History of Oil

30 June 2005

Contango - Is when the front end of the market is trading at a discount to the back end. It is more natural for markets to be in backwardation. Power markets being the exception to the rule.

Oil is now in contango, this means that the front prices in the prompt are lower than forward prices later on in the curve. The reason for this is a medium term supply problem coupled with an over supply problem in the front end. Contango markets encourage inventory building, because you can buy cheap and sell forward at higher prices. The last time there was a sustained contango in the market was in 1998 when Asian demand collapsed and production increased out of Iraq, oil was at $10 brl. Not surprisingly some will be wary of these numbers. Perhaps the main difference between now and then is that the drop in prompt oil prices was caused by a temporary blip in demand and supply. Today the cause is a sustained belief that supply is running out and that in the medium to long term, supply is only going to get worse. Perhaps interestingly, the power market is almost always in contango caused by the lack of a market to "inventory build", gas has been in contango as usual following oil. Carbon is contango (though marginally because of the bankability of permits and so the contango is more a reflection of cashflow). This cannot last forever, as players can stockpile, prompt gas, prompt oil prompt permits and still manage to procure prompt power. This will only lead to an eventual fall in the back end of a curve, causing a backwardation in most markets where they naturally belong.


Carbon  Oil  Contango 

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