Mind's Eye Can You Cotango?

Surprisingly, perhaps, this isn't me and rigsy doing the Latin
American at some embassy party of the past. It's about trading oil
and other commodities and the very strange efficiencies of such. Not
that I would have declined with someone on hand to hold my service
issue revolver, of course.

Producers of (say) oil enter into contracts with investment banks and
transfer ownership of the production on a short-term basis. They get
dollars for cash flow interest free, but also agree to buy back the
oil on a given date (after all, investment bankers drink champagne).
The producers now need to sell less oil to refiners, which gives them
chance to broker the price up - which we pay for at the pumps. Just
another way to rip off the jolly old consumer.

Another effect in this is that the demand for forward contracts for
the producer to buy the oil back again drove the forward price higher,
and this created what is defined as a 'contango' market. In fact, it
was so pronounced it was called a 'super-contango'. What happened as
a result was that traders began to buy oil, and to sell it forward,
since the contango difference in price enabled them to pay to insure
and finance the oil; to lease tank storage, and even to charter the
fleets of tankers which sat as floating storage off the UK coast
through spring and summer 2009. Passive investors, for their part,
lose money in such a contango market, because the oil lease contracts
are rolled over from month to month at a loss to them, since they
would (say) sell June delivery oil contracts which they are in no
position to perform, and have to buy July delivery oil contracts at a
higher price.

When no one wants to buy into the financial instruments created in the
above (which is about cash flow before the quick buck initiatives
start), the producers have to buy back oil that has never left their
wells. This has a knock on effect called backwardisation, unless a
wad of characters turn up with more dollars to buy oil futures
believing the price will go up.

The 'secrets' of much of the financial services industry are all
rather like this - and the trick is to do something obviously highly
inefficient and parasitic, claiming to 'make markets'. The role of
the rest of us is to pay up at the gas pump. Have you been cotangoed?