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Oil Contango Pays Most in Decade as Shell Holds Crude in Ships
- Thread starter Banjo
- Start date
Quote from daybyday:
I am still trying to understand contango and backwardation, that is why I ask.
Thanks.
normal backwardation of futures markets: When the nearby futures sell at a consistent premium to deferred futures prices and that long side speculators were paid to accept the risks of ownership of various commodities by owning those discounted futures contracts out into the future. In other words, is when there's more demand than supply, its a bullish condition.
Contango: when the spot rate is below the nearby futures, which is itself discountedthe next futures contract on the calendar, which is discounted to the next... and so on. In acontango term structure, hedgers are "paid" to store a commodity, and are able to sell deferred futures at a premium, earning the "cost of carry." On other words, when there is more supply than demand. Is a bearish condition.
In contango. Hedgers...(For example, grain elevators)... will accumulate grain, put it into storage, pay the price of the nearby futures + or - some difference known as the basis, and sell deferred futures if the deferred futures pay the elevator his costs of storage.
Thus, if the cost to store corn from March to May is, for example, 5 cents, and if the May futures trades at more than 5 cents premium to the March, the hedger will roll his short Marchfutures into May and store the grain. The fact that May is at a premium to March does notspeak to the notion that grain prices are expected to move higher; it speaks only to the notion that the borrowing, insurance and other ancillary costs of storage have been covered.
Right now we have a massive contango in the crude market.
Good explanation from the guy above.
Just to add, I would say 'contango' is considered the normal futures market. Backwardation is 'abnormal' condition or a sign of tight supply. Theoretically speaking anyway.
The issue we have here is that the spreads are so far in contango, that there must be sooooo much of the stuff about. Usually the market would bring the spreads to a normal level of contango where the cost of carry benefit becomes questionable.
At the moment it's a no brainer.... they can make a profit, no question, because the locked in profit in the spread far outweighs the cost of carry (which will differ from firm to firm by the way). The issue people have at the moment is they can't find any more places to store oil - Hence Shell holding crude in ships!
The value of the spreads are the real guide for how much demand / supply there is, not the flat price.
Just to add, I would say 'contango' is considered the normal futures market. Backwardation is 'abnormal' condition or a sign of tight supply. Theoretically speaking anyway.
The issue we have here is that the spreads are so far in contango, that there must be sooooo much of the stuff about. Usually the market would bring the spreads to a normal level of contango where the cost of carry benefit becomes questionable.
At the moment it's a no brainer.... they can make a profit, no question, because the locked in profit in the spread far outweighs the cost of carry (which will differ from firm to firm by the way). The issue people have at the moment is they can't find any more places to store oil - Hence Shell holding crude in ships!
The value of the spreads are the real guide for how much demand / supply there is, not the flat price.
you welcome guys, papa you are 100% right.
remember when ppl thought backwardation was "normal"