Consider PowerShares DB Oil Fund as a Contango Play

There is a straight way to play oil contango: buy physical oil and oil futures for the equal amount of it several months ahead. Store oil in Cushing, OK or in a supertanker somewhere offshore, paying about a dollar per barrel per month and deliver it when future contracts expire. This is for serious the oil speculators, who have big capital.

Is there anything individual investor can do? And filling up your swimming pool with crude is not what I have in mind. Yes, there is a possibility to speculate on contango.

Let's take a look at U.S. OIL FUND ETF (USO). As everybody knows, oil price, which usually means next month's future contracts for West Texas Intermediate oil (WTE), almost doubled since beginning of the year. USO, which represents next month's WTE futures, is up a whopping 9.5%. Why? There is a small problem with USO's design: this ETF buys next month futures contracts, and at the end of month rolls them over to the following month. Of course, in case of contango, it buys less contracts for the following month, because they are more expensive. Repeated every month, this procedure kills USO in the case of contango.

There is another trading tool for oil price: PowerShares DB Oil Fund (DBO). This fund also holds oil future contracts, but somehow loses much less money on contango effect.

Suppose, you shorted 1000 shares of USO at 33.10 and bought 1500 shares of DBO at 19.29. The net difference is $4165. If you sold/covered them today at the close, USO at 36.25 and DBO at 24.88, you'd get additional $1070 and a net gain of $5235 minus commissions.

There is a risk involved. If contango is replaced by backwardation (longer future contracts less expensive than near term ones), USO will outperform DBO. DBO is not as widely traded as USO, and there isn't much information available about it, so there are some unknown risks as well.

Full disclosure: At the time of publication author had no positions in DBO or USO. Positions can change any time.

Comments

[Ferdinand E...:]

Alex, I think that you mean buy physical oil and short futures, That way you lock in the present price, and if later the future looks bright for physical oil you can dump your futures. And so on and so forth.

Jun 05 10:41 AM

[Baboon:]

Why would paying for storage in a supertanker would cost less than the value of contango? Shouldn't contango amount to the cost of carry? I believe that only tankers themselves make money during contango as the amount of stored oil increases.

Jun 05 11:17 AM

[Brian Tall:]

DBO doesn't necessarily underperform on the upside. Read further into DB's "optimum yield" methodology. USO ALWAYS carries next month's contract, USL ALWAYS carries the 1 year contract, but DBO will move positions on the futures chain to either maximize positive roll yield in backwardation or minimize negative roll yield in contango. Because DBO is highly dynamic, it is very important to monitor which contract it is holding as that will tell you a lot about how it will perform relative to both USO and USL.

Jun 05 12:13 PM

[Alex Filonov:]

You can buy physical and short futures. Or you can buy short term futures for delivery and sell (short) long term futures for delivery. Doesn't make much difference.

On Jun 05 10:41 AM Ferdinand E. Banks wrote:

> Alex, I think that you mean buy physical oil and short futures,
> That way you lock in the present price, and if later the future looks
> bright for physical oil you can dump your futures. And so on and
> so forth.

Jun 05 02:48 PM

[Alex Filonov:]

If contango is less than a $1 per barrel per month, there is no money to be made. Any play only works when contango is greater that $1 per barrel per month, as it was for the first 5 months this year. As for the question if contango should amount to the cost of carry, it doesn't always work this way. In January-February, the difference for two consecutive months reached 3+ dollars.

On Jun 05 11:17 AM Baboon wrote:

> Why would paying for storage in a supertanker would cost less than
> the value of contango? Shouldn't contango amount to the cost of
> carry? I believe that only tankers themselves make money during contango
> as the amount of stored oil increases.

Jun 05 02:53 PM

[Baboon:]

Good, thanks.


On Jun 05 02:53 PM Alex Filonov wrote:

> If contango is less than a $1 per barrel per month, there is no money
> to be made. Any play only works when contango is greater that $1
> per barrel per month, as it was for the first 5 months this year.
> As for the question if contango should amount to the cost of carry,
> it doesn't always work this way. In January-February, the difference
> for two consecutive months reached 3+ dollars.
>
> On Jun 05 11:17 AM Baboon wrote:

Jun 05 03:13 PM

[searcher:]

It's not the change in the cost of carrying the money or a change the cost of carring the physical entity that is the engine for profit. It is the expectation of greater demand and/or less supply at future date(s) that fuels the expectation of higher prices for the commodity. Since change is in the future, so is the higher expected price.

Jun 05 04:34 PM