Crude oil and a recipe for easy money

We’re here to be a service column for our readers, with advice on removing stains from linen, short-selling Argentine gross domestic product, when to rotate tyres and, today’s topic, using Very Large Crude Carriers (VLCC) to hedge against Nigerian supply disruptions or Gulf of Mexico hurricanes.

I try to come up with topics that serve the typical FT reader, who, according to the advertising department, should have little difficulty finding the $115m-$130m necessary to buy a cargo of 270,000 tonnes of crude oil for storage on
a VLCC. Of course, prudent risk management dictates that such
a position should be no more than
5 per cent of one’s net worth, and
I have taken that into account in recommending the trading idea described below.

The energy-macro-risk chit-chat you hear among the political class tends to centre on the probabilities of a US or Israeli strike on Iran. However, the world of oil traders seems more fixated on events in Nigeria, such as the elections that did not generate
a Sweden-like consensus on the government’s legitimacy, and the continuing rebel attacks on oil installations. The Gulf gets more headlines, but west Africa is increasingly important to US energy supplies. An Iran strike would still be catastrophic, but it doesn’t seem likely enough to justify holding large crude positions.

The oil traders are also taking into account the risk of disruption to US production from Gulf of Mexico platforms. As we have noted before, this year’s weather pattern is much more likely to lead to storm disruptions than last year’s, although a repeat of the 2005 Katrina-related damage is not likely.

By April, both the Nigerian political risks and the problematic weather patterns were coming into sharper focus on the oil desks. In most past years, that could still not have been enough to lead to an increase in the use of tankers for offshore storage, but now, thanks to the Goldman Sachs Commodities index along with its followers and competitors, there is a huge amount of institutional money committed to buying the energy complex for future delivery.

Up to the recent past, crude oil for future delivery was usually in backwardation – that is, prices in future months were lower than prices for delivery closer to the present. That would give one little if any incentive to hold oil in above-ground, or floating, storage. However, with the institutional money crowding into the trade, crude is now in contango between the spot price and prices
a month or two out, meaning that you are paid to store oil. The ideal positions for traders are those in which they are paid to wait. If you can collect enough money to cover your interest payments and other costs, in anticipation of an increase in the value of your asset, you can keep the risk managers at bay while waiting for your ship to come in. Literally, in this case.

So let’s take a private oil trading firm, such as the Vitol Group, Koch Supply & Trading, or, prospectively, you. (No doubt by the end of the week you should be able to hire away enough of Vitol and Koch’s trading, finance and transport people to execute this idea.) How to play the Nigeria/hurricane/Iran/wild-card risk?

Well, since the end of April there has been a dramatic increase in the amount of floating storage of oil in the Gulf of Mexico. Usually, there are between two and six VLCCs discharging, or preparing to discharge, crude oil to delivery points on the US coast. In addition to those ships, there have been about 17 VLCCs dedicated to offshore crude storage. Of the 17, three have completed their contracts and a fourth is about to do so. These could be replaced, but that leaves about 13 supertankers bobbing around the Gulf of Mexico, waiting for prices to spike.

That’s about four days of imports to the US, which is, as they say in Texas, a whole bunch of oil. At 270,000 tonnes a vessel, that’s 2m barrels, times 17 ships for 34m barrels, times, say, $66 for something like $2.2bn worth of floating crude in storage.

That’s a lot of convincing of risk management people and top management. A lot of conviction on the part of the traders. This doesn’t happen all the time.

As one shipbroker points out: “That’s not all the same crude cargoes that were shipped out in the first place. Each cargo is stored for 10 to 30 days, then discharged. Then another crude carrier comes alongside the storage vessel, discharges a new cargo into the storage vessel, which is held for another 10 to 30 days, then landed and sold.” During the storage period, the crude is earning a positive carry with the contango in crude prices.

Got it? For the most part, I understand that the offshored crude is owned by trading houses, rather than the oil companies, although some could be owned by entities in Gulf producing states.

“It’s a trader thing, not an oilman thing,” as another shipbroker says. About half the oil being stored is Basra crude, the rest west African.

The shipbrokers are happy, of course, because the requirement for VLCCs for storage is another source of demand, and rates have been satisfyingly volatile, in the range
of $47,500 a day to more than $60,000
a day.

There you are: now just go out there and do it on your own. Drop me a line and tell me how it all worked out, and if you found there were any complications I forgot to mention.