My economics professor says the main reason petroleum is so expensive

[desy]

Yes that is the definition of inelastic commodity which oil is, because there are no substitutes people will pay whatever the price further prices are downward sticky meaning once they have reached a level suppliers reduce slowly back down.
Both are very basic economic principles.
OPEC doesn't want skyhigh prices either because if we aggresively seak out substutes like ethanol and efficiency their product is left in the ground and they make NOTHING.

Also, low hanging fruit is all the easy oil is gone and we have to resort to deep water and Tar sands to keep levels of production up to daily demand.

 

[rchiu]

is China and India are HUGE and they are now becoming industrialized nations.
They will need as much if not more than we do.

He said it has very little if anything to do with how much we consume or how we get it. He also says cheap gasoline is a thing of the past and even if the earth has massive amounts of it, the first and second largest nations in the world will keep consuming it at an increasing pace.
Price will never come down. We will burn it up eventually and then move on to something else.

My thoughts are: If thats true, I bet we figure out something better and as the price of gasoline moves up we will slowly move off it and the U.S. wont even be the country to gobble up the last drop. We will have left it for 3rd world nations to finish off.

Your thoughts?

Short term oil price has little to do with China and India oil demand. It has more to do with month to month oil supply and demand, amplified by the speculation and market expectation. If you are just talking about the oil price increase over the past year, the direct cause is the economic recovery and the oil demand increase across all nation over the last year.

Long term wise, the oil demand is correlated to GDP increase. China has the largest GDP increase, so probably fair to say China will contribute to the oil demand the most. India, I am not sure. A few other nation could have better GDP increase, like the other countries in the BRICS nation - Brazil, Russia and South Africa. But if you want to blame those countries with increasing GDP, you should also blame those with high existing GDP, including US that's using 1/4 of the world oil production alone.

It's simple economics, if the oil cost more than alternative, then people will move to alternative. The problem with US is government keep the oil price low because it is a politically sensitive thing. Gas cost much more in let's say Europe. So in Europe, people adopt to alternatives first. In developing country, many government subsidize oil, so gas is even cheaper than US and alternatives cost more in developing countries due to lack of technology. So it will be harder for them to move off oil. But eventually, people will move off of oil if demand and supply drives the oil price high enough. There are already oil alternatives in most of the oil product, just matter of economic replacement cost.

 

[halik]

I think what you're really hitting at is whether speculation in the futures market can affect the price in the spot market. It absolutely can. While the futures market is a zero sum game (somebody has to go long and somebody has to go short for the same amount, short sells the contract to the buyer/long), the price of oil at a futures price can effectively come back to influence the spot. Say, for example, we have a new futures price of $140 for delivery in August 2011. This gives us an expectation of what oil MAY be in August, according to the "market", but oil is at $100 right now. That means in 3 months somebody thinks oil is going to $140.

What happens if, because of that "expectation", somebody puts a new price target for oil to hit $140 by august, say Goldman. That means that people say "oohh wow, oil is going to $140 by august, I need to get in on the action". That also means that people will be willing to buy the oil now at $100 and store it, provided storage costs less than $40/bbl during the holding period. Now, you'd see oil inventories going up in this case, in 2008 there were many oil ships off coasts holding oil. In other cases you heard/saw tanks being full.

Now, what happens if nobody is collecting physical but the expecation is that spot will hit $140 by August. The futures pricing takes into account time-value, margin requirements and the fact you don't have to store anything, thus, once you subtract those out, that's what spot should be. What happens if there's a lot of conviction in the futures, say, tons of money flowing into futures? The stronger the conviction, the more the physical market can react to the conviction. Why sell oil now for $100 when it's actually worth $140 - TVM - storage - margin costs = $135.

So the new spot for oil should be $135. As others have mentioned, these futures offer huge leverage opportunities, you only need a small amount of capital to get a big contract.

Obviously people say that futures do not create spot demand and cannot influence the price of the supply/demand of the spot, but I disagree.

It doesn't help when people trumpet $200 oil, like T. Boone Pickens.

This.

In summary:
Spot + cost of carry = future

If I bid up futures because of my 12x leverage, the guys with access to storage have more incentive to carry until June 15

 

[halik]

This is the part that I don't understand. That $140 figure is the product of anylists at GS etc., and they must be looking at projected demand based on economic growth projections of the big oil consumers (US, EU, BRIC), projected supply based on conflicts in the ME or weather events on offshore rigs/refineries etc.

Or are you saying that the GS analyst (or any other analyst, not just picking on GS here) would throw out intentionally high projections to generate momentum in the futures market?

I do understand what you're saying about speculators being able to store oil and keep it off the market if they believe the price will go up, but I'm just surprised that that would work for more than a very short period of time.

Google for Arjun Murti; SarbOx mandated Chinese walls between banking and research; not prop trading and research.

Also part of the investment research comp is tied to #of mentions in the media... ask me how i know.