An article by Sarah Kent in Monday’s Wall Street Journal, “Traders Eye Oil Tanker Play”, (full text requires subscription*) purports to explain current action in the oil market, as 30 million barrels of crude oil are due to be released from the Strategic Petroleum Reserve (SPR) before August 31.
While they fall short of the lefty paranoia of ThinkProgress.org and its crack “investigative journalist”, the diminutive Lee Fang, the WSJ invokes the magic word of commodities trading — “Contango!” — without understanding the facts at hand.
In reality, oil refiners and traders have already made their profit. The President’s action of releasing SPR oil drove prices down — very temporarily. Today, prices are already about $5 per barrel above the average auction price of SPR oil. The successful bidders are not storing the oil to eke out a few cents per barrel profit: they are storing the oil because existing land-based storage is full. Given that reality, the perceptive reader might ask, “So where is the emergency?”
The reader can learn considerably more about the economics of the SPR release by reading this blog post at The Economist.
Key point #1: The SPR oil was sold based on the “Louisiana Light Sweet” (LLS) benchmark, not the “West Texas Intermediate” (WTI) barrel referenced in the WSJ article. LLS has historically traded near the WTI price, but for the last several months, LLS has been priced at a substantial premium to WTI. LLS can be arbitraged with Brent crude, the North Sea benchmark, so those two have been moving in tandem. The WTI price has suffered due to a regional glut: full storage at Cushing, OK (the trading center for WTI) and no good way to move Cushing oil to the Gulf Coast. (More on that subject in a future blog…)
The Economist documents who bought the SPR oil, and how much they paid (see table below). Fifteen companies were awarded sale lots; they competitively bid for the 30 million barrels at an LLS index price of $112.78 per barrel. (Based on LLS prices for the week 6/15 to 6/21/11. Discounts adjust for quality and location.) Friday’s closing price for Brent crude was $116.74 per barrel.
Key point #2: Brent crude is not in contango. Last Friday’s closing price had the September contract for Brent trading 21 cents higher than the October contract. If there is to be a futures trading profit to be made, it is speculative and not consistent with the current market. In late 2008, there was a true contango trading opportunity to lock in several dollars per barrel with scant risk. Today’s traders are not paying god money to store oil in hopes that the market turns around.
Key point #3: It takes a significant contango to justify the cost and risk of storing oil offshore. Let’s say there were a 43 cent per barrel profit opportunity for storing oil, as suggested in the WSJ article (based on WTI prices). At something like $20,000 per day for a tanker with a capacity of 1 to 2 million barrels, the cost merely to store the oil is 30 to 60 cents per barrel per month. That says nothing of the cost of insurance, handling or the risk of storing a large quantity of oil offshore — during hurricane season.
The future price strip is unusually flat. Contrary to the WSJ’s assessment, the buyers of SPR oil are not storing to profit on a future commodity trade; they’ve already made their profit. The loser in this deal is the American taxpayer, who now must (theoretically) replace $112 barrels with $117 barrels. And the only benefit to the consumer was a very transient spike down in price, lasting less than a week.
Note: No Koch Brothers!
*Tip: The full article may be viewed free if accessed via Google search. Type an 8-10 word phrase from the article into a search window to find and access the article.
Cross-posted at Stevemaley.com.