Oil Trading - Arbitrage into the EOY
Would it make sense to wait to sell oil to complete an arb into the end of this year (Nov/Dec)? I say this because Brent, for example, is in backwardation but the macroeconomic fundamentals of market point towards rising oil prices (picture of demand exceeding supply) seeing OPEC cuts, China's reopening (2022 demand still grew even with CH being closed), E&P underinvestment globally, and expanded refinery capacity globally.
I think the premise of your question comes from a common misunderstanding of what the forward curve is. Backwardation does not mean that “the market expects prices to fall into the future.” It is a set of economics for physical oil storage (or the lack there of).
You could make an argument that oil prices should be higher in the future based on the factors you describe, but this is not an arb in any sense of that term and is a speculative view, and there’s nothing wrong with that- it’s just not an arb.
Just another example of textbook vs reality. OP should have asked, "why is the crude market in backwardation you think guys?" Based on x,y,z this does not make sense. Would have got more value added answer, that said you did hint to storage economics and fact we are drawing from storage right now.
Seems this is the same poster who keeps trying to find a magic arb to make money.
Thanks for this answer. I wanted to ask a couple of follow-up questions to this hypothetical example:
- Then, does backwardation just mean a decrease of storage levels as traders / related parties try to take advantage of high prices?
- This play, I suppose, is a geographical arb in the sense that I am buying a discounted grade from Country A for delivery in September (at a discount to an international benchmark) and selling to a refinery that has demand for it in Country B at Brent + 5. I was trying to calibrate the right timing to sell (arrange delivery to port) to maximize profit by selling at when the buy-sell (price differential) spread would be the greatest (given the current freight costs for it). I was moreso confused by the backwardated market but the macro fundamentals indicating a price rise (due to my misunderstanding of what backwardation really means as you rightly point out). I know that typically the buy, store, and sell later strategy happens in a contango market and constitutes a timing transformation. So, using the scenario I mentioned prior, if I were to store it and sell it in Nov/Dec, would this only be considered a geographical arb or would it still be a pure play speculative play?
If you are “hoping” to “time” a price move, that’s speculation. There’s no risk free or low risk nature of that.
Not sure what echelon you went to and why you like to complicate things. The basic commodities forward curve is established just like dcf, using “cost of money to discount to PV” from there we add in variable costs. We look at a curve for a specific point to start, if I own a storage tank in cushing oklahoma I only care about future cushing prices.
A “physical arbitrage” is created by when our real asset can capture a market misspricing. So if I can store and sell 1000bbls for $1.50 and spread goes to $2.50 I can arb it. Beyond 1000bbls as mentioned is just speculation now.
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