Hedging and OIL, How is it related?
- Thread starter ratwell71
- Start date
EASYTRADER
Expert Expediter
Speaking as a former Series 3 licensed broker (Futures and Commodities). Hedging and speculating has nothing to do with the cash price or spot price of any commodity.
Speculating only affects the prices on the Futures contracts but has no effect on cash prices.
In fact without speculators the price swings would be so wild, every other season would be boom and bust like it used to be before futures exchanges.
In reality the only entities on the planet big enough to speculate on the cash price of anything is governments. To affect the cash price of an unregulated commodity one would have to have the money and storage capacity to buy up all of the supply, or to restrict production through laws. An individual can buy or sell all the futures contracts he can handle and still not move the cash price.
In general when news people talk about the speculative premium in oil prices they dont have a clue what they are talking about, in fact most people have no idea how the futures markets act and are doing the public harm by pretending they do.
Oil prices are high right now, only in relation to recent historical low prices.
Light Sweet Crude inflation adjusted should trade for $120.00 a barrel or there abouts.
So in actuality crude is right where it ought to be or even a little to low- since that figure failed to account for the decline in value of the US Dollar.
The US dollar index is around .73 these days which translates to a %27 discount to par. If you were to dollar adjust crude oil it would trade around $80 a barrel, and still be way to cheap inflation adjusted.
Most of the increase in oil prices is due to a low US Dollar, crude compared to the EURO is up
a fraction of its price in dollars.
High fuel costs have little to due with the price of oil and much to due with US Gov. refining restrictions and cost to create the 27 different fuel blends required to comply with the different state laws.
Only about 20% of the oil we buy actually gets turned in fuel, the rest goes in plastics, fertilizer and too many other things to name. Chances are if its man made it has a touch of crude oil in it.
Even if crude oil comes down the price of Gas and diesel will probably stay up. Demand for fuels is up at the same time the Gov. is placing more restrictions on refineries, new refineries aren't being built because the companies can't get environmental clearance and even if they could they don't want to build because every day some wacko in the House/Senate gets on TV and says we need to move the country off of oil based transportation, this eliminates any incentive to invest.
Anyway those are facts, I dont care about fuel prices either way - they are what they are. However if you want prices to come down then DC and state Gov. need to be told to deregulate.
Speculating only affects the prices on the Futures contracts but has no effect on cash prices.
In fact without speculators the price swings would be so wild, every other season would be boom and bust like it used to be before futures exchanges.
In reality the only entities on the planet big enough to speculate on the cash price of anything is governments. To affect the cash price of an unregulated commodity one would have to have the money and storage capacity to buy up all of the supply, or to restrict production through laws. An individual can buy or sell all the futures contracts he can handle and still not move the cash price.
In general when news people talk about the speculative premium in oil prices they dont have a clue what they are talking about, in fact most people have no idea how the futures markets act and are doing the public harm by pretending they do.
Oil prices are high right now, only in relation to recent historical low prices.
Light Sweet Crude inflation adjusted should trade for $120.00 a barrel or there abouts.
So in actuality crude is right where it ought to be or even a little to low- since that figure failed to account for the decline in value of the US Dollar.
The US dollar index is around .73 these days which translates to a %27 discount to par. If you were to dollar adjust crude oil it would trade around $80 a barrel, and still be way to cheap inflation adjusted.
Most of the increase in oil prices is due to a low US Dollar, crude compared to the EURO is up
a fraction of its price in dollars.
High fuel costs have little to due with the price of oil and much to due with US Gov. refining restrictions and cost to create the 27 different fuel blends required to comply with the different state laws.
Only about 20% of the oil we buy actually gets turned in fuel, the rest goes in plastics, fertilizer and too many other things to name. Chances are if its man made it has a touch of crude oil in it.
Even if crude oil comes down the price of Gas and diesel will probably stay up. Demand for fuels is up at the same time the Gov. is placing more restrictions on refineries, new refineries aren't being built because the companies can't get environmental clearance and even if they could they don't want to build because every day some wacko in the House/Senate gets on TV and says we need to move the country off of oil based transportation, this eliminates any incentive to invest.
Anyway those are facts, I dont care about fuel prices either way - they are what they are. However if you want prices to come down then DC and state Gov. need to be told to deregulate.
EASYTRADER
Expert Expediter
OOPS... I didn't answer the question, sorry about that, Heres how Hedging and Oil relate.
I'll use Cocoa futures as an explanation because it is easier to understand because in the oil markets there are so many different players it is hard to follow. The principle involved is exactly the same.
In the Cocoa market you have two major players, Cocoa farmers, and chocolate makers like Hersheys.
Hershey's buys cocoa all year long for delivery to there processing plant. Because commodities have volatile prices and cocoa is one of the worst. In order to flatten their cocoa price Hersheys can go to the futures market and buy or sell cocoa futures based on there needs - This is called Hedging it is typically only done by large producers or consumers of commodities.
When Hersheys actually buys their cocoa for delivery they will pay the SPOT price which the price for cocoa delivered on the spot in exchange for cash. The spot prices goes up and down based on supply and demand. Hershey knows every month how many rail cars of cocoa they need to buy, but they can't buy it on the spot market all at once and store it in their garage. so what Hershey's can do is Purchase a futures contracts for a set delivery month. Then they buy the actual commodity as needed on the spot market.
When cocoa futures prices come down to a level that Hershey is willing to pay, to keep there operation profitable they buy contracts across the board in all there delivery months.
If cocoa prices go up from there, Hershey's will profit on there futures trade and use that profit to offset the price increase when they buy on the SPOT. Should prices decline, then they will lose money on there futures trade but save on there SPOT purchase and still come out with a flat price.
The purpose of the hedge is not so much to make money as it is to transfer price risk. A good hedging program is designed to keep a producers or a consumers price in a stable range.
Hersheys used to be the largest player in the cocoa market I think MM/Mars is now. At any one time hersheys could be long in one account and short in another all designed to keep their cost to produce flat.
SOuthWest airlines which is one of the few airlines that turns a profit every year hedges their fuel costs in the oil market. I believe CH Robinson Worldwide which is a trucking company hedges their fuel costs through the oil market also.
Now if the futures markets didn't have speculators in the game when Hersheys called there broker to buy or sell, there would be no one on the other side to trade with and the whole system would collapse.
As far as speculators driving prices up, in reality they cant, if Hersheys aint buying specs cant sell and vice versa. 95% of all futures contracts are closed before they delivery date, which means they are paper transactions only and the ones that deliver are on expensive small commodities like gold and silver.
Since you cant speculate cash prices unless you have a whole lot of cash and warehouse space the spec premium is basically non-sense.
High oil prices are driven by demand, The US is the worlds largest consumer of oil, Japan is 2nd and China is third. China has a population that is 5 times the size of the US, at this time only about 1 in 20 chinamen owns a car. Well as they buy more they will need more fuel, not to mention plastic and every thing else that comes from oil, prices will keep going up because the demand curve is there. This sais nothing about India which has 4 times the population of the US.
Both China and India are in the same state of Industrialization that the US was in during the 20's they are growing up fast and buying more food and fuel and products. Oil is up because of demand.
I'll use Cocoa futures as an explanation because it is easier to understand because in the oil markets there are so many different players it is hard to follow. The principle involved is exactly the same.
In the Cocoa market you have two major players, Cocoa farmers, and chocolate makers like Hersheys.
Hershey's buys cocoa all year long for delivery to there processing plant. Because commodities have volatile prices and cocoa is one of the worst. In order to flatten their cocoa price Hersheys can go to the futures market and buy or sell cocoa futures based on there needs - This is called Hedging it is typically only done by large producers or consumers of commodities.
When Hersheys actually buys their cocoa for delivery they will pay the SPOT price which the price for cocoa delivered on the spot in exchange for cash. The spot prices goes up and down based on supply and demand. Hershey knows every month how many rail cars of cocoa they need to buy, but they can't buy it on the spot market all at once and store it in their garage. so what Hershey's can do is Purchase a futures contracts for a set delivery month. Then they buy the actual commodity as needed on the spot market.
When cocoa futures prices come down to a level that Hershey is willing to pay, to keep there operation profitable they buy contracts across the board in all there delivery months.
If cocoa prices go up from there, Hershey's will profit on there futures trade and use that profit to offset the price increase when they buy on the SPOT. Should prices decline, then they will lose money on there futures trade but save on there SPOT purchase and still come out with a flat price.
The purpose of the hedge is not so much to make money as it is to transfer price risk. A good hedging program is designed to keep a producers or a consumers price in a stable range.
Hersheys used to be the largest player in the cocoa market I think MM/Mars is now. At any one time hersheys could be long in one account and short in another all designed to keep their cost to produce flat.
SOuthWest airlines which is one of the few airlines that turns a profit every year hedges their fuel costs in the oil market. I believe CH Robinson Worldwide which is a trucking company hedges their fuel costs through the oil market also.
Now if the futures markets didn't have speculators in the game when Hersheys called there broker to buy or sell, there would be no one on the other side to trade with and the whole system would collapse.
As far as speculators driving prices up, in reality they cant, if Hersheys aint buying specs cant sell and vice versa. 95% of all futures contracts are closed before they delivery date, which means they are paper transactions only and the ones that deliver are on expensive small commodities like gold and silver.
Since you cant speculate cash prices unless you have a whole lot of cash and warehouse space the spec premium is basically non-sense.
High oil prices are driven by demand, The US is the worlds largest consumer of oil, Japan is 2nd and China is third. China has a population that is 5 times the size of the US, at this time only about 1 in 20 chinamen owns a car. Well as they buy more they will need more fuel, not to mention plastic and every thing else that comes from oil, prices will keep going up because the demand curve is there. This sais nothing about India which has 4 times the population of the US.
Both China and India are in the same state of Industrialization that the US was in during the 20's they are growing up fast and buying more food and fuel and products. Oil is up because of demand.
greg334
Veteran Expediter
Don't forget that we also compete with the EU for Diesel because we do not refine all the oil we use. We are not the source of the 'food' crisis but the EU is.
AND also in comparison to China and India with us in the 20's, the difference is that our exports were three to one in the 20's when it came to food and oil products. This is important from the standpoint that we didn't have an interdependence on foreign imports as we do today where India and China are both dependent on external markets to supply them. If that makes any sense.
EASYTRADER
Expert Expediter
I see the India and China boom as a BOON for the US. If we freetrade with them and wedge ourselves into thier markets we will be providing them all the TECH goods which we manufacture better than anyone else. I think this is the dollar has been allowed to depreciate so much it makes US manufacturing more competitive than the EU. As long as the dollar stays low our REAL exports will go up.
EASYTRADER
Expert Expediter
Another thing most people fail to realize is that the US is currently the worlds 3rd largest producer of Crude oil. Our oil is Light Sweet Crude, not that sulphur loaded crap we import from hugo chavez- US and Canada Oil is the cleanest and easiest to refine. We also have plenty of it
, If we wanted to end terrorism we'd open up ANWAR, drill of CA,LA,TX,FL and Colorado, dump so much oil on the market that the ARABS go broke. We have the reserves to do it to, the crazy environmentalists wont let us drill our reserves. It ridiculous!!!
, If we wanted to end terrorism we'd open up ANWAR, drill of CA,LA,TX,FL and Colorado, dump so much oil on the market that the ARABS go broke. We have the reserves to do it to, the crazy environmentalists wont let us drill our reserves. It ridiculous!!!
Very good input, however, I will add my input tomorrow. Anyone else want to add something?
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To hedge or not to hedge, that is the question? Do governments, companies, and/or individuals help the oil crisis when they hedge? American Airlines has hedged oil to keep it from going under. During World War II sugar was hedged by many big companies when they saw sugar prices soaring. Alot of those same companies went out of business because of their hedging. It also helped drive the price up (supply and demand).
EasyTrader's post is most excellent in explaining that this is NOT an investment but an insurance against the risk of rising prices. Speculation plays a big part, supply/demand, interest rates, exchange rates, dollar values, natural disasters (Katrina, etc.), etc.
So how beneficial is the act of hedging to the consumer?
EasyTrader's post is most excellent in explaining that this is NOT an investment but an insurance against the risk of rising prices. Speculation plays a big part, supply/demand, interest rates, exchange rates, dollar values, natural disasters (Katrina, etc.), etc.
So how beneficial is the act of hedging to the consumer?