The Great Debate UK
from The Great Debate:
The current contango structure in crude oil futures and most other commodity markets -- with future prices significantly above the spot market -- is providing a strong incentive to buy and store record quantities of raw materials, with most of the cost borne by retail investors in exchange-traded funds and institutional investors in long-only commodity indices.
This "cash-and-carry" strategy rewards market participants with access to storage or finance at the lowest cost. It is providing huge profits for physical commodity merchants, investment banks, and the owners and operators of warehouses and tank farms during the downturn, and helps explain the record profitability from commodity operations reported recently by some of the largest banking and trading groups.
In the current market, the cash-and-carry strategy rewards well-connected "insiders" such as investment and commercial banks able to secure almost unlimited financing at zero-cost as a result of quantitative easing programmes.
DOING THE CONTANGO
In a contango market, the Futures Price = Spot Price + Finance (interest rate on the money borrowed to own the physical commodity) + Storage (cost of hiring tanks, tankers or warehouses) + Insurance (premiums for insuring the commodity against loss, sinking, damage, theft etc). Click here for PDF. More generally, the equation can be re-written to cover any market (whether contango or backwardation, when the futures price is below spot) so the Futures Price = Spot + Finance + Storage + Insurance - Scarcity/Prompt/Convenience Premium. The prompt premium is the additional price a consumer is prepared to have spare material on hand "just in case" rather than risk having to go out into the market and buy it at an uncertain price or even find it is unavailable.