The Prize: The Epic Quest for Oil, Money, and Power

by Daniel Yergin

When a commodity is largely sold in spot markets, with prices that are very volatile and uncertain, buyers and sellers tend to try to find a mechanism to minimize their risk. That is what gave rise to futures markets, which allow a buyer to acquire the right to buy the commodity at some month in the future at a specific, known price. He is able to lock in his purchase price; he knows his risk. Similarly, a producer can sell his production forward, even before it is produced or, in the case of agricultural products, harvested. He, too, locks in his price. Both buyer and seller are hedgers. Their objective is to minimize their risk and reduce their exposure to volatility. “Liquidity” is provided by speculators, who hope to make a profit by getting themselves on the right side of swings in supply and demand—and market psychology. A number of different commodities, such as grain and pork bellies, have been traded for years on each of the several futures exchanges in the United States. As the world economy became more volatile in the 1970s and regulations fell away, futures emerged for gold, interest rates, currencies, and, finally, oil.