I learned a new word today, perusing this article that I found at Drudge (do I really need to give Drudge a hat tip?).

I don’t know a lot about the futures markets, but the article states that some contracts have become more expensive than the spot price for oil, and that this is a rare event called a contango.  The article also states that this means that either the futures markets are unhinged, or that participants in this market are wagering that there will be a supply issue in the coming years.

I would be interested to hear what our commenters and blogmates (who know a lot more about these types of things than myself) have to say about this.

11 thoughts on “Contango”

  1. An even better commodities word is “backwardation,” which is the opposite of contango.

    Suggested alternative use of the words:

    “My goodness, Jimmy Joe, you’ve got the backwardation if you think I’m going to do the contango with you at the prom.”

  2. It must be the zeitgeist of the time, because I just learned the word a couple of days ago myself.

  3. Been there, done that, priced the embedded swap in the Goldman-Sachs Oil Backwardation Note. It had to have been in the early 1990’s.

  4. From a recent Gartman newsletter:
    We are far more concerned, however, with what
    has happened and is continuing to happen within the term
    structure of the Brent and WTI crude futures markets, for
    both have gone contango across their entire term. WTI,
    from July ’08 on through December ’16, is now in
    contango, and although we suppose that that has
    happened at one point in the past (perhaps in the
    liquidation of MG trading many years ago), it is truly a rare
    circumstance. Note then that the 1st-to-5th futures spread
    for both WTI and Brent just keeps widening.

    There are two major problems with this shift in the term
    structure. Firstly, remember that Dr. Bernanke himself
    argued several months ago that the fact that the deferred
    futures prices for crude oil were lower as a reason for the
    Fed’s propensity to ease monetary policy. He argued that
    the futures told him that prices for crude were heading
    lower and that the Fed’s easier policies were warranted.
    We took him very strongly to task for this material
    misunderstanding of the term structure of the futures,
    noting that a backwardated market was the sign of future
    strength, not weakness. We argued that the work done by
    Professor Holbrook Working of the Stanford Food Institute
    many years ago regarding the grain futures market
    proved that markets in contango (that is, where the
    deferred futures are at a premium to the spot rate and to
    the nearer-by futures) tended to argue for lower prices as
    the underlying instrument “bids up” the price of storage.
    We argued further than Prof. Working proved that a
    market in backwardation (where the spot rate is at a
    premium to the nearest future, which is itself at a premium
    to the next future back, which is at a premium to the next
    and to the next and to the next) is a market that is strong
    and likely to rise. Backwardation, or a negative carrying
    cost, shows that demand is high and that the market
    wishes to price storage at a loss in order to draw
    inventories out into the market where they are needed.

    Dr. Bernanke and the others at the Fed have it now, and
    have had it in the past, entirely wrong regarding energy
    and the term structure of the futures. This we find wholly
    disconcerting. Having applauded Dr. Bernanke for his
    position regarding liquification of the banking system, we
    have to take him and the others at the Fed openly to task
    for this very ill advised position regarding oil prices,
    inflation, and Fed policy.

    That having been said, our friend, Phil Verlager, sent us a
    truly important note last evening that we wish, with his
    permission, to report in full here this morning. This is
    hugely important for those long or short of the deferred
    crude futures, and we urge them to take note. Noting the
    Hunt silver problem back in ’79, Dr. Verlager wrote:

    Dennis, There are clearly big problems in the
    dated crude contracts (Dec 11 to Dec 2016).
    One or more firms that sold the oil is trying to get
    out. They have a problem, though. The parties
    that are long do not want to exit. The situation is
    evident in the shift in open interest. From
    Monday to Tuesday the number of contracts
    outstanding for delivery from June 2013 to Dec
    16 declined while prices jumped $8/bbl. It is a
    classic squeeze.

    I would assert that this is not an oil market issue
    because the other indicator of long term oil
    prices, the BP Royalty Trust (BPT) did not
    increase with the 2016 crude.

    Someone has a big problem – and it could get
    much worse unless NYMEX and ICE order
    trading for liquidation….1979 redux.

    Phil has no position in crude. He is, as he says, and
    academic whose duty it is to observe and explain. We
    have been bringing this shift from backwardation to
    contango to everyone’s attention recently, arguing that
    this shift as prices move higher is unlike anything we’ve
    seen since the Hunt silver fiasco when silver moved from
    a contango to a massive backwardation, and since the
    days of MG Trading when crude moved from
    backwardation to contango… both moves in the term
    structures presaging massive changes in the flat price

    Something is terribly amiss in the crude futures… terribly,
    terribly amiss. The elephants are coming out into the field,
    and we mice would do well to clear the decks and let
    these elephants fight with one another. We needn’t know
    the elephant’s names at this point. We will know them
    soon enough, but fore warned is fore armed!:

  5. This is all very interesting….too bad I don’t understand it. (It takes TOO much intelligence to understand CONTANGO….or: “It takes’tango.”)

    Anyhow, does anyone care to explain this in terms that a blockhead can understand?

    If futures are a lot higher than spot prices, why don’t I buy a big oil tank, fill it up with oil at $132 per barrel, contract to sell it in 2016 at $142 per barrel?, then sit back and wait for my GUARANTEED profit?

  6. Sella, have you priced a big oil tank recently? They not easy to find at your local grocer. Or the cost of keeping it compliant with local environmental laws or even getting the oil there and out? There are scenarios where prices could allow for risk free arbitrage opportunities like you outlined but they probably wouldn’t last long and price difference likely needs to be much more than $10 per barrel to cover all the costs (transaction, transportation, cost of carry, etc.).

  7. If you took the $132/bbl and instead of buying oil you invested it at 5%, this would generate $6.60/bbl in annual interest. Ignoring compounding, this gets you $52.80 in addition to your original investment, for a total of $184.80…much better than buying & holding the oil.

    Also, the physical oil investment is risk-free only if you buy insurance to protect yourself against fires, oil spills, etc.

  8. If nearbys (including spots) are priced higher than far outs, it means (over the long run) prices are going down. If nearbys are priced higher than far outs, prices are rising. If you think about it, you will recognize the logic. Most people, especially news people, can’t understand this.


    If nearbys (including spots) are priced LOWER than far outs, it means (over the long run) prices are going down. If nearbys are priced HIGHER than far outs, prices are rising. If you think about it, you will recognize the logic. Most people, especially news people, can’t understand this.

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