The problem with the Oil Market is the commodity traders.

Just heard on the radio that the price of oil hit 60 again on news that there were some precautionary oil rig abandonments for that last tropical storm in the Gulf of Mexico.

Seems that every time a terrorist sneezes, the price of oil goes up. But it doesn't, does it?

We're dealing with the commodity market, which is based on future shipments. So, If I buy an oil future today, it's based on the presumption of availibility in two months. Terror and supply forecasts drastically spike these numbers.

What happens if the expected supply problems do not happen? Does the price go down? Not likely...Who pockets the money difference between the futures price and the production price?

Seems to me that the speculators are creating most of the problems in the oil market these days. They spook (or claim) violent shortages, and then people run to the market, and then the commodities traders make out like thieves?

Anyone have a better grasp on the situation?

Also, is there a legal means to gauge gasoline gouging? Seems that when the price of oil goes up, the price of gas goes up almost instantly. But, the gas in the ground was produced months perviously, at another speculated cost. It all just seems wrong...

Speculation is what drives the prices. In the case of oil, terror alerts can make the price fluctuate, but not to the point of driving it over $60 a barrell. OPEC, for the most part, sets a production quota. It is a supply and demand business, like everything else. If the demand exceeds their projected production, then the price rises. If demand is lower than expected, the the price tanks.

Here is an excerpt from an article I just read about the price of oil:

A year ago, a barrel of West Texas sweet crude sold for $37.05 on the spot market. On July 5, the price was $59.59, a 60% spike in price.



But don't worry. That rate of increase isn't sustainable forever. Eventually the good old laws of supply and demand will combine to slow the meteoric rise in oil prices.

Unfortunately, in the near term, those laws are taking their sweet time to go to work. There's certainly a good chance that over the next few days or weeks, oil prices will retrace part of their recent run to $60 from $48 as speculators take profits. But the trend for the rest of this year, and for 2006, is still up. I'd say we're likely to test $75 oil before the laws of supply and demand kick in to: 1) at least put a damper on the rate of price increases and 2) maybe even send the price back toward $50 a barrel for a while.

When Will Oil Run Out of Gas?

Part of the problem is that oil was depressed during the 90's and little investment went into oil development. China and India have started to use more oil creating more demand. The cheapest oil to refine is the sweet type of crude and there is not enough being produced to satisfy demand so other types of less attractive oil is having to fill in the production gap. These types of oil are heavy crude and they are more expensive to get out of the ground and to refine for use. Another issue is that there are roughly 1500 oil tankers for oil transportation. They are another bottleneck to get crude to the market. The last I saw it cost 50,000 per day to rent an oil tanker this does not take into effect the rising insurance costs associated with terrorism. Remember the oil tanker that al-qaida attacked of the coast of yemen? There are many different aspects causing the rise in crude prices oil speculation just being one of them.

If that were the case, the prices would plummet as we approach that month's expiration date. The commodity traders don't take delivery on the oil (what would they do, store the barrels in their basements???), so they are forced to liquidate long positions before this time. Oil is not settled in cash (like a forex contract would be), so if you own the future at expiration, you have to take delivery.

Originally posted by utrex
If that were the case, the prices would plummet as we approach that month's expiration date. The commodity traders don't take delivery on the oil (what would they do, store the barrels in their basements???), so they are forced to liquidate long positions before this time. Oil is not settled in cash (like a forex contract would be), so if you own the future at expiration, you have to take delivery.

Not neccesarily true:

A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. If you buy a futures contract, you are basically agreeing to buy something, for a set price, that a seller has not yet produced. But participating in the futures market does not necessarily mean that you will be responsible for receiving or delivering large inventories of physical commodities—remember, buyers and sellers in the futures market primarily enter into futures contracts to hedge risk or speculate rather than exchange physical goods (which is the primary activity of the cash/spot market). That is why futures are used as financial instruments by not only producers and consumers but also speculators.

Source: Investopedia

I have yet to trade in futures, but I am researching it.

Futures in the oil market are not settled in cash: one side delivers the actual oil, the other pays the spot price. This is in contrast to futures on currency or on an average (it is obviously ridiculous to deliver a S&P future -- what are you going to do, buy a basket of the stocks weighted appropriately?), which are often settled in cash.

If there were no real demand to justify the current prices (i.e. it was all speculative and driven by traders), we would see this near contract expiration. The traders don't want to/can't take delivery on the oil, so longs have to close out their positions before expiration. I'm not saying there isn't any speculation in this commodity market (there is always speculation in every commodity market), but the sans speculation supply/demand oil price is not being driven too much higher than current spot price by the speculation itself (that is, there is real support).

But the speculation pikes already high demand.

Example: US crude futures jumped $1.71 today to above $61 based on Tropical Storm worries. We get Tropical storms every year, but we never noticed this spike until now!?!?

Either the news is highlighting this chaos, thereby increasing the fears and fueling the increase, or this is a new fear. I suspect the former.

There is too much emotion on such an important commodity.

Also remember that futures traders are hoping for bad news. Bad news=Quick profit. On the OTC stocks, there are actually paid bashers, whose goal is to bash a stock to the point where it is almost worthless. This is done for the benefit of the short traders, who are gambling on the demise of a stock, while long traders get the short end of the stick.

Everything on the market drops with bad news. It is normal. That is the time to buy, then sell after all the hype to make a quick buck.

But the speculation pikes already high demand.

Example: US crude futures jumped $1.71 today to above $61 based on Tropical Storm worries.

That is a supply and demand issue. If there's going to be an interruption in the supply, the oil is inherently worth more. Light sweet crude consumption for a lot of companies isn't very elastic.