As Spot Prices Soar, A Popular Oil Trade Becomes Unprofitable

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Here’s one reason the price of oil is destined to fall, at least a little bit. As the price of a barrel rises, the return on buying oil on the spot market, then selling it forward has dropped to zero:

WSJs Liam Denning: Energy economist Phil Verleger demonstrates how lucrative this can be. On March 1, the cash price of light, sweet crude was $40.15 a barrel, while the 12-month forward contract sold for $50.26. Assume an investor bought the physical barrel borrowing 80% of the money at a rate of 3%, sold it forward, and paid 50 cents a month for storage. The resulting profit of $3.15 a barrel equates to a 39% return on investment.

In reality, financing and storage costs aren’t static. As spot prices have risen faster than futures, the spread has narrowed and the volatile trade recently turned unprofitable: On Friday, the return was zero.

With the return on this trade bottoming, there’s a good chance oil supply could come back into the market, depressing prices. The WSJ says there’s commercial inventories of 6 billion barrels built up around the world. That’s roughly $400 billion sitting around.

 

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