The Contango Coronavirus Trade
Russia and the Kingdom of Saudi Arabia (KSA) are pumping gluts of oil into an ungrateful market. It’s an act of terrorism. Virus-frozen transportation and manufacturing sectors won’t pay for what they don’t need in this downturn, so an oversupply of the sticky stuff is pushing down prices, overstretching storage capacity, and knocking American shale rivals out of the market.
Forget OPEC. It’s fallen already. This is a geopolitical price war with no end in sight, and an extraordinary plot line unfolding before investors. Every trader wants to know what’s coming next and how to trade it. Keep reading!
The price of Brent Crude is volatile at the moment, but it’s an essential commodity. That’s why countless businesses like to agree on prices in advance of taking delivery for oil, and the way to do that? Fire up the futures market!
‘Amalgamated Widgets hereby agrees to purchase two million barrels from X next year at a price of $36 dollars per barrel.’
That’s a good bit of business, or at least it would be if today’s price of oil was anywhere near $36. But it’s not. It’s lower. It’s $25.47, eleven bucks cheaper, creating a huge future premium (known as a ‘contango’) that businesses are paying. The reason why could make you money!
Amalgamated Widgets really, really doesn’t want to buy the barrels now. That would mean holding onto them for a year, and how? There’s no storage left. Goldman Sachs says land batteries are full, and ocean tankers are, well, getting full. The ‘cost of carry’ is huge!
Now, our community isn’t sitting on its hands. A bunch of land storage and oil tanker stocks have been identified that could go stratospheric. Seamen are agreeing to the futures at $36, buying barrels at spot $25, loading them onto crude carriers plucked from their normal trade routes, and then anchoring down. After one year, $11 made.
You can squeeze two million barrels onto one very large crude carrier (VLCC), and these futures contracts are legally binding. Amalgamated Widgets can’t escape. Amalgamated Widgets can’t hold onto the oil itself, and Amalgamated Widgets can’t afford to risk the volatility. Game. Set. Match!