The Daily Mail discovers contango | FT Alphaville

The Daily Mail discovers contango

We love talking about contango on FT Alphaville.

But no one, it turns out, can turn a nerdy market-structure story about the shape of the futures curve into an alarmist `evil speculator’ rant extraordinaire quite like the Daily Mail.

Indeed, as the Daily Outrage paper reports on Thursday, there are “Sharks off the British coast” in the form of oil tankers “refusing” to unload until prices rise, and “keeping YOUR fuel costs soaring”.


As it’s just so entertaining, here’s the bulk of it (emphasis of unnecessarily emotive language and questionable facts, FT Alphaville’s):

These tankers have been parked off our shores for months, refusing to unload their oil until prices have risen even higher. The delay makes millions for speculators… and keeps your petrol costs soaring.  Laden with fuel, three oil tankers sit idly within sight of the British coastline, playing a waiting game that is driving up petrol prices for hard-pressed motorists.  They are part of a flotilla of ten vessels refusing to unload their cargo until market speculation has driven up its price to the level they want. And as the value of that cargo is currently rising by over £1million a day, driven partly by profiteering traders and speculators, [err what traders aren’t supposed to be profiteering?] it is unlikely to see a petrol station any time soon.

With such tactics, it is not hard to see why prices at the pumps are forecast to have risen by 26 per cent in a year by this Christmas.  AA president Edmund King said [for he would know best]: ‘Traders and speculators seem to be storing up oil until the price rises. Drivers can expect more hikes in the pipeline. Motorists are paying the price of this at the pumps.’  Residents near Brixham in Devon have watched with growing anger as the tankers have anchored in Lyme Bay for the past two months.  The price of a barrel of oil has increased from $40 a barrel a year ago to $80, with the cost expected to soar even higher in the next few months [err, not by everybody].

Even from the start of the tankers’ stay in Lyme Bay, the value of the oil they carry has risen from £313million to £378million – an increase of £65million, or more than £1million a day.  It means a 21 per cent profit for doing nothing more than simply watching and waiting [err paying freight rates and monitoring specs too please].  Record amounts of fuel are now being stored in such a manner around the world – indirectly helping to push up petrol prices on the forecourt [indirectly being the key word we would say].

Oil pumped out of the ground by the major producers such as BP, Shell and Exxon goes by pipeline to tankers which then circle the globe.  In the course of their journey the oil may be bought and sold to different traders many times on the international commodity markets, often in just one day.  Some of these unidentified oil traders may be big-name players within the industry, but others could be the ‘Arthur Daleys of the international oil world’ , say City experts [David Buik?].

The price drivers pay at a forecourt – currently touching 110p-alitre or £5-a-gallon – is largely determined when the oil reaches an onshore refinery, from where it takes two months to work its way through to the pumps.  But until it gets to the refinery speculators are free to drive up the price thanks to the age-old capitalist model of supply and demand [The Daily Mail is a communist publication now?].

If the price is not high enough, the tankers simply cruise around the high seas – or park in a safe haven – until it goes up sufficiently high to sell on in the UK or elsewhere.  City analysts say the refusal to unload ultimately drives up the price motorists pay at the pumps.  Experts say every $2 rise in the price of oil puts 1p on the price of a litre – adding 50p to every fill-up.  In total, the Lyme Bay tankers carry a million tons of oil.  Once refined, that will create 250,000 tons of petrol – equivalent to 340million litres – enough to fill up nearly seven million Ford Mondeos.

A spokesman for Brixham coastguards said the huge ships were now a familiar sight in the bay: ‘Some have been there two months or more,’ she said.  ‘They’re awaiting orders. The cargo will be worth more now than when they first arrived.’  As the Mail reported on Tuesday it was disclosed that petrol prices were on track to have soared by 26 per cent this year – fuelled by speculators and tax rises – and were set to hit 110p a litre by Christmas.  They are already at 108.6p a litre with diesel just short of an average £5 gallon at 109.8p a litre.  The last time prices were so high was when oil was trading at $100 a barrel in September 2008.

The extent of oil speculation is even beginning to alarm producer countries. The Arab-dominated OPEC oil cartel warned last week it will increase supply and thus reduce the price if the speculators do not relent [????].  One of the giant crude oil tankers, the 159,300-ton SKS Segura, registered in Norway, first arrived on September 24 – more than eight weeks ago.  The 50,300-ton Tristar Kuwait tanker, registered in the Bahamas, has been awaiting orders in Lyme Bay since September 2.  Another anchored in Lyme Bay is the 43,000-ton Alkman, also registered in the Bahamas, which arrived on November 1.  The 72,000-ton Petali Lady, registered in Liberia, has been anchored in Lyme Bay since September 27.  And the 99,000-ton Danishregistered Torm Ingeborg has been there since October 10.  This is not the first time tankers have anchored in Lyme Bay. Several ships did the same last April before moving on.

Oh and if you’ve not had enough of oil tanker outrage, you can also read Alex Brummer’s editorial on the matter entitled “Held to ransom by the oily spivs“.

All we have to say is this:

Oil traders are storing oil in tankers because the market structure allows them to; the structure is reflective of there being a glut of supply on the market. And there isn’t enough onland storage. Opec turning on the taps therefore would not, as per the Daily Mail’s useful suggestion, solve the problem.

Prices are not dropping, if anything, because oil is proving an inflationary hedge against unconventional international monetary policy — a fact that arguably has disconnected crude prices from physical reality.

Most “city experts” would, we suggest, agree that commodity prices converge with supply and demand fundamentals in the end.

What’s stopping the world from being overloaded with surplus crude and products in the meantime, however, is the ability for physical traders to store these volumes cheaply on tankers instead. This is only possible because tanker rates are still depressed versus historical norms.

If tanker rates go up, there is a risk — if any — that too much crude and product might be released to the market, something which would end up hurting already vulnerable European refineries, especially if demand for products was still weak.

As Fitch reported just on Tuesday, the sector is already struggling on cash flow, “with no signs of a recovery yet”.

Fewer operational refineries in Europe in the long run (when demand recovers) would, of course, be bullish for gasoline prices.

Something — to use Daily Mail ‘speak’ — that’s bad for UK motorists.

As for traders “profiteering” from the contango: the trade is nothing more than the market attempting to resolve its imbalances. By buying cheap and selling forward, traders help push front-end prices higher and long-dated prices lower. They do this until the  “contango” physical trade peters out and is no longer cost effective.

The fact the contango trade has lasted this long is proof, if anything, of just how great the imbalances have been.

Related links:
Goldman warns of near-term downside risk in WTI
– FT Alphaville
Is oil about to have a physical reality check?
– FT Alphaville