Oil Prices: Speculation or supply and demand?

[Felch]

Originally posted by Victor Galis
The speculators don't trade in actual oil. They buy/sell futures (contracts for delivery at a future date). They then resell/buy those futures or settle the transaction for cash. No actual oil trades hands as a result.

For them to actually affect the oil market they would have to actually buy oil and stockpile it somewhere, thus creating more demand.

I understand that they're not actually sitting on 55 gallon drums of fuel, but wouldn't the fact that they're making money off of these transactions make them middle men of some sort?

I'm okay with price gouging middle men, so long as they don't go to the government for a handout when they're scam runs its course.

[Victor Galis]

Originally posted by Kuciwalker


Actually, all they have to do is get someone else to stockpile the oil in order to meet the futures contracts.

Not really. The transactions are generally settled with cash. It's kind of like betting on the outcome of a sporting event, except you're betting on commodity prices.

I understand that they're not actually sitting on 55 gallon drums of fuel, but wouldn't the fact that they're making money off of these transactions make them middle men of some sort?

Kind of yes. Except they're transfering profits from producers to themselves or from other investors that guessed poorly. I'm not exactly against that. They essentially allow producers to lock in a price by selling today the rights to that oil. Alternatively, someone who doesn't own any oil but thinks it will get cheaper can sell you oil at a future date, with the understanding that he won't actually deliver oil, but rather enough cash to buy that quantity of oil.

[Spaced Cowboy]

Read this please:

http://en.wikipedia.org/wiki/Futures_contract

Note the important points.

In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price.

A futures contract gives the holder the obligation to buy or sell, which differs from an options contract, which gives the holder the right, but not the obligation. In other words, the owner of an options contract may exercise the contract, but both parties of a "futures contract" must fulfill the contract on the settlement date. The seller delivers the commodity to the buyer, or, if it is a cash-settled future, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position has to offset his/her position by either selling a long position or buying back a short position, effectively closing out the futures position and its contract obligations.

Settlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract:

* Physical delivery - the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. Physical delivery is common with commodities and bonds. In practice, it occurs only on a minority of contracts. Most are canceled out by purchasing a covering position - that is, buying a contract to cancel out an earlier sale (covering a short), or selling a contract to liquidate an earlier purchase (covering a long). The Nymex crude futures contract uses this method of settlement upon expiration.

[Kuciwalker]

Originally posted by Victor Galis
Not really. The transactions are generally settled with cash. It's kind of like betting on the outcome of a sporting event, except you're betting on commodity prices.

Sigh.

Let's say I make a contract directly with an oil company (for the sake of simplicity) to buy X gallons of oil for $Y Z years in the future. Because I think demand for oil will rise faster than supply, $Y > $however much it costs now. This encourages the oil company to sell less oil now in order to sell more oil later (by stockpiling, or manipulating their production somehow). Immediately, that translates into a price increase now.

Speculation can and does affect prices now; that's the entire point, from a macroeconomic perspective. As such, even if it is largely responsible for prices now, that's probably a good thing.

[Victor Galis]

Originally posted by Kuciwalker

Originally posted by Victor Galis
Not really. The transactions are generally settled with cash. It's kind of like betting on the outcome of a sporting event, except you're betting on commodity prices.

Sigh.

Let's say I make a contract directly with an oil company (for the sake of simplicity) to buy X gallons of oil for $Y Z years in the future. Because I think demand for oil will rise faster than supply, $Y > $however much it costs now. This encourages the oil company to sell less oil now in order to sell more oil later (by stockpiling, or manipulating their production somehow). Immediately, that translates into a price increase now.

If this were actuall happening you'd see oil inventories rising, whereas they're not. No one's stockpiling oil on a big level as far as we can tell.

[Aeson]

Originally posted by Victor Galis
If this were actuall happening you'd see oil inventories rising, whereas they're not. No one's stockpiling oil on a big level as far as we can tell.

Or, as Kuci properly mentioned, you'd see production manipulated... which obviously never could happen, right?

[Kuciwalker]

I actually don't know whether there's any technical way you could decrease production now to ensure higher production later.

(In the short term, obviously.)

[Dinner]

Originally posted by Spaced Cowboy

But I do agree that the US is way too spread out, from the suburbs, to the far flung cities. This model relies on cheap personal transportation. I wish I could buy a cheap electric car, and keep a gas one for longer trips.

Buy a new VW Jetta turbo diesel and get 50 mpg highway. I test drove one yesterday after work just to see what they were like and I have to say the 5 door was pretty roomy plus the car was very quiet. You could hardly tell it was a diesel.

There are lots of good high mpg cars out there on the market right now.

[Dinner]

Another good way to slam the Speculators would be to release oil out of the Strategic Petroleum Reserve when ever there is a big increase in futures contracts coming due. Wash the speculators out a few times and they'll be less likely to keep betting on oil futures.

[Aeson]

You'd only hurt half the speculators. (And half already get "hurt" speculating anyways.)

[Kuciwalker]

Originally posted by Aeson
You'd only hurt half the speculators. (And half already get "hurt" speculating anyways.)

That's not true. Speculation isn't a zero-sum game. It's a sale of risk.

(throwing out numbers here randomly)

Let's say I think oil will be worth $200/barrel in 5 years, and so does an oil company. It may be worth it to them to sign a contract to sell it to me at $190/barrel in 5 years, if that $10/barrel is the cost of the risk, to them. The risk may be less costly to the speculator because 1) he holds positions whose values are negatively correlated with the value of oil and 2) he may be inherently less risk-averse.

[Aeson]

He's talking about option expiration manipulation. Flooding supply to "hurt speculators" at expiration is only going to hurt those who are "long" (long calls or short puts). It will actually help those who are "short" (short calls or long puts).

The amount of "hurt" and "help" is actually the same, since for every contract there will be someone making $X for those losing $X due to the manipulation of the price of the underlying.

[Kuciwalker]

Oh. I didn't actually read the post you were replying to.

edit: except, that's still not really the case. Ultimately the people selling the futures contracts are the oil companies; they're entering into a deal whose value is negatively correlated with their main assets (oil production). So they don't really benefit from the drop in oil prices.

[Kuciwalker]

Inasmuch as the speculators hedge their bets sufficiently, price manipulation doesn't really hurt them. Those that buy futures because they are actually less risk-averse than others are the ones who'd get hurt. I don't really see how that's a positive outcome.

(Well, those and the incompetent ones.)

[Victor Galis]

Originally posted by Aeson


Or, as Kuci properly mentioned, you'd see production manipulated... which obviously never could happen, right?

Except I'm not seeing how reducing production now lets them produce more later unless their fields are being rapidly depleted or they're producing the oil and hiding it. I could also see them doing maintence that would shut down production short term for a long term boost... but that's a good thing.