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The oil futures markets are exhibiting a very unusual price structure, usually you receive a discount for waiting for delivery.

The futures markets have a name for the unusual situation when future prices are higher than current prices, it’s called contango (anyone know why, i don’t). What it usually indicates, however is an excess of inventory. The only reason you would pay more for the TV in six months (and not instead take delivery today) is if you had no where to put it, or were concerned that you would have to pay for retransport (moving). So you might be willing to pay a bit more, because it would save you the money for storing it for the six months to the time when you really think you want it. This is exaclty what is happening in the oil markets. There is now so much inventory that the cost of storing the oil has skyrocketed. So, rather than manage storage, people are willing to pay a premium to take delivery in six months, when they assume that they will be able to sell it at even higher prices.

This is important – most of these purchases are speculative. As inventories continue to rise, however, prices should fall, since, at some point, it will simply be more profitable (or less costly) to unload the oil rather than to hold it, particularly as cost of holding inventory rises. This is why we are seeing large drops in oil prices – the hurricane season turned out to be mild. Those speculators who were hoping to hoard oil and sell in a squeezed market realized that there was not to be a squeeze, and needed to get out of positions before the carrying costs ate them alive.

I know this may seem surprising, but I believe the price of oil is headed down, not up. Prices have been held above “market clearing” price as everyone has raced to build inventory. The end of inventory building would unleash more than half a million barrels of supply for consumption overnight. And as inventory builders realized that they might have to take big write-downs on the value of that inventory (as prices fall), they will be encouraged to become sellers as well, further increasing supplies. This of course, is short-lived, as there is only so much inventory).

My biggest concern is that neophyte commodities investors are making bets on the oil markets that say oil prices should rise in summer because gas prices rise in summer. In the US at least, this is true, but the primary reason for the increase is not changes in the price of oil, it is the cost of the additional fuel additives required by various US states and municipalities.