Contango: 2012 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 (2011) delivery (which was $89.58) against that for August delivery ($94.49) and extrapolated that into an annual rate. The five month delay in delivery cost the buyer $4.91 at that time, which extrapolated into an annual figure would have been $11.82, which is roughly 12.5% the price of a barrel.

Checking the figures a year later ... the price of a barrel was $98.33 for March 2012 delivery last time last weekend. 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 $99.62. That's a difference of only $1.29 for storage for five months. This annualizes to $3.10, which is roughly 3.25 % the price of a barrel.

So contango has taken a sharp fall over the last year. Why is contango on the increase?  Don't know.  Three theories come to mind initially. First, this could be a reflection of a stronger dollar. Crude oil is priced in dollars, the dollar has picked up value against other currencies as the 'cleanest shirt left in a pile of dirty laundry' of late. A year ago, for example, a dollar could buy you .625 GBP. These days, it can buy you .642 GBP.  Perhaps, then, there's a deflationary effect built into contango.

Second, this could be the response to an increase in storage capacity. After all, back when contango was 12.5% of the price of a barrel, there was a great incentive to bring on line new facilities to hold the stuff.

Third, this could be a reaction by speculators to a presumed coming decline in the value of oil -- the long-feared second dip in a double-dip recession.