Oil and the Stock Market - I don't get it...

[SirKeats]

I'm confused as to how the stock market can dictate the price of a barrel of oil.

The oil itself is owned by someone else... like Canada, Mexico, and the Middle East. How is it that speculators can buy and trade (whatever it is that they're buying and selling) the cost of a barrel on the American market.

Aren't the owners of the oil (Canada, Mexico, Middle East) able to set their own price regardless of what it's traded at on the stock market?

I've always been way confused about how this whole thing works. Would love someone in the know to spell it out for me in VERY simple terms. LOL.

Thanks!

[Duffman]

You can only sell for what others are willing to pay, hence the market dictates the price. Also oil is not traded as a stock but as a commodity on the futures market. What that is is people buying future production but paying for it today, hence speculating on the future price of oil.

[SirKeats]

so a barrel trading for 150 bucks (or whatever) on the stock market doesn't mean that the suppliers HAVE to sell it for 150 bucks, but it indicates to them that this is what they can get for a barrel so they adjust their prices accordingly?

[ttoyoda]

Here:
http://futures-investing.suite101.co...trading_basics
better than I could explain it.

[ebacherville]

yeah it always looks like leaglized gambling to me .. basically that what it is .. betting on the future price of something to turn a profit... not that thats bad.

Just like betting on the future outcome of a race horse.. for a profit..

[ttoyoda]

Yes, a game of chance that you can fool yourself into thinking you can control because you are "smarter" than more than half of the other people doing it. And you have a 50% chance of being right. Thats a lot better odds than on a race horse.

[Duffman]

Originally Posted by SirKeats

so a barrel trading for 150 bucks (or whatever) on the stock market doesn't mean that the suppliers HAVE to sell it for 150 bucks, but it indicates to them that this is what they can get for a barrel so they adjust their prices accordingly?

Ttoyoda’s link provides a good little summary.
If I sell you a contract to deliver X barrels of oil on future day Y for $150/barrel. Whether the market price on day Y is $150 or not both sides must execute the contract for $150/barrel as it is a legal contract, both you and I have speculated what oil will be worth on that future day. This need not be a bad thing. In the case of a farmer selling his future on his crop, it allows him to put some money in his pocket to cover his farming expenses instead of taking out a loan so he is a beneficiary of the system. An example of a buyer might be a cereal company like Kellogs that knows they will need a continuous stream of materials to make their product and this guarantees them that the product will be delivered on day Y and allows them to lock into a price they can live with so they are a beneficiary of the system as well. What happens if the farmer has a crop failure and the farmer can not deliver? He must then find someone who will sell him a future contract or find some crop that is not in the commodity system to pick up to cover his contract. This is what causes the day to day commodity prices to move and why you see a shock to the price of oil when a pipeline goes down. People are scrambling to cover their futures which they are obligated to deliver.

[ttoyoda]

Duffman,
Do you know what controls the amount of time that elapses before the contract must be fulfilled? Is there a standard amount of time, or the buyer/seller choose a time?

[tjts1]

Originally Posted by ebacherville

yeah it always looks like leaglized gambling to me .. basically that what it is .. betting on the future price of something to turn a profit... not that thats bad.

Just like betting on the future outcome of a race horse.. for a profit..

If you think of it as gambling, you shouldn't get involved in it. You will lose money. I've been able to more than offset my entire gasoline use on USO options.
http://finance.yahoo.com/q/op?s=USO

[Duffman]

Originally Posted by ttoyoda

Duffman,
Do you know what controls the amount of time that elapses before the contract must be fulfilled? Is there a standard amount of time, or the buyer/seller choose a time?

Not sure, but I think there are standardized timeframes. I'm sure anything is possible though if you had real market power.