There is no duality, spot on one side and futures on the other, since the latter is where price formation for benchmark crudes takes place. You are correct to say that other grades of crude reference (+/-) to these marker crudes but it is incorrect to think prices for marker grades are set through the physical trade.

Heck, even prior to the modern oil price regime, S/D type models didn’t really apply too well; different forms of managed pricing have been used for over a century but post-1987 and particularly post-2000, price management became a function of the trade in paper barrels, a trade that is largely determinant of spot.

As Oxford Energy’s Robert Mabro put it in a 2005 paper:

A tidy mind will find it odd that the reference price for a physical commodity should be borrowed from a market where people buy or sell a contract that carries its name but which is only partly related to it.

It seems to me that in terms of productivity, the investment in oil futures by “non-commercials” does serve the very valuable social function of making it much more economically attractive to invest in the production of said commodity.

@ Cash Mundy, I generally think the Bush Administration has had a policy of putting support under the price of oil, though not for geopolitical ends as much as

a) high price of oil makes investment in agricultural endeavors more profitable. Many red states are basically ag states.

b) high price of oil brings a lot of idled drilling on-line in … most of the rest of the red states.

c) high price of oil encourages investment in alternative energy, which is in the interests of the United States.

You will note that Iran at times appeared to be hoarding in expectation of a higher price, specifically heavy crudes in tankers in the Persian Gulf. But Iran imports about 75% of their food requirement, and, so I suspect that this might have been done in order to try and indicate the costs of an attack to the Administration in DC, but ultimately proves self-defeating in Tehran.

The reinvigoration of Russia is frequently linked to oil income. Venezuela and Iran cannot be considered without reference to oil.

I indulged in some wild speculation regarding oil price and a possible attack on Iran.

Oil price manipulation, if reliably effective, would be a very valuable policy tool. I am not asserting that such manipulation is possible, or that it could be wielded politically, just that it probably would be if convenient.

Apologies for not providing links or further background. There was a period when we were on the oil beat almost daily, and some of the issues you mentioned were discussed at considerable length.

On price formation, see “Futures Prices Determine Physical Oil Prices.”

On speculation, we have complained that the term covers too many types of activity. As the Eskimos allegedly have lots of words for “snow”, we need more precise categories here.

The reason for using the term so broadly here is that there was a pretty strong consensus pre-July that the price runup was NOT due to speculation, no matter how narrowly or broadly one defined it, but supply and demand. We discussed quite a few phenomena that said the picture was far from simple: the fact that there was high demand for the sweetest grades of crude, which are also heavily represented in the benchmark contracts, distorting the perception of conditions in the entire marketplace; the undue reliance on inventories, when storage is costly and not efficacious and oil can also be stored in the ground; the fact that oil producers look at oil inventories as a short-term investment, just like financial instruments, and consider the near-term profit potential in deciding what level of inventories to carry.

You have the separate issue that commodities, strictly speaking, really are not an “investment” as in they do not support productive enterprise, but are really a store of value. Indeed, Miichael Frankfurter, a commodities industry analyst, has written papers that discuss how managed commodity futures are not an asset class

Cash market contracts for crude are either cargo or long term (usually one year) contracts.

Cargo contracts are priced at a differential to a marker price, meaning the spot price on the futures market of some futures contract, depending on the difference in quality of the crude in question, commercial concerns, etc.

One year contracts are priced at a differential to a marker price, meaning the spot price on the futures market of some futures contract, depending on the difference in quality of the crude in question, commercial concerns, etc., usually on a monthly average …

Futures spot prices are the marker prices that the cash market prices their contracts at a differential to.

Beyond that, I just don’t understand what is meant by “speculator” here … everyone in the market is a speculator … they are all speculating on the future.

There is no a priori way to know whether a “commercial” trader is making a trade based on the calculus of an increase in market value beyond his physical holdings anyway. The restatement of the CFTC was precisely that, a commercial trader was reclassified as a non-commercial.

Does good vs bad speculation just mean we don’t like the consequences of speculation in this particular example, but feel all warm and fuzzy about it in another?

http://www.reuters.com/article/ousiv/idUSN0419852620080904