Friday, April 21, 2006

Oil

According to this article, oil futures hit $75 per barrel today. This is based on futures which are a time-dated contract that two parties enter into that requires the buyer to take delivery (although often settled in cash) of the underlying commodity and the seller is required to provide the underlying commodity at some future date. Futures contracts often tend to be "derivatives" of the underlying commodity as the buyers don't actually want to possess the commodity rather they're betting on what it will be worth at some time in the future.

If the price of oil at the time the contract expires is lower than $75, the people who purchased the contract lose money because they have to pay $75 for a barrel of oil that costs less than that at that point in time. On the other hand, if people are buying futures contracts for oil at $75 a barrel today, they must believe it will be much, much higher by the time the contract expires.

Here's the take-home message...first, note that the futures contract reference in the article is short-dated which means the expiration of the contract is May. Secondly, the people that participate in the futures market mostly do it for a living and they tend to know what they're doing. This inclines me to believe that in another month or two oil is going to be very expensive.