Oil Contango Doubles in 2011 Recovery Betting With Frontline Ship Demand

Oil traders are showing increasing confidence that U.S. economic growth will rebound next year as they take advantage of the widening gap between current prices of crude and contracts for delivery six months from now.

The price advantage, or contango, to buy and hold crude more than doubled to $5.76 a barrel last month from $2.60 at the end of July, as contracts for October delivery fell 9.4 percent and March dropped 5.3 percent. ConocoPhillips hired the tanker TI Europe for storage in the Gulf of Mexico, according to data on the website of RS Platou A/S, an Oslo-based shipbroker.

Crude, gasoline and heating oil inventories reached a 20- year-high last month as the U.S. Commerce Department said the economy probably expanded at a 1.6 percent annual pace in the second quarter from an initially reported 2.4 percent. The gap, or curve, between the price of oil for immediate delivery and for March has increased to a three-month high, making storage a profitable wager on an American rebound next year.

“Demand is going to look a lot better in 2011,” said Adam Sieminski, chief energy economist at Deutsche Bank AG in Washington, who predicted prices will rise to $80 next year. “By then the overall numbers on things like industrial production, housing, investment and probably even consumer sentiment will be better.”

October futures rose 58 cents, or 0.8 percent, to settle at $74.67 a barrel on the New York Mercantile Exchange. The March contract rose 29 cents to $80.58. The spread narrowed by 4.7 percent to $5.91.

Tanker Demand

Frontline Ltd., the world’s largest tanker operator, said on Aug. 27 that demand for ships used for storage will rise in the fourth quarter.

“Floating storage will come back,” Inger Klemp, chief financial officer of Frontline’s management unit, said Sept. 1 at a conference in Oslo, where she’s based. “In fact, we have already been approached with various enquiries.”

The spread shows that traders are betting the economy will keep weakening through 2010 before improving in the first half of next year, said John Kilduff, a partner at Again Capital LLC, a New York-based hedge fund that focuses on energy. Again Capital declined to disclose its assets under management.

Oil for immediate delivery has fallen 14 percent from the 2010 high in April as government data reinforced concern that the U.S. recovery was faltering.

‘Double-Dip Feel’

Orders placed with U.S. factories rose 0.1 percent July, compared with the 0.2 percent median forecast of 64 economists in a Bloomberg News survey, following a 0.6 percent decline in June, the Commerce Department said last week. The Institute for Supply Management’s index of non-manufacturing businesses, which covers about 90 percent of the economy, fell to 51.5 from 54.3 in July, the weakest pace in seven months. Readings above 50 signal growth.

“It might not be an official double-dip, but it’s going to feel like one,” Kilduff said. “The curve is telling us that right now, based on current conditions and what the economic outlooks are, prices are going to be higher next year.”

Prospects for faster growth in 2011 help explain why oil is trading in the longest-running stretch of contango on record. As of Sept. 3, the prompt oil contract had been cheaper than the next month for 651 days. The previous record was 640 days from October 2005 to July 2007.

Private Payrolls

U.S. payrolls excluding those of government agencies climbed a greater-than-forecast 67,000 in August, after a revised 107,000 increase in July, the Labor Department said on Sept. 3. The world’s biggest economy will expand 2.5 percent in the third quarter and 2.6 percent in the fourth, accelerating to 3.2 percent by the end of 2011, according to the median of economist forecasts compiled by Bloomberg.

Contango doesn’t guarantee higher prices next year, said Edward Morse, the New York-based head of commodities research at Credit Suisse Group AG, the second-biggest Swiss bank by assets. If global growth falters, the Organization of Petroleum Exporting Countries would have to trim output to prevent inventories from increasing and driving down prices, Morse said.

The contango began in November 2008 after the bankruptcy of Lehman Brothers Holdings Inc. caused credit markets to freeze up. Oil inventories rose 33 percent from the start of 2008 to the week ended May 1, 2009, when they hit highest level since 1990, according to the Energy Department.

The spreads peaked in January 2009, when oil for delivery in six months cost $18.40 a barrel more than immediate contracts. BP Plc, Vitol Group and Royal Dutch Shell Plc leased tankers to store crude at sea, according to the companies.

BP Boost

The Energy Department said in May 2009 that as much as 130 million barrels were floating on ships around the world. The strategy helped boost BP’s profit by $500 million in the first quarter of 2009, the company said.

The TI Europe, the tanker hired by ConocoPhillips for storage in the Gulf, has a capacity of 3 million barrels, and ConocoPhillips is paying $41,000 a day, according to RS Platou’s website. John Roper, a spokesman for ConocoPhillips in Houston, declined to comment.

The trade diminished as spreads narrowed. The amount held on Very Large Crude Carriers hired for long-term storage has fallen 49 percent this year to 39 million barrels as of Aug. 27, according ICAP Shipping International Ltd.

The price advantage shrank 82 percent to $1.79 on July 20 from this year’s peak of $9.88 in May. As the premium evaporated, traders unloaded cargoes, pushing oil imports into the Gulf of Mexico to a record high in July.

The contango widened again as inventories resumed their climb. Stockpiles of crude, gasoline and heating oil rose to 1.14 billion barrels the week ended Aug. 27, the highest since the Energy Department began keeping the data in January 1990.

Demand Decline

A drop in demand could add to the near-record high stockpiles in Cushing, Oklahoma, the delivery point of the New York Mercantile Exchange benchmark oil futures.

“We’re starting to see that storage push up against capacity,” said Lawrence Eagles, head of commodities research at JPMorgan Chase & Co. in New York. “That’s going to continue for a while, which means you’re going to end up with periods of very large contango.”

The spreads, combined with falling tanker rates and low- cost financing, have cut the daily cost of storing a barrel offshore 24 percent this year, according to data from Simpson Spence and Young, the world’s second-largest shipbroker.

Leaving crude in supertankers costs about $1.50 a barrel per month, including financing, storage and insurance, said Stephen Schork, president of consultant Schork Group Inc. in Villanova, Pennsylvania. Keeping crude on land ranges from 60 cents to 75 cents a month, Credit Suisse’s Morse said.

Refinery Utilization

Spreads may widen as refineries shut for seasonal maintenance, which will weaken immediate demand and boost the incentive to store, said Andy Lipow, president of Lipow Oil Associates LLC in Houston.

Refinery utilization fell to 87 percent, the lowest level since April, the week ended Aug. 27 from a high of 91.5 percent in July, the Energy Department reported last week.

“The only thing that could really send the oil market down would be another Lehman Brothers type of event,” said Philip Verleger, a University of Calgary economist and principal and founder of PK Verleger LLC, an energy and commodity markets consulting firm. “I think you can go below $70, but as long as there’s a sufficient contango, you’ll have people adding to the inventories.”

To contact the reporter on this story: Asjylyn Loder in New York at aloder@bloomberg.net

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