Why speculators are stashing vast quantities of crude oil on tanker ships

The market for crude oil is now in a serious state of what’s called contango — a futures contract entitling you to delivery of a barrel of West Texas Intermediate crude oil in November 2016 is currently about $5 more expensive than a contract entitling you to that barrel in March 2015. As a result, speculators are trying to get their hands on old tanker ships, the Chinese government is stashing oil as in old salt mines, and you could potentially turn a profit by leaving a bunch of cans of gasoline in your basement.

Welcome to the exciting things that happen when the frictionless world of derivatives trading collides with the grubby physical realities of sucking oil out of the ground and storing it.

The basic issue is that oil drilling operations aren’t like faucets that you can simply turn on and off. Shutting one down safely takes time and money, and so does starting one back up. Consequently, declining prices don’t lead to an immediate decline in production. But markets expect that over time either global oil consumption will boom or else global oil production will decline, and either way the price will rise.

That expectation gives rise to the contango curve — where hypothetical future oil is more expensive than oil today. From an oil producer’s standpoint, this is unfortunate. If you could simply not pump any oil today and keep it in the ground until higher prices arrive, you’d make more money. But in most cases this doesn’t work logistically. The oil is coming out, even if market prices imply it should be kept in the ground.

That’s actually exactly what happens. Back in 1990 Lars Jacobsson started the Scandinavian Tank Storage Company which pioneered what’s known as the oil storage trade. The way it works is you buy a bunch of giant empty tanks — either based on land or seaborne tanker ships — and during periods of contango you buy up oil and sit on it. You can also execute a version of the storage trade by paying someone else to store your oil for you.

It sounds like a sweet deal, but of course building and operating an oil storage facility (or renting one out) isn’t free. So you can’t make money here if the contango curve is gently sloping. But during periods of sharp contango it works.

As Lynne Cook and Michele Norris explained back during the great contango of 2008, it’s typically easier to use tanker ships because land-based facilities fill up really quickly during periods of supply glut. Those very gluts reduce demand for actually moving oil around, creating the opportunity to use ships as pure storage.

Pretty much! In general, Vox does not advise average middle class people to attempt to execute any investment strategy other than buying-and-holding low-fee passively managed stock funds. But if you happen to have the space around the house to safely store a bunch of gasoline, then filling up now while gas is cheap to use later when it’s expensive is kind of a no-brainer.

But it’s unlikely that investing in storage infrastructure would actually pay off. A jerry can that holds five gallons of gasoline sells for over $30, so it’s hard to make a profit this way unless you’re able to operate at a massive scale and get a much better price on storage. But if you already have the cans on hand, then why not?

Kind of, yeah. The oil price drop of the past couple of months has already filled up land-based storage, and oil is once again taking to sea. This makes oil more expensive this winter than it would be if actual end-users of oil weren’t bidding against people just stockpiling oil to keep it off the market.

On the other hand, holding that oil in reserve today when it’s cheap will mitigate price increases down the road by giving global supplies a boost.

Governments also play a role here, as major states have developed strategic petroleum reserves — giant stockpiles of oil. The United States of America, for example, has 727 million barrels of oil stashed in salt caverns near the Gulf Coast. It’s common during periods of expensive gasoline to see calls to sell down that stockpile to increase supplies. Conversely, when oil is cheap the President typically orders it to be re-filled. Thus you have a kind of contango trade from the government sector. At the moment, the US SPR is totally filled up so we can’t get in on the action. But China is in the process of building and filling its own SPR facilities, so you can bet they’re socking away as much crude oil as they can while the going is good.