APPENDIX Rules for Pricing of Crude Oil Futures Contracts
This appendix outlines the procedures for determining the settlement price (SP) for crude oil futures contracts on the New York Mercantile Exchange (NYMEX). The SP is a daily price at which the clearing house clears all trades and settles all accounts between clearing members for each contract month. Since the SP is used to determine both the margin calls and invoice prices for deliveries, there are some very precise rules for its determination.13 By the same token, it is the best guide to the market’s views on the future course of prices.
There are two sets of rules, contingent on the volume of trade, for determining the SP. One set of rules applies if at the opening of business on any trading day, a given delivery month has more than 10 percent of the total open interest for all delivery months of the futures contracts.14 The second set of rules applies if the volume criterion is not met. These two sets of rules are considered below.
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Manmohan S, Kumar, an Economist in the Research Department, is a graduate of the London School of Economics and Political Science. He received his Ph.D. from Cambridge University, where he also taught before joining the IMF.
The author is grateful to Bijan Aghevli, Ernesto Hernandez-Cats, Peter Wickham, Charles Adams, William Perraudin, and Blair Rourke for helpful comments, to Tony Curtis of the CFTC for discussions on the oil futures contracts, and to Raja Hettiarachchi for computing assistance.
Each barrel includes roughly 42 gallons of oil.
The delivery point is the town of Cushing, in Oklahoma. The six other deliverable grades include two Algerian grades, two Nigerian grades, a Norwegian grade, and UK Brent Blend.
See, for instance. Petroleum Intelligence Weekly (1988). According to data provided by Petroleum Database Services, which has individual computer models of all U.S. refineries, the extra profit from five of the six deliverable crude, relative to WTI, exceeded the NYMEX value adjustment by 15 to 7(1 cents a barrel during the second quarter of 1988. North Sea Brent Blend, the most readily available substitute crude, was the only grade that appeared unattractive to buyers at Cushing, since it showed little or no extra profit compared to WTI, but the NYMEX adjustment method still penalized Brent with a slight premium.
It is worth noting that the delivery date was changed in 1985 when it was based on the fifth day prior to the twenty-fifth calendar day. An earlier study by Ma (1989) for the period 1984–86 apparently used the same delivery date. Given the extreme sensitivity of prices near the maturity date, the difference of even a couple of days can be important. For a somewhat different methodology. see, for instance, Dominguez (1987); see also Bopp and Sitzer (1987).
A related model is a random walk with drift; there was, however, no empirical support for the drift factor.
As noted above, given the variable number of trading days, the last 20 days in the month were utilized.
In the tests below, given the “adjustments” applied to forecasts obtained from econometric models, no attempt was made to separate the econometric and the judgmental forecasts. See, for instance, McNees (1990).
These two factors are particularly relevant when considering comparisons made, for instance, by Choe (1990).
The forecasts by the USEA are often in terms of constant dollars—they were converted into nominal dollars using the expected inflation rate.
Thus, for instance, for the six-month-ahead forecast, the error variance using futures and time-series models was 0.03577 and 0.04267, respectively (using ν = 1). The error variance of the combined forecast was 0.03447.
These rules are set out in the NYMEX Rule Guide. The rules for energy contracts (for crude oil, gasoline, as well as fuel oil) are given by Rule 6.52. The rules are set by the Exchange and approved by the Commodity Futures Trading Commission (CFTC). I am particularly grateful to Tony Curtis of the CFTC for his advice in interpreting these rules.
Open interest is defined as the total number of futures contracts, long or short, that have been entered into and not yet liquidated by an offsetting transaction or fulfilled by delivery. The term is interchangeable with “open contracts” and “open commitments.”
There are a number of different types of spread transactions: the intramarket spread—consisting of buying one month and selling another month in the same commodity: the intercommodity spread—consisting of a long position in one commodity and a short position in a related commodity: and the intramarket spread—consisting of buying a commodity at one exchange and selling the same commodity at another exchange. For the determination of the crude oil SP, the first of these spread transactions is relevant.
This committee consists of three members, including a floor trader, a floor broker, and an oil market expert.