Just as farmers guarantee payment for their crops in the commodities futures market, so do airlines, trucking companies, cruise lines, public utilities and any business relying on obtaining energy price guarantees... also trade in futures.
Since many of these contracts to
provide and buy go for months and even longer than a year, where and when do contract settlements take place? Hedging on these is usually comes from derivatives, which in turn are traded on margin.
Risk can be traded, but settlement differentials do not go away.
Perhaps someone here can explain why this subject seems to receive little or no attention, whether the largest US banks have a major stake in this. While there seems to be no definitive number, some financial sources have estimate as much as 3.9 Trillion in commodity derivative contracts.
So... when oil was selling at $100+/barrel, an airline might have seen a guarantee of $90 a barrel in January of 2014, to be worthwhile and contracted to pay that price when the January shipment was made. Not so good for the oil company if the price had stayed at $100. But the oil company would have hedged that potential profit loss, through a derivative guarantee. As the potential price changes played out, there would be offsetting derivatives... eventually to even out the hedge. The problem would come in when the actual contract came due. As in the days when the bottom fell out of the housing market.
Saved by the bell!... or the federal bailout.
As it turns out, the above example went the other way... but either way... a price differential, and risk.
Financialization is always based on the presumption that risk can be cancelled out by hedging bets made with counterparties. This sounds appealing, but risk cannot be disappeared, it can only be masked or transferred to others.
This stuff gets confusing to me... since almost no one in the finance industry or the government or here on ER seems to see this is as a worry, I wonder where my thinking goes wrong?
I'm not alone in this:
Rob Kirby: Oil Derivatives Explode In Early 2015 | ETF DAILY NEWS