Enrico has been studying the oil futures market, and learning a lot. Well, he must confess, everything he knows about this, he has learned in the last two weeks.
Oil futures are a contract to take delivery or make delivery of oil at a specified date in the future. Unlike options, the buyer or seller of the contract is obliged to fulfill it. “Take delivery” can mean settling with cash or with a longer dated future contract. In other words, if one contracts to buy 1000 barrels of oil on March 15, 2009, at $44 per barrel, and the spot price for oil at that time is $40 per barrel, the buyer of the contract can simply pay the seller of the contract $4,000, and be done with it.
Normally, you’d expect the price of oil in the future to be roughly the sum of today’s spot price, plus the cost of storage of the oil until that point in the future. In other words, if the spot price today is $40, and it costs $1 per barrel per month to store it, you’d expect the futures price one month hence to be very close to $41. The reason for this is simple to understand: if the future price is much higher than this, everyone will buy oil and store it to make a risk-free profit. This ought to force the prices back to the point of this equilibrium.
It is typical that oil futures are higher than the spot price. This is called a “contango” market, from a Latin root word which also gives us “contingent,” denoting the contingent future delivery aspect of the futures contract.
Well, right now, the spot price for West Texas Intermediate is about about $41.70, and the price of the futures contract that settles roughly mid March 2009 is about $47. This is a SUPER contango.
As best Enrico can determine, the problem is that all available oil storage in North America is completely full. Thus, the normal market mechanism to bring these two prices closer is going haywire. It does, of course, still reflect the sum of the spot price and the price of storage, but the price of storage has become comparatively astronomical, even if you can find it. People are renting tankers to store oil. It is a no brainer: buy at $41, sell at $47, make $5-6 per barrel in one month. IF you can find storage.
Enrico guesses that another issue may be that the usual suspects who use their capital to perform this public service of market efficiency may be temporarily absent from the market due to an embarrassing but purely temporary problem of liquidity. These days when the phone rings on Wall Street you can be sure it is either a margin call or a call to come identify the body of another trader who has somehow tumbled to his death from a great height.
Here’s another oddity: until 2007, the price of North Sea Brent, which is the Europe-traded comparable grade of crude to West Texas Intermediate, was typically a few dollars a barrel cheaper than WTI. Right now there is a $6 premium for Brent. This is very strange, because oil can be shipped to the market delivery point for Brent for waaaaay less than $6 per barrel.
Enrico frankly doesn’t know what’s going on, exactly. Certainly this is an odd situation. Usually, these types of oddities are resolved with a relatively high degree of drama. Enrico is NOT suggesting some kind of trading maneuver. He thinks he’d be taken out and shot if he did that.
But it is certainly interesting.