Friday, February 6, 2009

Oil | Contango Continues Supertanker Storage

The super contango arbitrage remains in play for investors as oil continues to be stored on supertankers in anticipation of prices rising.

Oil companies are still building up vast floating reserves of unsold crude oil on supertankers at sea because oil for immediate delivery is much cheaper than futures prices, traders and shipping brokers said on Friday.

The stockpile, mostly on Very Large Crude Carriers (VLCCs) in the North Sea, U.S. Gulf, in the Mediterranean and off the coast of West Africa, is now so large that it probably exceeds 80 million barrels -- about equivalent to a day's global oil consumption, brokers say.

Despite the recent sale of a handful of cargoes of North Sea crude from a supertanker at Scapa Flow in Scotland's Orkney Islands last week, the economics still make a compelling argument for buying oil now, putting it in a ship and selling it in a few months' time, traders say.

Much of the oil is North Sea crude such as Forties and Brent, but it also includes Russian Urals crude, West African and other grades.

Margins can be locked in at the time of purchase through a series of time spreads or contracts for differences as well as trades on London's ICE futures market.

"The amount of oil stored at sea is increasing steadily and will keep increasing until the numbers no longer make sense," said Simon Wardell, oil analyst at Global Insight in London.

Deepening global recession has dragged oil prices down more than 70 percent since they hit a record high of almost $150 a barrel last July, but oil futures prices are much higher, more than paying for storage and other costs such as financing.

CONTANGO

This discount for North Sea oil now below oil for the future, known as a contango, has been as wide as $8 over the last two months and much of the oil now stored at sea was put afloat in December.

Last week, the trading arm of Royal Dutch Shell (RDSa.L) sold three cargoes of North Sea Forties crude by transshipment, prompting talk that the storage trade might be coming to an end.

The contango had flattened out, allowing Shell and some other companies that had stored oil to cash in and make a profit.

But the discount for prompt oil has deepened again over the last week, partly perhaps because of the release of some of oil from storage, and traders have again started booking vessels on long-term contracts with storage options, shipping brokers say.

BP Plc (BP.L), U.S. oil company Koch and independent Swiss-based trader Gunvor have all been in the market for, or taken options on, VLCCs with flexible, long-term storage options in the last few days, brokers say.

"There is no doubt that the contango play works again," said one oil broker, who declined to be identified. "The margin is there and is being filled."

By early Friday, there was a spread between light, sweet physical North Sea crude for delivery next week and June Brent futures LCOc1 of around $6.75, and closer to $8 against July futures.

Assuming rental rates for a 2.4 million-barrel VLCC of around $60,000 per day, that would put the cost of oil storage at around 75 cents per barrel per month, well inside the time spread even with hefty financing costs.

Many traders now storing oil believe the market for prompt oil will begin to strengthen over the next month or so as promised cuts in production by members of the Organization of the Petroleum Exporting Countries begin to tighten supply.

The onset of the northern hemisphere summer could also spur an increase in demand for gasoline in the United States.

But analysts suggest the sheer size of the floating stockpile represents a threat to any quick recovery in oil prices. The oil will be released on to the market as prices recover, helping to slow or at least dampen any recovery.

"At some point all this oil will come flooding back into the market once the prompt price comes up against the futures," said Wardell. "That is likely to depress prices again."

The super contango arbitrage play is one of the few sureties for investors, and well worth investing in to assure profits.

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