May 10, 2005

Oil Futures Trade Contango

From the FT:
The crude oil futures market has produced plenty of hot news in the past 18 months. However, one of the more recent - and striking - developments has been the widening gap between nearby prices and the longer-dated prices, which has encouraged US refiners to buy oil and store it in the hope of selling it for a higher price later in the year.

This price pattern, known as "contango" - the industry term for when future delivery prices are higher than more immediate transactions - has reversed the normal price behaviour of crude futures markets. Usually nearby prices trade higher than longer-dated deliverable prices because oil markets have seen tight balance between supply and demand, which in turn pushes up nearby prices.
"Investors will have to hope that oil prices will have to rise strongly in absolute terms for them to hold on to their investments, because if the price were to remain flat and the steep contango persists, the losses will continue and their overall returns from crude futures will reduce," said Mr Lewis.

A while back I mentioned the spot market's focus on projected future shortages rather than current inventory levels. The market has now worked that out.

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