A Contango Trade

I bet most of you have never heard about this word, Contango. Here is the definition: A state in which the price of a futures contract is higher than the eventual or expected spot price of the underlying commodity or security (oil for this case). So what does it mean? Well, simply put, you need to pay higher price for oil for a future contract than the current price of oil (spot price). This dose not often occur but right now there is a quite significant Contango for oil: e.g. at the moment the crude oil costs about $50 but for the oil in Mar 2016, its price is around $60. So if someone buys oil now and sells it in about year, he can make a profit of $10 minus all the costs. With this kind of easy money in the future market, you bet people are just busy buying oil now and simply keeping it for a higher price in the future. This is another important factor that the oil inventory will keep increasing, given more oil is bought and stored. Higher inventory usually is depressing for the oil price. Therefore as long as the Contango exists, it is hard for me to confidently say oil has bottomed.

So which business will flourish in the oil Contango? You bet, it is the storage business. It is reported that there are a lot of huge storage tanks floating in the ocean. Nowadays, there is a shortage of storage room for crude oil. There is simply too much demand for it. So the companies engaged in oil storage is doing very well. NuStar Energy LP (NS) is one of them. It is a MLP and paying a high dividend at 7%. As shown below in the past 3 months when the oil price has crashed most, NS is simply going up (red). As long as Contango continues, NS will benefit and be doing fine. Of course this is not a risk free trade. Although I don't expect Contango will disappear soon, no one knows for sure when it will stop and reverse. When that happens the impact for NS will be damaging. So you need to protect yourself while enjoying its high dividend and potential capital gain. I suggest you set a tight stop loss of $60 (currently NS is trading at over $62). If it drops below that at closing, the trend may be turning and you don't want to be trapped in. But I suspect this will be at least a few months trade while oil is fluctuating sideways or going lower.