Beware the super contango

2 May 2006

Rising crude prices and a flood of speculative money has ensured that the oil show has played to packed audiences. A steepening of the oil market s current contango into a super contango could see investors suddenly rushing for the door.

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The oil futures market traditionally trades in backwardation – that is oil for future delivery sells at a discount to spot prices. Lately, however, it has traded in contango – in other words, oil for future delivery is at a premium to nearer prices. The current spread between May and August futures contract for West Text Intermediate is over 4%.

The cost to investors in a contango market of rolling over their short term contracts into longer dated contracts produces a negative roll yield. This negative yield subtracted around 20% of the total return on commodity index funds last year. However, rising commodity prices overall ensured that the funds made positive returns.

Energy constitutes around two thirds of the benchmark Goldman Sachs Commodity Index basket.

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