There is a huge discrepancy between the near-month and far-month futures contracts.
As I write, the going price for near-month West Texas Intermediate crude is $41.42per barrel. The December 2009 contract, on the other hand, is trading at $53.44.
That is a monster spread. We’re talking a difference of more than $12 a barrel between spot crude – the stuff you can buy in the cash market – and crude slated for delivery at the end of this year.
The technical name for this situation is contango. That’s what they call it when a forward-month commodity contract is trading at a higher price than the near month. (You don’t really need to know this right now, but the opposite of contango, when near-term prices are higher than the back months, is backwardation.)
The reason this is strange is because of the massive profit opportunity embedded in the crude market.
Assuming you had the means, you could go out right now and sell millions of dollars worth of December crude contracts at $53 dollars a barrel... buy the equivalent amount in the cash market for $41 a barrel or less... and then just wait until it’s time to deliver the oil (and lock in your $12 profit).
The only hitch in the deal is finding a place to store the stuff. If you were to buy crude now, you would have to take delivery and store it until late November (or whatever month your delivery date rolls in, when you close the trade and take your locked-in profit).
The puzzling question is why the anomaly persists. Why has the spread not come in?
Remember that once the far-month contracts are sold, price risk is removed from the equation. If you’ve entered into a deal to sell 2MM barrels of crude at $53 after buying at $41, you don’t have to worry about where prices go between now and your delivery date. You can just sit and wait.
When a no-brainer opportunity like this comes along, Wall Street normally jumps all over it. Traders exploit the anomaly in size until it disappears.
If markets weren’t so out of whack, you would gradually see the spread between near-month and far-month crude contracts get smaller and smaller as more and more players piled in. The profit in the spread would be reduced to the point where putting on the trade no longer made sense.
Two constraints that keep this from happening now are financing and storage.
First the finance angle: This is a trade that requires a serious cash outlay (or a major line of credit) to pull off. To fill up a supertanker with crude and sit on it for a year, you’re talking $50 million to $100 million as table stakes. The big Wall Street houses have been so bruised and battered, it’s hard for them to come up with that kind of dough – even for slam-dunk opportunities.
The other major constraint to the trade is storage. Such huge volumes of cash market crude are being held off the market now, traders are literally running out of places to put it. (It’s not like you can just pop into the local EZ-storage or stash a million barrels of oil in the shed.)
We’ve got oil coming out of our ears in the short-term... but the price of oil is still head-scratchingly higher – much, much higher – in the longer term.