Today In Silver

NOTE: Originally published for Metal Augmentor subscribers on January 6, 2010 at 10:22PM EST.

Over the past year or so, I’ve written several times about the interesting situation in the crude oil market that essentially allows a few big players to lock in an arbitrage profit by storing crude oil in tankers offshore and selling the oil forward on the NYMEX or other futures market. For example there is this posting called Watch the Contango in Oil!

It turns out that in these earlier studies of the subject matter of the crude oil contango and storage scenario, I used a fixed price for the cost of crude storage but in fact the price has been quite variable as demonstrated in a recent post by Mike Shedlock called 26 Mile Long Glut of Idle Oil Tankers. In his commentary, we find a Bloomberg story that references the daily rental cost of a supertanker as around $30,000 right now. By contrast, according to the sources I quoted earlier last year, the rental cost was $75,000 per day. At the time, I calculated that it would cost $1.10 per barrel to store crude oil for one month on a tanker. Using the lower rate of $30,000, however, the monthly cost would be around $0.45 per barrel. In addition, it is possible that individual rates might be negotiated even lower (especially since the tankers are basically just floating and therefore have reduced operating costs). Perhaps the $30,000 per day being quoted for this year is higher than the rate that some players have been able to negotiate. If so, the monthly cost would be lower than $0.45 per barrel.

Why is this worth discussing, you might ask? Because, as Mike Shedlock and others have pointed out, all of this stored crude will eventually come to market and if it does so quickly because storage is no longer affordable then we could literally have a major liquidation event in the crude oil market, causing a sharp and seemingly inexplicable drop in oil prices. That in turn could create ripple effects in other commodity markets including the metals. But even if the reverberations are minor, there could be a very attractive speculative play in just crude oil itself if we are able to recognize the early signs and act appropriately.

Such “early signs” in this case include primarily the same signals that we look for in the gold and silver basis — a shrinking of the contango. Thus, I’ve dolled up a crude spread chart that I think might be useful in taking a look at the situation. The chart below is the spread between the current front month February 2010 NYMEX crude oil futures contract and the December 2010 futures. This chart will be adjusted as the NYMEX crude contract rolls to the next front month (e.g. by January 15 the front month will be the March contract). I’ve drawn a line showing the $0.45 per barrel storage cost ($4.50 per barrel based on the 10 months between expiration of the February 2010 and December 2010 contracts). As the chart shows, crude prices have been flirting with this breakeven $0.45 per barrel-month storage level and it seems like we should keep an eye on the situation. Trading ideas to follow if and when appropriate.

Click on the chart below for a full size image.

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