How betting on oil prices greases the industry’s wheels

lines of all the characters in all the scenes in “Casablanca”, the ones that resonate most are spoken not by Humphrey Bogart, the leading man, but by Claude Rains, who plays Louis Renault, a cynical police captain. Needing a pretext to shut down Rick’s, the nightclub owned by Bogart’s character, he declares that he is “shocked, shocked to find that gambling is going on in here”.

The benefits hinge on the relationship between spot prices, futures prices and inventories. The spot price is what you pay if you need a barrel of oil immediately. The futures price is more like a wager on a sporting match. If the spot price of Brent crude in a year’s time proves to be higher than $67, the current 12-month futures price, the buyer wins the bet; if it is lower, the seller wins. If oil prices are hard to predict, futures prices should be lower than spot prices.

What links the spot and futures prices is the level of stocks held by the oil industry. Storage is costly, but so is running out of supply. As a rule, the lower stocks are, the higher the premium speculators should demand. Just as ample stocks tend to dampen price volatility, skimpy stocks tend to amplify it, making speculation riskier. Backwardation gives speculators a compensating reward.agreed in December to cut production. Demand is picking up.

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