Futures Market Growing More Important in Oil Pricing

By John C. Given, Ap | THE JOURNAL RECORD, June 14, 1986 | Go to article overview

Futures Market Growing More Important in Oil Pricing


John C. Given, Ap, THE JOURNAL RECORD


NEW YORK - The frenzied din of the New York Mercantile Exchange has the atmosphere of a big time prize fight, but it is the world pri ce of oil at stake and not a boxing title.

Shouting, screaming, waving their arms, traders jostle one another in three circular pits to buy and sell contracts for crude oil, gasoline and heating oil.

In the three years since crude oil trading began at the exchange - and especially since prices began to collapse in late November - the three rings have emerged as a major focal point of the world oil trade.

The New York Mercantile is just one of several futures exchanges sharing a trading floor the size of a sports arena. Trading in gold, silver, cotton, coffee, cocoa and sugar goes on around the roomat the same time.

At the crude oil pit, traders deal in contracts calling for the future delivery of 1,000 42-gallon barrels of West Texas Intermediate, the major U.S. grade.

After each sale, sellers jot down the price, the contract month and the buyer's name, then flip the note into the center of the pit. Exchange employees, sometimes wearing goggles to protect their eyes from flying paper, pick them up for recording on a big electronic board high up on the wall.

Prices can change many times a minute. Each time, the price flashes simultaneously on other boards and video screens around the world.

In recent weeks, daily transactions have averaged about 32 million barrels of crude - or the equivalent of about three-fourths of the estimated 44.1 million barrels the non-Communist world is consuming each day.

An additional 18 million barrels of refined products have been trading every day.

Each crude contract usually calls for delivery up to 18 months later at any pipeline or storage facility in Cushing, Okla.

But in fact, less than 1 percent actually results in the physical transfer of ""wet barrels,'' since the industry still relies mainly on the cash market for such transactions.

The New York Mercantile is used mainly for dealing in ""paper barrels'' - both to hedge against price declines and for speculation.

""About 50 percent of all trading here is done by the industry - international major oil companies, trading companies, independent refiners, producers, users and municipalities,'' said Rosemary McFadden, the exchange's 37-year-old president. The balance is accounted for by speculators.

For contacts carried from one day to the next - the ""open interest'' - 70 percent are held by the industry, hedging product or their anticipated needs, she said.

Perhaps the most widely celebrated example of successful hedging was conducted by T. Boone Pickens Jr., chairman of Mesa Petroleum Co.

Believing oil prices were in for a plunge, Pickens sold contracts in November to deliver at a future date about 3 million barrels of crude at the then-prevailing price of $26.50 a barrel. That was the equivalent of almost all of Mesa's projected crude production for 1986.

The market collapsed. Several months later, Pickens bought contracts to buy 3 million barrels at an average $16.50 a barrel.

By offsetting the promise to deliver oil for $26.50 a barrel with the contract to buy the same amount for $16.50, Pickens realized a net gain of $10 a barrel, or a total of $30 million profit for Mesa.

Of course, had oil prices risen instead of declined - and stayed higher when his promise to deliver came due, Pickens would have lost money.

But in the event of such a rise, he could have cut his loss by buying a contract for immediate delivery sometime between the date he first sold the contract to sell the oil and the date the initialcontract came due.

In any case, the device enables a company to reduce the risks of wild swings in the market, much as the agriculture industry has for years.

For the oil industry, however, the idea of petroleum as a commodity - like hog bellies, gold, soybeans, wheat or corn - is something new. …

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