BC: FUTURES 101
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This is a very clear explanation of how futures markets function
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I will try to explain this once again. Supply and demand drive prices. The product that is traded on oil futures markets is oil futures contracts, i.e. pieces of paper. If the supply of paper was limited, and lots of money flowed into the market, then the price of the paper would go up.
This is what happens with stocks. The number of shares outstanding is limited. If you want to buy a share of stock, you need to outbid the other people who want to buy a share. This drives up the price.
This is not what happens on oil futures markets. The supply of contracts is not limited. Anyone can create a new one at any time. The people who talk about the "hot cash" flowing into oil futures invariably point to the huge increase in "open interest" as evidence of this. However, an increase in open interest represents an increase in the supply of futures contracts, not an increase in demand. One can reasonably infer an increase in demand from the increase in contracts, but one cannot reasonably infer any change in the balance between supply and demand. Remember: contracts are the product traded on futures markets. Therefore an increase in open interest represents an increase in the supply of what is traded.
Furthermore, every futures contract has one person betting prices are going up and one person betting prices are going down. That, coupled with the dynamic supply, means that money flows are neutral. Prices respond to other things, but they do not go up just because money is flowing in. What makes the idea even more absurd is that speculators are now net short. How can people shorting something drive the price up?
In short, the "hot cash" flowing into futures markets isn't "hot cash". It is liquidity (in the proper sense of the word). It makes it easier to buy a contract and easier to convert a contract into cash. It greases the wheels of the market and makes it more efficient. But guess what? The price of oil is going up. Liquidity isn't going to keep it down. Shooting all the speculators isn't going to keep it down.
I can understand how a peak oil denialist would look to blame the high prices on anything but supply problems. What I don't understand is why people who are peak oil aware can't accept the basic principles of Econ 101. Production has been flat for 2+ years. Net exports are down. Net energy is down even more. Demand over that time has increased. Reserve oil capacity is almost non-existent, and what there is, is mostly heavy and/or sour. What more evidence do people need that the driver behind oil prices is (at least in large part) a supply-demand imbalance? This is almost exactly like global warming denialism: the evidence is right out front, but people are still digging around in every bush looking for an explanation other than what is right in front of their face. |
