Who Is Buying Oil Futures?
Across the globe, the most widely traded physical commodity is crude oil. The standard-size sweet crude oil futures contract consistently has the highest volume of trading activity based on a physical commodity and is used to determined world prices. Oil futures contracts are primarily traded in exchanges located in New York and London. Products made from crude oil---such as gasoline, kerosene heating oil and high grade diesel fuel---are purchased and sold in nearly every corner of the globe.
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Facts
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Oil futures contracts are financial instruments that are legally binding transactions calling for the future delivery of oil at a certain price by a specific date. These contracts are traded on future exchanges electronically, by open outcry on trading floors or a combination of the two methods. Trading exchanges are regulated by government agencies such as the Commodity Futures Trading Commission, which is the regulatory body for future exchanges in the United States. Trading on the exchange floor is only permitted by members. Typically, members are licensed brokers who are paid fees to execute trade orders on the behalf of clients. These clients are usually classified as speculators or hedgers. Exchange members may also execute trades for their personal accounts.
Contract Features
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Crude oil futures are mainly traded on the New York Mercantile Exchange and the Intercontinental Exchange. The Energy Intelligence Group states there are 161 types of crude oil, including West Texas Intermediate (WTI) and Brent. They are known as sweet crude oil; their higher quality makes them popular for refining. The price of WTI is utilized as a standard for determining the price other types of crude oil. All contracts are standard, which means that one future contract consist of 1,000 barrels of oil, also called a lot. Each contract has a specific expiration date. When the contract expires, the purchaser of the contract will receive delivery of 1,000 barrels of oil on a certain date, in a predetermined location or a cash settlement.
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Long or Short
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Oil futures contracts can either be bought long or bought short. A speculator who purchases a short hedge of oil futures will profit from the contract if prices fall. Should oil futures price rise, the speculator will suffer a loss. If the same speculator anticipates that oil prices will rise in the future, he may go long or buy a long hedge of oil futures. If the prediction is correct and prices go up, the speculator will make a profit. If he is wrong, and the price of oil declines, the speculator will lose money.
Hedgers
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Hedgers buy oil futures to protect themselves against price volatility in the oil market. Business organizations---including airlines, refineries, utility companies and large trucking operations that depend on oil for daily operation---become hedgers in the oil market. By purchasing oil futures as part of their business strategy, these companies can minimize the effect unpredictable oil prices can have on their bottom line.
Hedgers will also buy an opposite position in the cash or spot market. The spot market is where oil (stocks and other goods) are sold for cash and are usually delivered immediately. Buying cash positions to mirror their oil futures transactions ensures they are safe from oil price volatility.
To implement the complete hedging strategy, a company that hedges long in the oil futures market will buy short on the spot market. If the company hedges short in the futures market, they will go long on the cash market.
Speculators
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Speculators purchase oil futures with the intentions of making a profit. Their primary concern is not whether prices go up or down, but that they make the right call regarding the direction that prices will move. If speculators successfully anticipate the direction of oil prices, they can earn large profits quickly. Conversely, if speculators are wrong in their prediction of oil price movement, they can just as easily lose a significant amount of money. Unlike hedgers, speculators do not participate in the spot market.
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