If you've been eyeing a new gas-guzzling SUV as your next vehicle, you may want to reconsider that Prius once more. That's because today's low gas prices won't be around forever and oil prices aren't about to "tank" any time soon.
In fact, the oil price crash has created a state of "contango," a market anomaly that savvy investors can exploit. It's presenting a rare market opportunity to profit that only comes around once every few years.
A Market Anomaly That Leads to Big Profits
Let's start with a definition. Contango is trading jargon. It means the current price of a commodity is lower than prices for delivery in the future.
That's where we are in the oil market right now, and it's created a chance to profit.
The last time this happened was during the 2008-2009 "supercontango." Back then, oil tanker ships stored millions of barrels of crude oil off the coasts of major producing or strategic areas like the Gulf of Mexico, England, and Singapore. Spreads between near-month prices and those for delivery 12 months later ran better than $23 a barrel for West Texas Intermediate Crude (WTIC).
It led to a massive 100 million barrels just floating around in seaborne oil tankers for months on end. Big oil players bought the oil cheaply, and sold it on futures markets for much higher prices. Then, they simply stored it and waited for the delivery date to arrive, pocketing some hefty profits.
None of this was even possible until about 25 years ago. In 1990 entrepreneur Lars Jacobsson founded Scandinavian Tank Storage AB, introducing the concept of an oil storage trade.
Fast forward to today's opportunity which, while more modest, is still substantial.
Saudi price cuts, sustained North American shale production, and a worldwide slowdown are pressuring oil prices now.
But markets are forward looking. They know that drilling can't simply be "turned off" at a moment's notice. Doing that is a multi-step process requiring time, technical expertise, and money. So there's a lag between lower prices and lower output.
Right now markets are forecasting WTIC prices will be higher by $10 a barrel (conservative, in my view) a year from now. And a number of players are positioning to lock in those profits.
The most obvious benefactors are the large integrated oil companies like Exxon, Shell, and Total. They have the product and excess storage capacity to simply stockpile and sit on the oil, while selling it in the futures market for later delivery.
By digging into their deep pockets or accessing capital, large commodities traders like Trafigura and Vitol, and even Wall Street bigwigs like Goldman Sachs and Morgan Stanley, are cleaning up with big gains and little risk.
In the last eight months these heavy hitters have bought nearly 30 million barrels to store in supertankers.
Oil futures prices exhibit a distinctly upward sloping curve, confirming the opportunity remains solid. So long as the spread is sufficient to pay for insurance and storage plus an acceptable profit margin, the opportunity is in place.
How to Profit from Contango
Don't be dismayed, it's not just for the big boys.
For retail investors, there's also a way to profit from oil's current state of contango, and that's through the oil services subsector that benefits from oil storage .
World Point Terminals LP (NYSE: WPT ) is a limited partnership which owns and operates terminals and storage facilities for light refined products, heavy refined products, and crude oil. It is focused on three key areas in the United States, specifically the East Coast, the Gulf Coast, and the Midwest. More specifically, the company stores gas distillates, jet fuel, fuel oils, liquid asphalt, and crude oil.
WPT boasts 12.8 million barrels of storage capacity over 14 terminals in strategic locations. This allows the company to offer integrated terminals and storage to oil refiners, distributors, marketers, and traders. Thanks to its locations, WPT's assets provide efficient access to transportation infrastructure near demand markets and exports hubs.
With a $670 million market cap, World Point is trading at a reasonable 18.9 current P/E and an attractive 17.2 forward P/E. Profit margins are thick at nearly 39% and return on equity is healthy at 21%. Its quarterly earnings have been growing at a robust clip of 28.3%. All of that has meant a generous yield of 6% from the quarterly dividend.
I wouldn't be surprised to see shares gain 40% to 50% over the next six months as the market comes to realize that production cuts will soon kick in and demand isn't about to fall off a cliff. In fact, I expect demand to get somewhat more robust as retail, commercial, and industrial consumers find ways to use more at these lower prices.
Consider too that some of the biggest demand in this market comes from the official sector. You can be sure that China's stocking up while oil's on sale to add to its currently growing strategic petroleum reserve. Now that you know and understand contango, you can take your own steps to benefit from this rare but lucrative oil price arbitrage opportunity.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
