Weaker Oil Curve Structure Incentivizes Contango Trade

September 18, 2020
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More upward slope in the oil curve has again made storing crude at sea profitable for some. The use of so-called “floating storage” on large crude vessels comes amid swollen inland crude stocks that are near capacity globally.

The spread between Brent crude for prompt delivery and one-month into the future (M1-M2) has been widening recently, now near $0.50. Our chart below shows the spread of Brent’s M2-M1, which has become more positive as the curve slopes more steeply upward. Brent’s six-month to prompt month delivery (i.e. M6-M1), a common time-charter length for those trading the contango (upward sloping) structure at sea, has been nearing $3.00/Bbl, a spread not reached since late May.

Lower tanker rates have made the floating-storage play easier to execute. Freight rates for many vessel classes, with the very large crude carrier (VLCC) being the most popular and economic choice for traders and shippers, have been very low. Only recently have VLCC rates (dark blue line) risen as oil traders book additional vessels to store crude.

The chart below plots the break-even for a VLCC along with the Brent M2-M1 spread. The break-even (dotted line) below the M2-M1 spread (dark blue line) represents times when it could be profitable to book a VLCC and store crude at sea for future sale. Recently, with the combination of cheap vessel rates and a widening contango structure, traders have been taking advantage of storing crude, according to industry reports and trading companies’ announcements.

The margins are thin, though. It could be the case that traders are storing crude at sea for a loss, as inland storage globally is near capacity.

Oil is usually forced into storage when supply exceeds demand. Therefore, whether it be on land or sea, increases in inventories is typically regarded as a sign of a weak physical market. The fact that floating storage is re-emerging, especially while OPEC+ is still curtailing its production, means that oil fundamentals likely have a long road ahead to recovery and balance.

We continue to monitor oil, gas, NGLs, regional markets, jet fuel, and interest rates for hedging opportunities. To learn more and see AEGIS opinion and recommendations, go to AEGIS View publications, or contact info@aegis-energy.com. Like what you see? Share this article with the button on the bottom right of your desktop. Market questions or comments? Contact us at view@aegis-energy.com.

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