Oil Super-Contango: When Banks Started Renting Tankers

There is a tiny town in Oklahoma called Cushing. Fewer than 10,000 people. It has a Walmart. A few fast food places. And somehow, this place is the center of the global oil market. Chapter 32 of Torsten Dennin’s “From Tulips to Bitcoins” tells the story of what happened when oil prices collapsed and the biggest banks in the world started renting supertankers just to have somewhere to put the stuff.

From $145 to $35

In the summer of 2008, crude oil briefly touched $145 per barrel. That was the peak. The world economy was already falling apart, but oil was still priced like everything was fine. Then reality caught up.

By early 2009, oil was trading below $45. The front-end WTI contracts dropped as low as $35. That is a 75% crash in a matter of months. The financial crisis was dragging everything down, and oil was no exception.

But here is the part that made this situation truly strange. While the spot price was down at $35, futures contracts for December 2009 were still trading above $50. The market was saying: oil is cheap right now, but it will be more expensive later. That gap between today’s price and tomorrow’s price has a name. It is called contango.

And the gap in late 2008 was enormous. Between October and December, the spread between January 2009 and December 2009 contracts exceeded $20. Traders had a word for this too. Super-contango.

Why Cushing Matters

To understand why this mattered, you need to understand Cushing. This little Oklahoma town is the only delivery location for WTI crude oil traded on NYMEX. All those futures contracts that traders buy and sell in New York? If someone actually wants to take physical delivery, it goes through Cushing.

The town has strategic oil reserve capacity of 35 million barrels. That sounds like a lot until you realize how much oil the world uses. And in early 2009, Cushing’s storage was filling up fast. Inventories hit 33 million barrels and climbing. The capacity was disappearing.

The problem was getting so bad that one Barclays analyst compared WTI pricing to being “as useful as a chocolate oven glove.” The benchmark crude oil price for the entire American market was being distorted because one small town in Oklahoma was running out of storage space.

The Contango Trade

Here is the thing about contango. When the price today is much lower than the price in the future, there is an obvious trade. Buy oil cheap today. Store it somewhere. Sell a futures contract at the higher price. Wait. Deliver the oil when the contract expires. Pocket the difference.

The math was simple. If you could buy oil at $35 and sell a December futures contract at $55, you made $20 per barrel minus your storage costs. As long as storage was cheap enough, this was basically free money.

And everybody saw it. Every bank, every trading house, every fund with a commodity desk was doing this calculation. The only constraint was finding somewhere to actually put the oil.

Supertankers as Floating Warehouses

Cushing was almost full. Land-based storage everywhere was getting tight. So the banks looked at the ocean and had an idea.

Freight rates had crashed 85% from their summer 2008 highs. The Baltic Dry Index, which tracks shipping costs, had fallen 94% because the global economic slowdown meant fewer goods being shipped. Shipping companies were desperate for business. Their giant vessels were sitting empty.

So investment banks started renting supertankers. Not to transport oil from one place to another. Just to park them somewhere and fill them up.

Merrill Lynch. Morgan Stanley. Goldman Sachs. Citibank. Barclays. Deutsche Bank. All of them. The biggest names in global banking were suddenly in the oil storage business.

The cost? About 90 cents per barrel in January 2009. When the contango spread was $15 to $20 per barrel, paying 90 cents for storage was nothing. The trade was wildly profitable.

Frontline, the world’s largest supertanker owner, reported that 25 of their tankers had been chartered for storage. The International Energy Agency estimated 80 million barrels of oil were floating on water around the world. That is more than twice the entire storage capacity of Cushing, Oklahoma. Just sitting on ships. Going nowhere.

About 35 supertankers were being used this way. That represented roughly 10% of the entire crude oil tanker capacity on the planet. One out of every ten crude oil tankers was not shipping oil. It was just holding it.

A Quick Note on Oil Types

Dennin takes a moment in this chapter to explain something about crude oil that most people do not know. There is not just one “oil price.”

WTI, or West Texas Intermediate, is what trades on NYMEX in New York. Brent crude trades on the ICE exchange in London. In Singapore, they trade a type called Tapis. Then there is the OPEC basket price, which is an average of seven different crude oil types from various producing countries.

These are all different products with different prices. When you see “the oil price” on the news, they usually mean either WTI or Brent. And in early 2009, WTI was behaving strangely compared to Brent because of the Cushing storage crunch. The storage problem was making the American benchmark unreliable.

The IEA Report Nobody Wanted to Hear

While all this was happening, the International Energy Agency put out a report saying global oil demand had declined for the first time since 1983. Think about that. For 26 years straight, the world had used more oil every single year. And then the 2008 financial crisis hit so hard that demand actually went backwards.

Less demand meant more oil sitting around with nobody to buy it. More oil sitting around meant more need for storage. More need for storage meant more supertankers getting rented. It was a cycle that fed on itself.

The Hangover

Here is the part that lasted long after the crisis itself. All those floating inventories, 80 million barrels on water plus everything stored on land, did not just disappear when the economy started recovering. That oil overhang sat on the market and prevented any significant price recovery for years.

Every time oil prices tried to climb back up, there was cheap stored oil available to sell into the rally. The contango trade that made banks rich in 2009 became an anchor that dragged on oil prices for the years that followed.

What Stays With Me

This chapter shows a side of the oil market that most people never see. We think of oil as something that gets pumped from the ground, put on a ship, and delivered to a refinery. The idea that Goldman Sachs was renting supertankers just to park crude oil in the middle of the ocean sounds absurd. But the math made it rational.

What gets me is the scale of it. Eighty million barrels floating on water. Thirty-five supertankers turned into warehouses. Ten percent of the world’s crude tanker fleet doing absolutely nothing productive. All because the price curve was shaped in a way that made storing oil more profitable than actually using it.

And poor Cushing. A town smaller than most neighborhoods in any major city, and the entire WTI pricing mechanism depended on whether its storage tanks had room. The most important oil benchmark in the Americas was being bent out of shape by the physical limitations of one town in Oklahoma.

Dennin keeps showing throughout this book how commodity markets are not abstract. They are physical. Oil has weight. It takes up space. You need tanks and ships and pipelines. And when the math says “store everything,” you eventually run out of places to put it. That is when the market breaks in ways that nobody at a trading desk in New York ever expected.

The banks made their money on the contango trade. But the oil sitting on those tankers took years to work through the system. Short-term profit for the banks. Long-term price suppression for the entire oil market. As with so many stories in this book, someone always pays for the clever trade. It is just usually not the person who made it.

Based on Chapter 32 of “From Tulips to Bitcoins” by Torsten Dennin (ISBN: 978-1-63299-227-7, River Grove Books, 2019).

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