What Are Super-Contango Oil Profits?

by William Davies
(UK)

Normally the futures price of a commodity a few months out is higher than the current spot price and the difference is called contango.

After the big fall in crude oil prices and the decision by OPEC last December to cut significantly its oil output by 2.2 million barrels per day, many observers expect the price of oil to begin its steady climb back towards the $70 level.

Indeed King Abdullah of Saudi Arabia said before the OPEC meeting in Oran, Algeria that a price around the $70 mark would be best for both producers and consumers.

What happened recently can best be described as an example of super-contango, where the growing differential between the futures price and cash spot price of oil is attracting the attention of a growing number of traders who can see big profit potential.

The NYMEX US light, sweet crude oil futures contract for February delivery expired last Tuesday (20 January 2009) trading just above $34 a barrel, a fall of 77 per cent from the July high of $147 last year.

But the interesting part is that the NYMEX crude futures contract for June delivery settled at an astonishing $52 a barrel. In this example, that is an amazing premium of $18 a barrel.

Is it any surprise that we get reports of companies hiring supertankers with a capacity of 1 million, maybe 2 million, filling them with oil and anchoring the tankers off the coast as mobile storage.

The excess profit potential is hugely attractive.

In fact as early as last December, Royal Dutch Shell had leased some supertankers for this very purpose, parking the cargo of crude oil off the UK coast.

Paying for the storage even for 4 to 5 months at say $1 per barrel would still leave a profit of $17 a barrel in the above example.

So storing 1 million barrels of crude oil nets the investor $17 m when they sell the contract for June delivery.

Benchmark indexes for commodity shipping rates such as the Baltic Dry index have been moving up sharply in recent weeks after a massive slump in the last few months of 2008, in the aftermath of the fall in commodity prices.

Since early January tanker rates have risen by around 50 per cent as more companies are cashing in on the developing super-contango effect in crude oil prices.

No it appears as if even some investment banks are getting in on the arbitrage.

And as more tankers are taken up for this mini-arbitrage exercise, there will be fewer free left on the market and so we can expect tanker rates to rise even further.

According to Money Morning there could be as much as 80 million barrels of crude oil sitting in tankers anchored off coastlines across the world, which equals about a day’s world consumption.

So what about OPEC? Will it follow through on its stated commitment to cut output by 2.2 m barrels per day as agreed at its December Conference in Oran, Algeria.

The current global economic downturn is causing a continuous destruction in demand for crude oil and the OPEC cuts would, if carried through in full, make a big dent in supply and bring it back into equilibrium with consumption.

Just think about this super-contango opportunity that many commodity trading firms are now exploiting to maximise profits.

What is the difference between storing oil in moored supertankers and just leaving it in the ground?

None that I can see apart from the cost of leasing a tanker, and so it begs the question:

Why are most OPEC members dragging their feet on carrying out the agreed production cuts, as this would mean that they could profit in the same way as those storing oil in supertankers?

Is it perhaps because they need the revenues and that cash in hand is more important than oil in the ground?

Let's see over the next few months whether this super-contango effect continues or we return to the normal relationship.