Oil Futures, or Any Other Futures For That Matter

[Mule]

I'm far from an expert in these areas so maybe somebody here can answer this. Is there some (any) advantage to the country from the futures market. It seems to me that it is a combination of speculation and an attempt to manipulate markets, to the detriment of both the general public and the producers of the product. Am I missing something here or would all but the speculators be better off if this practice was not allowed?

[The Gaijin]

It companies the ability to plan for the future. If they are dependant on any particular commodity (oil or cocca beans or coffee) they can purchase "futures" and lock in their material costs going forward..

It is not all speculation.

[Mule]

This is like govt agencies buying highly inflated service contracts in order to "fix" their costs. Is the benefit worth the cost?

[MRM]

Yes, you are missing something. The futures market allows buyers and producers of the product or raw material to manage their risk. For instance, a farmer can get seed money for spring planting by selling futures on his crop. General Mills can assure itself a steady supply of wheat at a known price by buying grain futures. Manufacturing companies who need large amounts of oil can budget around a known cost and ensure supply buy buying futures. Most multinationals also buy and sell currencies to hedge against increases or decreases in the local currency vis a vis the Dollar.

If producers or consumers of comodities were held to selling only at the time of production or consumption they would be at the mercy of the days' spot prices, and would be open to supply, demand and pricing shocks.

[Mule]

Originally Posted by MRM

Yes, you are missing something. The futures market allows buyers and producers of the product or raw material to manage their risk. For instance, a farmer can get seed money for spring planting by selling futures on his crop. General Mills can assure itself a steady supply of wheat at a known price by buying grain futures. Manufacturing companies who need large amounts of oil can budget around a known cost and ensure supply buy buying futures.

If producers or consumers of comodities were held to selling only at the time of production or consumption they would be at the mercy of the days' spot prices, and would be open to supply, demand and pricing shocks.

I appreciate your description of the process. I guess my question is, if we adjusted the system to eliminate the speculators, would we be any worse off? I see that some changes might be required. But I also see that oil speculation is about to crash our economy.

[Jim Richards]

by it's very nature, a futures contract is speculative.

[MRM]

The problem is that speculators are what keep the markets efficient. They take the risk of great swings in the price, hoping to make a profit. The people who need to buy or sell at a known price or secure a long term supply need these people to keep the markets moving. Sometimes that drives prices too high or too low for a short time, creating an anomoly in the market, but the underlying law of supply and demand always brings things back in line with the fundamentals.

[Mule]

Is it just me or has the law of supply and demand been swept under the rug right now as pertains to oil?

[trader220]

Originally Posted by MRM

The problem is that speculators are what keep the markets efficient. They take the risk of great swings in the price, hoping to make a profit. The people who need to buy or sell at a known price or secure a long term supply need these people to keep the markets moving. Sometimes that drives prices too high or too low for a short time, creating an anomoly in the market, but the underlying law of supply and demand always brings things back in line with the fundamentals.

MRM is exactly right. I would only add if the govt imposes regulations to eliminate the speculater then you dont have anything that resembles a free market and more players would leave which in turn would do 1 of two things. 1) send the futures trading in crude to an exchange outside the US 2) disrupt the global market in crude which would not be a good thing.

[jyl]

As more of the volume in the oil futures market (or any other futures market) is financial players buying for investment and speculation, rather than physical producers and consumers buying for operational hedging, I believe the market will tend to be more volatile, more correlated to other financial markets (including inversely), and less correlated to current supply and demand for the physical commodity.

My understanding is that in the oil market, the financial players now far outnumber the physical players, in trading volume.

trader, do you agree/disagree?

[trader220]

That really depends on your definition of who is a financial player and who is a true end user. The latter is easier to define. How would you position someone like Goldman Sachs’ energy group? Now they have huge clients who are hedgers but they also take the other side of those trades and do speculate in the energy markets.

In theory the more volume the more efficient the market place an the lower the volatility in the market.

I believe that crude and all commodities are mean reversion markets so in the end supply and demand will rule the day. But as you can see in the market right now, mean reversion is a long term view of the markets and there can be long stretches of time where prices are far out of long term line.

[Mule]

Originally Posted by trader220

That really depends on your definition of who is a financial player and who is a true end user. The latter is easier to define. How would you position someone like Goldman Sachs’ energy group? Now they have huge clients who are hedgers but they also take the other side of those trades and do speculate in the energy markets.

In theory the more volume the more efficient the market place an the lower the volatility in the market.

I believe that crude and all commodities are mean reversion markets so in the end supply and demand will rule the day. But as you can see in the market right now, mean reversion is a long term view of the markets and there can be long stretches of time where prices are far out of long term line.

I think crude oil is the highest volume item on earth & it's volatile to the point of crippling the economy.

How does this differ from (illegal) price fixing?

[trader220]

Originally Posted by Mule

I think crude oil is the highest volume item on earth & it's volatile to the point of crippling the economy.

How does this differ from (illegal) price fixing?

I was speaking of volume in the futures market not in the raw commodity.

What part would you define as price fixing an illegal?

[Mule]

Collaboration among the traders to keep the price artificially high? Again, I'm no expert, just an ordinary guy trying to make sense of this.

[trader220]

Who would be collaborating? Could you expand? Lets assume roughly 100 different firms making makets in the crude futures pit and thousands of firms around the globe who add liquidity to the futures market in crude from off the floor.

[Mule]

100 is not that big a number. Add liquidity? Isn't that a little bit of a rosy term for what's going on?

[trader220]

100 market making firms is not all that big. Adding liquidity from off the floor means just what it says they contribute liquidity to the futures market from off the floor. If you needed more size at apsecific price you would not want to keep lifting the offer from the market makers in the pit but you might have a good institutional broker who can call the desks of a lot of shops and find you the liuidity you need at the price you need.

We're off floor liquidity providers in a few dozen options books.

[dd74]

The earthquake in China is currently one reason oil and gasoline prices will go up again, particularly diesel. I can't remember until recently a time when natural disasters caused blips in the energy sector. Not to be disrespectful, but it looks like any worldwide scenario gone bad seems to be a reason for oil and gas prices to rise. Why is that?

[trader220]

Just to keep the record straight, I don’t trade crude futures or options and no one at my firm does.

One part of the equation you’re forgetting is that the NYMEX prices crude products in US Dollars which is hurting the price of crude.

I am not sure what the earthquake in China really does to the crude markets, its really not may area of expertise.

Nat Gas looks rediculous to me at this price

[Mule]

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