Contango: 2011 Edition

Regular readers may remember that every year at this time I do some basic arithmetic regarding contango.

As a refresher, contango is the discount you can get on a non-perishable commodity by virtue of your willingness to accept delivery at once, or (stated inversely) the extra payment you make if you want the seller to hold it for you for some interim.

One would naturally expect this discount to be closely related to the costs of storage space. After all, if I buy crude today and tell you to deliver it six months from now, you have to keep it somewhere during the interval, and pay the maintenance on the storage facilities. If I take delivery now but I don't use it over the six months, then the cost of storage falls on me.

So: a year ago I simply measured the per-barrel price for March delivery (which was $74.14) against that for August delivery ($77.08) and extrapolated that into an annual rate. The five month delay in delivery cost the buyer $2.94 at that time, which extrapolated into an annual figure would have been $7.06 or about 9.5% of the price of the barrel.

Checking the figures a year later ... the price of a barrel was $89.58 for March 2011 delivery last time I checked. Never mind the question of why that has gone up. I'm focusing on just one piece of the puzzle now. The price for August delivery was $94.49. That's a difference of $4.91 for storage. This annualizes to $11.82, which is roughly 12.5% the price of a barrel.

Why is contango on the increase? I might like to suggest that this confirms that the market is signalling a recovery soon. People are willing to pay to store the crude NOT because the costs of carry have gone up dramatically but because speculators would rather have crude oil several months from now than now. And they'd rather have in six months from now because they are getting signals that people are going to be driving more, the wheels of industry are going to be turning ... good times will be back. At least to some degree.

But then ... I'm still uncomfortable. After all, forgetting speculation, the simple cost-of-carry sort of contango might have increased to 38% annually. Why not? Maybe all the easy storage spaces are all used up, and it takes extra expense to bring new storage space on line (marginalism, anyone?) and THAT is leading to a sizeable discount for anyone who will take the stuff out of the marketers' hands quickly.

All this is making my head hurt. Enough!