How Energy Prices Are Set Today

Abstract

Our wild guess is that the petroleum industry pays traders be-
tween $5 and $10 billion per year for their service.
“Energy Futures Markets” which were initially developed for
hedging purposes, originated for trading WTI (West Texas Intermediate)
crude oil futures at Cushing, Oklahoma. Many pipelines come together
there, and tankage is available for storage of wet barrels for contract
settlement. This allowed the oil producers and oil refiners to hedge their
production or refinery inputs as needed. Speculative oil traders in New
York kept this market active.
Energy futures increased dramatically with the deregulation of
natural gas pipelines, and even more so with electricity. It Is interesting
to observe that as these futures markets evolved, the need for storage of
the product at the settlement site became less and less. (Electricity, essen-
tially, cannot be stored.)
Natural gas deregulation dealt with deregulation of interstate gas
pipelines. The long distance pipelines now have to haul other’s natural
gas, not just their own. Natural gas distribution is still regulated by the
states. Most states allow for direct natural gas sales to industrial and
large commercial consumers. A few states allow for direct sales of natu-
ral gas to residential customers.