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Glossary of terms on Wall Street's intersection with oil

Kevin G. Hall - McClatchy Newspapers

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May 20, 2009 03:50 PM

WASHINGTON — The relationship between Wall Street and oil prices is complex. Here's a glossary to help understand the interplay between finance and energy prices:

Barrel: 42 gallons of oil.

Commodities: Things such as oil, natural gas, grains or precious metals that can be purchased in advance at a price that speculates what the product will cost at a specific future date.

Dark markets: Where big Wall Street players enter into private contracts, called swaps, with another party. Sometimes called over-the-counter markets.

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Exchange-traded funds: ETF's operate much as mutual funds do, but they're traded on stock exchanges throughout the day instead of having a single price at the end of the trading day. Through ETFs, big Wall Street banks can offer investors a chance to invest in commodities indices.

Futures: Contracts for future deliveries of a commodity.

Hedge exemption: Companies that take deliveries of oil are exempted from position limits because they use the futures markets to manage the risk from volatile prices. This exemption was extended in the early 1990s to include Wall Street banks and institutional investors if they invested in unregulated derivatives markets.

Index Investment: The practice by which big investors such as pension funds allocate a percentage of their assets under management to an index of different commodities. Such investments assume that prices will rise, and they're weighted, so that, for example, 40 percent of an index investment might go into oil futures, 20 percent to gasoline futures, another 10 percent to soybean futures and so forth.

Oil contracts: Contracts that grant the obligation or the right to buy oil at a specific price at a specific date in the future. Oil contracts held by speculators far outweigh those held by large fuel consumers such as airlines and trucking companies.

Position limits: Futures markets limit the number of contracts that a speculator can hold to prevent excessive speculation from driving prices artificially high or low.

Swaps: Private contracts that transfer, or swap, exposure to risk. A large oil producer might lock in a fixed price for its oil over a period of two years at, say, $60 a barrel. The producer might then enter a swap, in which a speculator is betting that oil prices will rise higher than that. Over the two years, the speculator will either pay the producer or receive money from the producer, depending on whether oil prices are above or below that $60 a barrel.

Swaps dealers: Issuers of swaps contracts, mostly large Wall Street banks.

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