Wrong about oil derivatives

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.

Chris Ladd is a Texan living in the Chicago area. He has been involved in grassroots Republican politics for most of his life. He was a Republican precinct committeeman in suburban Chicago until he resigned from the party and his position after the 2016 Republican Convention. He can be reached at gopliferchicago at gmail dot com.

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16 comments on “Wrong about oil derivatives
  1. way2gosassy says:

    “I’m no weatherman” and apparently not an oil speculator either! 😉

    • way2gosassy says:

      OMG that is hilarious! How you guys doing up there? Staying dry?

      • rightonrush says:

        I’m back and airing out the camping gear. It rained damn near every day. My son said it had not rained since I left…except after he cut & baled hay. It came a gusher soaking the bales. How’s things in the great state of Tennessee? Still loving it I bet.

    • way2gosassy says:

      Abso-damned-lutely! My “small” garden turned into a 1/4 acre that produces much faster than I can, cook, can, pickle or freeze. We have been reduced to begging people to take the stuff home with them. The food bank is well stocked too. We now have 10 blackberry, 6 blueberry, a black apple, sub rosa plum and a partridge and two pear trees. We even have 5 new puppies that are currently cutting their teeth on my toes. Local deer, fish and turkey in the freezer makes me wonder what the heck took me so long to get my hiney out of the flat lands.

      • 1mime says:

        Sassy, I am so happy that your life is happy and full. I never had a 1/4 acre garden, but we did have a robust small garden that kept me busy. These are the years to let er rip! Live!

      • way2gosassy says:

        If I keep livin at the pace I’ve been going they are going to bury me soon 😉 Who said retirement was easy? Still loving it though.

      • bubbabobcat says:

        Truly glad to hear Sassy and RoR are doing so well! That is the cherry on top icing to a terrific week! 🙂

        Side note, great week for me personally too. Went home to NYC and attended my first Gay Pride Parade there. Absolutely electric and a joy of a time for the crowd and parade participants. Though I thought it would be more of a madhouse considering the historic significance. It was genuinely celebratory but in my mind relatively low key for the historic moment. Of course there was a lot of dancing and cheering but to me it seemed more like a victory parade after a Super Bowl than the combined Mardi Gras/New Year’s I had mistakenly envisioned.

      • 1mime says:

        Good for you, Bubba!

      • way2gosassy says:

        Good for you and glad you had a great time! Safe travels my friend.

  2. MichaelL says:

    I have a small clarification on definitions. Contango is simply when prices are projected to be higher in the future than they are today. In this case Oil Futures contracts for future months are higher than the spot price. Backwardation is the opposite of that, when prices are expected to decline in future months. Contango is the more common state of most commodity prices. This storage strategy is simply due to the fact that many folks still think oil prices will be higher in the future and storage is cheap enough that it makes economic sense to store it for future use. I’m not sure how much of a concern Oil storage should be in the long term since like most market mechanisms, it tends to balance itself out with supply/demand barring some kind of major event.

  3. Crogged says:

    Beware of Greeks bearing gifts

  4. johngalt says:

    You got it wrong if you were placing short-term bets. But if the world economy weakens further, and there are signs in that direction, then I wouldn’t rule out a further price crash.

    • goplifer says:

      That’s true and I think that’s still likely. Unfortunately it probably doesn’t rescue my thesis. I was operating under the suspicion that the structure of commodities trading was itself creating a bubble, or rubber band effect. The outcome would be more than just price declines, but a wider collapse of the primary entities tied up on those trades.

      That is starting to appear unlikely. Prices have already been low enough for long enough to blow up a structural bubble. At least that’s the impression I’m getting. We’ll see I guess.

  5. texan5142 says:

    Sorry, Yes you did Scalia, admitting it is the first step to recovery.

  6. texan5142 says:

    ” I got this one wrong.”

    Yes you Scalia, admitting it is the first step to recovery.

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