...I worked in Petroleum and the people I worked with (DOD) had yearly contracts, quite complicated but they only bought at the spot price when something unforeseen happend. Of course they have huge inventories. Lets see this wasn't the crude side this was the JP4, JP5 type stuff. I assumed the crude side was the same way, the refineries enter into contracts and go to the spot to buy or sell when something goes wrong...
Sure. Actually, I think long term oil supply contracts that were entered years ago by refiners is what's keeping retail gas prices down around $4 instead of the $5-6 we'd expect if the refiners were paying spot prices. Similarly, some airlines have recently benefited greatly compared to their competition from long term hedging of their fuel costs.
However, long term contracts and hedges eventually run out. When they do, the new contracts will have to be closer to the prevailing spot price. That's why the refiners can hold out for only so long keeping retail gas prices low. Same for airlines, which face enormous fuel cost increases as their hedges expire.
I guess there's the possibility that most oil is currently being delivered under low priced long term contracts. If demand increases suddenly, that might spike the spot price up since most of the oil would already be spoken for. But I can't think of a way for spot prices to spike up so hard if there's plenty of supply or if demand goes lower.
Originally Posted by
Roody
...Investors are scared of future shortages of oil due to supply disruptions, so they're willing to pay more for current supplies. Add to this a measure of speculative investment--that is, betting that prices will continue to rise, ensuring big future earnings.
Yes, the price of long dated oil futures factors in people's expectations about the supply and demand situation in, say, March 2011. However, as the March 2011 settlement date approaches, the contract price will start converging with the spot price. At expiration the final value of the contract should be very close to spot, which reflects actual supply and demand.
Normally, the present value of a long dated future contract is lower than spot. That's because if you bought now and stored the oil for a few years, the storage costs would be considerable and you would forgo interest on the money you've invested in storing the oil. This normal situation is referred to as backwardation. However - if people expect diminished future supplies or increased future demand, the price of long dated oil contracts will go up. That situation is called contango.
You can speculate about backwardation vs. contango in long dated futures, and this is the exact type of speculation you describe. However, it doesn't directly drive the current real price of actual oil. The investors who guess right about the supply/demand situation in March 2011 take money from those who guess wrong, and in the end in March 2011 the oil will change hands at the spot price.
Originally Posted by
Roody
Is there any way that pure supply & demand can account for a 25 % jump in prices in barely two weeks, as we have just seen? I think s & d would usually trigger a slower rate of increases over a longer time frame?
(Obviously, you and others here know more than I do about economics, so I'm eagerly awaiting your thoughts on it.)
I don't know. A market can get wild when inflexible demand bumps up against a hard limit on supply. It's Musical Chairs in real life. If people are willing to pay any price for gas but supply dictates that there's only supply for 99% of the buyers, something has to give. What's happening may be that gas prices have to go up really, really high to bring the demand down enough to fit the supply.
All this is just my amateur opinion. I have a busted prediction somewhere in the archives here about oil never reaching $100 a barrel because economic recession would reduce the demand. So you can factor that into your evaluation.
Economics isn't our focus on LCF and that is as it should be. On the other hand the discussions about bicycling on the economics and oil forums is equally rudimentary. So in writing this post, I have to ask forbearance from those who don't want to talk about fuel issues here. If you keep your ears open, though, you know it's Topic A around town and it's the lead story on the national news now.