The Energy Report

The oil market is said to be in ‘contango’ (a condition in which distant delivery prices for futures exceed spot prices, often due to the costs of storing and insuring the underlying commodity). It is the opposite of backwardation.

This morning, West Texas Intermediate January oil futures prices were $45.80. This rises to $52.28 by just April. A few days ago, the spread between the first and fifth futures months had risen to $8.06—the highest ever. When oil was at $147, the spread was an average of $3.25, or about 2.5%. You can buy January ‘09 crude futures at a stunning 34.5% lower than January 2010.

That means if you could find a place to store that oil, you could lock in a guaranteed 34% profit, less the cost of storage. Sounds like easy money. What this tells us is that storage for oil is very tight. Without nowhere store it on land, oil producers are leasing very large ships to store excess oil. Storing oil on ships is expensive, so the cost of storage gets figured into the price of oil a year out.

So far, the OPEC nations are not cutting back any significant amount of production compared with the destruction in demand. Oil is backing up in the system. Global demand is down by over 5 million barrels a day to 81.6 million barrels a day. Non-OPEC countries produce almost 50 million barrels; OPEC produces roughly 31 million. OPEC oil production needs to drop by almost 25%, to somewhere under 24 million barrels a day.

Demand could fall further, and excess supply could be at all-time highs within a few months. Longer term, I still think oil is going higher; but it could be wild ride, and the longer term is now a lot further off. I would not want to be long oil for the next few quarters, until there is some serious growth in demand and some cuts in production.