The Oil Drum

Imagine you're a wealthy institution (or individual) with some cash you want to invest.  You could put it into 3-month treasury bills and make 3.5% (annual rate).  Or, you could buy oil on the spot market and (at the same moment) sell a future contract for the same oil 3 months out.  If the three-month future oil price is enough higher than the current price to cover the transaction and storage costs and still return more than the 3.5% annual rate of return, then obviously you want to buy the spot oil and sell the oil future.

Observe that it makes no difference what the price of oil actually is three months from now.  You've locked in your rate of return right at the start.

In practice there are some extra costs and risks.  For example, a hurricane might make it impossible for you to actually deliver the oil you've got sitting in your storage tank.  Then your tank is tied up longer than the 3 months you'd planned (raising your costs) and you're in danger of defaulting on your delivery (if the market doesn't declare force majeure and say you can deliver later).  But that just means that threshold where you make the trade is higher than 3.5%.

You can make the same trade the other direction--you have oil now and you need oil in 3 months.  You can just store your oil for three months, or you can sell it now and invest the cash in treasury bills, while simultaneously buying a futures contract for oil for delivery in three months.  As long as the future price is not so much more than current price that the interest on the treasury bill can't make up the difference, then the trade makes sense.  If you would otherwise have to pay for storage, that's another plus to the trade.

The actual future price of oil has almost nothing to do with it.  It's all a matter of interest rates.