'Black Gold'

Wednesday, 13th May 2009 15:58 - by GedW

The world is awash with ‘Black Gold’! In this Blog - the first of its type from me – I look at sectors that are in the news for a variety of reasons. Hopefully, by looking at sectors’ trends, pointers will be given as to where share prices amongst the sector’s constituents may be heading. Reports released show that the world has an oversupply of oil, as the world economic contraction bites into the demand for oil. So much so, that storing of the over-supply is become a major issue amongst producers. Supertankers are being commissioned to store this over-supply. The largest tanker company has never had it so good (http://www.frontline.bm/company/history.shtml). There are estimates of up to 50 such supertankers anchored around the world, each carrying some 2mns barrels of oil, the equivalent to one days global oil demand. With the forward price of oil much higher than current selling price, producers and others are storing oil in the hope of making huge future gains in what is a ‘contango’ situation. That is, a state in which the forward price of a commodity is higher than the spot price to a greater extent than can be explained by the interest and storage costs that explain the usual state of forwarding or contango. Producers of non-perishable resources (such as oil and metals) may also exploit the arbitrage opportunity by delaying production, effectively storing the commodity before releasing it to the market. In spite of the apparent arbitrage opportunity, contango does occasionally occur. There are a number of possible reasons: • There is a shortage of storage capacity • Output is already expected to run at capacity for the future delivery dates, so storage in the ground in not an option • The costs of adjusting output levels • There is a lack of credit to fund the arbitrage trade; if the cost of borrowing is high contango will also be high • Producers are desperate for cash. This is clearly also linked to the availability of credit • Political pressures and constraints: this is particularly likely to be true of oil where output is set by a cartel The oil sector looks like showing no signs of recovery for now and, more to the point, some smaller producers will find the problem of storage an expensive headache. But the reward will be, hopefully, higher oil income in the years to come.