In early 2009, I did a segment on CNBC with Erin Burnett and the late Mark Haines, pointing out a way for us to band together and make some serious money.
I proposed we find the funds (or the financing) to buy currently priced oil on the physical markets, trading somewhere in the mid 30’s, and then selling the futures about six months out, which were trading for nearly $15 dollars a barrel more.
A simple idea – we would store the oil, pay the fees, and deliver at the futures price later, banking about, I estimated, 11 dollars a barrel – a huge profit in any language. There were problems with the plan, however; credit was, in the depths of the financial bust, nearly impossible to find, and you needed storage as well, also a really tough problem with collapsing demand and economies shutting down.
I wasn’t a genius in devising this scheme, of course. Those who had ready credit and ready storage – like Koch and Conoco-Phillips – were already doing this primitive ‘carry trade’ and making those fortunes denied to Erin, Mark, and I. However, I was, I think, the first crude observer to bring the idea of a profitable oil carry trade to the public eye.
Since then, over the course of many years, there’s been an increasing interest in the spreads between futures and what it might portend for prices and the movements of oil in storage. Today, there’s a virtual frenzy of discussion about what are almost insignificant movements in spreads, signifying apparently big moves from physical players in their commitments to prices and storage.
In this new world, a contango (like in 2009, when futures prices were higher than current ones) is bearish and indicates a strain on storage. Now, according to theory, everyone awaits a big shift towards backwardation (where prices in front of the curve are premium) to indicate an emptying of storage and prices moving higher.
I feel like I’ve created a Frankenstein.
2009, and even the far less deep contango we saw in February and March of 2016, definitely indicated a financial opportunity to horde oil and play a carry trade – and also helped (and I say only helped) indicate a bottom in oil prices. But the overall theory that I helped spawn of spreads indicating universal trends for oil prices just isn’t true – and there’s a big, overwrought hunt for the red herring of spreads telling a bigger story than is actually there to be had, almost all of the time.
For example, oil made its biggest price moves from 2005 through 2007 to $142 dollars a barrel – with a very sharp contango throughout the curve that stubbornly refused to go into backwardation. That crude curve fooled plenty of traders into selling that rally early and often and losing fortunes of money on one of the most intense, one-sided trends the oil futures market ever saw.
During my 23 years of daily trade of the crude market, curves would move regularly from contango to backwardation, for a variety of reasons – and woe be the trader who had decided that he had found the ‘secret’ through those spreads to understanding completely and predicting, without fail, future moves in the price of oil.
All this to say that the crude curves have been historically a lousy indicator of future market action, except under the completely extreme conditions we saw during the financial crisis of 2008 and recently during the extreme oil bust of 2016.
It strikes me, instead, that this latest drop in oil prices is almost entirely due to too many longs in a market being spooked by the hand-wringing of multiple CEO’s and OPEC at CERAweek. Now, having chased out the weakest of these longs, indicates, to me, an opportunity to buy some great oil companies at discount prices.
And ignore the clomping Frankenstein of tiny spread movements that are marching with great fanfare through the public square. I built him, and you can take it from me – he’s (almost always) completely harmless.