Shell floats crude on "contango"

An interesting article on how oil majors are buying and storing crude on water on a contango market for crude. The strategy is to buy crude at low price and lock in the profits by selling it forward. The cost of "floating the crude" is estimated at 90cts a month. That equates to $10.80 of financing cost and this means that the crude has to be sold paper at a premium of at least $10.80 to breakeven.

Interestingly clever but unfortunately only a privilege to companies with huge reserves that are largely unaffected by the credit crunch. The oil majors or oil trading companies with reserves would be able to play this well with holding power.

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By Robert Tuttle and Alexander Kwiatkowski
Dec. 8 (Bloomberg) -- In the worst year ever for oil, investors can lock in the biggest profits in a decade by storing crude. Traders who bought oil at the $40.81 a barrel on Dec. 5 could sell futures contracts for delivery next December at $54.65, a 34 percent gain. After taking into account storage and financing costs investors would earn about 11 percent, according to Andy Lipow, president of Houston consultant Lipow Oil Associates LLC. The premium, known as contango, is the biggest for a 12-month span of futures since 1998, when a glut drove crude down to $10.

Stockpiling crude may provide higher returns than commodities, stocks and Treasuries as the U.S., Japan and Europe endure simultaneous recessions for the first time since World War II. Crude sank 72 percent in New York since peaking at $147.27 in July. The Standard & Poor’s 500 Index fell 40 percent this year and two-year government notes yield 0.9 percent. “The bottom line is that you buy crude at a low price and lock in a profit by selling it forward,” said Mike Wittner, head of oil market research at Societe Generale SA in London. “It’s low risk. The contango can definitely pay for storage and the cost of capital and leave plenty left over.”

Royal Dutch Shell Plc sees so much potential in the strategy that it anchored a supertanker holding as much as $80 million of oil off the U.K. to take advantage of higher prices for future delivery. The ship is one of as many as 16 booked for potential storage instead of transporting crude, said Johnny Plumbe, chief executive officer of London shipbroker ACM Shipping Group Plc.
Oil Storage - The tankers, if full, hold about 26 million barrels worth about $1 billion, more than the 22.9 million barrels sitting in Cushing, Oklahoma, where oil is stored for delivery against Nymex contracts. U.S. crude inventories rose 11 percent this year to 320.4 million barrels, according to the Energy Department.
“All the market operators keep placing oil in storage,” said Francisco Blanch, head of global commodities research at Merrill Lynch & Co. in London. “Even though the contango is steep, it could get steeper.”

Crude oil for January delivery rose as much as $2.66, or 6.5 percent, to $43.47 a barrel in electronic trading on the New York Mercantile Exchange today. It was at $42.86 at 11:53 a.m. London time. Blanch said last week that oil may fall to $25 a barrel should the Chinese economy slip into recession and the
Organization of Petroleum Exporting Countries fail to take enough crude off the
market.

Shell, Koch ,The Hague-based Shell, Europe’s largest oil company, last month chartered the supertanker Leander with an option to store North Sea Forties crude, according to Paris shipbroker Barry Rogliano Salles. The vessel arrived at Scotland’s Hound Point, the loading port for Forties, on Nov. 20, according to tracking data compiled by Bloomberg. Sally Hepton, a London-based spokeswoman at Shell, declined to comment. Shell and Koch Industries Inc. of Wichita, Kansas, also hired four supertankers to hold oil in the U.S. Gulf Coast to take advantage of rising prices in the months ahead. They took Very Large Crude Carriers, or VLCCs, to move oil from the Middle East, said Bruce Kahler, a broker at Lone Star, R.S. Platou in Houston. Koch Supply & Trading LP spokeswoman Katie Stavinoha declined to comment.

Tanker Shares
Demand for tankers to store crude oil may help revive the share prices of shipowners including Knightsbridge Tankers Ltd., down 43 percent this year, economist Dennis Gartman said in today’s edition of his Gartman Letter.
“If contango has gone so far in crude oil where Shell and Koch and others are chartering ships to store oil on the water, then demand for tankers is rising,” he said. “Shares of the tanker companies must be ‘cheap.’” The cost to store crude at Cushing averages about 35 cents a barrel a month, Lipow said in an interview. The cost of financing the crude would also be about 35 cents a month. A trader would have to take ownership of the oil in January 2009 and deliver it during December, according to Nymex rules. A supertanker would cost about 90 cents a barrel per month for storage, according to data from shipbroker Galbraith’s Ltd. The amount varies, depending on the duration of the storage.
“The economics make sense if you can find somewhere to store the oil,” said Tony Quinn, managing director of Lincolnshire, U.K.-based Global Storage Agency Ltd., a bulk liquid storage terminal consultant. With depots in Europe almost full, “companies don’t have anything else they can do, so are chartering commercial tankers for floating storage.”

Reduced Credit
The reduced availability of credit may make it harder for traders and companies to purchase and store oil, said Merrill’s Blanch and Societe Generale’s Wittner. “With this sort of contango, we would probably have seen a larger stock build were it not for the credit crunch,” said Olivier Jakob, managing director of consultant PetroMatrix in Zug, Switzerland.
The opportunity to benefit from the storage trade may disappear in weeks should OPEC cut output after its Dec. 17 meeting in Algeria. The group postponed a decision on production at its Nov. 29 gathering in Cairo.
“It’s still quite profitable as long as inventories are ample and OPEC does not remove the barrels from the market,” said Johannes Benigni, chief executive officer at Vienna-based consultants JBC Energy GmbH.

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Reflexivity on the Financial Crisis

In light of the recent financial crisis, we are more likely to be overwhelmed and swamped by the devastation that it has brought then to look back into history and try to understand how this could have happened. Apart from the primary reason that we would all be so familiar by now, the current nemesis of financial markets, known as "sub prime mortgages", there lies i think other impetus or factors that could have led to the series of catastrophic events. Not to mention, Lehman Bros collapse, Fed's aid to ailing financial giants such as AIG and Citibank etc ....

An article was written by George Soro on his theory known as the theory of"reflexivity". Reflexivity in sociology refers to the circular relationship between cause and effect. A reflexive relationship is bidirectional with both the cause and effect affecting one another i.e the cause results in a effect influences the cause and vice versa.If you were to plot a line for world stock indices for the period of 2005 -2007, it can be seen that the stock market was on a bull run to a point where investors or traders (if there were able to differentiate among themselves) or most of us were led to think that there is safety in numbers i.e if everyone had their money in the market it seems like a safe heaven.The stock markets during this period was trending upwards, from bubble to bubble that did not seem to burst.The bubble that grew and established "equilibrium" (or what we would call support level) to "equilibrium", thereby drawing millions to invest in a falsified notion which provided them with a support/safety in numbers.The market was then grossly overvalued.

This illustrates the theory of reflexivity, where the cause leads to an effect which affects the cause in the first place.If traders believe that prices will fall, they sell thus driving down the prices whereas if they believe prices will rise they will buy thus driving the prices up. The prices that goes up and down then in turn influences the perception/fundamentals of trading/investing in stocks. As you can gather, this can lead to a vicious cycle of two natures,the bull or the bear cycles in stock markets.

An excerpt from wikipedia further illustrates this as below -

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A current example of reflexivity in modern financial markets is that of the debt and equity of housing markets.Lenders began to make more money available to more people in the 1990s to buy houses. More people bought houses with this larger amount of money, thus increasing the prices ofthese houses. Lenders looked at their balance sheets which not only showed that they had made more loans, but that their equity backing the loans--the value of the houses, had gone up (because more money was chasing the same amount of housing, relatively). Thus they lent out more money because their balance sheets looked good, and prices went up more, and they lent more, etc. Prices increased rapidly, and lending standards were relaxed. The salient issue regarding reflexivity is that it explains why markets gyrate over time, and do not just stick to equilibrium--they tend to overshoot or undershoot.

Reflexivity is based on three main ideas:

1. Reflexivity is best observed under special conditions where investor bias grows and spreads throughout the investment arena. Examples of factors that may give rise to this bias include (a) equity leveraging or (b) the trend-following habits of speculators.
2. Reflexivity appears intermittently since it is most likely to be revealed under certain conditions; i.e., the equilibrium process's character is best considered in terms of probabilities.
3. Investors' observation of and participation in the capital markets may at times influence valuations and fundamental conditions or outcomes.
unquote"

But would understanding and applying our understanding of reflexivity have averted this crisis altogether? I think that remains a question to be answered given that the human behaviour have been known not to change over the years......