Lessons from ‘robber baron’
ANDREW CARNEGIE’S BOTCHED CRUDE STORAGE
Acentury and a half before t he c urrent supply glut sent oil prices into contango, one of America’s greatest industrialists tried to make money by storing crude. He failed.
In 1862, Andrew Carnegie and a partner bought several oil wells in Pennsylvania and dug a giant hole in the ground to hold the crude. That year, oil was worth about $1 a barrel. The partners thought they could make $1 million when supply ran out and prices jumped to $10. Instead, supply kept coming, the oil began leaking and Carnegie had to abandon the idea.
The storage trade is back in fashion in today’s oil world, and contango is the talk of the market. It’s the term used in commodity trading when the price for prompt delivery falls below the long- term value. Right now, with the contango near a four-year high at about $2.15 a barrel, oil traders are bidding up the cost of leasing tank space, and even looking at renting supertankers to hold oil offshore.
While modern financial markets allow traders to minimize the risk of storage trades turning out as poorly as Carnegie’s, his misfortune is still a valuable lesson for anyone waiting around for a rise in crude prices. “After losing many thousands of barrels waiting for the expected day (which has not yet arrived) we abandoned the reserve,” Carnegie, referred to as a “robber baron” along with fellow industrialists such as Standard Oil Co.’s John D. Rockefeller, for his ruthless pursuit of wealth, wrote in his autobiography. “We did not think then of Nature’s storehouse below which still keeps on yielding many thousands of barrels per day without apparent exhaustion.”
The main difference between traders now and Carnegie is that they have a financial market that lets them sell higher-priced oil futures at the same time that they buy cheaper crude to put in a tank. The only trick is to make sure the cost of storage and financing doesn’t eat up all the profits, and to make sure you can deliver the oil where it needs to go when the futures contract expires.
That’s one of the reasons there’s a record amount of oil in Cushing, Okla., the delivery point for West Texas intermediate futures contracts. WTI for March delivery sold for US$2.62 a barrel less than April delivery last week, the widest gap since 2011.
“Traders have zero risk if they’re storing oil in Cushing,” said Phil Verleger of PKVerleger LLC. “This is just commodity economics 101.”
While the oil storage trade didn’t work out for Carnegie, the story did have a happy ending for him. The investment in Pennsylvania oil wells returned far more than his $ 40,000 investment, allowing him to quit his job at the railroad and start on the path to becoming one of the richest men who ever lived.
“Thenceforth,” he wrote, “I never worked for a salary.”