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Give Oil a Future

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forbes.com: Give Oil a Future

William Baldwin

05.19.08

The energy market is misbehaving. See the story by Christopher Helman, explaining the mystifying failure of consumers to cut back and producers to open the spigot. Here’s one more weirdness: the absence of a long-term futures market.

Users of petroleum pay $120 a barrel and wonder when the price is going to $240, which would wreck a lot of businesses and careers being invested in today. Amid all this agony there is exotic oil that could be profitably extracted at $60 but is just sitting there because producers have their own angst. They’re wondering whether the market will crash before they can get the stuff out of the ground. Petroleum price crashes have happened before, turning synfuel projects into rust buckets.

The oil sheikhs love this uncertainty. “For OPEC the optimum pricing pattern is $100, $100, $100, $10, $100, $100,” says Robert Wescott, president of Keybridge Research in Washington, D.C. “Just when oil shale and tar sands get investment lined up, you crush the investors.”

Solution: a futures market. Say the price settles on $90 for future delivery, lowering economic risk to energy consumers while guaranteeing profits to producers now sitting on $60 oil. For a soybean farmer a 12-month forward market is quite adequate to tell him how many acres to plant. For Royal Dutch Shell (nyse: RDSA – news – people ), maybe the action needs to stretch out to 2028 to take the risk out of an Arctic platform or a transcontinental pipeline.

There are, of course, futures markets for energy, but liquidity dries up beyond a few years out. Buyers and sellers should show a little more imagination. Is it so absurd to hedge costs decades in advance? Alcoa (nyse: AA – news – people ) lined up a 30-year electricity supply before sinking capital into Massena, N.Y. Consumers of real estate–like homeowners and retailers–prepay years of rent, in effect, by buying rather than leasing. Pension sponsors hedge their future exposures by owning bonds due in 2038.

The federal government could set a good example by buying, in advance, some of the 1.6 billion barrels of oil it will burn up over the next decade. If this were done via contracts traded on a Chicago exchange, producers, consumers and speculators could dive in. The resulting market would send valuable price signals about what kind of homes, airplanes, highways, drilling rigs, factories and insulation we should be investing in today.

http://www.forbes.com/forbes/2008/0519/014.html?partner=alerts

 

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