Avoid USO because oil in contango?

[srm555]

One of the TV traders who is essentially thinking oil will go back up said to avoid playing oil by using the USO ETF because oil is in contango. What is the logic here?

[XOM]

Sounds like he was confused about the meaning of contango. It's the same reason that some Nymex traders are taking actual delivery and leasing supertankers to store crude.

[aiki14]

I agree with X, that doesn't make sense.

[clavocat]

What he means is that the contract now is cheaper than next month by a good margin. When USO renews the contract they will sell the current for less than next months contract (causing a loss of some money). When we were in backwardation, it was the opposite, exactly why USO had great returns above and beyond actual crude. Since it is lower today, capitalists are buying the crude now and selling the contract for some arbitrage (riskless money). This arbitrage opportunity probably would not be available if we weren't so deep in this credit crunch.

[ZaNoob]

Does anyone here think the contango is caused by the storage costs? Assuming oil keeps getting pumped out and the current glut remains then sooner or later those hoarding the oil will have to sell at a loss. Unless of course the prices get a nice jump. I could be talking apples and oranges here since I'm not into oil.

[clavocat]

Does anyone here think the contango is caused by the storage costs? Assuming oil keeps getting pumped out and the current glut remains then sooner or later those hoarding the oil will have to sell at a loss. Unless of course the prices get a nice jump. I could be talking apples and oranges here since I'm not into oil.

To my understanding, they already sold the oil in the future via futures contract.

[XOM]

Saw a story on Bloomberg last night talking about how the December contract has come in quite a bit (about $10 from early Jan prices) and Shell actually unloaded and sold the crude it had one of the supertankers it leased for storage because the storage costs were infringing on the risk/reward basically.

The lower that December contract goes the more it will force the traders to liquidate, flooding the market again and further depressing prices.

The contango situation doesn't make a whole lot of sense unless the economy recovers in the second half, but even if does turn around then after getting worse in the meantime (as is the consensus from so called experts), the crude trade will have to start it's rise upward from a lower starting point than futures prices are currently indicating.

[XOM]

I misquoted the differential reduction it's dropped closer to $7 than $10.

Anyhow, here's a decent article explaining the trade with figures on what they pay for storage in Cushing and on tankers plus financing costs;

In the worst year ever for oil, investors can lock in the biggest profits in a decade by storing crude.


Traders who bought oil at the $40.81 a barrel on Dec. 5 could sell futures contracts for delivery next December at $54.65, a 34 percent gain. After taking into account storage and financing costs investors would earn about 11 percent, according to Andy Lipow, president of Houston consultant Lipow Oil Associates LLC. The premium, known as contango, is the biggest for a 12-month span of futures since 1998, when a glut drove crude down to $10.


Stockpiling crude may provide higher returns than commodities, stocks and Treasuries as the U.S., Japan and Europe endure simultaneous recessions for the first time since World War II. Crude sank 72 percent in New York since peaking at $147.27 in July. The Standard & Poor’s 500 Index fell 40 percent this year and two-year government notes yield 0.9 percent.


“The bottom line is that you buy crude at a low price and lock in a profit by selling it forward,” said Mike Wittner, head of oil market research at Societe Generale SA in London. “It’s low risk. The contango can definitely pay for storage and the cost of capital and leave plenty left over.”


Royal Dutch Shell Plc sees so much potential in the strategy that it anchored a supertanker holding as much as $80 million of oil off the U.K. to take advantage of higher prices for future delivery. The ship is one of as many as 16 booked for potential storage instead of transporting crude, said Johnny Plumbe, chief executive officer of London shipbroker ACM Shipping Group Plc.
The tankers, if full, hold about 26 million barrels worth about $1 billion, more than the 22.9 million barrels sitting in Cushing, Oklahoma, where oil is stored for delivery against Nymex contracts. U.S. crude inventories rose 11 percent this year to 320.4 million barrels, according to the Energy Department.


“All the market operators keep placing oil in storage,” said Francisco Blanch, head of global commodities research at Merrill Lynch & Co. in London. “Even though the contango is steep, it could get steeper.”
Crude oil for January delivery rose as much as $2.66, or 6.5 percent, to $43.47 a barrel in electronic trading on the New York Mercantile Exchange today. It was at $42.86 at 11:53 a.m. London time.
Blanch said last week that oil may fall to $25 a barrel should the Chinese economy slip into recession and the Organization of Petroleum Exporting Countries fail to take enough crude off the market.


The Hague-based Shell, Europe’s largest oil company, last month chartered the supertanker Leander with an option to store North Sea Forties crude, according to Paris shipbroker Barry Rogliano Salles. The vessel arrived at Scotland’s Hound Point, the loading port for Forties, on Nov. 20, according to tracking data compiled by Bloomberg. Sally Hepton, a London-based spokeswoman at Shell, declined to comment.


Shell and Koch Industries Inc. of Wichita, Kansas, also hired four supertankers to hold oil in the U.S. Gulf Coast to take advantage of rising prices in the months ahead. They took Very Large Crude Carriers, or VLCCs, to move oil from the Middle East, said Bruce Kahler, a broker at Lone Star, R.S. Platou in Houston.


Koch Supply & Trading LP spokeswoman Katie Stavinoha declined to comment.
Demand for tankers to store crude oil may help revive the share prices of shipowners including Knightsbridge Tankers Ltd., down 43 percent this year, economist Dennis Gartman said in today’s edition of his Gartman Letter.
“If contango has gone so far in crude oil where Shell and Koch and others are chartering ships to store oil on the water, then demand for tankers is rising,” he said. “Shares of the tanker companies must be ‘cheap.’”


The cost to store crude at Cushing averages about 35 cents a barrel a month, Lipow said in an interview. The cost of financing the crude would also be about 35 cents a month. A trader would have to take ownership of the oil in January 2009 and deliver it during December, according to Nymex rules.
A supertanker would cost about 90 cents a barrel per month for storage, according to data from shipbroker Galbraith’s Ltd. The amount varies, depending on the duration of the storage.


“The economics make sense if you can find somewhere to store the oil,” said Tony Quinn, managing director of Lincolnshire, U.K.-based Global Storage Agency Ltd., a bulk liquid storage terminal consultant. With depots in Europe almost full, “companies don’t have anything else they can do, so are chartering commercial tankers for floating storage.”
The reduced availability of credit may make it harder for traders and companies to purchase and store oil, said Merrill’s Blanch and Societe Generale’s Wittner.


“With this sort of contango, we would probably have seen a larger stock build were it not for the credit crunch,” said Olivier Jakob, managing director of consultant PetroMatrix in Zug, Switzerland.


The opportunity to benefit from the storage trade may disappear in weeks should OPEC cut output after its Dec. 17 meeting in Algeria. The group postponed a decision on production at its Nov. 29 gathering in Cairo.
“It’s still quite profitable as long as inventories are ample and OPEC does not remove the barrels from the market,” said Johannes Benigni, chief executive officer at Vienna-based consultants JBC Energy GmbH.
www.bloomberg.com

[madcowdisease]

Perhaps these tanker companies will benefit:

GLNG
HOS
TOO - Oil storage tankers
TNK
KSP
VLCCF - focuses on VLCC
DHT - focuses on VLCC
OSP
GASS
ONAV
ULTR
TK
KEX
CKH
OSG
NAT
SFL
TGP
TRMD
TNP

Reputation/karma votes appreciated ;)

[ZaNoob]

How much more to insure it? I tanker of oil sitting off the coast is a huge potential hazard.

If I was an oil buyer and knew there was so much oil floating around I wouldn't pay the contango prices. I'd see if I can get it cheaper. I might even hedge and see if I can get it in the spot market or play it both ways. I'm not an oil trader and I don't even know the basics of it. But it seems to me someone should be able to spot this glut and be able to get the oil for less. Unless of course that's what's happening here now. When there is no more storage left and oil still keeps pumping out of the ground then you might see a few of these investors panic. But if the economy turns around soon then they could have some very fat profits.

[0ICU812]

I am not convinced that the tanker deal makes all that much difference. There is only so much that the tankers can hold. Ultimately, I think it is demand destruction. However, that being said, I do like DXO, and have bought some as a ticket betting on some world political flare-up occuring which will drive the price up before demand can be stoked again. Barring that, oil could be in for a long slow downturn.

[XOM]

I am not convinced that the tanker deal makes all that much difference. There is only so much that the tankers can hold. Ultimately, I think it is demand destruction. However, that being said, I do like DXO, and have bought some as a ticket betting on some world political flare-up occuring which will drive the price up before demand can be stoked again. Barring that, oil could be in for a long slow downturn.

The tankers are a bigger deal than you're thinking; one tanker can store 26 million barrels, not much you say? Consider that the normal storage facility in Cushing, OK only holds 22.9 million barrels. Granted that in the case of the tanker that Shell just recently unloaded they were only storing about a tenth of that, it would be interesting and helpful to know just exactly how much oil is sitting on tankers around the world.

Either way you slice it, there is a serious glut of oil in the market and with reduced leverage available to the traders, fundamentals may become more important going forward.

[ZaNoob]

Simple math. What's the maximum number that can be stored? How many tankers are out there? Then look at the daily oil production versus daily consumption. All tankers can't be used for storage or else commerce would stop. Unless demand goes up soon the production will outpace consumption. Production will continue because oil is money. The producers need the oil money so what they don't officially show on their records are being sold in the black market.

Oil in tankers is risky. Wait till some environmentalists nuts blow one of these things up and everyone will be rushing to unload those tankers. The cost of lawsuits and cleanup will eat any profits. Or some freak storm comes along.

The only thing that could stem the transport from producing to consuming areas and spike the price of oil will be war.

[clavocat]

Oil in tankers is risky. Wait till some environmentalists nuts blow one of these things up and everyone will be rushing to unload those tankers. The cost of lawsuits and cleanup will eat any profits. Or some freak storm comes along.


That's why they have insurance.

[madcowdisease]

with reduced leverage available to the traders,

Am I reading this correctly? Has there been a development in the futures markets reducing permitted leverage that I am not aware of?

[XOM]

Am I reading this correctly? Has there been a development in the futures markets reducing permitted leverage that I am not aware of?

Credit is tight everywhere, I'm not aware of anything that would prevent oil traders from being subject to lenders limiting their risk and exposure.

[Screwball]

One of the TV traders who is essentially thinking oil will go back up said to avoid playing oil by using the USO ETF because oil is in contango. What is the logic here?

I've been looking at this, and I think your right.

Where you get whacked is the roll to the next month. As I understand it (and please someone correct me if I'm wrong) in a contango situation (when front months are higher than current month) the holders of the contracts (in the case of UCO, who don't want to take physical inventory) are forced to sell before the current months contract expires.

Since they are forced to sell early, they lose money since the front month is higher. If the front month is lower (a backwardation situation) they would sell early at a higher price than the front month, therefore make a profit.

It would seem in a contango situation, a short play such as DUG would be a better play. If you overlay the charts from today, that is exactly the case.

I'm a rookie at this, and have not read everything I can find, but one thing I am sure of, today you are losing money on either one. Just more on UCO than DUG. :confused2:

[aiki14]

I've been looking at this, and I think your right.

Where you get whacked is the roll to the next month. As I understand it (and please someone correct me if I'm wrong) in a contango situation (when front months are higher than current month) the holders of the contracts (in the case of UCO, who don't want to take physical inventory) are forced to sell before the current months contract expires.

Since they are forced to sell early, they lose money since the front month is higher. If the front month is lower (a backwardation situation) they would sell early at a higher price than the front month, therefore make a profit.

It would seem in a contango situation, a short play such as DUG would be a better play. If you overlay the charts from today, that is exactly the case.

I'm a rookie at this, and have not read everything I can find, but one thing I am sure of, today you are losing money on either one. Just more on UCO than DUG. :confused2:

Your theory is correct but your terms are not. The front month is the current month, the following is called the next month or first back month and then all the others are back month contracts. Also note the fund can roll over to the next month any time before the expiration, unless they are required to hold to a certain point by the fund rules.

[aiki14]

Now maybe somebody can explain why the crude contract is up $3+bbl and the USO is down?

[Screwball]

Your theory is correct but your terms are not. The front month is the current month, the following is called the next month or first back month and then all the others are back month contracts. Also note the fund can roll over to the next month any time before the expiration, unless they are required to hold to a certain point by the fund rules.

Yep, I had that backward. Thanks!

I have been doing more research on this. UCO tracks the Dow Jone-AIG Crude Oil Sub-Index. The ticker is .djaigc if you type it in Google. Can't get it to work in my platform. The ProShares site gives us this:

Index Summary

The Dow Jones—AIG Crude Oil Sub-Index ( a sub-index of DJ—AIG Commodity Index) is intended to reflect the crude oil segment of the commodities market. The Index consists of futures contracts on crude oil only. Visit Dow Jones Indexes (http://www.djindexes.com/) for more information.


Unlike equities, which entitle the holder to a continuing stake in a corporation, commodity futures contracts specify a delivery date for an underlying physical commodity. The Dow Jones—AIG Commodity Index purchases futures contracts of a commodity, and, as the date for a futures contract comes due, the DJ—AIGCI sells that contract and purchases a new short-term contract with delivery dates a few months out. The Dow Jones—AIG Commodity index thus "rolls" its futures positions, and continually avoids delivery of the physical commodity.


The Dow Jones—AIG Commodity Index is valued using the settlement prices for the underlying futures contracts. The DJ—AIGCI rolls its contracts over the course of 5 consecutive business days, starting on the 6th business day of the month. Each day, 20% of each futures position that is included in the month’s roll is rolled. Not all contracts are rolled every month. Visit Dow Jones Indexes (http://www.djindexes.com/) (http://www.djindexes.com/) for a list of futures and their roll months.


If you go here: http://www.djindexes.com/aig/index.cfm?go=home
(http://www.djindexes.com/aig/index.cfm?go=home)
That link will show the index, or offer a download to what it contains. Looks like it tracks more than just crude.

This whole thing seems quite complicated for something that claims to track the price of crude oil, but that's probably by design. The more I search for information, from here to there, to there, it seems like more of a scam than anything.

I guess it would be too easy to have something we could use to correlate the price action of the ETF vs. The .djaigc ticker is the Dow Index it claims to track is down 2.13% while UCO is down over 6. To me, it should be 4.26.

[Horace Kent]

HAHZA! (or whatever) This should put this to rest permanently.

The basic issue is called "the roll yield" - since oil is in contango, and since the USO buys the front month, it has to "pay up" when it rolls its contracts forward.

This post explains all the nitty gritty.

http://www.marketfolly.com/2009/01/how-contango-affects-crude-oil-etfs-and.html

[aiki14]

HAHZA! (or whatever) This should put this to rest permanently.

The basic issue is called "the roll yield" - since oil is in contango, and since the USO buys the front month, it has to "pay up" when it rolls its contracts forward.

This post explains all the nitty gritty.

http://www.marketfolly.com/2009/01/how-contango-affects-crude-oil-etfs-and.html

The fund managers changed their methodology today and are now going to roll over the contracts over 4 days instead of the one. Turns out the USO owns 19% of all the Nymex crude contracts and 30% of a similer contract on the ICE, and there are complaints about them moving the price unnaturally.

[Horace Kent]

The fund managers changed their methodology today and are now going to roll over the contracts over 4 days instead of the one. Turns out the USO owns 19% of all the Nymex crude contracts and 30% of a similer contract on the ICE, and there are complaints about them moving the price unnaturally.

link?

[Horace Kent]

found it. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aZYy1UXKZRb0

bloomberg had it. but i don't see anything about those nymex numbers - it seems right, the USO is a big fund.

regardless, the fund will still invest in the front month, as far as i can tell, that won't necessarily help the contango problem.

[aiki14]

link?


I got it from the dow jones news wire:

http://www.djnewsplus.com/nae/al%rnd=Mlsnl%2fsr8Wx5SRnreUHyJQ%3D%3D

[Screwball]

Kind of long, but interesting. Today from Financial Times.

http://ftalphaville.ft.com/blog/2009/02/25/52879/a-self-propelled-pyramid/

[XOM]

Very good information came to light in this thread, looks like the bottom line is that etfs in the futures markets are best left to traders and even then they had better be aware of when the roll is going to occur.

[Horace Kent]

this situation appears to be either reversing (for now) or the run-up in the front month has caught up with the rest of the curve.

from the EXCELLENT blog, zerohedge....this dude knows his shit.

http://zerohedge.blogspot.com/2009/03/contango-disappearing-fast.html

[aiki14]

this situation appears to be either reversing (for now) or the run-up in the front month has caught up with the rest of the curve.

from the EXCELLENT blog, zerohedge....this dude knows his shit.

http://zerohedge.blogspot.com/2009/03/contango-disappearing-fast.html


Got a feeling he is right and bought june calls on USO (almost typed $USO lol). I will say this has been a virtual cash machine to trade over the last week and a half, reacting in a very predictable manner to the market writ large.