Contango In Oil Markets Explained

The supply glut in the oil market has led to a contango price structure, in which oil futures are priced higher than their spot price. Lynn Cook, an energy reporter with the Houston Chronicle, says the glut in oil supply is related to the economic recession.

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MICHELE NORRIS, host:

Today OPEC agreed to cut its oil production by 2.2 million barrels a day in an effort to stem falling prices. The White House called the action short-sighted, but there's a lot more oil in the market right now than is being used. How big is this oil glut? So big that oil companies are running out of places to store their excess crude. So they're keeping it offshore in ships. A couple of dozen supertankers holding millions and millions of barrels of oil are being used for storage instead of transportation. Lynn Cook covers the oil beat for the Houston Chronicle and she joins us now to discuss what's happening with this glut. Welcome, Ms. Cook.

Ms. LYNN COOK (Energy Reporter, Houston Chronicle): Hi.

NORRIS: I understand that there's a very interesting term to describe this market condition.

Ms. COOK: There is. It's called contango, which actually may sound like a lightning round at the end of "Dancing with the Stars," but it's actually this strange economic phenomenon that's going on right now where oil prices today are a lot lower than at any time going forward in the future - in the futures market.

NORRIS: Why is this happening?

Ms. COOK: Usually, the market goes into contango when there is a supply glut, when there's too much oil on the market. And this is what we've seen happen just in the last few months as the recession fully set in and people realized the days of easy credit and high oil prices are gone. You know, there's just a lot of oil floating around with no demand to take it up.

NORRIS: So you note the "Dancing with the Stars" reference. It almost sounds like a high stakes game of cards or something where you have to decide whether to buy, hold, or sell. In this case, they're holding.

Ms. COOK: Yeah, that's actually a good way to put it because it is an arbitrage play. I mean, basically, if an oil trader wanted to buy a barrel of oil today for $43, he could do that or she could do that. They lock in that price. They sell a futures contract for that oil down the road. They could get, you know, if they wanted to deliver that oil a year from now, in January 2010, they could lock in $53 per barrel. And that's a 22 percent profit margin. So what's not to like if you're a trader? I mean, you can do a deal today and lock in your profits today, and all you have to do is find a place to store it in the meantime.

NORRIS: I'm just curious. Why are they looking to supertankers to store this oil? Why not store it onshore, on ground?

Ms. COOK: Well, it's just that storage is really tough to find on land. Every little nook and cranny has been filled up in the last several weeks, and it makes sense to take a supertanker that's sitting there and not transporting oil, fill it up, and just either park it in a port or set it on a slow drift across the high seas and wait until the demand comes back.

NORRIS: Sounds very expensive.

Ms. COOK: You know, the prices range anywhere from 40 cents a barrel to $2 a barrel to store oil on a tanker. But you know, if you can lock in a $10 per barrel premium, you can easily afford to do that.

NORRIS: The price of oil slid to its lowest point in more than four years today. It's an eight percent drop down to 39.99 a barrel. When do you think we'll see higher oil prices?

Ms. COOK: You know, I talk to people about this all day, every day. And every person I talk to has a different opinion. Guy Caruso, who's at the Centers for Strategic and International Studies, spoke at an energy conference here in Houston last week, and he said he thinks it's going to be 18 to 24 months before we see any real meaningful, long-term rebound in oil prices. And he predicted that even then, it's going to be a crude oil price of 60 to 70 dollars a barrel, which is half of what we saw this summer.

NORRIS: Lynn Cook is a reporter with the Houston Chronicle. Lynn, thanks so much.

Ms. COOK: Thank you.

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