EDITOR'S NOTE - The price of oil was controlled for years by Texas regulators and then by Arab sheiks, but the focus on setting that value has shifted to a small commodities exchange that once traded in potatoes. This is another in a continuining series of stories about the oil price slide.
Jun. 13, 1986
Undated (AP) _ By JOHN C. GIVEN AP Business Writer
NEW YORK (AP) - The frenzied din of the New York Mercantile Exchange has the atmosphere of a big time prize fight, but it is the world price of oil at stake and not a boxing title.
Shouting, screaming, waving their arms, traders jostle one another in three circular pits to buy and sell contracts for crude oil, gasoline and heating oil.
In the three years since crude oil trading began at the exchange - and especially since prices began to collapse in late November - the three rings have emerged as a major focal point of the world oil trade.
The New York Mercantile is just one of several futures exchanges sharing a trading floor the size of a sports arena. Trading in gold, silver, cotton, coffee, cocoa and sugar goes on around the room at the same time.
At the crude oil pit, traders deal in contracts calling for the future delivery of 1,000 42-gallon barrels of West Texas Intermediate, the major U.S. grade.
After each sale, sellers jot down the price, the contract month and the buyer's name, then flip the note into the center of the pit. Exchange employees, sometimes wearing goggles to protect their eyes from flying paper, pick them up for recording on a big electronic board high up on the wall.
Prices can change many times a minute. Each time, the price flashes simultaneously on other boards and video screens around the world.
In recent weeks, daily transactions have averaged about 32 million barrels of crude - or the equivalent of about three-fourths of the estimated 44.1 million barrels the non-Communist world is consuming each day.
An additional 18 million barrels of refined products have been trading every day.
Each crude contract usually calls for delivery up to 18 months later at any pipeline or storage facility in Cushing, Okla.
But in fact, less than 1 percent actually results in the physical transfer of ''wet barrels,'' since the industry still relies mainly on the cash market for such transactions.
The New York Mercantile is used mainly for dealing in ''paper barrels'' - both to hedge against price declines and for speculation.
''About 50 percent of all trading here is done by the industry - international major oil companies, trading companies, independent refiners, producers, users and municipalities,'' said Rosemary McFadden, the exchange's 37-year-old president. The balance is accounted for by speculators.
For contacts carried from one day to the next - the ''open interest'' - 70 percent are held by the industry, hedging product or their anticipated needs, she said.
Perhaps the most widely celebrated example of successful hedging was conducted by T. Boone Pickens Jr., chairman of Mesa Petroleum Co.
Believing oil prices were in for a plunge, Pickens sold contracts in November to deliver at a future date about 3 million barrels of crude at the then-prevailing price of $26.50 a barrel. That was the equivalent of almost all of Mesa's projected crude production for 1986.
The market collapsed. Several months later, Pickens bought contracts to buy 3 million barrels at an average $16.50 a barrel.
By offsetting the promise to deliver oil for $26.50 a barrel with the contract to buy the same amount for $16.50, Pickens realized a net gain of $10 a barrel, or a total of $30 million profit for Mesa.
Of course, had oil prices risen instead of declined - and stayed higher when his promise to deliver came due, Pickens would have lost money.
But in the event of such a rise, he could have cut his loss by buying a contract for immediate delivery sometime between the date he first sold the contract to sell the oil and the date the initial contract came due.
In any case, the device enables a company to reduce the risks of wild swings in the market, much as the agriculture industry has for years.
For the oil industry, however, the idea of petroleum as a commodity - like hog bellies, gold, soybeans, wheat or corn - is something new.
Ever since the first well was drilled in Titusville, Pa., in 1859, petroleum has often been controlled by one power block or another.
John D. Rockefeller's Standard Oil Trust emerged in the first 50 years to dominate the young domestic industry until it was broken up by the Supreme Court in 1911.
The next two decades marked a period of boom and bust.
After prices hit 10 cents a barrel in 1933, the Texas Railroad Commission moved in.
Officially, the board's purpose was to regulate production to prevent the premature depletion of Texas' oil fields. But in matching output to the oil companies' estimates of demand, it set the world's price for oil.
Meanwhile, as international demand outstripped Texas' surplus supply, the major companies extended their prospecting overseas.
Within two decades, the major American and British oil companies were setting the prices they paid other nations for their crude, then presiding over pricing decisions all the way to the gas pump.
The companies' grip began to weaken in the 1960s as oil-producing countries grew more insistent about controlling their own resources.
The Organization of Petroleum Exporting Countries, born in 1960, grew stronger. Producing nations, led by Libya in 1970, began to nationalize their oil industries.
In 1973, OPEC, which produced more than half the non-Communist world's oil, finally wrested control of the market from the major oil companies after the Arab oil embargo disrupted world supplies. The price of oil soared nearly 12 1/2 times, from $2.55 a barrel to a peak of $34.16 by the end of 1981.
But the high prices encouraged energy conservation, pushing consumption down. And major new oil fields were discovered outside OPEC, including finds in the North Sea, Alaska's North Slope and Mexico.
The cartel tried to keep its grip on oil prices by limiting its own production. But the growing glut in world supplies overwhelmed those efforts.
Companies, which once had to sign contracts for OPEC oil at OPEC prices, turned to the spot market to buy oil at cheaper prices.
Trying to hold onto customers, some OPEC members ignored the cartel's price structure by offering discounts.
Then last year, Saudi Arabia, the world's biggest exporter, began selling oil at prices linked to the value of refined products.
Finally, OPEC announced in December that it was abandoning production quotas to seek a higher market share, and prices collapsed.
While OPEC was struggling to retain its control of the market in the early 1980s, the New York Mercantile was a minor commodities exchange for potatoes, two minor metals, gasoline and heating oil.
It added crude oil to its small portfolio on March 30, 1983, drawing little interest initially, with 323,153 crude contracts changing hands by the end of the year. But interest has soared with the problems of the oil market. In the first five months of this year, trading had mushroomed to 2.9 million contracts.
Speculation is a definite part of the action. But, unlike a gambling casino, the exchange does not play the role of ''the house.''
It is a non-profit operation, depending on revenue from fees on each transaction by traders who occupy the 816 ''seats,'' or memberships, that are owned by companies, brokerage houses and individuals.
Before crude oil futures were introduced, a seat on the exchange cost $35,000. In late May, a seat changed hands for $125,000, exchange spokeswoman Mary Ann Matlock said.
Some people in the oil business maintain the exchange has helped drive down the price of oil by focusing attention on ''paper'' barrels instead of the prices paid for ''wet'' barrels on the cash, or spot, market.
In fact, there is no central clearinghouse for spot sales, while the ''posted'' prices that are paid by refiners for delivery of crude vary.
Often these prices differ from that of the contract for the closest-month futures contract available, sometimes by as much as $1 or more per barrel. But those differences have narrowed, as more companies have come to use the Mercantile Exchange as a reference point.
''It wasn't NYMEX that announced in mid-December that it was increasing production. It was Sheik (Ahmed Zaki) Yamani,'' McFadden said, referring to Saudi Arabia's oil minister.
''Does NYMEX lead the cash market or does the cash market lead NYMEX? My response is: There's a simultaneity of these transactions, the use of electronic CRT screens in Mexico City, Tokyo, Riyadh (Saudi Arabia) - the entire world can look instantly and know these prices.
''We don't set prices. We reflect prices. We are the free market,'' she said. ''We reflect market conditions, and as such are used as a price reference.''
The exchange's trading, she said, ''has tended to reduce price volatility (because) people aren't going to be doing deals dramatically off what the market is trading.''
End Adv PMs Friday June 13