THE BLOG

Next Week's OPEC Meeting "Looney Tunes" and the Contango "High Step"

01/12/2009 05:12 am ET | Updated May 25, 2011

There we go again. Accepting OPEC proclamations as though it was received wisdom from the "Mount." In anticipation of Wednesday's OPEC gathering, we are told by Saudi Oil Minister Al-Naimi that as an example of commitment to its OPEC brethren and their previously prescribed OPEC quotas the Saudi's, last month, pumped 8.49 million barrels a day (thank you Saudi Arabia) "absolutely" in line with its OPEC mandate. The ever obliging industry commentators and talking heads are falling all over themselves complimenting the Saudis for their seriousness in abiding by its OPEC allocation. As Bloomberg reported yesterday "The Saudis might have been impatient with market's skepticism so they decided some transparency is needed," or "This may encourage others to behave similarly to end the free fall in prices".

Really? Could it be, just could it be that providentially for the OPEC chorus there was no need for more than 8.49mm barrels/day from the Saudis in November. You see the world is awash in oil. Storage is virtually unavailable and many of the traders who in another time might have taken positions on spot deliveries are out of the game because the banks will no longer finance their inventories of wet barrels.

All that brings us to another oil patch fiction. The brilliance ascribed to those producers or major refiners playing the contango spread i.e. buying at today's prices, storing the oil wherever they can including VLCC tankers, and selling contracts for December 2009 delivery or beyond at significant premiums exceeding current cost of product, storage costs and financing. A good deal if you can organize it (but only available to the major major players because bank financing is now otherwise unavailable). And then to bask in the glory of the press and talking heads visiting praise and commendation on the acumen of the players of the contango game.

A thought. Imagine you are a producer of oil. It is in your interest to keep the price of oil as high as possible, and to keep the psychology of the oil market conducive to high oil prices (bless those $147/bbl days). And then, suddenly the market becomes skeptical of all it has heard about oil from the oil industry flacks and pliant "experts" these many years. Then in addition economic realities bring about a crash in oil consumption. Suddenly the world is awash in oil to the point where there is virtually no storage. Oil production is not exactly a tap that can easily be turned off and on without ancillary costs and damage. And if you continue to produce to the point where your storage and virtually all other land storage brimming over, you are reduced to the last option available, you charter tankers, fill them up with your production or inventory for which you have no current use, and anchor them at sea. And if it were clearly understood that you are loading up tankers because the world is awash with oil and no longer any place to store it on land, what would that do to the psychology of the marketplace, and how to deal with it?

Ah, here comes Contango playing its soulful tune, turning a market disaster into a brilliant marketing ploy. Remember with future delivery you are dealing with paper barrels determined on commodity exchanges representing projected prices of oil at some point in the near or distant future. And the more distant in the future the thinner the market becomes. And therefore, poof! If you can push those futures prices to a significant premium above cost, interest and storage costs your current market disaster becomes a brilliant trading ploy. Are markets being manipulated? It has been the contention of these posts that as they are currently constituted, the futures trading of oil lends itself to manipulation and speculation. And oil is not alone. Only yesterday the omnipresent Jim Cramer in his nightly TV segment on CNBC appropriately entitled "The Game is Rigged" would tell his viewers, referring to the stock market, "You have every reason to distrust everything the market throws at you". Can we really expect anything different from the commodities (read oil) trading markets?