Contango and Storage Arbitrage

Michael Giberson

From the Houston Chronicle, “Oil players stockpile cheap crude on tankers“:

…the oil market has gone into contango, a condition in which the current price of crude is less than contracts for future delivery of oil months from now. That’s motivating players in the energy market to stockpile.

Here’s why: Oil purchased Friday for $41.68 a barrel could immediately be sold through a forward contract for September delivery at a price of $52.85 a barrel. That’s a gross profit of more than $11 per barrel before storage costs.

Those costs vary, but tanker rates have been dropping and [Simmons & Company International analyst Jeff] Dietert says chartering a vessel that holds up to 2 million barrels of oil is running about $60,000 a day. That means storing oil at sea for six months would cost roughly $1 per barrel per month, leaving a profit of more than $5 per barrel.

An investor must tie up nearly $100 million in capital, and may have insurance fees and other transaction costs, but ends up with a nearly riskless transaction that generates about a 10 percent return in six months.

While there have been reports that tanker leasing costs are up dramatically on storage demands, the mid-range outlook is not strong for the tanker industry as ship builders are expected to complete the highest number of new tankers in 35 years during 2009 even as oil consumption will fall due to macroeconomic conditions.

Tankers full of oil are idling in the Gulf of Mexicon, circling the Orkney Islands in the North Sea, and parked offshore of once booming Asian economies according to the Chronicle.  Probably safe spots, but investors would do well to avoid parking their tankers anywhere near the Gulf of Aden, that strip of sea between Yemen and Somalia nicknamed “Pirate Alley.”  Despite increased international patrols, pirates seized another ship on January 29.