Contango is a situation where the futures price of a commodity is higher than the spot price. Brent and U.S. crude contracts were deep into contango as oil prices lost as much as a third of their value after Saudi Arabia signalled it would hike output to win market share.
The Oil Sell-off
Fears of a COVID19-related slump in global energy demand have flipped the market into contango this week – a structure that encourages traders to keep crude in storage for more profitable resale in the future. This also means that the market is moving to carry a humongous amount of oil barrels into inventories, which leads us to the next question ‘where do we store the oil?’
Tankers To The Rescue
The oil glut and contango has made it potentially profitable to buy oil now, store it offshore onboard vessels and sell it later at higher prices. This has led to a fixing frenzy by producers, traders and refiners looking to transport crude as well as store supplies on tankers to take advantage of the widening contango.
https://www.tradewindsnews.com/tankers/vlcc-rates-surge-as-shipowners-firmly-in-control/2-1-771976
VLCC – Very Large Cash Cows
With unrestrained production arriving in April after the breakdown of the OPEC+ alliance, along with lower global demand due to the coronavirus (COVID-19) outbreak, we can expect crude balance to have huge stockbuilds going forward. The huge amount of oil to be stored means that available storage capacity will be exhausted and that floating storage will be required to fully accommodate the surplus.
From my research, onshore crude storage typically requires contango of -$0.25 to -$0.40 a barrel to fill, while floating storage needs more than -$0.70/barrel to compensate shipowners for extended-term charters with often uncertain destinations. Markets are currently well below -$1.50. So business is real. This is also why demand for storage capacity is soaring and tankers dayrates are exploding.
The OPEC+ war means that tankers will generate significant earnings in Q2/2020 (Q1/2020 rates are generally already 60-70% fixed and at multi-year highs). Then we also have the seasonally strong Q4 coming up.
This means that tanker companies like Teekay Tankers (NYSE:TNK) are going to have a huge inflow of cash. Their P/FCF ratio is incredibly low at 2.1 if we based on TNK’s Q419 FCF of $2.375/share. This is very conservative considering that we will be looking forward to even better performances for the rest of the year (Q12020 results already expected to be better than Q419).
Summary
In a nutshell, there is going to be way too much crude, way not enough demand, leading to Brent contango, and the million dollar question is whether there will be enough storage.
Conclusion… BTFD
Saudi/Russia wasn’t why I got into shipping. I am still bullish even though the IMO2020 effect did not play out due to the Covid-19 as I felt that demand will increase after the pandemic is over when everyone tries to jumpstart their economy, starting with China. Even without the virus and the Saudi-Russia spat, tanker rates are going to go up as we still have the Phase 1 of the trade deal which will drive demand for US-China routes. Also, newbuilds have been decreasing and there are many more demolitions since the last cycle.
(See my previous post on STNG https://themosspiglets.com/2019/10/05/scorpio-tankers-nysestng-imo2020-an-upcoming-catalyst/)
Hence, like a mad man, I have been buying up tankers on every 10-15% drop in the market (sinking with the ship lol). Recent gains have been promising but I still felt that investors are still gun-shy due to liquidity issues and the “failed” IMO2020 speculation play. I have been following the shipping industry for a few months only and I do not dare call myself an expert on this. Those interested should do their own research first.
Hopefully by following STNG’s degenerate crazy b****** CEO Bugbee, we can make some decent profits out of this crazy industry.
Cheers
The Moss Piglet owns TNK, STNG, EURN & FRO shares.
One thought on “Oil Contango”