Explain oil speculation and futures, and how it effects ACTUAL prices at the pump.?

Question

Same with corn wheat, hops, soybean futures.

Answer 1

it doesn't.

Answer 2

Gasoline retailers buy gasoline by entering into contracts called gasoline futures, which are agreements to buy certain amounts of gasoline in the future for a set price.

Speculation happens when people are buying securities for no sound reason. When enough speculators buy gasoline futures, their prices go up and the speculators profit. Now, the gasoline retailers are forced to buy the futures at a higher price, leading to a higher price at the pump.

Answer 3

All the noise about speculators forcing the price of gas up is bunk.  For every speculator putting buying pressure on oil, there is another who thinks the price is too high and is selling short.  Bottom line: the speculators are canceling each other out.  This has been investigated by the regulators.  Link to report is below.

Answer 4

oil speculation, supply, and demand all cause (crude) oil spot prices to rise.  Gas you buy at the pump, heating oil, etc is all refined from that crude oil.  Thus, it does affect the price.  But there is more that effects the price than just the price of crude... now that we have a finished refined product such as heating oil, it too has supply and demand affecting the price, as well as the cost of refining the crude oil.

Answer 5

Most, but not all, oil is still traded on the spot market and by contract.  The futures prices set a benchmark for those two prices.  Speculators buy and sell futures contracts, but dont take delivery of the physical oil, based on what they think prices are going to be in the future.  This creates a liquid market for trading.  So prices at the pump are based on the price of the next shipment of gasoline, not what they already have.  As futures prices increase, demand is going to decrease.  And eventually create a surplus of oil, relative to demand.

Answer 6

You have actually asked a very difficult question that in many ways deserves one or two semesters at the doctoral level to answer.

I am greatly simplifying the issue to give you an answer.

The price of any good sold should be based not on what was paid for it, but what it costs to replace.  A gallon of gas at the pump should be priced based on the price to replace that gallon, not the price the gas station owner paid.  If an owner paid $3.90 per gallon yesterday for today's gas, but the replacement cost is 3.95, then you should pay $4.00 at the pump.  If the owner paid 3.95 but the price fell dramatically to say $3.80, then you should pay 3.85.  This is not the "market price," but rather the dealer's price.

The dealer prices their oil off the market price and other variable costs such as transportation costs.  This price changes minute by minute.  Futures prices do not affect gas station prices in a direct manner.  Indirectly they matter.  Futures and their cousins, forward contracts, are the price to buy gasoline tomorrow at today's price, or next week, or next month, or two years from now.  If they move substantially from the spot price then people stop delivering to the spot market, or dump on the spot market, until the two prices start moving closer together.

Speculators in any commodities market are in an incredibly dangerous position.  Insider trading is not only legal, it is expected.  If you are a speculator and you believe oil will hit 160 in two months and buy a contract for that amount, your counter party might be Exxon.  Exxon knows how much supply will really hit the market in two months and knows what the real price is likely to be.  If enough people make that speculation Exxon can buy tons of those contracts and then dump oil onto the market in two months making those contracts not only worthless, but collect extra fees from those contracts.  So you may be required to pay 160 a barrel, but Exxon could drive the price down to 140, buy the oil from other parties and pocket the 20 and then dry up the supply.

In practice this means that speculation has a very limited effect on real prices because the parties that control supply can usually guarantee a speculators destruction.  Indirectly speculators drive down the price of goods by supplying liquidity.  They remove the risk to society in general by taking it on by using their cash much like a bank takes credit risks.  This lowers the price and grants the speculators a profit, but not a very large profit on average over time.  The price is lower because speculators place their money at risk to keep the market liquid.  Illiquid markets make transactions riskier and these risks must be priced in or oil will not be drilled for.  So, on average, speculators hold prices down by substituting their cash for a chance at profits.  Producers hold prices down by being able to destroy speculators.  Consumers hold prices down by choosing to drive or not drive.  Any defect in the process drives up prices.  The defect in the process for Americans has been US energy and regulatory policy in the banking sector.  If you want to understand oil prices, look at a failed administration.