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Contango driving VLCC rates

In the press recently we have seen reports that analysts expect the VLCC freight rate to spike in the coming months. Good news indeed for owners in that sector and hopefully some payback for the tougher times.

Low fleet growth and seasonal effects have helped but most of the optimism is driven by 'contango' in the oil price.

So what is contango and why is it helping to drive VLCC rates?

Well, if (after taking into account freight and storage costs) the oil price in the future (i.e. the price of the futures contracts) is higher than the current price then it is worth buying oil now, taking a futures contract and storing it until the delivery date on the futures contract.

So, for example, at the moment traders are buying oil for storage to South Africa's Saldanha Bay which has a large oil storage terminal (and is incidentally nicely positioned between markets in the East and West). At the same time they are selling on the futures markets at the higher price. When the futures contract expires they will sell the oil thereby locking in a profit.

The VLCC owners benefit from the improved freight rates and utilization driven by the traders chartering tankers to transport the oil. Simple (well in theory at least!).

It is worth noting that the tankers are often used to store the oil itself and in 2008/2009 up to 1 in 12 of the largest oil tankers were being used for the temporary storage of oil, rather than transportation. 

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