Is it the cost of storage? Is it that difficult to store natgas?
why is natgas usually in contango and oil usually in backwardation
- Thread starter billyjoerob
- Start date
Uhh, oil is in contango and has been for quite a while.
Yeah both have been in steep contango for awhile. Economically speaking, when markets are over supplied they go into contango. You are discounting the front end of the curve to entice buyers because there is too much supply.
I forget where I read that oil is usually in backwardation and natgas in contango, but it seems to make sense. Oil certainly spends more time in backwardation than contango. Maybe it has to do with the commercial buyers - the buyers of natgas are utilities who want to lock in supply. The buyer of oil are ultimately ordinary consumers who don't lock in prices.
Natty is backwardated much more then oil. Think about what it means to be in backwardation economically. How are oil and gas different. Here is hint: Elasticities...
when I say backwardated I simply mean inverted futures curve.
oil demand is inelastic. 1% in price -> .02% change in demand. natgas is harder to store and demand can switch back and forth between coal and natgas, so more elastic.
oil demand is inelastic. 1% in price -> .02% change in demand. natgas is harder to store and demand can switch back and forth between coal and natgas, so more elastic.
Some markets indeed are characterized by a persistent backwardation. It is a
well-known phenomenon in the case of the crude oil market, as reported, for example, by Litzenberger and Rabinowitz (1995). In almost 20 years, the market witnessed only three contango situations: in 1993-1994, in 1998, and more recently in 2005-2006.
http://webcache.googleusercontent.c...HIER_22_LAUTIER.pdf+&cd=4&hl=en&ct=clnk&gl=us
well-known phenomenon in the case of the crude oil market, as reported, for example, by Litzenberger and Rabinowitz (1995). In almost 20 years, the market witnessed only three contango situations: in 1993-1994, in 1998, and more recently in 2005-2006.
http://webcache.googleusercontent.c...HIER_22_LAUTIER.pdf+&cd=4&hl=en&ct=clnk&gl=us
ok, a little history here. For the better part of the last 50 years, a large majority of the oil produced in the world was by OPEC nations. This means they controlled the price of oil because they had a cartel. Cartels can set the market price by withholding supply. Because of their cartel, the forward curve was backwardated. There also was geographical issues with transport that made it harder to transport oil so when there were supply shocks, you couldn't get access to it.
Today these issues are moot. OPEC no longer sets the price of oil. The US is now the largest producer of oil in the world and transport gluts are gone. Because of this, oil going forward will most likely be in contango as long as we are drowning in supply. This is why I said one needs to understand the economics. The supply curve for any commodity is going to dictate the contango or backardation conditions.
So the backwardation in oil was due to the optionality of holding onto the physical oil - if something should happen, you had the option to sell into the spike. OK, that makes sense. But why do you say that natgas is in backwardation? Spot natgas is at $2 and the curve is in contango.
http://www.marketqview.com/forwardcurvechart.php?ID=58&TYPE=Price
http://www.marketqview.com/forwardcurvechart.php?ID=58&TYPE=Price
No, nat gas is "usually" in backwardation. Again, the overabundance of supply is abnormal for nat gas although it appears to be the new normal for awhile now.
And yes, the economic term we use and the one you can google is called "convenience yield". It's extra return one has by having the optionality of holding the physical.