Oil Prices

June/27/2008 19:29PM
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Everyone looks at the future’s market to see what is going on with crude oil prices. I thought Bill O’Reilly was going to stroke out with Stossel the other night. He was literally screaming at Stossel insisting the speculators and Big Oil are two factors that are driving up the gasoline price. He shouted over any arguments Stossel made that were logical and held to his paranoid beliefs much like lawmakers and citizens do. 

Let’s try a different approach. If you own a refinery in the US you need to buy crude oil as a feedstock for your refinery. Since there is not much available in the US, you have to look to the open market for supply. Most refiners have some combination of contract and spot supply. The contract supply would be bought at a delivered or spot price based on the contract plus freight. The contract that was negotiated would determine the pricing. One way it would be priced is on the day the order was placed at a designated spot price. Then freight would be added. On a delivered basis the price would be the NY spot or Gulf Coast spot price on the day the product was delivered. With rising prices, the delivered price favors the seller and the order placed date favors the buyer. If the market is going down, it’s just the reverse. So, even with contract crude there is some speculation between buyer and seller based on how the contract was negotiated. There is a quality adjustment for crude oil since light crude is worth more. Light meaning less sulphur. 

If you want to gamble on a surplus of crude oil being available on the high seas seeking a buyer, you leave some space in your supply plan for spot purchases. There will be less secure than contract volume, but you might get the crude at a lower price than your locked in contract terms. In this market, most refiners are probably getting as much on contract as they can, since gambling on spot might be very high risk and result in even higher prices. 

Notice, so far, no mention of the futures market. A refiner who believes the price of oil will go up may buy futures contracts at a specified price to hedge against that price increase. An airline might do the same. A railroad may do the same. A marketer who has no refinery but 500 retail outlets may do it also. If they do and the price goes up they can take delivery of the product or close out the contract and keep the difference between the price they locked into and the true price. 

Key to all this is the spot price. That is the price wet barrels are being sold for today. There is no speculation in spot prices. If you offer to buy you own the wet barrels. You offer to sell, you have the obligation to deliver the wet barrels. The price you hear quoted every day in the news is the spot price New York Harbor for sweet Saudi crude. It’s the real price, there is no speculation in it.

The futures market probably delivers no more than 20% of the barrels under contract. The other 80% are contracts that get closed out. It’s a zero sum game. If there is a loser on a contract there has to be a winner and vice versa. 

If anything, the futures market may be keeping the price of gasoline down. If a refiner has hedged well he can meet his margin goals and not be forced to raise prices even though the cost of crude has gone up. Refiner margins are down significantly this year and some of that may be due to hedging profits.

I know this is complex and you may have a headache by now. Just a few points were intended. First, refiners make their crude deals on contract and they are many days out since the time for delivery may be 45 days. Second, most crude is bought on contract to assure reliable delivery and pre-priced based on the contract terms. Third, if the futures market is used, it may be helping to hold gasoline prices down in this rising market. Fourth, everything O’Reilly is ranting about and the Congress is investigating has absolutely nothing to do with the price of gasoline since wet barrels and the spot market drive that and they are an immediate clearing house of buyers and sellers with no speculators involved. 

Speculators is the 2008 version of all the tankers that were offshore in 1974 going in circles to keep the gasoline lines long. Something to blame to avoid having to take the blame. Gasoline prices in the US are due to the unwillingness of your elected officials to develop and implement a solid energy plan for the past 25 years. Now that it’s almost desperation time, they are still refusing to do so. Believe what you want, but that’s the simple truth.

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