Crude oil, also referred to as black gold, is one of the most commonly traded commodities globally. As a raw material, it is usually found in North America and the Middle East. It is used to manufacture a myriad of items, from cosmetics to cars, fabrics to plastics, pharmaceuticals to petroleum.
In recent years, oil prices have been fluctuating rapidly, which has made oil trading risky. This is because the supply and demand of oil change constantly, and so does its price. However, oil is a liquid commodity, which means it can be traded in large volumes.
Types of crude oil
Crude oil is classified according to its region of origin. Since oil is sourced from many different areas of the world, there are many types of crude oil. However, two primary types of oil are used as a global benchmark for prices.
- Brent crude oil: This is a blend of sweet, light crude oil, extracted from oil fields in the North Sea. It’s the benchmark for oil prices in European, Middle Eastern, and African oil markets, which make up about two-thirds of the world’s oil contract trades.
- West Texas Intermediary (WTI) crude oil: It is produced in North America, and it is the primary benchmark of oil prices in the US. It has a low density and low sulfur content, making it cheaper to produce and easier to refine than other oils.
Each crude oil has distinct qualities depending on its area of origin and where it’s refined. Therefore, a crude oil’s price is determined by how close in consistency it is to the benchmark. For instance, heavy Iranian crude is cheaper than WTI, as it yields less gasoline and diesel when refined.
The benchmark’s prices will fluctuate, but the difference between other crudes and the benchmark will always remain constant. So if the heavy Iranian oil costs $2 less per barrel than WTI, no matter how much the price of WTI fluctuates, the heavy crude will always be $2 cheaper.
What moves oil prices?
Primarily, oil prices are moved by oil’s supply and demand. When global oil demand surpasses supply, the price of oil rises. If demand falls and supply saturates the market, oil prices will fall. The factors affecting this demand and supply of oil are.
- OPEC’s influence
The Organization of Petroleum Exporting Countries (OPEC) regulates production levels to meet global oil demand. They can regulate prices by regulating their oil output. In 2020, OPEC decided to cut oil production to stabilize prices. However, a disagreement with Russia, a non-member but prominent exporter, caused a drastic drop in oil prices.
- Performance of global economies
In periods of global economic growth, demand for oil rises which drives oil prices up. Conversely, during periods of recession, global oil demand falls, leading to lower prices.
- Oil storage
When there’s a surplus of oil in the market, it is transferred to storage facilities. However, there are limited storage facilities, and as they fill up, this impacts market prices. In April 2020, there were concerns about an oil surplus after oil storage facilities tightened amidst the coronavirus pandemic. Consequently, oil prices plummeted to negative numbers for the first time.
- Push for renewable energy
As climate change conversations take precedence globally, the move to renewable energy sources could lower the oil demand.
How can one trade oil?
Spread betting on a crude oil market means taking a long or short position on the future price of oil. For instance, after extensive research, if you believe the price of oil will rise, you can spread bet on oil to rise.
Spread betting is leveraged. This means you only need a percentage of the total trade value as a deposit to take a position on the oil market. You do not own the oil, but you can speculate on its price movements. Spread betting is risky because while you can win more than your initial stake, you can also lose more than your initial investment.
Crude oil contracts for difference (CFDs)
CFDs are essentially contracts between a trader and a broker to exchange the difference in price between when a position is opened and closed. CFDs are leveraged. You can make a crude oil CFD order of as little as 25 barrels, compared to the 1000 barrels minimum for a futures contract. However, this may vary with brokerage firms.
Oil exchange-traded funds (ETFs)
ETFs are shares in oil companies. Some oil ETFs are leveraged, which can happen in two ways;
- Standard leveraged. This yields a multiple of a performance index. For instance, if you have a 3* standard leverage and the market rises 1.5%, you will get a 4.5% gain of your initial stake.
- Inverse leveraged. This yields a multiple of the opposite of a performance index. For instance, say you have a 3* inverse leverage and the market falls 1.5%, you will get a 4.5% gain from your initial investment.
Oil futures are a contract to buy or sell a specified quantity of oil at a set price on a specific future date. Futures prices predict the value of the oil when the contract expires. Futures prices fluctuate according to the price of oil, so trading oil futures carries some risk. Futures contracts are fulfilled by physically delivering the barrels of oil or cash settlements, so you should be careful to keep track of delivery and expiry dates. To prevent losses, you can rollover your position another month or close it before your futures contract expires.
Trading oil options
An oil option works similarly to a futures contract, except there is no obligation to buy or sell the oil when the option expires. There are two types of options, calls and puts. You buy a call if you think the oil price will rise, and a put if you think it’ll fall. To generate income, you can sell calls and puts if you want to take the opposing positions. However, you could make huge losses if the market goes against you.
Trading oil spot prices
The spot price of oil is the price of oil at that given moment. Spot oil trading is usually a short-term transaction that enables you to take shorter-term positions. This way, you can perform a deeper technical analysis to predict the price movements.
Oil is one of the most traded commodities globally. Global oil prices are expressed as a relation to Brent and WTI crude oils. This price fluctuates with worldwide demand and supply. One can get in on the oil market by spread betting, trading oil futures, CFDs, ETFs, spot prices, or options.