Connie Sellecca, the Price of Oil in 2018, and How Obama Reminds Me of Lenin

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Back in the mid-1980's there was a program on NBC called "TV's Bloopers and Practical Jokes". The most memorable episode to me was when they had a semi truck full of pigs show up in front of actress Connie Sellecca's house. The driver and a friend of hers tried to explain that her broker had allowed her investment in pork belly futures to expire without being sold, so she would have to take delivery of 60 pigs right then and there at her big house. It was pretty funny, and I suppose it may even be theoretically possible.

In the world of finance, commodity futures are an interesting instrument. You buy a contract to take delivery of a commodity at some particular "expiration date" in the future at a particular price. As the value of the underlying commodity changes, the value of the contract changes too. You can sell that contract at any time before the expiration date, and hopefully make money on your brilliant insight.

Typically, you need a fairly large chunk of money to play directly in the futures market. But with the introduction of Exchange Traded Funds (ETF), regular folks can invest too. ETF's trade just like stocks. The commodity-based ones usually invest in a set of futures contracts over a period of time, or in futures contracts that expire in the next month.

I have always known that futures contracts exist for most commodities out several years into the future, but recently I was surprised to find out exactly how far they go. As of Friday, the price of June 2018 oil is trading at $96.01 per barrel. This seems low to me, but then again a lot can happen in eight years. The price could be $500 per barrel or $30 per barrel by then.

Here is a chart of Friday's closing crude oil futures prices through December 2011 from WSJ.com.

Click for larger version

As you can see, the prices for future delivery are higher than the price next month.  This situation is called "contango", and is fairly unusual if you stop to think that it costs money to store any commodity.   Often, the price of a commodity for future delivery tends to be less than the near-term price -- a situation called backwardization.

Right now, pretty much every tank that can hold oil is full of oil.  Even old tanker ships that do not go into the open seas anymore are sitting off the coast being used as storage tanks.  So the fact that oil is still in contango means there is significant nervousness about oil supply.  Part of the reason we have such a stockpile is because of people like me who are invested in oil ETFs and futures. If a war were to break out in the Mideast, the large stockpile of oil in the US would be a very good thing.  Thus, speculation serves to ensure adequate future supplies.

The International Petroleum Exchange in London 

If you look at history, communists and socialists always rail against "speculators".  They consider them criminals, particularly if they make high profits in bad times.  I am reminded of this every time I hear about "price gouging" during disasters.  Shouldn't a prudent person, who rents a warehouse and stockpiles food and water, be able to make good money when the disaster he was planning for actually occurs?  If there are laws forbidding "price gouging", then there is no incentive to prepare for the worst, or to truck in supplies, or really to help in any way.

For example, a couple of years ago there was a gasoline shortage on the east coast, because of a pipeline problem if I remember correctly.  Because of price gouging laws, there was no incentive to truck in additional gasoline at a higher cost, so gas pumps ran dry.  If people could price gouge, trucks would have been rented and diverted, and gas from other areas of the country brought in.  Instead, Congress talked about how they needed to control oil companies more, telling them where to build pipelines and refineries, and how to ensure a more reliable system. The government now sees a need to be in charge of gasoline distribution because "the free market failed".

I am also reminded of all the old communist decrees against "speculators" every time Obama speaks about how "Wall Street speculators" and "oil speculators" need to be controlled.  (Already the government has shut down several leveraged oil ETFs because "they contributed to excessive speculation".)

Obama sounds exactly like Lenin did in the early 1900's.

Without speculators, markets do not work at all.  Maybe that is what Mr. 0 wants.

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