Text says: oil producers hold valuable real options to produce or not to produce. They may not exercise this option unless spot prices begin to rise. Production may occur only if futures prices are below the current spot price, which is associated with a downward-sloping term structure of futures prices. So producers want spot prices to begin to rise, but production occurs only if futures prices are below current spot. Does this contradict?
If spot prices rise, eventually they’ll get above futures prices.
Doesn’t sound contradictory to me.
Okay thanks. So why does production only occur if futures prices are below current spot? Wouldn’t a producer want the futures price to be higher so they get more for producing?
They don’t get more when futures prices are high; they sell at the spot price.
Producer sells at spot; If spot is low, there is excess inventory; So producer wants the spot to go above Futures=contagion; so producer rather than the broker, who sell futures, make money;
Magician can you pls correct my thinking?
It’s not a matter of excess inventory since producers here are assumed to be price takers, they will produce only at will when the price seems attractive.
The producer will only produce when the future price is in backwardation, because then, any supply will get absorbed at proftiable prices, and since supply is dry and demand is heavy, the market wants the commodity now, not in 3-months time. So producers are more incentivized to ‘exercise’ this option of production.