– John Kemp is a Reuters market analyst. The views expressed are his own –
For the last two years, the contango structure embedded in futures prices has far exceeded the actual cost of owning physical raw materials such as crude oil, aluminium and copper, explaining the strong interest from traders and hedge funds in owning inventories or the warehouses, elevators and tank farms that store them. Well-connected banks and physical traders have exploited the difference between the actual cost of financing, storing and insuring raw materials and the implied cost in upward sloping futures prices, as a source of comparatively low risk profits.
It has helped commodity markets carry record stocks and supported overproduction of many raw materials through the recession and the early stages of the recovery with only minimal downward pressure on prices.But the days of physical commodity storage as a licence to print money are ending. An increasing number of other institutions and hedge funds have created their own “virtual storage” plays, with negative positions in the spreads, or a short position against commodity indices or customised swaps. As storage plays become more crowded, the contango will continue to erode gradually until it resembles the actual costs of finance, storage and insurance, and this source of relatively risk-free profit is removed.