Contango: The Most Profitable “Buy-and-Hold” for 2009
by Matt Weinschenk, Senior Analyst, White Cap Report
A different buy-and-hold strategy has become the #1 profit-maker for 2009. And I’m not talking about stocks.
Direct investments in oil, right now, are paying off in spades. And it’s because oil markets are… well, totally screwed up.
Right now, you can buy oil for $36 a barrel. And you can lock in a contract to trade oil in June for $51.30. When futures prices are higher than current prices, it’s a situation called “contango.” Oil markets expect a little bit of contango, but the spreads we’re seeing today are off the charts.
Of course, any time there is a market anomaly this severe, there’s got to be a way to profit.
The Forbidden Contango
The reason such a large contango is rare is because it’s too easy to profit from it. If you were so inclined, you could right now buy the actual physical oil for $36 a barrel, keep it for six months and have a locked in price of $51 in June. Traders do this all the time. All of that buying and selling generally brings market prices to levels where there isn’t such a large profit to be made.
So where is the breakdown in today’s market? Storage capacity has run out. Oil tanks are filled to the brim. Instead of traditional on-shore tanks, investors have taken to borrowing tanker ships, filling them up, and letting them float offshore.
(Doesn’t sound like that could be profitable? Let’s say you could get your hands on a Suez-max tanker. They run about $46,000 per day for rental and max out at 1 million barrels. With current spreads, that’s $15 million for an outlay of $8,280,000. Easy money!)
When there’s money like this being made, we’d like to earn our share.
I’ve looked into building some storage tanks in my backyard. But I’ve decided I’m not that handy.
So we’ll have to figure out exactly what is happening to find a chance to profit.
Where Has This Anomaly Come From?
Right now, world production for oil is about 73.8 million barrels per day (mbd) . But apparently we’re not using quite that much and we don’t have anywhere to store the remainder. That is part of the reason that prices have cratered.
Traditionally, OPEC would slow down production. If you can sell oil now for $36 and in June for $51, why pump any now? Save it for later and boost production during higher prices, right?
Well, they are not doing that. Production is still at 99.6% of what was pumped at June’s record highs. The question is why.
There are two theories. Generally, oil-producing companies are not the most forthcoming with reliable facts, so it’s hard to confirm either one.
First, consider that there’s a global liquidity crisis, collapsed asset prices, and instability in the Middle East. Could oil-producing countries be hard up for cash?
Middle Eastern countries make about one-fifth the revenue they did in June because of oil prices. And they invested heavily in American stocks that are down 44% off their peak. If they got a little reckless during the boom-times… they may have more bills than they can cover right now.
So while they may be able to make more in June, they need to get any money they can right now… leading them to sell oil at depressed prices.
The second possibility is that production is already maxed out. If the 85 mbd they are producing now is the max they could produce in June, there’s no incentive to slow down production now, because they can’t ramp it up when prices are higher anyway. (Slowing down today would still pay off in the very long-term… but it seems no one thinks on that time frame in the financial world anymore).
Each of those scenarios leads to a different way for the average American investor.
Profits for Those of Us Who Aren’t Oil Barons
In the first scenario, the Middle East cash grab, expect storage investment in storage to pick up. Companies like Teekay (NYSE: TK) and Frontline (NYSE: FRO) that manage and lease tankers should get a boost. As well as refiners like Valero (NYSE: VLO) and Marathon Oil (NYSE: MRO) as they take in extra crude at low prices.
In the second scenario, maxed out capacity for oil producers, drillers and explorers will return to prominence. Expect to see a resurgence of offshore oil drillers like Transocean (NYSE: RIG) and Atwood Oceanics (NYSE: ATW) and on-shore drillers like Nabors Industries (NYSE: NBR).
At the White Cap Report we’re currently scouring for some smaller cap innovators providing new niche technologies to oil providers. As oil marches back to up more reasonable valuations in the $50 to $70 range, oil companies will want to increase production… but with smart and efficient technology.
In any case, the there are two things that won’t last for too long: oil contango and low prices.
Ahead of the tape,
Matt Weinschenk
Companies mentioned in this article: TK, FRO, VLO, MRO, RIG, ATW and NBR
Related Investment U Articles:
- Why It’s the Perfect Time to Invest in Shale Oil Stocks
- Upward Pressure to Remain on Brent Crude in 2012
- Backwardation: How to Play the Moving Oil Market
- The Data Storage Sector Succumbs to Takeover Fever
- WTI Crude: Cheaper Than Brent Oil for the Foreseeable Future
One Response to “Contango: The Most Profitable “Buy-and-Hold” for 2009”
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Hi Matt,
I totally agree but I don’t know how to invest in physical crude oil. Could you please point to who can provide the total package: buy and sell crude, arrange for storage and all logistics involved.
Thanks..Anh
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