Bernie Sanders needs a lesson about the curve

Sanders, in a statement announcing his legislation, said traders were "hoarding" oil, trying to "artificially" raise prices by holding oil offshore, awaiting the kill. Keep the oil off the market, raise the price in the process, and then take advantage of the higher price through a highly-profitable trade.

Where do we begin to take apart this argument?

First of all, the alleged perpetrators of this play already have made a sale. They have made a sale taking advantage of the slope of the forward curve, because the entire crude market and the entire distillate market -- both on exchanges like NYMEX, or in physical markets -- are in contango, in some cases steep contango. Contango is the situation where prices down the curve are higher than current prices. For example, the NYMEX No. 2 heating oil setttlement today, June 11, was $1.8534/gal for July barrels, and $1.9974/gal for November barrels. So the easy play is to buy July product, sell it into the November contract and store the oil in the interim. Platts has been reporting stories of floating storage being held in the crude and distillate (heating oil/diesel/jet) markets all over the world, because those markets are in contango. The trade practically cries out to be done.

What we're not reporting are stories of floating storage in gasoline, because gasoline is in backwardation. That's the opposite of contango, with the price declining as you go out the curve. So, for example, the NYMEX RBOB contract today settled at $2.0649 for July, and $1.8954 for November. There is a total disincentive to store gasoline, traders are acting accordingly, and yet it's rising prices at the pump that is starting to grip the headlines again. But gasoline is not being held in floating storage.

So Sanders' argument that the oil being held in floating storage is being "hoarded" ignores the fact that if the market was in backwardation, it is not going to be hoarded. Further, he is ignoring the fact that oil already has been sold, directly or indirectly. Maybe it's already sold for delivery into a future month to a specific buyer, with the profits locked in. The only thing left to do is keep it in storage.

Or maybe the owner of it sold a swap for six months out, since not all physical markets are set up for the sort of easy "down the curve" selling that the NYMEX enables. So the physical oil in the floating storage would not have a buyer for six months out. But when that time comes along, the swap would be unwound, and a buyer would be found for the oil. But the profits would not be from holding the oil all that time; the profit would be from having sold the (higher-priced) swap at the time the oil was bought months earlier. A sharp rise in the outright price would not benefit the position.

What Sanders seems to be alleging is that oil sitting on these tankers is all unsold. In industry parlance, the traders who own it are all taking naked long positions, a trade that benefits only if the price of oil rises. Spreads between months, the shape of the curve...in the Sanders' world, none of that exists.

But here's the thing: if a trader wants to do that, why on earth would he need to put oil on a ship? All he needs to do is buy a number of positions on the NYMEX, or other paper instruments, and hope that several months later, they will be worth more. In terms of exposure to a rising price, it's the same thing. But in reality, it's not the same thing; it's better. You don't need to charter a ship. You don't need to hire a crew. You don't need to pay the day-to-day costs for bobbing out on the ocean, called demurrage. Why would anybody do that if the plan consists solely of just riding a rising market higher?

Well, here's a possible guess as to what Sanders is thinking. The senator envisions a trader thinking: "I'll take this oil off the market, and the resulting tightness will make the price go higher, and I'll cash in that way." But any trader with half a brain knows that even taking a few tankers off the market for a period of time, in an oil economy that consumes 84 million barrels each and every day, is pointless. It would be the modern version of King Canute. Any trader with that sort of mindset either lost his job or a long time ago, or is well on his way to that occuring.

The proposal requiring disclosure of floating storage may indeed become law. But let's hope that the members of Congress who vote on it learn that the reasons for approving it have nothing to do with the allegations of the senator from Vermont.