Tuesday, June 17, 2008

How Exploration Can Affect Oil Prices Now

I stumbled across this article at National Review today, and it is very informative. I suggest that you read it and learn a little more about the oil futures markets. This portion of the article is particularly significant.

With that in mind, anything Congress did today that indicated a change in philosophy concerning U.S. oil production would send shockwaves throughout commodities exchanges across the globe.

Just how much of an impact could such a change in policy have? Well, one of the factors involved in prices being determined on futures exchanges is the current disincentive for oil producers to sell their product today rather than months from now, a condition called “contango.”

As of Friday, the New York Mercantile Exchange price for July delivery was $134.86. By comparison, the November contract closed at $136.04, giving producers $1.16 more to hold their product an additional four months.

Commodities experts for years have claimed this contango acts to restrain the immediately available supply as oil companies opt to sell their product more expensively in the future rather than at today’s prices.

The point being an announcement today of vastly increased exploration will remove the financial incentive for oil companies to hold supply for later higher prices. This is actually the piece of the puzzle that has been missing in my mind. Demand has not risen so significantly this year as to justify the run up in price, so there is a supply component involved here. With Saudi Arabia and Iran even saying that there is enough oil out there for oil to be under $100 a barrel, opening up domestic exploration would go a long way to break the speculation bubble and remove any incentives to sell oil "more expensively in the future."

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