When you say contango has worsened, you mean the gap in spot and future price has grown?
Yes. It's usually quoted as the difference between the front month and a further-out contract, like the 7 month.
You can also visualize the term structure as a curve, with the delivery date on the x-axis and the price on the y-axis. If it curves up, the market is in contango; if it curves down, the market is backwarded.
Most of the time, the market is backwarded, since the people "storing" oil are the producers - it's "stored" in the ground. Since that's actually free, and the producers are trying to reduce risk, they pay for the privilege.
Shouldn't that drive up the price of oil in the short term and pull down the future price?
That depends. If the spread is greater than the cost to store the oil, then yes, arbitrageurs will buy oil in the tank and sell the long-dated futures, which will compress the curve.
Generally speaking, this arbitrage drives up the cost of storage even as it drives the futures price down, until an equilibrium is reached. However, that equilibrium is dynamic for a few reasons:
1) During an oil glut, oil stocks are increasing over time because the supply exceeds demand. Right now there's about 7 million bbl going into storage in the US every week. There's a whole speculative market in storage itself.
2) Speculative action by traders: managed money may increase or decrease their long/short positions based on new data.
3) Producers: if the oil price bounces up enough, the long-dated contracts may be attractive enough that they can just buy them and start new oil projects. For example, if a producer is looking at a project that requires $60 oil to make sense and takes 1 year to come online (shale is very fast turnaround), based on the spot price they'd put it on hold.
But with oil in contango, they can short the Feb 2016 contract at $61 and keep on chugging with the project without any risk. In that sense a big contango actually propagates the oil glut.
Once we reach the point where storage costs increase and the price gap decreases enough to eliminate the profit margin, we'll face another sell-off which will push the price back to its previous lows.
It's more complicated than this for a lot of reasons, but ultimately I agree.
I'm currently considering buying stock in oil tanker companies, particularly the ones that own VLCC fleets, for two reasons:
1) They're at historic low valuations
2) As the storage market gets tighter and tighter under the constant excess oil flow and persistent contango, banks and hedge funds will start arbitraging the term structure by hiring oil tankers, filling them with oil, and having them float offshore (actually, about 2 dozen VLCCs have already been put on contract with the option to do this).
As that happens, pressure will mount on the VLCC spot market, which could cause explosive upside in the day rate (you can't use oil in Saudi Arabia, it has to move, at basically any price). That money would flow straight to the bottom line of the tanker companies.