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Oil and contango

There are very high levels of oil storage at present are the main reason for oil prices to go below US$50. Why are the storage tanks so full reports The Economist?

1. OPEC’s agreement with non-members such a Russia to cut production from 1st January attracted a lot of demand to take advantage of future price increases. This did produce higher prices which win turn encourages more supply as American shall producers started to pump more oil. American oil rigs have increased in number from 386 in 2016 to 617 in 2017 producing 400,000 barrels of oil a day more than the low levels in September 2016. Much of the oil has gone into storage terminals.

2. Before OPEC cut production it increased output and exports. A lot of this oil went into storage in the USA as refineries there were down for maintenance reasons.

3. Futures prices of oil are closely related to the level of inventories. It was hoped that the OPEC cut in production would push the futures market into ‘backwardation’ – short-term prices are greater than long-term (futures) prices which means that purchasers will use the oil rather than storing it. However with the release of US storage levels the immediate price of oil fell in comparison to longer-term rates – referred to as “contango” which makes it worthwhile to buy oil and store it. It is estimate that the price of storing a barrel oil is 41 cents per month compared to contango of 65 cents for the same period. Therefore you make 24 cents on each barrel. See video below from EKTInteractive.

So the more oil stored the lower the short-term prices go – the challenge is to break the loop. Maybe oil output cuts beyond June may force some to release their inventory.

Source: The Economist 16th March 2017

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