Back in the spring I joined a collection of commentators expressing concern about distortions in oil markets. Price declines were being cushioned by a practice sometimes described as “contango,” in which traders were paying to store, rather than sell, oil that they had never intended to take delivery on.
It appeared then that the strategy might be approaching a breaking point in which a tightening supply of storage forced speculators to begin dumping their contracts, a move that would cause a downward cascade in oil prices. Here’s what I said:
There is a chance that the industry may avoid a reckoning, but only if producers and traders can navigate an ugly challenge over the next few months. It appears that the US is running out of cheap oil storage. At the current production pace we will run out of capacity at the main “contango” facility at Cushing, Oklahoma in June. Avoiding a price crash will depend on finding new places to store the stuff until production finally declines and demand recovers – whenever that might be.
Well, traders have been successful in finding cheap storage. That reckoning has not happened.
Oil storage is cheap and across short timeframes even the simplest containment methods can be effective. Iran is currently storing more than 40m barrels of oil, about a tenth of the total US supply, on tanker ships. Costs are low enough that this form of long-term speculation can carry on for a very long period.
The logic behind this concern remains valid. Carried out over a long enough time-frame there is a theoretical danger that this could develop into a troubling crash. However, time is a critical element of any prediction.I can tell you with absolute confidence that it is going to rain. However, if I can’t tell you when it will rain, then I’m no weatherman.
It is not clear that the contango strategy oil producers are using to support crude oil prices will cause any major disruptions. So far it has worked splendidly. US oil production has barely dropped in response to the Saudi supply dump.
Most predictions end up being wrong. I got this one wrong.