2009 Is Back, And So Is The "Risk-Free" Contango Trade

In many ways what is going on in late 2014 is a carbon copy of events in early 2009: back then the market was melting down every single day. Now, it is also melting, only in reverse. Back then the the interest rate was 0%, as it is now 6 years later (only with $3 trillion more in the Fed's balance sheet), and while then the Fed was scrambling to recover from the disaster of its latest bubble bursting, now it is focused on preventing the same bubble it successfully reflated - the third consecutive in a row - from popping. It will fail as it always does.

Just as notably, like in early 2009 so too now the price of crude oil and the entire commodity complex has disintegrated. Back then nobody doubted it was due to a global depression, while now the collapse is being spun as bullish (because apparently OPEC is oversupplying not just crude but copper, steel, iron ore and all those other commodities which China suddenly no longer wants - for more details speaks to Australia and Brazil). The result of this is that just like in 2009 so now the crude curve has entered full-blown contango. Which means that suddenly storing crude is all the rage as one can effectively pocket a risk-free profit if one can simply buy the product now and sell it at some point in the future for a guaranteed roll up the non-backwardated curve. Just like in 2009, as long as one has a place to store said contango-ed commodity.

As the following snapshot from January 2009 shows, the 12 month, $25 contango back then was without precedent, and as a result there was an epic scramble by hedge funds, banks and various other speculators to store about 100 million barrels on tankers with the intention to sell later. Since the contango was so wide one could easily lease any number of VLCCs and still be profitable on the trade. In fact, a big reason for the renormalization of the crude curve back then was because so many funds jumped on this arb.

Fast forward to today, because the "risk-free" contango trade is back.

As Reuters reports, "global oil traders are likely to store crude in tankers next year, as a widening contango makes large-scale storage at sea profitable for the first time since the financial crisis more than five years ago, industry sources said."

Just like in 2009, "with Brent for prompt delivery dropping sharply versus later contracts in the past week, traders are increasingly requesting to lease vessels for storage."

The spread between buying now and selling later means that "the current contango on the ICE Brent market would already be sufficient to make floating storage viable based on average 2014 freight rates," JBC Energy said in a note. Analysts at JBC Energy expect 30-60 million barrels of oil to be stored offshore worldwide in the first six months of 2015.

And while it may not be anywhere close to the massive curve dislocation from early 2009, Brent for February delivery is currently close to $3.95 cheaper than for delivery five months later, the widest gap since 2010. And yet, so far in 2014 "only a few tankers have stored oil at sea as the discount for the front month crude futures has been insufficient to finance chartering. Ship owners have also been resisting calls to lease out vessels for oil storage given a seasonal hike in freight rates."

However, as day rates drop, ship owners will be compelled to lock in deals to allow charterers to store crude for months, industry sources said.

"Moving into the first quarter of 2015, freight rates are likely to correct downwards, opening up floating storage opportunities," JBC Energy said.

The problem is that with oversupply on deck (pun not intended) suddenly the world may find it does not have enough tankers!

The International Energy Agency expects 300 million barrels of crude to be put into storage globally, including onshore and offshore, in the first half of 2015, which could "bump against storage capacity limits" in OECD countries.

Which paradoxically means that all those trounced tanker stocks may suddenly get a strong tail wind as a result not of actual end-customer demand, but as specs try to lock in a risk-free spread on the contango and rent tankers for sub-1 year charters, until the physical delivery date comes.And if indeed capacity limits are hit, then quite soon not a single tanker will be available to actually transit crude from source to end market, as all will be leased by hedge funds to simply sail in circles with thousands of tons of precious black gold cargo.

So for all those who have hundreds of millions to spend on storage costs and can take advantage of economies of scale, the contango trade is a no-brainer. What about everyone else? This question brings us to the "risk-free" profit idea we first presented in January 2009. For those who may not have been around back then here it is again.

Risk-Free Profit Idea of the Day

 

Buy: Barrels of Oil

Why? You pocket $25 RISK FREE per barrel for just holding on to it for 11 months

What is the Catch? U need a place to store a couple of barrels of oil...

What is the CNBC Catchphrase? Contango

What is the math? Buy oil for February physical delivery (perfect, gives you time to organize this brilliant strategy), with the goal to sell it in January 2010, for an 11 month holding. According to most recent NYMEX quotes, you pocket exactly $25/barrel doing this trade.



Some geometry. A Barrel of Oil, is a standard volume measure equivalent to 42 gallons, or 158.9873 liters for our 2 European readers. This "black gold" is stored in 55-gallon drums, which have dimensions of roughly 24" by 34"; while traditionally these have been made of steel, you can buy plastic alternatives. Since you don't care about the quality of the drums you can buy used drums. According to this Craigslist seller you can buy bulk used drums for $8/each. The average circular barrel takes up on average 4 square feet in area and is roughly 3 feet high. You can stack barrels as many as you need high, limited by the height of the storage facility.

Next you want to find an average sized warehouse - presumably somewhere cheap, let's say Stamford, CT, which is terrific for two reasons 1) most of our readers are in the greater Stamford area, and 2) if there is a leak, you will pollute not some endangered crane breeding ground, but the domiciles of some of the richest people in the US. Elsewhere in the country, rates will be cheaper. According to this link, you can rent a 2,200 sq/ foot warehouse in Stamford, CT for $3000 month (this assumes no haggling). Plugging all these variables in the below spreadsheet, and you end up with a risk free profit of $41,800 over 11 months without moving your finger... And this is a scalable and leverageable idea - meaning you can potentially book unlimited profit, as long as you can find the storage, the barrels and someone to finance it if you don't have the upfront costs. Even if inflation has a "hyper" prefix at some point over the next 11 months (which we at Zero Hedge are very concerned about and believe it might happen), you will still be locking in a real profit.

 

Obviously, one has to scale all the aspects of the trade to the current reality, but the underlying math is still applicable and if the crude collapse continues will make it that much more attractive.