I haven’t ever had a habit of carefully following oil prices, even when they are entertainingly volatile. I don’t know much about commodities beyond the concepts I had to learn twenty years ago to get a specific securities trading license that would allow me to collect fees on alternative investment vehicles. I don’t even care about the price of gas when I fill up my car. I can tell you which gas stations sell tamales though.
But since I decided to gamble (and I do mean gamble) in the commodities casino when the price of oil crashed and exploration company stocks were more than sliced in half, I have kind-of, sort-of been following oil. (Yes, I am still holding that turd stock hoping it will pay off when the world is bailed out by the collective printing press.)
Contango is a term for when the futures price of a commodity is higher than the spot price (the asset’s current price in the market). Contango occurs when the price of an asset is expected to rise over time. When this occurs, commodities traders have an economic incentive to store – physically store – as much of the commodity as they can get their hands on.
Back in 2008 the economy suffered from massive oil demand destruction. The result was an epic contango structure in the futures curve which encouraged traders to charter tanks to store oil.
A contango (the opposite of backwardation) manifests whenever the price of commodities in futures contracts is higher than the cash price of commodities available today.
This allows traders to profit from buying cheap oil today and selling it on the futures market at a premium tomorrow. As long as the cost of storage is lower than the profit generated by the trade, the market structure encourages hoarding.
In 2008 the contango got so big (it was known as the super-contango) the economy ran out of spare capacity in on-the-ground facilities to store it in. But the profitability of the contango trade was so huge it actually paid to charter tankers explicitly just for the purpose of storing oil.
It’s sort of like buying up all the toilet paper in January and then selling it for all-your-401k-is-belongs-to-me today.
Here we are again, in the same scenario as 2008, where there has been a massive demand destruction in oil, thanks to governments thinking it is a grand idea to shut down the entire global economy so senior citizens do not catch a cold virus, and a price war between the Saudis and Russians.
Is it profitable to store oil now and sell it for a later time? There are reasons to believe there might not be:
The problem the sector is now facing is that there will probably not be enough physical storage capacity to park all the unneeded global oil supply for the duration of this crisis.
If that’s true, some fields may have to be shut down irrespective of what Opec targets dictate. Not doing so would pose an environmental disaster, otherwise.
But again it’s not as easy as just turning off the tap.
Some fields are much less capable of adjusting their pump rates than others. This is especially true of Russian fields, where temporary shutdowns pose the risk of them never being able to be revived at the same rates again.
People are now talking about a $10 target for WTI. We’d argue that in a scenario where there’s literally nowhere to put oil, it’s not inconceivable prices could go negative.
Such rates would indicate that permanent supply destruction — which might never be brought back again — was now going on. Which would be a big problem for the world if the same rate of economic activity as before was returned to post Covid-19.
Negative prices on oil? As in, they can’t stop pumping out oil because they hate each other, but there’s no place left to put it, they’ve filled up all their palace bathtubs, so they are going to pay people to take it off their hands? No way, I give up.
I don’t know if you’ve ever been to London, Kentucky, but I have. It’s a lovely small town (population 8,006) in the Appalachians with wonderful people. And those nice people seem to be hoarding an epic ton of gasoline because it suddenly dropped below a dollar a gallon:
GasBuddy analyst Patrick De Haan was tipped off by users of the GasBuddy app that the Spur 7 BP in on state route 25 in London had dropped below a buck.
Don’t head there looking for a deal right now, though, because an employee at the station told Fox News Autos that the price was already 99 cents on Wednesday and that they’re currently sold out of fuel and didn’t know when the pumps would be open again.
I mean, maybe all of the gasoline was bought up by people traveling through the mountains. But I’d like to think there are some people up there with bourbon barrels full of gasoline in the back 40.
This has been a crazy week.