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Tickers in this Article: C, BP, FRO, OSG
People say oil and water don't mix, but when there's a so-called "contango" in oil markets, putting a whole lot of oil on water makes perfect sense.

Buy Today, Sell Today For Tomorrow
Right now the futures market for crude oil to be delivered in February 2010 is about 41% higher than the current, or spot, price - the price that one pays to get oil for immediate delivery. This huge price gap between spot and forward prices has prompted a number of players in the oil markets, including big banks like Citigroup (NYSE:C) and major producers like BP Plc (NYSE:BP), to enter into a forward transaction to profit from this situation.

The deal basically works like this: Buy a whole load of crude oil at current prices and then simultaneously sell it to the futures market for delivery at some date in the future, say one or more years out. The trick is to find a way to store all that crude at a cost that is less than the profit you lock through the forward transaction. That's what is known as the "carrying cost" when trading in futures markets. Usually forward prices incorporate an estimate of what this cost is, so there is an underlying economic rationale for forward prices to be higher than the spot prices. Hence a contango situation is generally the norm. (To learn more about the futures curve, be sure to read Contango Vs. Normal Backwardation.)

Tanker Operators Benefit From Upsurge In Charter Demand
With the oil markets in such an extreme contango, traders looking to lock in an arbitrage profit have given crude oil tanker operators a nice bit of new business; and they are more than happy to meet the demand. The world's largest tanker operator, Frontline (NYSE:FRO), has been reporting strong interest lately by companies wanting to charter vessels to stockpile crude. As reported in a recent telephone interview with Bloomberg, a company spokesman indicated that about 25 supertankers have already been hired to store crude, and indications were that another 10 vessels could be chartered for the same purpose. With each ship capable of storing about 20 million barrels, potentially another 200 million barrels could be parked in this fashion. That's roughly equal to about 10 days' consumption by the European Union. A total of 35 tankers put to this use would represent about 7% of the world's tanker fleet.

Drop In Crude Demand Continues To Pressure Tanker Charter Rates
The interest in chartering tankers for storage couldn't come at a better time for Frontline and other tanker operators like Overseas Shipholding Group (NYSE:OSG). With the global slump in energy demand, tanker charter rates have plunged 78%. Leading maritime business commentator Lloyd's List recently reported that crude oil production cutbacks by OPEC still threaten to put a damper on charter rates during the first half of 2009, a time when 34 new crude supertankers are expected to come into service. Citing various market analysts, Lloyd's reported that charter rates could drop another 20-25% in the fist half of 2009.

The Bottom Line
The upsurge in interest in leasing tankers for storage has thrown the tanker operators a much-needed lifeline at a time when they appeared to be dead in the water. This could be the time to get on board.

Be sure to check out our Futures Fundamentals Tutorial to learn more about trading in this complex market.

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