Living in Peace and Wisdom on our Planet

Okay, maybe oil futures aren't entirely real. Buying propane to fill my tank is buying something real... but my propane tank is full right now, and it isn't very easy to just sell some of that propane to a neighbor...

The most important thing to keep in mind is that energy is real, money is not.

Right now, we see that the "value" of money is falling... "the dollar is weak" we hear, or "there is inflation" or some such nonsense.

Money isn't real. Energy is real.

What we should be looking at is how many units of energy we can buy for a given amount of "money". For example, the price of oil, propane, gasoline, diesel, etc. have doubled. What that means, is that the value of our money has been cut in half. It is as if we traded in all our $10 bills for the same number of $5 bills... but of course, we didn't have to trade them in, the $10's (and all the rest) are now simply worth half as much.

Thus, my interest in buying oil. Oil is real. Our entire industrial world is built upon it. Our society could no more live without oil than we humans could live without blood. It can't happen. Blood is how energy is transferred within our bodies, and as a secondary effect, the rest of the products (nutrients) are transferred as well. In our civilization, oil the energy that moves from the ground to everywhere in our industrial society. Not only does it move, but it does the moving. We transport products as well, but it is oil that must come first. Without oil, there is no transportation, at least not in the society that we are talking about.

The question of course is "How?"

How do we buy oil?

Well, I've filled up my propane tank for my house (the "pig"), filled up my cars' gas tanks, and filled up a few gas cans as well. But all in all, that isn't very much in the great scheme of things.

Buy Oil Futures Contract

Since learning about peak oil, nearly three years ago, I've been thinking about how it would be a good idea to invest in oil, to buy oil. A little over a year ago, I wrote this article, which was my understanding (at the time) of oil futures.

Gas Prices, Peak Oil, & the Futures Market

One correction from that article, at the time, I thought that 20% of the value of the contract was required for the initial margin. In fact, at the current moment, it is 12%. I suggest reading that article first, because this story picks up where that one left off.

SO, I'd been thinking about how all of my cash assets, physical gold (in the bank), and stocks and mutual funds had been losing value compared to energy, and I must have thought to myself, "if I know that energy is the only real thing of value, why don't I buy that?"

I started looking into how to go about buying oil futures. Google was not as helpful as I had hoped on this, but eventually, I collected enough information to understand that to buy a contract, it would take a lot of money.

The way a contract works, you "buy" it, which really means that you promise to buy the oil on the 20th of the month prior to you taking delivery. For example, I "bought" a contract for December 2012, which means that around the 20th of November 2012, I have to actually buy that contract for whatever huge sum of money it is. Then, I have to go and get it, that is, 1000 barrels, or 42,000 gallons, from, I believe, Cushing, Oklahoma.

Now, I don't want to actually go and get the oil. Rather, I want to sell the contract before then, and with practically no luck given peak oil, the price of oil will be much higher. For example, if oil is $200/barrel then, and I "bought" the contract at $141.25, then I'll have locked in $58.75 x 1000 = $58,750 of profit. In other words, for every $1 that the price of oil goes up, the contract could be sold for an extra $1,000.

Of course, the opposite is true. If I was still holding the contract in November of 2012, and oil dropped to $100, (due to a pandemic that had killed off half of the world's population or some other unlikely event), then I would, at sale, lock in a loss of $41.25 x 1000 or $41,250.

I say this just to illustrate that losing money in futures could be a lot of money, for me at least.

Not to belabor the point, but I bought in at the $141.25/barrel that I previously mentioned. That cost $11,813... which is to say, that was the "initial margin", which was 12% of the full contract. If oil goes down a little bit for that Dec. 2012 contract, that is not a problem, but if it goes down more than $3, then the brokerage issues a "margin call", which means, they call me on the phone and tell me that in order to maintain a 9% interest in the contract, that I'll need to send in more money, that day, or the brokerage would sell the contract.

This could get dicey if oil dropped $10, for example. I'd need to send in $7,000 more.

A couple years ago, oil actually dropped by 31%. If it were to do that again, I'd need to come up with a lot of cash. In fact, if oil dropped 31%, and I still had to hold a 9% margin, that means I shouldn't buy the contract unless I have enough cash to buy 40% of the contract... $56,500 in this case.

Yes, this is not a cheap purchase, and it is one that requires a bit of careful money management. As I mentioned, my initial margin was only about $12,000... which means that I need to keep cash, or very liquid investments, of $44,500... or I might not be able to keep the contract, if the cost of oil drops down that 31%.

That is seriously a lot of money for us. We have normal jobs, and no significant other sources of income. The one thing we have done is to be frugal with our spending. For example, we bought a house for half as much as the mortgage company would have loaned us. Then, instead of paying it off in 15 years, we paid it off in under eight. Then, instead of buying a bunch of things with the freed up cash, we just deposited it in the bank, figuring that there was a chance that one of us would lose our jobs some day due to unforeseen circumstances.

The upshot is that we had (just barely) the $56,500 that we needed to be able to seriously consider "buying" the oil futures contract. I don't imagine that many people in the USA or the world are in that position. For most, it would take selling a whole lot of stocks and other things to raise that much cash.

The risk in buying the contract is actually higher. If oil were to drop in price by 50%, somehow, then we'd have to come up with a total of 59% of the contract... which is over $83,000. That would be a stretch for us, although we could do it if necessary. A 60% or 70% or higher drop might be beyond what we could find in cash, without taking out a mortgage on the house, or selling all of our other investments. If oil went back down to $10, we'd have to cover basically 100%, which would be $141,250... which is the maximum risk, and the maximum loss, for this one contract.

All that is to say is that the risk is really quite high.

That being said, why would I buy such a thing, that has such high risk?

Because I don't think oil will ever see $10 again, or $20, or $50, or $100. We are, after all, in the peak oil era, and oil is going be going up, and up, and up, to prices that most would not even consider. Couple that with the inflation in the dollar, and I don't think we'll see oil under $130 or so, and, in the converse, I think we'll be up to $150, $175, $200 well before this contract comes due.

For each $1 that oil increases, the "profit" is $1,000. The risks are high, but so are the potential wins.

How I Bought

After doing all the math, making a spreadsheet to calculate the potential returns, I started trying to find some way to actually buy the contract. After a while, I stumbled upon a company called "Lind Waldock", and while on the web site, a little pop-up asked if I'd like to chat with a real person. I clicked "Yes", and after a three line exchange with the person on the other end, he asked for my number, and gave me a ring.

I asked a bunch of questions.

There are a lot of forms to fill out. It must be verifiable that I had a bunch of cash, and a fair about of net worth. I would have to wire Lind Waldock the money. Yes, Lind Waldock was a wholly owned company of MF Global which is also Mann Financial. Yes, MF was taking a beating on their share value BUT client money was, by law, held separately, so even if MF were to go bankrupt, my account would still be there.

After doing some more calculations on the spreadsheet, and a night's sleep, I introduced the idea of buying a contract to my wife. Initially, she wasn't too hot on the idea, given the amount of risk, and the fact that we'd need to keep liquid a fairly large amount of cash for potentially a long time. That evening, we talked a lot more about it, and in the evening, we filled out the paperwork on the Lind Waldock web site so we could get moving the next day.

After the paperwork was filled out, I checked the stock value of MF Global... *gasp*... they went from $30/share to $5/share!!! in the past few months. Not so good. I decided to look into some other choices.

The next morning, I did some research with "Futures Magazine" online to try to find some other brokers. After looking over their stock values, I realized that ALL of the brokers were losing share value, although MF had been doing better for a while, until something happened, and their shares dropped like a stone below the others.

So, I made a couple calls: Morgan Stanley was one, Merrill Lynch was the other. Citigroup and Prudential were two other choices on my list, but I called neither one, so I can't say anything about them except that Citigroup has been losing a lot of share value also.

Morgan Stanley and Merrill Lynch were less than exciting to me. One of them was unable to connect me with someone that could help me buy the futures contract. The other said it would take five business days. I got confirmation that no matter who I bought the contract with, the money would be held separately AND that I could always sell with one firm, transfer the money, and buy back with another firm.

I was set. I wanted to buy NOW, so with some groundwork already taken care of, I was ready to go with MF's Lind Waldock.

I emailed, or the broker called, but in either event, I chatted with the broker and said that we wanted to do this thing today. The broker had to work on his end to get our paperwork approved, an account set up, and our information into the system. He emailed me a form that explained how to wire the money from my bank to Lind, plus the number for a holding account.

Off to the bank I went, and the wiring process was straight forward. I wired $25,000, which I knew was a lot more than would be needed for the initial margin, but this would allow the price of oil to drop by a total of $15 before my broker would have to call me about sending in more money to meet the margin. AND, it isn't like that money could be doing too much else, as it had to be liquid to send in for a margin call anyway.

After the wire was in to Lind Waldock, and everything was set on that end, it was time for the purchase. The broker gave me information so that I could go into the Lind Walcock web site and see the actual minute by minute buy and sell prices on the various futures contracts. Initially, I was looking at the December 2015, which was the furthest out, but the spread between the sell and buy was a bit large AND the contract from 2012 was selling more cheaply. So, I settled on the Dec. 2012 contract.

We went to the screen that showed the "tick" for each few seconds, which showed both the bid and the ask. The bid at the moment was around $139.50 and the ask was around $142.00, so I knew, that with only a few minutes left to go with trading, that I'd need to split the difference. $140.50... nope, others were bidding higher. $141.00... almost, but someone else was starting to bid higher. There was some downward motion on the ask/sell side... Let's get it done, I thought. $141.25, which looked like a big upwards spike on the graph... BAM... sold/bought, we had our contract.

The phone call wrapped up about 30 seconds later, and now we "own", so to speak, one oil futures contract for December 2012. Suddenly, I am much more interested in the daily price of oil. Will it go up? Will it go down? Will the $25,000 be enough so that I never get a margin call? Are there things that I didn't consider? Should I have bought the "miNY" contract, which is 500 barrels, with have the price, and have the amount of money needed? The questions are now flowing in... but you know what? I suddenly feel like I've made the first real, logical, well thought out, and almost certain to win "investment" of my life.