Killing the contango. Since the expiration day of the February crude contract the formerly super contango has gotten crushed. This now means that the super contango is not so super. Sure you can credit the big rally in the front end of oil to a splash of economic confidence. You can talk about the surging stock market, the retreating dollar and the obliterated bond futures. You might even point to a renewed sense of hope and optimism in a market place that seemed so scared just the day before. And you would be right on all counts. But putting aside all that groundwork for a potential bottom on oil, what may be more interesting and significant about the last few days trading action is the blowout of the super contango spread.
Many readers of The Energy Report already know what a contango is. If you don't, very simply it is when the price of the near term delivery contracts are trading at a discount or at a lower price than future delivery contracts. When this spread widens players in the cash market are encouraged to buy oil at the current lower price, store it and lock in the higher future price. They can make themselves a profit assuming that their storage costs and insurance costs are less than the money they make on the difference in the two prices. In recent months the contango has been so large that players have been falling all over themselves to find a place to store oil so they could take advantage of this tremendous opportunity to make money. In fact this spread has driven the supplies of oil to a record high at the delivery point for the NYMEX crude in Cushing Oklahoma. There are reports of super tankers all over the ocean filled with crude just waiting to be delivered. Now over the last few days the incentive to store oil has come in dramatically especially if you talk about relative short term contango play over three or four months. In fact with storage cost soaring it might not be as attractive to play the contango unless you can store oil for 5 months or more. Why has the contango come in so fast and so quickly?
First of all you have to ponder and wonder why the market was in contango in the first place. When the futures market is paying the marketplace to store oil it is usually because it believes that the demand for oil will rise in the future from current levels therefore being wise to build inventory to meet an expected increase in demand. Of course sometimes that explanation might be just too easy. In this case it is possible that the collective wisdom of the market is predicting that the drop in oil prices and OPEC production cuts will stop much needed production and projects and will lead to a future tightness in supply when demand comes back. Or it could signal that the market believes the current economic crisis and the rapid increase in the money supply will lead to hyper inflation down the road making it wise to store cheap oil now. Or maybe the market was hoping that a new era of low oil prices will create a new round of strong economic growth in the future similar to what happened in the late nineties leading to the oil price and demand boom in this new millennium.
Or it could be as simple as we are running out of places to put oil and we will see or oil exports rise to Europe. With no place to put oil in the US, we may just start sending some of that WTI (West Texas Intermediate) Nymex delivery grade overseas. That may start to work off the US massive supply.
In fact today when we get the release of the EIA (Energy Information Agency) report we may find that Cushing, Oklahoma storage is filled to the brim. Linda Rafield who was a former floor trader extraordinaire, a crack reporter for Platts and a lady that never saw a Doji Star she didn't like, says that Cushing, Oklahoma is about to runneth over. Capacity at Cushing is supposed to be about 42.4 million barrels but according to Rafield only about 80%, or roughly 34 million barrels, of that is operable storage space. Currently there is 33 million barrels of oil in Cushing which means that if Rafield is correct, they can only store about a million more barrels. It is possible that the contango is in part blowing out because oil cannot be stored in Cushing and because there is nowhere else to go with it. And with Brent crude trading at a premium to the WTI and the closing contango some of that crude floating on those ships might be in for a European adventure.
Despite the impressive rally in crude, for the market to get real bullish, we really would need to get back above $50.To do that we will need more than just a one day snap back rally in the stock market. To turn oil around we will need to see signs that the economy can actually handle higher oil prices. Right now that is not clear. Just today Dow Jones reported that China's diesel output in December declined 9.5% on year while gasoline output maintained 7.5% growth to post a record high. Dow Jones says that the figures indicate that China's demand for diesel, which is largely consumed by the industrial and power sectors, may have been particularly sluggish due to the sharply slowing economy and the nation's refiners are expecting it to remain so at least through February. Dow says that data showed that China's economy grew only 6.8% in the fourth quarter, the lowest quarterly growth rate in seven years, as domestic manufacturing and investment activity slowed. They said record high gasoline output at the nation's refineries raised gasoline output to a record monthly level of 5.75 million metric tons in December in anticipation of seasonal peak demand for the fuel this month when many people travel long distances during the week-long Chinese New Year holiday. Sounds a little bullish but Dow also says that China imported 60% less gasoline than in December 2007, at 7,025 tons. Check it out.
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Still short oil after all these months!
We're short March Crude from apprx 4354 on what is now a quadruple rollover!!! Stop to 5350!
Sell March heating oil at 15500 - stop 15700.
Sell March RBOB at 12500 - stop 12700.
Sell March natural gas at 550 - stop 590.