One of you asked me to explain how the price of oil or futures is determined. Politicians have done nothing to decrease our dependency on oil or find more of it or encourage alternate energy sources that actually produce energy, like nuclear. Rather many would simply tax oil company profits, remember we tried that in the 1980s, did it work, do we have more oil? No, but I digress.
I direct you to the NYMEX. That would be the New York Mercantile Exchange. Here energy futures are traded every day by traders all over the world (read unscrupulous energy traders, there are of course no unscrupulous politicians who would seek political advantage from this). The hyperlink takes you to the NYMEX education forum for a genuinely accurate and longer explanation than I can give here. But
It works like this. Companies that must buy oil in the future, buy futures now to hedge against further price increases. If a utility or airline must buy oil in August, they might buy oil futures today for say $122 basis August. If oil is above that come August, they have hedged their position by assuring themselves a price of $122. If it goes down they can buy the cash market, they will still have not paid more than $122. Sellers do the same. In a down market one might sell forward guaranteeing a minimum price for the commodity. One sells at $122, if the price is lower the seller is still assured of getting, yes, $122 in August.
Trades are done by open outcry so the best bid and offer are paired at an agreed price. And every contract must settle to the actual real price at settlement, or the contract must be closed out before a specific date.
Yes there is more oil traded than produced, but all trades must still settle to the cash market.
IT is true that Exxon Mobil made a lot of money lately. It is also true that they are paying billions of dollars in taxes lately. It is also true that their net profit percentage is below what most banks are making-or Revlon for that matter. But no one is griping about Revlon's excess profits. And Exxon's return on assets is about 8.3%, just above the all industry average of 7.5% or so. But do not expect the politicians to talk about that. Now if you were in the oil business, would you price your product at what you expect to pay for the next barrel of oil you must purchase? Of course you would! If the prices go down you will be stuck with high priced inventory. And of course the cost of exploration continues to go up. Understanding accounting helps one get through the political maze.
Check out NYMEX or Trading Places last scene at the NYMEX. It was actually filmed there and Akroyd's explanation is right on accurate. See my fascination with the movies once again has an education link!
There are several videos at this link, how would you like to do this every day for a living, talk about stress!
Comments