There has been much made about the crash in oil prices the past 18 months. It has served to send energy stocks (IYE) into a significant bear market and could bankrupt many small players as they are burdened with debt based on $60 oil. (After all, it was just 18 months ago the idea of sub $60 oil was preposterous but all of a sudden $60+ oil seems beyond comprehension.) The image above is today's headline from CNBC and while you may have a hard time reading the small print, let me fill it in. Two lines apart from one another read the following headlines:
- Relax! History shows oil can't go any lower
- Kilduff: If oil breaks this price, watch out!
These two stories are painting the exact opposite picture for the future price of oil, one bearish and one bullish! What to believe?
Well, here's the terribly uncomfortable truth about oil prices.
While the December '15 expiration for oil is trading at $36.43 (and presumably the spot is right at that price), the December '16 contract is trading at $45.30. This is nearly $9 in contango which equates to a 24% premium. A 24% premium for a contract that is a mere 12 months out. This is an asinine amount of contango. I don't have any historical statistics to back it up, but this has to be unprecedented.
What does it all mean?
It means that oil prices are going back up. And fairly soon. The July '16 contract is trading north of $42. The market knows prices are artifically low right now and they have already priced in a big rally next year. It also means that if you have the misfortunate of owning a retail fund like USO, your investment is going to underperform the price of the physical by at least 24% over the next 12 months. And this is an investment vehicle that has already been decimated by the Wall Street bankers kicking it around like a "red-headed stepchild".