The Crude Oil Contango: How to Profit From Rising Oil Prices

by Matt Weinschenk, Senior Analyst, The White Cap Report
Wednesday, January 28, 2009: Issue # 923

http://www.investmentu.com/IUEL/2009/January/crude-oil-contango.html

I uncovered a situation last week call contango. It’s a feature of futures markets where you can buy crude oil cheap right now and lock in a contract to sell it in the future for a higher price. Normally, the difference between those prices is so close to the cost of storing the oil that it’s not a profitable trade. But right now, we’re in a state of super-contango. Prices are way out of whack. And commodity investors are storing crude oil everywhere they can to earn the excess profits.

USO buys a contract for crude oil for the very next month. Before it expires, they sell it off and buy one for the next month. In a contango situation the returns will indisputably be lower. (Conversely, during the opposite of contango, “backwardation,” the fund returns will be higher). USO makes no secret of this. They print it in their risk disclosures that contango is not good for their fund.

But don’t give up on investing in oil.

In fact, the same manager that runs the USO fund runs another exchange traded security that’s custom designed to benefit from situations like the crude oil contango. It’s called the United States 12 Month Oil Fund (NYSE: USL). It uses a 12-month average of futures prices that will lessen the losses caused by a contango market.