Can the open interest - number of future contracts on a certain commodity - outstrip the actual available quantity of the underlying asset and if so what happens if physical delivery is requested?

Answer 1

You're not supposed to INTENTIONALLY do it. Here's an example of how you might do it: you own some oil wells that you know can pump 1000 barrels per day, and you sell futures for twice that much. If someone exercises his contract, you better come up with that much oil or you're going to jail for securities fraud. But it's possible that you could accidentally do it. This happens in agricultural commodities trading. You're a wheat farmer and you're going to grow 100,000 bushels of wheat. You sell futures contracts on this wheat to Domino's Pizza--who likes doing business this way because it removes pricing uncertainty. At the end of the season, you harvest the 100,000 bushels and send it to a grain elevator...and, three days later, a defective motor in the elevator ignites grain dust in the elevator, causing a huge explosion and burning up your entire harvest. (This used to happen a lot.) Things like this are why they make crop insurance, because Domino's will want their money back.