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WSJ on Oil Prices



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Environmental Capital examines why oil is trading at a discount to future prices:

How severe is the global oil glut? It’s the worst in at least a decade, if oil-market tea leaves are any guide.

Crude oil for delivery next month is now trading at a whopping $15 discount to oil for delivery in January 2010. When far-out oil prices are higher than “prompt” oil prices, traders say the oil market is in “contango.” The dance the market is doing now is a “super-contango” — the spread hasn’t been that big since oil prices collapsed in 1998, Bloomberg reports, and it widened slightly today.

The contango is basically a surplus-o-meter: When the market is well-supplied with oil, near-term prices lag future prices. It’s also usually self-correcting. Oil companies and traders can snap up oil, store it, and make money off that future price premium. That buying and selling generally squeezes the contango back into shape, the same way arbitrage closes the gap on share prices.

So why is today’s super-contango only getting bigger? Because it’s now acting as a credit-crunch-o-meter as well. The main limitation to taking advantage of fatter future prices is financing the cost of buying and storing the oil. With credit markets frozen, many of the smaller players that would normally be diving head first into the contango are left on the sidelines. So the market’s normal self-correction isn’t happening.

Not everybody is weeping, though. Big oil companies have healthy cash flows, so they don’t need external financing, and they have easy access to floating storage in the form of crude supertankers. That explains why oil companies like Shell have contracted more than 16 supertankers (including our friend the Leander) to simply hold onto crude until prices go up. Bloomberg estimates that there’s now more oil floating at sea in storage than held in the U.S. oil repository at Cushing, Oklahoma.

What will it take to rein in the contango? A more-balanced supply-demand picture in the global oil markets. And with demand seemingly headed south in every major economy, that just leaves the supply side of the picture. All the more reason to keep an eye on how large a cut OPEC decides on later this month in Algeria.



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