Here is a new word for you, or at least it’s a new word unless you are unusually savvy. The word is contango. And here is another which refers to the precise opposite: backwardation.
The first of these two words sounds like it should have been included in Queen’s Bohemian Rhapsody. The second, well, it sounds like it should never have been invented in the first place.
But we have this sneaky suspicion that you are going to be hearing a great deal more about these words over the next year or so. So here is your chance to add another term to your lexicon, to sit next to Carry Trade, and just before Credit Default Swaps.
Of late, contango has been rising. In fact, recently, Michael Lynch, president of Strategic Energy & Economic Research said: “We are probably witnessing the strongest contango we’ve ever had.”
At the moment the usage of this word relates to oil sitting on cargo ships, when the owners of the oil have no intention of making an immediate delivery. It seems that contango is high right now, because speculators reckon oil will rise in price down the line.
So what is it, and why is it important?
Contango is when the price of delivering a commodity at some point in the future is higher than the spot price.
Storage costs money. If oil is to sit on a tanker, then you have to pay for that tanker – and even in today’s times, when the Baltic Dry Index is relatively low, hiring a tanker ain’t cheap. So, if you indeed stick some oil in vessels and leave it there, you must feel the price is sure to rise down the line.
Backwardation occurs, of course, when the price of future delivery is lower than the spot price.
Right now, it seems that around 80 million barrels of oil are sitting in large tankers offshore. Associated Press quoted Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates as saying: “We’re filling up every crevice of storage that anybody can find.”
According to Investors Chronicle magazine: “Brent crude for immediate delivery is around $42 a barrel, but for delivery in a year’s time the price rises to $55.”
It seems there is this feeling going around that come the end of this year, oil will start shooting up in price again.
Well, that might be right. But we are a little sceptical.
In the medium term there are good reasons to believe oil will go up in price. After all, the issue of peak oil has not gone away, and come the economic recovery it seems likely that demand will soon outstrip supply. In the longer term, and providing we get our acts together, the supply of renewable energy should be such that oil should then start falling in price again.
The challenge of course lies in getting the timing right.
And it all boils down to how soon you expect the economic recovery to begin. Presumably, those who are pricing in sharp rises in oil expect the downturn to be short. OPEC’s cuts in oil supply are influencing these expectations too. But we are a little cynical that OPEC members are going to show that much enthusiasm for cutting oil supply. After all, they do want some revenue.
The recession won’t last for ever, but neither will the economy come roaring back any time soon. Every day brings news that the economic downturn is becoming more widespread. For example, electricity production in China fell dramatically in the last few months of 2008. It seems unlikely the global economy will see any real recovery until way into 2010. Demand for oil is likely to lag behind this. Expectations of rises in the price of oil in 2010, on the back of surging global demand, do seem a tad optimistic.
© Investment & Business News 2013