Money and Investing Thoughts

Oil falls below $34 ahead of Feb contract expiry: Financial News – Yahoo! Finance.

I found the article linked above very interesting and thought provoking. The main point of the story is that oil traders are dumping their near term contracts because they have no where to store the oil. Since reading this article this morning oil has recovered over 10% as other traders (I assume) rush in to cover their positions. Reading the article above and the oil news through the day has me wondering whether oil traders are setting themselves up for a big squeeze. Let me lay out the facts as I see them.

• Worldwide oil consumption has fallen about 500,000 barrels per day from the levels of last year.
• The contango in the oil futures has producers of oil selling it in forward contracts. The 6 month futures were $17 to $18 /barrel higher than the current spot last  time I looked and end of 2009 contracts were $20 better than current prices.
• Oil in storage for future delivery is starting to take up all available storage space.
• If there is not enough storage or demand where will current and near term  production go? Prices will have to drop to the point where producers reduce production to something less than current demand.
• If production does not contract significantly, in a few months their will be future’s contract holders buying $55 oil that is worth less than $40.
• Somebodies will be going broke!

I know OPEC has committed to significant cuts in production and that is the reason for the oil price contango (so I read).  But there seems to be a problem is the oil industry runs out of storage for oil sold into future contracts. I do not know what the effects of this can be, and it appears that somewhere there is going to be a big squeeze!

I would appreciate your feedback and thoughts on this topic.