Saturday, August 27

Why No longer Term Bets in the Oil Market?

Tyler Cowen wonders why futures markets, such as the NYMEX, don't sell longer term bets, and offers up a few possible reasons why.

My take is that these markets develop and grow out of the needs of the hedgers, who look to lay off the risk of future price changes, and focus their efforts on profiting from efficient development, marketing, and production, etc., where they can play a strong hand.

For a market in longer term contracts,like 10 years out, it may not be enough that speculators want them. Speculators can come and go as they please, and their activity alone would probably not provide enough consistent liquidity to sustain the operation.

But firms whose existence requires them to be consistent buyers or sellers of a commodity, like refining and exploration companies are with oil, may have business needs which only require them to lay off price risk a few years out and not beyond.

Without the hedgers participation in the longer term contracts, there is little hope of enough liquidity to justify the contracts existence.

But over-the-counter contracts can be created by the larger brokerage houses, who will take the other side of any bet you care to make--for the right price. If enough of the same kind of OTC bet keeps getting requested, then someone there will eventually get the idea to standardize and list it.

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