Oil futures, also known as futures contracts, are agreements to buy or sell oil at a certain price at a specific date in the future. Traders in oil futures make bids on the price of oil based on their expectations for future prices. To decide the price, they look at predicted supply and demand. Traders will raise the price of oil if they believe demand will rise as the global economy expands. Even when there is ample supply, this might result in high oil prices.
What can we learn from oil futures?
In theory, oil futures contracts are straightforward. They keep the time-honored practice of certain market participants selling risk to others who willingly buy it in the expectation of profiting. To put it another way, buyers and sellers agree on a price for oil (or soybeans, or gold) that will be traded at some point in the future, rather than today. While no one knows what price oil will trade at in nine months, futures market participants believe they can.
Do oil futures pricing aid in the forecasting of future oil prices?
The price of oil futures is frequently used as a proxy for the predicted price of oil in the future. Some people also believe that futures contracts, especially actively traded contracts, are stronger predictors than econometric forecasts based on historical data.
What are the five most important elements that influence oil prices?
Demand, like any other commodity, is a factor that influences price. The global crude oil demand is roughly 90 million barrels per day. Many countries provide inhabitants with fuel subsidies. This can be beneficial or detrimental. It’s much worse when a business is forced to sell at a loss.
Price is influenced by supply. By around one million barrels per day, supply is frequently kept slightly below demand.
How do oil futures work?
Oil futures are agreements to exchange a specific amount of oil at a specific price on a specific date. They’re traded on exchanges and reflect distinct forms of oil demand. Oil futures are a popular way to purchase and sell oil since they allow you to trade increasing and decreasing prices.
What impact do oil futures have on gas prices?
Over the previous decade, crude oil prices have influenced at least half of the price of each gallon of gasoline. Gas prices fluctuate on a daily basis, just as oil prices do. Refinery and distribution costs, business earnings, and state and federal taxes make up the balance of the gas price.
To trade oil futures, how much money do you need?
The amount of money you’ll need in your account to day trade a crude oil futures contract varies depending on your futures broker, but you’ll need at least $1,000. Keep in mind that you’ll need enough funds in your account to cover any possible losses. If you don’t want to risk more than 1% of your cash on every single trade, you can limit yourself to $10 per trade.
Do spot prices predict futures prices?
Futures market prices can occasionally be used as spot price estimates. They don’t in other circumstances. The federal funds futures market, for example, can be used to forecast interest rate adjustments by the Federal Open Market Committee (FOMC). When making a soybean production loan, a bank loan officer should not rely solely on soybean futures prices to estimate future spot prices. To make matters even more complicated, a company that wants to estimate oil prices six months from now can occasionally rely on the futures market for a realistic forecast, but it can sometimes fail to do so.
To accommodate for these various eventualities, commodities must be divided into three categories: non-storable, storable with significant inventory “overhangs,” and storable with modest stocks.
Non-storable Commodities
Non-storable commodity futures prices reflect merely market projections of future supply and demand situations. These are the only commodities for which futures prices may be used as easy forecasting tools. Non-storable commodities are perishables, or items that vary in quantity or quality frequently. Eggs, for example, are considered non-storable because they spoil quickly; a fresh egg is not the same as an egg that has been sitting in the refrigerator for a month.
Non-storable commodity futures prices might differ dramatically from spot prices due to anticipated changes in supply or demand. Assume the market anticipates a decrease in egg supply in three months. The price of three-month futures would rise above the current spot price. Because vendors cannot keep the eggs (take them out of the spot market) to sell later, spot pricing would be unaffected. They have to sell today’s eggs at today’s market prices. In contrast, if the market expects egg production to rise in the next three months, the futures price will fall below the unchanged spot price.
There is also a futures market for federal funds, as well as an interbank market for reserves (deposit balances held by banks at the Federal Reserve). Because a bank cannot store reserves today to meet future reserve requirements, these products are non-storable. Federal funds futures pricing can be used to infer market expectations for future interest rate changes by the FOMC. 2 Current federal funds market conditions have no bearing on future conditions, and vice versa.
Storable Commodities with Large Inventories
Futures prices simply represent the current spot price plus carrying costs for storable commodities with huge inventory overhangssay, several months’ worth of consumption. Carrying costs are the interest and storage fees that would be incurred if the commodity were retained in inventory between the current date and the maturity date of the futures contract. For example, the market price for soybeans on November 1, 2001 was $4.26 per bushel, but the January 2002 futures quote on November 1 was $4.34.3. The eight-cent difference represents the per-bushel carrying costs of soybeans for two months.
Why are carrying costs required to link spot and futures prices? If the soybean futures price was higher than the spot price by more than carrying costs, an arbitrageur could make a guaranteed profit by selling a soybean futures contract, borrowing money to buy soybeans in the spot market, and delivering the soybeans to the futures contract buyer on the settlement date. A risk-free profit would be guaranteed because the difference between the futures price received and the spot price paid would more than cover carrying costs. If the futures price went below the spot price plus carrying costs, market players would sell their inventories in the spot market and buy futures contracts, putting downward pressure on the spot price while simultaneously increasing upward pressure on the futures price. As a result, traders seeking risk-free profit opportunities would soon return spot and futures prices to the above-mentioned relationship: The spot price plus carrying expenses will be the futures price. Traders, in effect, distribute the vast existing inventory across time, based on the cost of carrying inventory.
Storable Commodities with Modest Inventories
For storable commodities with low current stockpiles compared to current consumption needs, interpreting futures pricing is a little more difficult. We must distinguish between two scenarios in these marketplaces. The non-storable commodities analysis is used when futures prices are lower than spot prices (a pricing structure known as backwardation). The futures price is the market’s prediction of the spot price in the future. The study of storable commodities with substantial stockpiles applies if futures prices are higher than spot prices (a contango market).
The oil futures market is an excellent example of a storable commodity with low inventory levels. If future oil supply is predicted to grow, futures prices will decline in relation to spot prices. Although arbitrageurs might potentially benefit by selling oil on the spot market when the spot price is greater than the futures price, inventory shortages prohibit this. The spot price for a barrel of crude oil on November 1, 2001 was $21.70; the November 2002 futures price was $21.27.4 An arbitrageur could clearly profit by selling spot oil in 2001 before the price drops, but inventory limitations prohibit this.
If, on the other hand, future supply is predicted to be limited, future spot prices are expected to be higher than present spot prices. Arbitrageurs might buy “cheap” spot oil with borrowed money, sell oil futures contracts, and store the oil for future delivery, so the futures price could not soar arbitrarily high above today’s spot price. The arbitrageur pushes the spot price higher and the futures price lower by taking advantage of projected high future prices and the storability of oil. This is the same issue we discussed earlier for commodities with substantial inventory overhangs. The gap between the futures and spot prices represents only the carrying costs in this scenario, not the market’s estimate of future spot prices. As a result, futures market pricing for storable commodities with relatively small inventory overhangs must be viewed with caution.
What factors influence gas prices?
- The price of crude oil is the major determinant of the price we pay at the pump, and it is determined by market forces of supply and demand, not by individual firms. Oil prices have risen to a seven-year high, owing to a continuing global supply shortage, labor shortages, growing geopolitical instability in Eastern Europe, the economic recovery following the pandemic’s early stages, and policy uncertainty in Washington.
- Choices in policy are important. As supply continues to lag, American producers are attempting to satisfy rising energy demand, but regulatory and legal uncertainty is exacerbating market issues.
- The administration needs to rethink its energy policies, and Europe serves as a warning example.
- We only need to look at the situation in Europe to realize what occurs when countries rely on energy production from foreign sources with their own objectives. More could be done by legislators to assure inexpensive and reliable energy, beginning with promoting American production and energy infrastructure and conveying a clear message that America is open to energy investment.
- Changes in gasoline prices are based on market fundamentals, not illegal behavior, according to repeated FTC investigations, and the American people are searching for solutions, not finger pointing. The present price at the pump in the United States is a result of increased demand and trailing supply, as well as geopolitical upheaval caused by Russia’s intervention in Ukraine.
- Instead of political grandstanding that discourages investment at a time when it is most needed, lawmakers should focus on policies that enhance US supply to help mitigate the situation.
What impact do futures have on gas prices?
Take note of the rows of foreclosed properties you’ll see along the route the next time you travel to the gas station and discover prices are still sky high compared to just a few years ago. High gas costs and home foreclosures may appear to be two sections of the same economic bad luck spell, but they are actually extremely closely linked. Investment managers abandoned failing mortgage-backed securities and looked for new attractive assets before most people even realized there was an economic crisis. They decided to invest in oil futures.
An oil future is basically a contract between a buyer and a seller in which the buyer agrees to buy a specific amount of a commodity (in this case, oil) at a predetermined price. Futures allow a buyer to wager on whether the price of a commodity will rise in the future. Even if the market price was higher when the barrel was actually delivered, a futures buyer would receive a barrel of oil for the price stipulated in the future contract.
What causes the price of oil to rise?
The principle of supply and demand is rather simple. As demand grows (and supply shrinks), the price should rise. As demand falls (and supply rises), the price should fall.