Contango?
One of the new sources of news I have been consuming recently is the news aggregator “The Energy Bulletin”.
On May 22, they linked to an article in a Canadian publication (Globe and Mail) entitled “Record oil prices signal ‘new world’”. In this article, they mention the term “Contango”, meant to describe a “rare” trading pattern in the oil industry where speculating traders are buying futures at prices well above current actual (non-futures) prices.
What a funky word, contango.
The wiki says this about contango:
Contango is a term used in the futures market to describe an upward sloping forward curve (as in the normal yield curve). One says that such a forward curve is “in contango” (or sometimes “contangoed”).
Formally, it is the situation where, and the amount by which, the price of a commodity for future delivery is higher than the spot price, or a far future delivery price higher than a nearer future delivery.
The opposite market condition to contango is known as backwardation. (SOURCE)
NPR podcast (August 24, 2006) on this term, visit that page.
Why does there need to be a new jargony term for speculative market manipulation?
The example given in the article is as follows:
May 21st on the NY Merchantile Exchange, crude oil for July delivery rose $4.19 to close at $133.17.
Meanwhile, contracts for future deliveries (I guess July is not in the future? It is May after all) well outpaced those numbers. December 2008 crude rose to $135.24, December 2010 to $135.15, December 2012 to $136.78, December 2014 to $137.52 and December 2016 to a whopping $142.00.
This, by definition, is an artificial construction. Who thinks that what traded on May 21st for those particular deliveries will be the same today? How is this different than betting on futures for a basketball game or on the baseball game your son will play 5 years from now?
How is this not gambling?
The question of whether it is gambling is not about morality in the first derivative. Its the second derivative, the psychology of the traders that moves in the direction of rationalized risk taking that is what makes gambling psychology matter.
I am not naive to think that this is a sea change either. It seems like we humans as a general lot LIKE to gamble on our future, why else would we allow such a system to exist in the first place?
The article says that “seasoned oil traders” claim that this contango arises from the fact that new traders are coming to the party (laying any sort of “blame” on “others”). These new traders seem to be pension fund and hedge fund managers putting one-way bets on oil futures. They say that these new traders are playing the “peak oil” fervor.
I think the real take away message from that article is found in the final lines. Its not speculation itself that is to blame (it is a symptom not the cause) but rather the utter stupidity of the Bush administration’s Fed in it’s mismanagement of the financial structural fundamentals that is giving rise to a weak dollar and a futures market that is destined for such dynamics.
Kevin Cook at Stockhouse.com said:
“Well, a shift is starting to occur that may win the argument for the peak camp. Today, as oil hits another new all-time high, above $129 per barrel, the back month contracts are on the rise too. Normally, futures markets for physical commodities will display a “contango” price relationship, where contracts for further delivery are higher than the near months. This is usually a function of a market where oil for future delivery trades at a premium because producers have fixed costs for storage that must be priced into those contracts. But, the last few months have seen markets driven by the demand spikes in the spot and front month contracts. This forced those near contracts higher, while the back months drifted lower. Now that “backward” market is starting to shift back to the more normal contango pricing.
What’s the reason for this shift?
Some analysts and traders think that the market is recognizing the real possibility of supply disruptions. I spoke to expert oil analyst Phil Flynn from Alaron Research this morning, and he told me that oil traders may be taking a longer-term view here on the situation and instead of discounting the demand spikes by selling the further out contracts, the market is actually acting like it may “pay to put oil away.” In other words, if oil industry participants believe that prices will maintain at these levels, then they will gladly store it in hopes they can charge even more down the road.” (SOURCE)
Stockpiling for profit – this leads to an obvious vicious circle.
I try to not be pessimistic but this seems like a self-propagating situation.
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