Posted on 08/22/2008 6:05:20 AM PDT by 300magnum
We've all read that speculators are driving oil prices artificially high — a claim that gets more interesting in light of oil's recent fall below $115. But maybe we're looking at it from the wrong perspective. Suppose that major suppliers in the oil industry are these manipulative speculators.
Is it possible that oil prices are rigged? You bet. Here's how:
Just how would you raise prices if you were an oil supplier? Controlling the supply — as in the 1973 OPEC embargo — has become less effective with more sources of oil worldwide. And oil suppliers clearly cannot raise prices by controlling demand in the physical oil market; ultimately, they need to sell their oil, not buy it. However, with the market inefficiencies that we expose here, oil suppliers can regain the upper hand by artificially inflating demand using a different market. To understand this mechanism, we must take a glimpse into the future — the futures market, that is.
The price of oil reported in the news is actually the price of oil in the futures market. In this market, traders do not exchange physical barrels of oil, but instead trade contracts which obligate them to exchange oil at a quoted price at a specific date in the future, usually months in advance. Such a contract allows companies to hedge positions by locking in prices early. Airlines might buy futures contracts to reduce their exposure to rising fuel prices. Conversely, oil companies might sell futures contracts to assure a profit against future price drops. It's all about reducing risk and uncertainty. But what if oil suppliers were instead buying oil futures, compounding their own risk and reaping enormous profits from the explosion in the price of physical oil?
The futures market has become the public driving force in pricing
(Excerpt) Read more at time.com ...
When investors are lined up, more than willing to drill in ANWR and off shore, but the government is the ultimate power that issues the permission slip that allows drilling, who exactly is limiting supply??
It’s the government stupid. Not the oil companies limiting supply.
Why don’t people understand??
Oh, and NOT all oil is used for gas....
True, in fact the majority of an average barrel of oil is used for other products. Depending on the quality of the crude the percentage used for gasoline can vary widely.
Their entire premise appears to be that the market is rigged because oil suppliers are going to do what's in their best interests...
Of course they are going to do what is in their best interests. At times that is going to mean producing less than what they might be able to produce because overproduction causes a glut of supply and drives down the prices. It also drive up demand, but at some point they are better off selling less for more.
Underproduction causes scarcity and drives up prices but drives down demand. It also makes it more cost effective for others to develop new sources of oil.
Thus the free market regulates itself.
The only real way the market is rigged is the political and regulatory hurdles to developing additional sources of oil limit supply and the ability to develop new sources of supply.
The article tries to make it sound like the fact that you don't have to have the full purchase price of the oil you are buying a future contract for in that bank is something strange and nefarious.
The oil has to be paid for when it is delivered. You have to put some money down when buying the future to reduce the risk that you will be unable to pay for the price of the oil, or cover the loss if the oil is can be sold for less than you agreed to pay for it.
Even if they know that the price of oil is too high (to the point of reducing demand) it is not in their interest to correct it. By setting prices in the smaller but more "trusted" futures market, oil producers realize multiplied gains on their physical oil sales.
Suppliers don't set prices in the futures market. The sell the futures for the price that purchasers are willing to pay. If purchasers are willing to pay more the price goes up, if they are willing to pay less the price goes down, though if the price goes down too far the suppliers may reduce the amount of futures they are willing to sell in hopes that the price will go back up. That's the way a market works.
Prices in the futures market — and, indeed, any real-life market on a standardized good — do not form where actual supply meets actual demand; they form where perceived supply meets perceived demand. Participants in the futures market merely represent the world around them. A veil has been placed over the public's eyes, and they accept this illusion of a fair price.
What a bunch of garbage. Just because there is risk involved that they will incorrectly predict future supply or future demand, fairness becomes an illusion?
No one is forcing people to buy futures. They do so because they feel they can make money through assuming the risk that supply or demand will change. Suppliers offer futures because it reduces the risk for them. They know they have a buyer for the oil before they pump it out of the ground. They know what it will be sold for, and they can make business decisions based on that price.
Oil futures offer value to the suppliers through a guaranteed price, and opportunity to investors.
The futures market has become the public driving force in pricing oil. But the vast majority of oil consumed in the world is purchased through private deals, given the massive undertaking of physically delivering millions of barrels. However, a series of private deals cannot establish a market price.
Absolutely and completely absurd.
The private deals behind the scenes unquestionably have a great effect on the market price.
Investors that invest in oil futures need to sell that oil to someone that is actually going to use it, and no one is going to buy it from those investors for a price that is greatly different than they can get it for in some private deal.
Investors in the futures market try to anticipate what people will be willing to pay for oil. To say that the futures market, which is a small portion of the total oil, independently sets the price for all oil is absolutely ridicules. The futures market tries to anticipate what they oil can be sold for when that oil is actually delivered. However, the actual price they can sell it for is still determined by the market.
The owners of the futures can't just decide to sit on the oil they purchased when it comes time for the oil to be delivered unless they've got some place to store the oil. It is the market price of oil at that time that determines what the oil can be sold for. If they guessed well they make a profit, if they guessed poorly, they lose money.
Let alone understand inventories and its effects on pricing
Because whiners are bad at math.
If I understand correctly, the authors are students at Stanford and not professors.
Uh oh, you are insinuating oil companies, suppliers and retailers are gouging and manipulating price....get ready to be flamed by the supply and demand Freepers who believe that could and will never happen. Shame on you for thinking that could happen.
North Dakota sweet crude (Williston Basin) was $6.50, sour was $4.50. The only people up here who were busy in the oil patch were plugging stripper wells and jacking casing. I also knew a Canadian who was slowing down pump jacks to cut losses because the price was below lift costs.
“Obvious” of what?
North Dakota Daily Oil Produced and Price, 1970-present
Note the downtick in price late 1988/early 1999 (drilling also stopped completely for the only time since oil was discovered in the state).
Oil falls from 147 to 111, a 24% decrease. Meanwhile at the same time, gas prices fall from $4.11 to $3.69, a 10.2% decrease. Should be obvious.
Uh oh, you are insinuating oil companies, suppliers and retailers are gouging and manipulating price....get ready to be flamed by the supply and demand Freepers who believe that could and will never happen. Shame on you for thinking that could happen.
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Not going to flame you, but we are going to correct you. I hate to point this simple fact out, but oil is not gasoline. The logic applied by the genteleman who cited the drop in oil relative to gas is simply faulty. It is the same faulty logic that someone would make by claiming that a 50% drop in aluminum prices *must* cause a 50% drop in automobiles. It simply ignores the cost of every other input that goes into the final product.
In the sense that Russia is using it’s oil as political
leverage and blackmailing it’s customers, it is rigged.
Give me a break. Everyone here has seen gas prices shoot up 20-30 cents INSTANTLY when oil jumps $10/barrel. But when it falls just as quickly, gas prices seem to stay there.
Defend this if you will, but there is something wrong.
Your points are very well-made, but what about in a world-wide scenario where the big players are the sheiks who have their hands on the oil spigots? If THEY were the ones taking big positions through hedge funds, couldn’t they just protect themselves by turning supply up or down? Just asking...
Oil prices are very bullish again, in part thanks to the Russian invasion of Georgia, coupled with increased fear of Putin’s energy blackmail routine this coming winter.
Failed to mention the artificial restriction of supply created by legislatures that prevent drilling in the US. I wonder how much money has been funneled to Pelosi and Co. to keep domestic supplies off the table.
Give me a break. Everyone here has seen gas prices shoot up 20-30 cents INSTANTLY when oil jumps $10/barrel. But when it falls just as quickly, gas prices seem to stay there.
Defend this if you will, but there is something wrong.
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You are noticing a very common effect in business. There is a tendency to set prices high and then lower them down to the profit-maximizing point of equilibrium. If you have noticed, gas prices have been steadily dropping since summer. There may be a recent hiccup due to events related to the Baku-Tbilisi-Ceyhan oil pipeline, but the trend has been down since the summer break/vacation period is over.
If it makes you feel any better those evil oil companies only maximize their profit at equilibrium, so if they are really pricing gas too high, then it will continue to fall until they maximize profits (which after all is a function of price AND units sold....not simply price).
Then it comes to me, I would have to become a politician.
The bottom of the news story states they are teachers-—
“”””Ari J. Officer teaches financial mathematics at Stanford University. Garrett J. Hayes teaches materials science and engineering at Stanford University””””
I agree with your comments.
In reading the comments of other FReepers on this subject it looks like we need to devote an entire forum to a discussion of crude oil supply and demand.
The forum would include topics like:
Where is crude oil produced in the world?
Where is crude oil consumed in the world?
Who are the top exporters of crude oil in the world?
Who are the top importers of crude oil in the world?
How does manipulation of the money supply affect the price of raw materials?
How does hedging by financial institutions of their corporate stock portfolio impact the price of raw materials?
This would a starting point.
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