact, many countries are already taking advantage of the slump in oil prices to stockpile reserves. The Chinese recently acknowledged that all four of their emergency oil reserve tanks holding 100 million barrels are filled to the brim.

The big problem for the storage trade this year will be weakness in the chemicals industry. Emerging markets have been the main engine of growth for the industry in recent years and that engine is clapped out. But the tanks of the major storage groups (see below) are already near capacity. And with a serious shortage in port capacity the 10% capacity that is expected to be added by industry leader Vopak over the next two years has already been rented out, according to UBS analyst David Kerstens this is an industry that will continue to thrive as long as oil remains the world's fuel of choice.

The best bet in the oil storage sector

Vopak (Euronext:VPK), is the world's largest independent owner of storage tanks. The company has a worldwide network of 74 tank terminals, with a capacity of more than 22 million cubic metres across 30 countries. That gives it a market share of about 20%.

Its customers include everyone from oil companies to trading firms, from governments to chemical titans. It recently reported earnings growth of 24% for 2008, as considerable interest in oil storage helped the group to maintain a 95% occupancy rate.

The stock has been unfairly written off, says Jospehine Moulds in CNBC European Business. It now trades on a forward p/e of 9.1 and offers a dividend yield of 4.3%. A large part of the company's contracts are fixed, with only 30% shorter than a year. It hasn't benefited a great deal from contango yet as its tanks were full anyway, but that's one more reason to be upbeat: while Vopak has warned about weakness in storage of chemicals, occupancy will still remain in the 90%-95% range, according to David Kerstens of UBS. Vopak looks too cheap for a company with such a dominant position in a thriving industry.

Eoin came to MoneyWeek in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.