Cost of carry, causality and arbitrage between oil futures and tanker freight markets

This paper investigates the dynamic relationship between oil futures and spot markets and tanker freight rates across two major tanker routes. In particular, we examine the validity of the cost of carry relationship in the WTI futures market, which suggests that the difference between physical and futures crude oil prices should reflect the transportation costs. We also examine whether the futures-physical oil differential contains information regarding tanker freight rate formation. Using physical crude oil prices for the Brent and Bonny markets, WTI futures prices and freight rates we find no evidence to support the existence of a relationship between tanker freight rates and physical-futures differentials in the crude oil market. This is mainly attributed to regional supply and demand imbalances and suggests that arbitrage opportunities between oil derivatives and tanker freight markets exist. Simulated trading strategies reveal the existence of excess profits, which are robust to variations in transaction costs, pipeline charges and timing of initiation of arbitrage. (C) 2004 Elsevier Ltd. All rights reserved.