Crude Oil – Commodity

Instrument description

One of the most essential and valuable commodity in the world is without a doubt, crude oil, which many of us know as ‘petroleum.’ Crude oil is the primary energy source that is necessary to ensure the transportation of motor vehicles and also in the generation of electricity. Crude oil is the name given to the naturally occurring oil in raw form that is made up of hydrocarbons, organic compounds, and traces of various metals. Crude oil is a non-renewable energy resource, which means there is a finite amount of oil in the world that cannot be replenished.

Crude oil is extracted from drilling either on land or sea, and the natural crude oil is refined to give diesel, petrol and other petroleum products. Crude oil is also a vital element in the production of plastics, steel, fertilizers, textiles, and cosmetics. But major use of crude oil acts as a fuel for vehicles such as cars, motorbikes, buses, trains, and airplanes.

Crude oil affects nearly every sector of the global economy and is also linked with other major macro-economic factors such as inflation. For decades, crude oil is traded in the commodity market through different financial instruments, and the crude oil market is known for consistent volatility and price fluctuations.

Agricultural commodities such as wheat and corn were considered the most important commodities before the Industrial Revolution, but now crude oil is considered the most important commodity and actively traded in the financial markets.

History of Crude Oil

Crude oil is an intrinsic part of everyday life, but its importance was not valued before the 19th century. People in ancient times mostly used kerosene (a product of petrol) for lighting and greasing purposes. The first oil well was built in 1895, and the first oil pipeline was functional in 1865. It was in 1901 when a big oil geyser was discovered in Spindletop, Texas, that produced nearly 100,000 barrels of oil a day.

Crude oil contains hydrogen and carbon from the plants and animals that have died in prehistoric periods of Paleozoic and Mesozoic eras, which is said to be 65 million years ago. Due to the constant movement of earth and shifting of plates, the organic remains combined with rocks, mud, pressure, and heat present in the underground surface to become what we call ‘fossil fuels.’ Apart from crude oil, natural gas and coal are also called fossil fuels.

Crude oil is extracted from various regions of the world, but its value is depended on the type and quality of crude oil. The oil is extracted either from the bottom of the ocean or from deep drilling in the earth. The most important element in crude oil is the sulfur content in the oil mix. Crude oil is graded according to density (light to heavy) and by sweetness or sourness. The premium crude oil is light (lower density) and sweet (have low sulfur content). It is considered inexpensive to produce petrol and diesel using light and sweet crude oil.

There are more than 150 types of crude oil that are traded on the market, but the two benchmarks in crude oil pricing are the Brent Crude Oil (extracted in North Sea, Europe) and West Texas Intermediate (extracted in the United States). The Brent crude oil has 0.37% sulfur content, while the WTI crude oil is a sweet and light type of oil with 0.24% sulfur content and gravity of 40 as given by the American Petroleum Institute (API).

Crude oil is measured in a standard 42 gallon, which gives nearly 45 gallons of petrol, from which more than 80% is used for transportation purposes, and nearly 13% is used for the production of consumer products. According to statistics, nearly 3 gallons of petrol is used by an average American. The top five countries, according to oil reserves, include Venezuela, Saudi Arabia, Canada, Iran, and Iraq. But the top five countries that produce crude oil along with other petroleum liquids measured in millions of barrels per day are

1. USA – 15.5
2. Saudi Arabia – 11.8
3. Russia – 11.5
4. Canada – 5.5
5. China – 4.9

The WTI is also known as U.S. Crude Oil as it is produced in the American Midwest and sent to Oklahoma through a pipeline. WTI oil is considered quite expensive to ship around the world, and WTI oil also said to be superior in quality as compared to Brent crude oil. The WTI oil is traded on the New York Mercantile Exchange (NYMEX). The certain grades of oil can also be used for trading purposes, which means a contract of 500 barrels of WTI crude oil will be the same regardless if it is extracted in North Dakota or Texas.

Supply and Demand of Crude Oil

As with other essential commodities, supply and demand play a major role in determining the prices of oil in the international market. The production and distribution of oil to all parts of the world limits the influence of any one oil producer to have control over the oil prices. However, the fundamental principle of supply and demand and its effect on oil prices stays the same.

For instance, the oil prices will fall when there is an increase in supply and decrease in demand as seen recently due to the Coronavirus pandemic that oil prices have plummeted all across the world as millions of people are staying at home. Similarly, the oil prices will rise when there is an increase in demand and a shortage of oil supply. However, the value and demand for oil will continue to increase due to an increase in population and the necessary use of oil as a primary energy source in transportation and power generation.

How to read the price change of Crude Oil

The Chicago Mercantile Exchange (CME) Globex is the global platform that allows electronic trading for 24 hours and 6 days a week. You can trade WTI crude oil with Contract for Difference (CFD) in the U.K. from Monday to Thursday from 00:00 – 21:00 and 22.05 – 00.00 and on Friday from 00:00 – 21:00. The symbol of WTI oil on CME Globex is ‘L.O.’, the price quotation is USD per barrel, and the minimum contract is 1000 barrels.

Suppose we analyze the WTI Oil price chart we see the oil prices trading from $50.00 to $60.00 per barrel from July 2019 to the last week of February 2020. The WTI Crude oil recorded the highest value of $54.83/barrel on February 21, 2020. There is a sudden drop in the price of WTI Crude oil from the last week of February, and the WTI Crude oil drops significantly in the third week of April and trade at the lowest value of $28.97 on April 20, 2020. There have been constant fluctuations since March, and WTI Crude oil currently trades at $40.57/barrel. The Bid price is $40.79, while the Ask price is $40.66.

How to Trade Crude Oil

Trading oil can be very beneficial to diversify a portfolio, opportunity to magnify profits due to sudden price movements, hedging against inflation, and crude oil can retain its value with time. The common ways to participate in oil trading include Exchange Traded Funds (ETFs), Futures Contract, Options, Contract for Difference (CFD), buying shares, and buying and selling of oil barrels.

One of the most popular forms of the trading commodity is through CFD, which is a derivative contract and allows short term traders to potentially profit from the price difference of crude oil from opening to closing of the trade. Many of the CFD providers allow traders to speculate on the value of crude oil Futures contracts, but the contract size is smaller as compared to the standard Future contracts. The standard crude oil Future Contract is 1000 barrels.

However, trading CFD has many advantages, which include trading using leverage, not having to buy or store crude oil physically, and the opportunity to profit from both the Bullish and Bearish trends in the market. Trading with leverage means with a small initial deposit; you can manage a large trading position. For example, with a leverage of 1:10 you can place an order for $1000 worth of U.S. crude oil CFD, with $100 to the broker to open the trade. Trading CFD may allow fast potential gains but with a high degree of risk, so a risk management tool can be used.

Another way to trade oil is by buying shares of major oil companies that distribute refine oil all over the world. The famous oil companies generate huge amount in revenue and pay a handsome dividend to its shareholders. Some of the profitable oil companies to buy shares from including ExxonMobil, British Petroleum (B.P.), Royal Dutch Shell, and Total S.A.

What causes the price change of Crude Oil?

Crude oil is a vital commodity that has its wide usage in the transportation and energy sector. The wheels of transportation cannot function, and the world can come to a standstill if crude oil is taken out of the equation. As such as a global commodity, the prices of oil are monitored by not only the governments but also the local consumers. The crude oil market is very liquid and volatile, and apart from supply and demand, other economic factors influence the oil prices.

• Crude oil supply factors

➤ OPEC

The Organization of Petroleum Exporting Countries, commonly called OPEC, consists of 14 oil-producing countries that manage the supply and prices of oil in the market. The OPEC committee meets regularly and discusses the supply, demand issues as well as fixing the oil prices per barrel in the market. A cut in production or supply will cause a rise in oil prices while a production boost will lower the oil prices.

➤ Crude Oil Reports

The Energy Information Administration (EIA) issues a weekly report that informs on the oil inventory numbers in the U.S, which significantly impacts the oil prices in the international market. A higher inventory number means an increase in supply and a decline in oil prices while a lower inventory will mean a rise in oil prices.

➤ Political Factors

The domestic and international political news and events also influence oil prices. For example, unrest and turmoil in oil-producing countries in Middle East Asia directly impacts the oil supply and tends to increase oil prices.

➤ Climate Changes

Another important aspect that affects supply is sudden weather events due to climate change. A sudden earthquake, flood, or hurricane in the oil extraction site can significantly hamper the complete oil extraction process and lead to a decrease in oil supply.

• Crude Oil Demand Factors

➤ Alternative Energy Sources

Alternative oil sources such as U.S shale oil and Canadian oil sands affect oil prices. In times of demand, the availability of alternative sources can decrease oil prices. However, the cost of extraction of alternative oil is quite high.

➤ Global Economic Performance

U.S, China, and Europe are the leading consumers of oil, and with improved economic stability, the demand for fuel rises, and so does the rise in oil prices. But on the other hand, in times of crisis and recession, the oil prices fall

➤ Global Events

Certain events affect the entire globe, as seen with the Coronavirus pandemic that has affected every household and business sector. The Covid-19 outbreak has plummeted the oil prices globally, and experts suggest that oil consumption would be less until the end of the year.

As oil is denominated in U.S Dollars, the value of USD as a currency and quote of USD with other global currencies is also considered a crucial factor in determining the oil prices. When the USD strengthens, the oil prices decline, and when USD weakens, the oil prices rise. Both the traders and investors need to track all the current and developing political and financial news to determine the current and future oil prices. Oil prices are sensitive to news, and knowing the news allows traders to try and take advantage of the price movements.

The information above is for education purposes only and cannot be considered as investment advice. Past performance is not reliable indicator of future results.