Marin Katusa: You may have come across the word “contango” in an oil-related news report or article recently and wondered, “What’s contango?”
It isn’t the Chinese version of the tango.
Contango is a condition in a commodity market where the futures price for the commodity is higher than the current spot price. Essentially, the future price of oil is higher than what oil is worth today.
The above forward curve on oil is what contango looks like. There’s more value placed on a barrel of oil tomorrow and in the future than over a barrel today because of the increased value of storage.
I personally believe our resource portfolios are in portfolio contango—but that’s an entirely separate discussion that I’ll get to later. In today’s missive, I want to focus entirely on oil contango.
Crude oil under $50 per barrel may seem to put most of the producers out of business, but many oil and gas exploring and producing (E&P) companies are sheltered from falling prices in the form of hedges. Often, companies will lock in a price for their future production in form of a futures commodity contract. This provides the company with price stability, as it’s sure to realize the price it locked in at some future date when it must deliver its oil.
But the market will always figure out a way to make money—and here’s one opportunity: the current oil contango leads to plenty of demand for storage of that extra oil production.
With US shale being one of the main culprits of excess crude oil production, storage of crude in US markets have risen above seasonally adjusted highs in the last year. This abundance of stored crude has pushed the current spot price of crude oil toward five-year lows, as current demand is just not there to take on more crude production.
When in contango, a guaranteed result is an increase in demand for cheap storage of the commodity, in order to clip the profit between the higher commodity price in the future versus what’s being paid for the commodity at present. This is precisely what’ playing out in oil today.
Contago, Five Years Later
Looking back at the similarities of the 2009 dramatic free-fall in oil prices to $35 per barrel, after a five-year hiatus, crude has returned to a similar price point, and the futures market has returned to contango (green shows oil in contango).
Floating Storage Is Back in Vogue
Oil traders are now taking advantage of the contango curve through floating storage in the form of waterborne oil tankers.
This is what a big oil tanker looks like:
I’m personally reminded of contango whenever I look out my living room window:
Here’s a photo taken out my living room window—and this is non-busy part of the harbor. At times when I do my runs along the seawall, there have been up to 30 large oil tankers just sitting in the harbor. (On a side note, Olivier and I went for a run in July along the Vancouver seawall, and we counted 26 oil tankers.) All that pricey Vancouver waterfront will have an incredible view of even more oil tankers in the years to come when the pipelines are eventually built. I can only imagine what the major import harbors of China and the US look like… never mind the number of oil tankers sitting in the export nations’ harbors and the Strait of Hormuz. Multiply the above by at least 50 red circles.