How Storable is Oil?

Reader Steve made a terrific comment on a recent blog post:

Long speculators continually roll their long position forward at expiration time. I don’t have direct experience with oil markets but in grain markets long speculators have held onto their long positions for as much as 4-5 years. When their futures come due they sell the near by contract and purchase a more differed contract. This has no effect on the current price since they are both buying and selling the same amounts. The effect is on the relative price of the nearby contract versus the deferred. This is why grain markets have been at or near carrying charges at expiration for years now. The cost to the long speculators has been that each time they roll their position forward they pay more for the deferred contract than they sell the nearby contract for. In doing this they have been in effect paying farmers, grain companies and others to store grain and hold it. I would be surprised if something like this has not been going on in the oil markets.

This makes a lot of sense to me. But the question remains - how storable are large quantities of oil?

When we talk about "storability", there are two types we need to consider. First we need to consider above ground strorage. But we also need to consider "storage" in the ground - that is oil companies choosing how much or little to produce based on current spot and futures prices.

If oil is not particularly storable, then oil today and oil 3 years from now are two very different animals. In that case, the spot price of oil need not be related to the future price of oil, just as the price of oranges need not be related to the price of Toyotas.

If oil is storable (and storage is relatively inexpensive), then the future price of oil should only marginally differ from spot prices, with the differences coming from storage costs and the opportunity cost of having your money tied up in oil rather than, say, stocks or bonds.

I must admit I have always operated under the not storable assumption (largely because I never really thought about the problem). But if oil is storable, then the recent run up in prices makes a lot more sense - investors believe oil prices will rise a great deal in the future (demand from China and India, peak oil, inflation due to loose Fed monetary policy, etc.) This expectation of higher prices in the future causes oil to get stored (either above ground or below ground) which causes prices to rise today.

I have absolutely no idea how storable oil is. It is not my area of expertise and we all know how I feel about economists giving 'expert' opinions on things they know little about.

A number of economists, who I hope know more than I do about the storability issue, have given their two cents. See: Arnold Kling, Mark Thoma, Tyler Cowen and Paul Krugman.

As far as why speculators think the price of oil will go up in the future - I can't read their minds, obviously, but the two factors which make the most sense to me are:

• Inflation expectations due to loose monetary policy



• Currently loose monetary policy is driving down the U.S. dollar. Since commodities are often measured in U.S. dollars, the rise in commodity prices appears more dramatic than it really is.