Economics of Oil Futures Trading, Part II

Jun. 17, 2008 11:17 AM ETDBO, USO, OIL-OLD11 Comments
Mark J. Perry profile picture
Mark J. Perry
940 Followers

From this previous post on the economics of oil futures trading:

$100 Spot Price per barrel + $5 Carrying Cost Per Barrel = $105 Futures Price (1 year)

Now suppose that speculators anticipate rising future oil prices, due to increasing global demand in China and India, and tightening world oil supplies. As in my previous example, let's assume that the increased speculative futures trading raises the price of oil in the futures market to $110 per barrel for delivery in one year, which then also raises the spot price to $105.


Q: What's could be so beneficial about speculators trading in oil futures, especially if they are contributing to both increases in spot prices and increases in futures prices for oil?

As Bloomberg's Kevin Hassett
points out, "If speculators know that the price of something is going to go up a month (year) from now, they buy today. If they are correct, they make money, and the price change is smoothed by the higher demand today. By loading up on futures, speculators pulled some of the price increase forward to today. This change is beneficial for society, as it forces consumers to conserve sooner, and suppliers to search for new deposits."

For example, think about what would happen if futures speculators were able to increase the futures price of oil to $110, without affecting the spot price (stays at $100). Consumers would then NOT conserve oil, and suppliers would NOT search for new oil. If speculators were correct about the rising future price of oil in one year, and if consumers and producers did not change their behavior (because the spot price didn't change), then it's likely that the future price of oil would rise above $110, say to $115 per barrel. And that would be an increase in price volatility over time - oil prices would increase to $115 without speculation in one year, instead of $110 with speculation.

This article was written by

Mark J. Perry profile picture
940 Followers
Dr. Mark J. Perry is a full professor of economics at the Flint campus of The University of Michigan, where he has taught undergraduate and graduate courses in economics and finance since 1996. Starting in the fall of 2009, Perry has also held a joint appointment as a scholar at The American Enterprise Institute. Perry holds two graduate degrees in economics (M.A. and Ph.D.) from George Mason University and in addition, and has an MBA degree in finance from The University of Minnesota. In addition to an active scholarly research agenda, Perry enjoys writing op-eds for a general audience on current economic issues and his opinion pieces have appeared in most major newspapers around the country, including USA Today, Wall Street Journal, Washington Post, Investor’s Business Daily, The Hill, Washington Examiner, Dallas Morning News, Sacramento Bee, Saint Paul Pioneer Press, Miami Herald, Pittsburgh Tribune-Review, Detroit News, Detroit Free Press and many others. Mark Perry has been best known in recent years as the creator and editor of one of the nation’s most popular economics blogs, Carpe Diem. Professor Perry has written on a daily basis since the fall of 2006 to share his thoughts, opinions and expertise on economic issues, with a strong emphasis on displaying economic data in a visually appealing way using graphs, charts and tables.

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