Winners and Losers from Oil Contango

Contango is one of the simplest arbitrages in the markets: you buy oil today, contract to sell it at a higher price in a few months' time, and just sit on it in the interim. The problem is finding a place to store it: oil traders will use up all available storage capacity very quickly so long as contango persists. Thankfully, they have a steady stream of cash they can use to build ever more barges: not just their profits from the contango trade, but also all the money pouring into oil ETFs from schmucks retail investors looking to "diversify" their portfolios.

Izabella Kaminska has a gloriously geeky 2,300-word blog entry on what she calls the "passive self-propelled pyramidization" caused by the structure of the USO fund:

Oil market participants win precisely because they can play the contango trade effectively and predictably. Retail investors just lose and will continue to do so until either the contango disappears or the oil price shoots up beyond the rate of their losses. Yet many analysts agree the oil price is unlikley to ascend much higher while the contango is in place, and as Schork highlights, the contango is unlikely to disappear while the market can continue to benefit from its structure.

Kaminska's great at explaining that the bigger USO gets -- and it's huge already -- the more inefficient it gets, and the more its very structure exacerbates the contango which is costing it dear. If you want to bet on oil, maybe it's easier to just do it the old-fashioned way and buy oil stocks instead.