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374 comments on DrumBeat: July 9, 2008

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shargash on July 9, 2008 - 11:36am Permalink | Subthread | Parent | Comments top

Every contract requires 2 parties. When a hedger wants to hedge one way or the other, they need someone to take the other side of the contract. That's where speculators come in. Without speculators, it becomes harder to hedge, and harder to hedge at the economically efficient price. The volume traded on the exchanges goes down and volatility goes up.

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The Dude on July 9, 2008 - 12:09pm Permalink | Subthread | Parent | Comments top

JD has a post on FUTURES PRICES DETERMINE PHYSICAL OIL PRICES. ACK, WISH HE'D LOSE THE CAPITALS. He says futures actually do have a role to play:

Thus, instead of using dated Brent as the basis of pricing crude exports to Europe, several major oil-producing countries such as Saudi Arabia, Kuwait and Iran rely on the IPE Brent Weighted Average (BWAVE).

The BWAVE is the weighted average of all futures price quotations that arise for a given contract of the futures exchange (IPE) during a trading day. The weights are the shares of the relevant volume of transactions on that day. Specifically, this change places the futures market, which is a market for financial contracts, at the heart of the current pricing system.

That's from OPEC Pricing Power (PDF). This is what Paul Krugman et al don't know about, sez JD. What think you?

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shargash on July 9, 2008 - 12:45pm Permalink | Subthread | Parent | Comments top

Some private sales are set based on futures prices. Some are not. That's old news, and it doesn't mean that futures prices determine oil prices. The Saudis, for example, change the formula all the time when they don't like it. There was just a headline this week that they were raising prices.

The thing JD misses is that, if fundamentals don't support the price the Saudis want to charge, NO ONE WILL BUY THE OIL. In fact, exactly this is happening to Saudi Arabia (light sour oil) and Iran (heavy sour oil). They are asking more than people are willing to pay, so people aren't buying.

Prices are set by supply and demand. I just don't get why that is so hard for people to understand. If there is excess supply, suppliers will undercut each other until the price falls far enough. If supply is unconstrained, prices will usually fall to close to the production price. Otherwise, suppliers will ALWAYS charge the maximum price the market will bear. That's what businesses do. And that's what is happening with oil now.

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374 comments on DrumBeat: July 9, 2008

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