A Brief Introduction About Oil Futures Contracts
The oil prices have an impact on everyone’s life, be it a consumer or an oil futures trader. But oil prices have something more for investors to offer. Oil futures always propose profit prospects from the varied fluctuations in the oil barrel prices to the oil futures investor. The terms and conditions of oil future contracts are crafted in such a way that enables the participants to trade uniformly.
The delivery dates accessible are up to nine-year from now into the future, and every contract can cover a thousand barrels. Parties of such a contract are either hedgers; that maximize the value of their asset and reduce financial risk, and the others are speculators that try and profit from price fluctuations. Oil futures curve for major oil benchmarks helps oil and gas traders, speculators, and investors to read the relationship between current and future prices (“The Oil Futures Curve | Sell Side Handbook”, 2019).
The two parties involved in the oil futures contract manage through their brokers. They decide on the prices and the contract numbers. This transaction is framed as two contracts; each one is between one party and the clearinghouse of the exchange (“How Oil Futures Work”, 2019). This helps in keeping preventing each party to view others credit risk involved.
Who Takes the Oil Futures Contracts? – People Involved
An oil future contract is signed between the oil producers or sellers and oil consumers. It allows an oil futures trader to accept a contract to either deliver or accept delivery of oil, which is the commodity here in the future based on the price contracted today. The two parties are; the one that agrees to accept the delivery and is known as long position and the other party that delivers is known as a short position (“How Oil Futures Work”, 2019).
Purpose of Oil Futures Contracts – Why Do You Need It?
The main purpose of oil future contracts is to bring together the oil producers and oil consumers. Since we are aware of the fact that oil prices fluctuate a lot hence having such future contracts in place benefits, the oil producer to lock the current prices. Though the future oil contract prices vary every day, hence the oil producer will get a financial credit every time the future prices go down, compensating the dip in prices. Similarly, if the crude oil futures contract prices go up, the oil seller or the producer will face a loss, counterbalancing the subsequent gain he will receive in the future due to this higher priced oil future contract (Caplinger, 2019).
Contents of Oil Futures Contracts – Inclusions
Oil futures contract specifications – The oil futures contract template includes the following contents
- Contract Unit– The units of the commodity agreed upon here it is oil.
- Price Quotation – The agreed future price of the commodity.
- Minimum Price Fluctuation
- Product Code – Unique identification of the commodity being dealt in
- Listed Contracts
- Settlement Method – It could be financially settled
- Termination of Trading
- Delivery Arrangement details
- Parties – This includes the details of the parties to this contract
How to Draft Oil Futures Contracts?
- Choose the correct contract sample
- Simple English must be used for comprehension
- Details should be specifically mentioned
- Final proofreading is very critical and must be done
Negotiation Strategy
When two parties sign long term oil futures contracts, negotiations happen through the broker. The negotiation happens on the prices and the number of contracts. The negotiation should happen before the signing of the contract (“How Oil Futures Work”, 2019).
Benefits & Drawbacks of Oil Futures Contracts
Benefits
- They are high leveraging investments
- The market for oil future contract is very liquid
- Easy way to make money for speculators (“Advantages of Trading Futures (APPL)”, 2019)
- Good for diversifying the risk
- They are only paper investments
Drawback
The only drawback that can be thought of having an oil futures contract in place is that such contracts can make their investors vulnerable as there is a risk of huge losses too, hence before having an oil futures contract, due diligence is a must (Caplinger, 2019).
[ Also Read: Crude Oil Pipeline Throughput Agreement ]
What Happens in Case of Violation?
An oil future contract comes with certain obligations for involved parties. If a party is unable to fulfill the contractual obligation, it is considered a breach. It happens when the commodity is not delivered, or the prices quoted are not paid as per the contract. The parties can contest this violation by filing a lawsuit(1).
Oil Future Contracts is very tempting, as it benefits the investors to avoid the oil price mishaps. But it is essential that before stepping into it, one should consider their financial resources, understand the contract obligations, assess the risk involved, and measure the affordability of taking risks.