Sunday, December 07, 2008

Calling All Pirates!

An article I read on Bloomberg today sent of all of my "looming unintended consequences" radar into turbo overdrive. It's about the spread between current and futures oil prices, apparently called Contango, and the fact that this spread is so unusually large right now -- $41 current price vs. $55 December 2009 futures contract, so $14 per barrel -- that it's actually cost effective to:
a) rent a supertanker
b) borrow enough money to buy a Buh-Buh-Billion dollars worth of oil
c) anchor said tanker offshore somewhere and
d) physically deliver the oil a year hence.

Some Oil Dude in London is reliably quoted as saying that this strategy should deliver 11% profits over the forthcoming year, which looks pretty darn tasty when Ye Olde Worlde is ending all around us, and Treasuries are paying less than 1%.
pirate oil money flag
The reason that my looming disaster radar is going Beep! Beep! Beep! is because as sensible as it sounds, this is just the sort of nothing-can-go-wrong "auction off our lottery and our turnpike" sort of thinking that has gotten us so deep into our current financial crisis.

So for those who habitually stomp through graveyards, the foolish of all stripes, and investment bankers in particular, here's a short list of what could go wrong with this strategy, from the likely to the formerly absurd:

* Bankruptcy and/or default of whoever is sitting on the other end of that billion dollars worth of futures contracts. I can certainly imagine that entity either having gone under in the normal course of business 12 months from now, or seeking bankruptcy protection to avoid paying what could literally be $500 million worth of additional costs, if oil is at $28 instead of $56 when December '09 rolls around. Since every contract we can imagine has turned out to be worth the equivalent of toilet paper over the past 12 months, what's to say that oil delivery futures contracts won't suffer the same fate?

* Storm and/or other damage and destruction of the tanker and the oil. Sure, there's insurance against such things. Insurance companies are just SO financially stable these days, and happy to pay billion-dollar losses rapidly and fully, don't you agree? (cough) AIG (cough).

* Pirates and terrorists, oh my! The article goes on to say that as many as 16 supertankers may be booked for such use; which means that they'll be sprinkled around the globe in all sorts of locations, ripe to be hijacked, blown up, spirited away, or other malfeasant use.

Seriously, what really gets my hackles up (in fear not in anger) is that this sort of stupidly rational strategy is the height of "the system works" thinking, which assumes that a long complex interlocking string of contracts will be honored. Let's look at the string here:
* A current contract to buy a billion dollars of oil
* A loan to finance a billion dollar purchase
* Rental of a supertanker [and crew?]
* Insurance on the tanker and the oil
* Some sort of anchoring rights [or the knowledge where to anchor in international waters]
* A futures delivery contract for the oil

Think that anything could go wrong here? See any arcane interconnection of previously uncorrelated financial instruments and indices? Worried about the odds that at least one single thing in this long chain will go slightly wrong, in a world where Things Going Wrong has lately proven to be the approximate statistical equivalent of the sun rising in the east?

Nah. Count me in. Pirates be damned -- 11% sounds awesome!

PS. 2:1 leverage for 22%? Anyone? Hello, calling 2006... anyone?

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