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Showing content with the highest reputation on 04/22/2006 in all areas

  1. 1 point
    In the case that some people are not aware of the way oil is bought and sold, markets determine the cost of sweet crude oil. Here's a lesson in finance: Oil is bought and sold on the NY merchantile exchange. There are professional purchasers that work for... say Exxonmobil or even a company like United Airlines. They take the spot rate (the rate oil costs right exactly now) if they want to buy today. There is another market, however, called the futures market. This market sells claims on future oil. The stuff that is still in the ground that will be on the market soon. Oil 90 days from now. I can say, "well I work for Southwest Air and I want to make sure that I buy oil that I am reasonably sure will cost more tomorrow then it does today". So I pay a premium on this oil. But I am sure that it's still less then what oil itself will cost on the spot market in 90 days. This is called an option for a futures contract. Then I do something called hedging and make another investment in another commodity or security that will offset the extra cost of the oil I bought. The idea is that I can cut my present value (today's true price) cost of oil versus buying it in the spot market as I need it. The reason this all works is because there is risk in buying something in the future, and people are willing to compensate others for bearing risk (see interest rates). The net result of all of this is that there is simply a given supply and demand for oil. If people (corporations and banks, really) see that the cost of oil is going to go up in the future, they will buy more of it today. This of course raises the cost. At the present moment, oil is at a record of $75 a barrel. People drive more in the summer, but heat their houses less (with heating oil), but the net of that is still higher demand in the summer season. What I think is really going on here is uncertainty over the Iran situation (they are the 3rd or 4th largest oil producer) and high demand from emerging markets (China/India). Oil companies have seen record profits, but that is only becuase of record demand. They may not be the price gougers as much as people still really demand it.