[Marxism] PEMEX looks to lock in current oil prices

Joaquin Bustelo jbustelo at gmail.com
Sat Jul 26 09:43:05 MDT 2008

Brad says, "PEMEX operates in this example as both the seller and the buyer
through the futures contract." 

This makes no sense to my understanding of the basic operations of a futures
market. If PEMEX has BOTH contracted to buy, say in December, 2015, 1
million barrels at $150 each, and obligated itself to SELL at that same time
1 million barrels at $150 each, then all it has done is generate transaction
fees for the exchanges and brokers involved, but hasn't really hedged
anything at all. That is literally what would happen is one were taking on
both the long and short position in the futures contract, irrespective of
price movements, the two positions cancel each other out completely. 

I understand that future trading strategies can be complex and one might
decide to hold long and short positions simultaneously, often  in related
markets (i.e., in the London and New York exchanges, or even better, in
related commodities like diesel, bunker, gasoline or some other refined
products, if there are futures for those) or time frames (June 2015 as
opposed to December 2015) based especially on computerized statistical
models believed to express real-world relationships between these different
contracts and their interaction. And such games supposedly will allow you to
minimize downside risk but still allow for some upside for
higher-than-anticipated prices rather than sacrificing it all. But in the
last analysis, net, you're EITHER locking in a selling price OR a purchase
price at a given future moment. 

For a producer, you're "buying" a price "floor" by "paying" (giving away to
your counterparty) everything above the "floor." Of course, the floor can be
made "squishy" -- the easiest way to understand it is with a simple example:
you promise to sell half your production at the futures contract price, but
withhold the other half to sell on the spot market. Now, you figure you need
an average price of, say $90 to avoid catastrophe. So you commit 100 of the
200 barrels you expect to produce at $150, but not the other 100 barrels,
anticipating that oil will never see $30 a barrel again. 

Now, if the price winds up at $200, you will have made an average of $175 a
barrel, in other words, you only "sacrificed" 50 cents of every one dollar
increase in price above $150. But if the price winds up even at a
worst-case-scenario $30, you won't be happy, but you won't be out of
business because your AVERAGE PRICE is $90 (100 barrels @ $150= $15,000; 100
barrels @ $30 = $3,000. Add the two up, you get $18,000, divided by 200
total barrels equals an AVERAGE price of $90). What if the price winds up at
$10? Well, on the way down it will pass through $140, $125, $100, $50 and so
on, and at any given point you can pat yourself on the back for having
decided to lock in $150/barrel for half your production but you ALSO decide
there's too much risk now left in the OTHER 100 barrels, so at various spots
on the way down you pre-sell 20 or 50 or even all 100 remaining barrels.

At any rate, the point is this: for any effective hedging to take place for
a producer seeking to set a floor (minimum) price levels, even a squishy
one, YES, there has to be a counterparty willing to bet the price will be
HIGHER than that "floor" and, no, the counterparty can't be yourself,
because the two "bets" (that prices will be higher/lower) perfectly cancel
each other out.

And that tends to be the case for two closely related bets, i.e., going
"long" on one million barrels for December 2010 and "short" on one million
barrels for the following or previous month. It may be that at the end of
2010, the price may be $30 or $300, but almost certainly, in November 2010
or January 2011 the price will be within 10% or 20% of the previous month's
price, not ten times or one tenth as much. 

*  *  *

I notice Brad doesn't have anything to say substantively on my OTHER point,
which is that (taking for good coin what the article says, that this is a
government-imposed hedging policy against price declines in order to assure
balanced budgets going forward) it makes no political sense for the Mexican
government to have such a policy at this time, because it runs counter to
the government's "energy reform" privatization proposal.

Of course, Brad was in no way obligated to respond to my comments about that
or the article in general. He sent us an interesting piece about a subject
much discussed hereabouts, which I am grateful for. 

But since he has responded on the broader subject, what I would appreciate
is that he illustrate with an "oversimplified" hypothetical example like the
ones I've been presenting how one could do what he says PEMEX is doing --
locking in a future price by either taking a net neutral position (in
essence, being their own counterparty) or being guaranteed the right to sell
at $150/gallon in, say, 2012, WITHOUT a counterparty willing to promise to
BUY that production then at that price.

*  *  *

Brad also says: "There are also numerous large hedge funds beginning to
liquidate their commodity holdings.  As we begin to see large amounts of
capital flow out of the commodity futures market we will see both a decline
in commodity prices and a commensurate rise in some other investment

Commodity *holdings* are one thing; commodity *futures* are another.
Futures, in and of themselves, are a zero sum game, because every contract
involves both a long and a short position: every penny made by one comes out
of the pocket of the other, and in the case of petroleum futures, contracts
are settled daily. There is no need to hang on to a position to realize a
gain; every day is, in effect, a new bet. 


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