Tuesday, January 13, 2009

Super-Contango in the Oil Markets

The oil market is currently in super-contango (forward prices are much higher than current prices). February crude oil is trading at $37.12 per barrel, while May crude is trading at $49.26 per barrel. This is an opportunity for instant profit. Buy current oil, sell it in the futures market and lock in the difference (less storages charges) as profit.

Indeed, shipping prices, which collapsed as trade slowed last year, are now rising sharply as oil traders fill oil tankers and moor them off Scotland, according to WSJ . They hold the oil in the tankers and deliver them against the futures contracts they have sold.

However, even these arbitrage activities have not been enough to reverse the contango.

Why aren't oil producers, themselves, also holding oil off the market to sell in future months at higher prices?

Most likely it is that the international demand for cash that has crashed the oil price, has put oil producers in a desperate situation to maintain their own cash flow at pre-crash levels, to support the oil bull market life styles they are accustomed to. Thus, the oil they are extracting, they are selling at current rates, because like General Motors and the real estate industry, they are suffering from cash flow problems.

Once Bernanke's huge money injection works its way into the economy, the contago will disappear by current prices moving higher, and eventually moving above future market prices.

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