A Profile of the Oil and Gas Industry: Resources, Market Forces, Geopolitics, and Technology by Herkenhoff Linda

Author:Herkenhoff, Linda
Language: eng
Format: epub
Publisher: Business Expert Press
Published: 2013-11-21T16:00:00+00:00

Exhibit 4.6. Correlations Between Daily Returns on Crude Oil Futures with Financial Investments

Note: Correlations computed quarterly.

Abbreviations: S&P, Standard & Poor’s; WTI, West Texas Intermediate.

Oil options are option contracts in which the underlying asset is a crude oil futures contract. The holder of a crude oil option possesses the right but not the obligation to assume a long position (in the case of a call option) or a short position (in the case of a put option) in the underlying crude oil futures at the strike price. The strike price is the price fixed by the seller of the oil option. This right ends when the option expires after market close on the stated expiration date.

OTC swap contracts are similar to futures contracts as the buyer can buy and sell oil contracts for some date in the future. The difference is that futures contracts are standardized and traded on a futures exchange, whereas OTC swaps can be completely customizable and are traded between two private parties. Usually, the players in the OTC oil market are large organizations rather than individuals. Future markets (FM) and OTC trading are pricing complements; FM sets general trends for pricing, whereas OTC works out relative prices for different quality crudes.

The market condition when the future price of a commodity (oil) is higher than its present price is referred to as contango. Under this scenario, it is more profitable for the commodities producer to hold the commodity and sell it at a later date. Contango is a contributor to oil price volatility; storage of a commodity causes supply to be reduced in the present, raising spot prices, whereas expectations regarding future supply increase, thereby reversing the cycle, which then causes contango all over again.

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