Who Issues Oil Futures Contracts?
Oil is a commodity like any other commodity. Oil futures contracts are like any other commodities futures contract. You can enter into futures contracts on corn, orange juice, soybeans, corn, cattle, etc. Anything that is a commodity may be bought or sold under futures contracts with a supplier for an agreed-upon amount of the commodity at an agreed-upon price on an agreed-upon date. The contracts that bind the buyer(s) and seller(s) are a little more convoluted than standard contracts because the buying and selling takes place through an intermediary, the New York Mercantile Exchange, but it is the brokers or brokerage houses that issue the contracts to buy and sell. Because of their role as agents of the buyers and sellers, respectively, they assume responsibility for meeting the terms of the contract if the buyer or seller are unable to do so. It's more risky than stock trading, which is based primarily on commissions.
How It Works
Commodities futures are all based on speculation. Imagine you are a buyer in the commodities market and you want to buy pork bellies. You think the demand (price) will be $1 a belly next September, so you want to buy as many pork bellies as you can now for less than $1 so that when it comes time to sell the pork bellies on the market you can sell them for a profit. So if you bought pork bellies at 70 cents and sold them later at $1, you've just made a 30 percent profit. Conversely, if there is a glut of pork bellies and the price falls to 50 cents, you've just lost almost 30 percent of your investment. That is the simple version. Speculation can get much more complicated, especially when brokering oil futures.
Which Are the Most Important Commodities?
Oil is the most heavily scrutinized commodity, along with gold, because of its economic importance. Oil is especially important because it drives the engine that runs the world's economy and it is vulnerable to dicey politics filled with land mines, making it a sometimes volatile commodity to invest in. It's volatile because the vast amount of oil that is produced is in the hands of a cartel of Middle Eastern countries that operate as an oligarchy, OPEC (the Organization of Petroleum Exporting Countries). OPEC member nations, composed of 12 Middle Eastern, African and South American countries, have the ability to manipulate the market outside of what the free market might otherwise dictate by the laws of supply and demand.
Brokers
When you want to invest in the futures market, unless you're doing it online, you need a broker. Even online, there are people behind the scenes executing the orders you place. They too are brokers of an electronic age. Brokers are the middlemen between the producers and buyers of commodities. Brokers put the buyers and sellers together in a complex web of traded commodities, in the futures business, on the NYME. Whether it's on the Internet or through a brokerage house, the buyer and seller must enter into a contract to buy or sell at an agreed-upon price at an agreed-upon time. The contract is issued by either the Internet company or the brokerage company. The contract specifies that the buyer or seller meet the terms of the agreement---basically to sell what is owed or to buy what is owed, as would be specified in most any agreement. However, if the buyer or seller cannot meet those obligations, the liability falls to the brokers. Needless to say, brokers do thorough background checks and require money in the bank before they agree to represent a buyer or seller. If buyers have a solid verifiable background, they can purchase futures on "margin," or credit. Unlike their brethren in futures trading, stock brokers win regardless of whether the producer or buyer wins or loses because, in most cases, brokers charge a fee that they collect no matter whether you make or lose money. Of course brokers in both futures and stocks want to earn a reputation for making money for investors to attract more money and thus more transactions. The more transactions they make, the more money they make. In the futures market, that is only partly true, depending on the fortunes of the buyer or seller. The broker himself may become liable for losses that cannot be covered by the buyer in the futures commodities market. That makes speculation on commodities futures much more volatile than trading in the stock market. That is the simple part. The difficult part comes with the complexity of oil futures. Because they aren't strictly guided by the forces of supply and demand, a good broker must have his finger on the pulse of international events to anticipate when and at what prices to invest. You wouldn't likely return repeatedly to a broker who consistently lost you money.
Knowledge Equals Money
Some contend that knowledge is power, but in the futures market, as a broker or investor, knowledge is money. If, for example, you knew that Iraq was going to invade Kuwait (member of OPEC), thus reducing the amount of oil production from that country, a smart broker might advise his clients to buy at a higher futures price than otherwise anticipated because with the loss of oil production the price of oil is likely to rise. However, since OPEC isn't, in the short term, anyway, guided by supply and demand, the other member countries could increase production to offset the loss of Kuwaiti oil and thus keep the price level. This is how world events affect the prices of commodities, which in no small part is influenced by politics and futures brokering itself.
Win-win?
While stock brokers sit in the winner's seat no matter the fortunes of their clients, they won't remain there long unless success comes to both their clients and themselves. In commodities futures, knowledge of the markets and how they will respond is much more crucial. With the United States on a mission to minimize its reliance on oil in an attempt to move toward "sustainable" and "renewable" sources of energy, demand for oil worldwide will likely decrease. OPEC could repeat its actions of the 1970s when President Jimmy Carter declared a war on energy. OPEC slashed their prices and the war was over before it began. Demand for oil continued. But consider countries like China and the Soviet Union, who have made no similar commitment to reducing oil consumption. As they are quickly emerging as significant players on the world market, countries such as those could easily pick up the slack in demand lost in the United States. And this is why it is important to do a lot of research on the integrity and knowledge of the broker and brokerage firm in whom you are entrusting your futures investment.
