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How the Fed Influences Contango Crude Oil Market Traders

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Federal Reserve

As we saw in the previous part of this series, the interest rate hike weighed on the crude oil market. Let’s see how it would affect the crude oil contango market. January WTI (West Texas Intermediate) crude oil futures contracts settled at around $35.5 per barrel on December 16, 2015. Likewise, December 2016 WTI crude oil futures contracts settled at $43.6 per barrel on the same day. The contango as per this contract is at $8.1 per barrel. The positive spread between the near month and front month’s futures contracts is called contango.

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Contango market

Crude oil traders like Vitol and BP (BP) benefit from a broader contango market. They buy near months crude oil contracts and store them in Cushing for six months, then sell at higher crude oil prices in six months. Market surveys project that leasing costs at large tanks in Cushing were at 25 to 35 cents per barrel per month compared to the 12-month contango of $8.1 per barrel. So, storage cost for 12 months could be at $4.2 per barrel at maximum, keeping administrative fees and other pumping costs at $1 per barrel for 12 months. This means that they could make a profit of $3 per barrel.

On the other hand, the recent hike in the interest rate could curb the profit by a tenth of the profit as per some traders. The calculation of profit may change depending on the cost of borrowing for trading in the contango market. These drops make contango market trading less attractive. The debt-trapped oil companies that trade the contango to negate lower oil prices could reduce the trading if they used 80% of the debt from financing. The trade is non-profitable at the current interest rate if 80% of the debt is financed.

Crude oil tanker stocks

Meanwhile, the broader contango benefits crude oil tankers stocks like Teekay Tankers (TNK), Nordic American Tanker (NAT), and Frontline (FRO) because these tankers are used for storing crude oil in the sea and selling oil at higher prices in the future. Citigroup suggests that if oil prices fall below $30 per barrel, then it would be unviable to store crude oil at sea.

ETFs like the United States Oil Fund LP (USO) and the iShares US Oil Equipment & Services ETF (IEZ) are also affected the uncertainty in the crude oil market. Read the next part of the series to know how the Federal Reserve affects major oil and gas exploration and production companies.

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