A contango?

Ok, correct me if I am wrong. The US is awash in oil. Yea that is correct, the largest consumer of oil on the planet is literally running out of places to put oil. Now mind you this does NOT mean prices are going to drop any time soon. This is called the "contango" effect.

(Remember when the weather got all screwed up and suddenly there was this word "elnino" and you were like el what? Well this is another of those.)

See if there is no place to put any more oil it means traders are buying all the oil they can because they don't have faith in the future supply of oil. The fear over future supplies causes over buying (thus filling up storage tanks) and higher prices. Now for those of you in ECON 101 you may be confused. If there is more supply than demand and storage tanks are filling up and there is no where to put any more oil shouldn't prices FALL?

NO. See as we reach the estimated capacity of 370 million gallons of storage there will be no place to put the oil. Thus producers will cut back. When they cut back on production, the price will rise further.

Hello, you following this? Logic says, if the storage tanks are full, then the purchases of oil on the market will fall (ie; lower demand for crude) and this should result in a drop in oil prices, right?

NO. See the smart money says the US has not built enough storage tanks over the past 10 years so we really should be able to store more oil. See if we could store more oil then we could meet the higher future demand. By not storing more oil, traders are nervous that if there is a drop in supply from some big event like, Nigeria becomes part of a large global sink hole, then the storage capacity will not hold us through the crises. So they keep buying oil like a drunk that cannot get enough alcohol and rolling over the stock piles they currently have to the next month. Now what happens is the storage people start charging more to store the oil. That means it gets MORE expensive to store the oil and contracts to store the oil go up in price.

Get it now. It is not the lack of supply of oil on the market, it is the lack of storage capacity that is the culprit.

Mind you, all this comes from the psyche of the oil traders that there is going to be a crises. So lets recap:

• Oil demand is rising globally
• Oil traders start hoarding oil for fear of supply crunch
• Oil prices start to rise
• Oil traders buy even more oil
• Oil storage tanks become full
• Oil storage costs begin to rise
• Oil in storage becomes more expensive
• Investors jump in to finance the "rolling price of oil in and out of storage"
• Demand increases further
• Prices on the long end rise and higher prices become entrenched in the system.

What is the way out of this contango? Increase the refining output and capacity of Oil. See bringing on more refining capacity will bring additional supplies "product" to the market thus removing pressures on the storage capacity and this will result in lower prices.

Forget that the entire cycle was caused by "fear" of the oil traders of the immanent sink hole in Nigeria and that all this is a bunch of human psyche gone amuck, this is ECON 101 here and we all learn that Econ is a social "SCIENCE" right?

So next time someone tells you that the US is "awash in oil" to the point they are up to their "eyeballs" in the stuff and that is why the price is going through the roof, don't laugh.

Peace