Oil Prices Poised for a Big Rise by Year End

We've seen the price of crude oil and the price of gasoline fall dramatically in the last year, but some very big bets are being made that the price is going to go back up substantially this year. While these plans could backfire, they are being made by those who are in the best position to forecast rates going forward.

First, a little background: most crude oil is loaded onto tanker ships and is brought to refineries around the world. The biggest of these ships are called Very Large Crude Carriers or VLCCs. Each VLCC can hold roughly 2 million barrels of oil. If you do the math even at $30/ barrel, you can see why the ship owner (or more likely, its insurance company) was willing to pay such a large ransom for the release of one of these ships after it was captured by Somali pirates last month. Although the number of tanker ships varies as new ones are built and old ones are scrapped or repurposed, the total capacity of the global oil tanker fleet is roughly equal to 500 of these VLCCs although it is comprised of ships of varying sizes.

Bloomberg is now reporting that oil traders have chartered 25 of these VLCCs and are looking for another 10 to use as floating storage tanks. That is to say that oil traders are buying oil at today's prices and taking it out of the market for now. Instead of reselling it as they normally would, they are holding onto the oil with plans of selling it when prices rise later in the year. According to Bloomberg, the leases are for six to nine months. That suggests that these oil traders expect oil prices in late summer and fall of 2009 to be much higher than they are today. Higher oil prices, of course, will mean higher gasoline prices.

The cost of storing the oil Bloomberg says is about 90 cents per barrel per month, citing Galbraiths LTD, a major ship broker. OK, so nine months, at current charter rates is only about $8.10 per barrel. Then, there's the opportunity cost of all that money. In other words, the oil traders are locking up all that money in inventory with no return at all for nine months. Very, very roughly, it looks as though it would take oil to go to $60/ barrel for this move to pay off. If you add in a risk premium, then it's likely they are expecting prices to hit at least $70/ barrel by this autumn.

On the other hand, this strategy means that approximately 70 million barrels of oil will be sitting and waiting to be released into the market on top of the normal daily oil production. The sale of all this stored oil could actually help to lower oil prices or at least stop them from rising further, especially if it is all released near the same point in time. Imagine being the last holder of this stored excess oil and seeing all the other traders selling off their oil and lowering the price on you. Of course, you'd sell it as quickly as possible, or lengthen the VLCC lease and pay for storage for a few more months.

So we look for oil to be in the $70/ barrel range this fall where it may stall for the rest of the year. In early 2010 expect prices to climb further if the US economy is showing strong signs of recovery and GDP is on the rise again.

Stock position: None.

Comments

[Perry1961:]

They've already locked in the profit. If a trader bought at $41 right now,and sold the June contract for $50,he's locked in a profit of $6.30 per barrel,or roughly $12M. Assuming he doesn't park off the Somali coast.

Jan 29 07:22 AM

[john s. gordon:]

a new type of strategic petroleum reserve, but not gov't owned.
> jack

Jan 29 08:21 AM

[bgstrong:]

I certainly hope that the US govt. is taking this opportunity to
completely fill the Strategic Petroleum Reserve.

Jan 29 11:56 AM

[ROLEX18K:]

First article on SA on Oil where writer at least checked prices, names for vessels, storage capacity, costs- all precise, I trust Bloomberg.
It is great that speculators lease those tankers ( great for a leasing party that pockets profits after the deal is signed ), speculators are the core to market trading, they allow other speculators to lose and make money.
Now I look at logic of those deal, not at possibility as I don't know where Oil will be in 9 months, not even in 9 days.But we have those tanker traders who probably know it.
December 09 Oil is trading at 55$ a barrel and spot at 42$.
So where the holder of tanker is making money?
As you rightly say 70$ would be acceptable price to sell for November or December delivery.
Logically looking in this deals I don't see big risk, the only problem will be declining Oil price, it will put pressure on margins as the lease rate must be paid as you checked on Bloomberg 1$ per month and a difference between front and next month in Oil futures is about 4$, the sharply declining spot Oil price will put pressure on this difference plus further months will decline too and deal can become uneconomic.
I think what else could be, maybe traders bought tankers and immediately sold Sept,Nov,Dec Oil futures but this trade is more like to be even than money maker.
To me personally this deals stink, this traders make profits only if forward months prices are rising so IN THE END THIS IS PURE SPECULATIVE LONG OIL TRADE it only works if prices go up.
There is no backup plan in this trade.

Jan 29 12:37 PM

[BrotherMaynard:]

"That suggests that these oil traders expect oil prices in late summer and fall of 2009 to be much higher than they are today."


I think you are a little confused.

First of all, and as you illustrated yourself, futures prices are just spot prices multiplied by some discount rate.

They are NOT actual projections of what oil will be trading at in the future.

The discount rate is typically just a function of the cost of carry . 0.90 for storage is about right, but what you failed to mention is that financing is also another ~60-90 cents. $1.50 to 1.80 per month is more like the cost of carry these days, and as storage capacity becomes tighter, that will only increase -- and therefore, so must the spread between spot and futures.

Recently, though, we've seen the curve come in a little bit, but this has been rumored to be because of index rebalancing and retail money being put to work at the front end of the curve...but just as we saw during the past couple front months, as we get closer to expiry, the contango will again get steeper as positions in the front month are abandoned, given the dearth of storage capacity (e.g. Cushing). That will eventually work its way down the curve and pull those $50-$60 and $70 contracts down to spot levels.

Jan 29 03:34 PM

[The Greates...:]

The oil industry as a whole are to blame for the worlds ecomomy going into the toliet, may the price keep falling. And not rise until the economies are much better off then today.

Jan 29 06:15 PM

[BMW62009:]

Ok...so why would oil traders rent VLCC's???


On Jan 29 03:34 PM BrotherMaynard wrote:

> "That suggests that these oil traders expect oil prices in late summer
> and fall of 2009 to be much higher than they are today."
>
>
> I think you are a little confused.
>
> First of all, and as you illustrated yourself, futures prices are
> just spot prices multiplied by some discount rate.
>
> They are NOT actual projections of what oil will be trading at in
> the future.
>
> The discount rate is typically just a function of the cost of carry
> . 0.90 for storage is about right, but what you failed to mention
> is that financing is also another ~60-90 cents. $1.50 to 1.80 per
> month is more like the cost of carry these days, and as storage capacity
> becomes tighter, that will only increase -- and therefore, so must
> the spread between spot and futures.
>
> Recently, though, we've seen the curve come in a little bit, but
> this has been rumored to be because of index rebalancing and retail
> money being put to work at the front end of the curve...but just
> as we saw during the past couple front months, as we get closer to
> expiry, the contango will again get steeper as positions in the front
> month are abandoned, given the dearth of storage capacity (e.g. Cushing).
> That will eventually work its way down the curve and pull those $50-$60
> and $70 contracts down to spot levels.

Feb 03 03:50 PM

[Maxi:]

Oil Prices came down because of Recession when economy will start to improve Oil Prices will go up again.

Feb 05 11:04 PM