Crude oil trading basics provides readers, a complete summary of everything they should know for trading crude oil. Having a firm foundations on the basics of crude oil trading is important. It can help you navigate the tumultuous and many a times, volatile periods as well. While crude oil trading seems like a common term, the truth is that this is just an umbrella term. There are many different ways you can trade crude oil.
This article aims to help the reader to understand the basic concepts of crude oil trading. You will get to understand the broader oil market terminology. We will also cover the different concepts that you will come across in your journey as an oil trader. This guide on crude oil trading basics is structured in a way to give you a good view of the oil markets. From learning what the commodity is, you will gain an understand of the different ways you can trade crude oil.
We will also briefly touch upon some of the most common oil trading jargon that you will certainly come across during your time.
The topics covered in this article will be useful, especially if move on to read the advanced concepts of crude oil trading.
What is crude oil?
Crude oil, or fossil fuel has been powering the global economy for centuries since its discovery. Although the term crude oil is not that widely used in social circles, you might have heard of Petroleum or gas for short. It should be evident by now why crude oil is so important. It is not just used in powering your automobile, but is used in a number of other products. The commodity powers industries and the manufacturing sector.
If the world was a human, then crude oil is certainly its blood!
While the above statement seems like a bit of an exaggeration, is indeed true and to a very good extent. Petroleum based products are used also in other products, ranging from faucet washers to medical antiseptics.
Crude oil is the thick black liquid that springs up from underground. Crude oil is also referred to as the black gold. This pseudonym is appropriate, because there literally a number of products one can make out of the earth’s raw material. Crude oil is naturally occurring, coming from years of dead fossils.
Crude oil is basically a hydrocarbon, which is a mixture of hydrogen and carbon atoms.
As a commodity that finds its way into just about every aspect of our daily lives, it is no wonder that oil as a commodity is so important.
Crude oil trading basics – The essentials
Just as any other financial asset, crude oil also has specific characteristics. As an oil trader you should be aware of the various intricate aspects of the oil markets. In this section, we will briefly cover the essential crude oil trading basics. It all begins with extracting crude oil from underground. There are many companies that are into the business of oil extraction and drilling, which can be on land and on sea.
The extracted crude can then be sent over for further processing. The next step is at the oil refinery. The job of the oil refinery is to refine the raw product into usable products. It is estimated that close to 85% of crude oil is refined into products such as petroleum, diesel, gas oil, heating oil, LPG and so on. Once crude oil is then shipped off via shipping tankers and existing oil pipeline networks.
Supply and demand
Crude oil is important, not just because of its rich and varied use. It is important for a country, both in terms of powering its economy and maintaining its security. Without good enough crude oil inventory, a nation can quickly fall on its knees.
Historically, crude oil was found in just about every other country. But a majority of oil reserves are concentrated around the Middle East, Central Asia and parts of Latin America. The countries from around these regions have managed to take advantage of these reserves, turning themselves into net exporters of crude oil.
Meanwhile, fast growing economies saw their appetite for crude oil rise over the years. Due to the fact that the demand for crude oil outstripped their domestic production, such countries had to import oil. These countries are known as the net importers of crude oil.
In some countries, where oil reserves are negligible, they rely entirely on crude oil imports. This makes them particularly vulnerable, from a national security stand point.
Transportation and logistics
As you can see, with the supply and demand set up, transportation is another crucial factor in the supply chain. Due to the geographically distant locations between the importers and exporters, transportation and logistics play a key role.
Crude oil is typically shipped by land where possible and mostly by sea.
Oil is transported in large container ships. Depending on their size, they also have distinctive names, such as VLCC which stands for Very Large Crude Carrier and so on.
Because majority of the crude oil is transported by sea, maintaining the shipping lines is essential. Disruptions can arise in a jiffy and this can lead to chaos. There are two critical choke points when it comes to the sea routes. These are the Suez canal in Egypt and the Straits of Hormuz near the Arabian peninsula. Due to the fact that both these shipping routes are narrow, traffic disruptions are common.
Besides the traffic, due to the instability in the Middle East, things can quickly escalate. This can in turn cascade into rising crude oil prices.
The dollar value and price of crude oil
Crude oil is bought and sold for using the world’s reserve currency, the United states dollar. As a result, crude oil prices are also sensitive to the USD. When the U.S. dollar appreciates, it can lead to lower oil prices. But this lower oil price is only when comparing to the U.S. dollar.
For a non-U.S. net oil importer, it will should be expensive because they need to use their dollar reserves to pay for delivery of crude oil.
Take a look at the chart below, showing the Dollar Index price on the left side and the U.S. WTI Crude oil price on the right.
The U.S. dollar is mostly steady, but it can exhibit periods of sharp fluctuation. This usually happens due to sudden shifts in the market expectations for rising interest rates. This happens during the expanding economic cycle. Despite the dollar being strong, demand for crude oil also tends to rise during these expansionary economic cycles.
OPEC – The Organization of Petroleum Exporting Countries
No crude oil trading basics can be called complete without the mention of OPEC. OPEC is a big player in the oil markets and it is currently made up of 15 oil exporting countries. Together, this organization (or oil cartel as they are informally called) has the ability to influence oil prices directly. You can visit the OPEC website here to learn more about them.
When you trade crude oil, OPEC is a name that you will constantly hear.
The organization meets twice a year to decide on their export quotas. Although the cartel does not yield as much influence as it once had, the OPEC meetings can still move oil prices around.
It is not just the OPEC but also other key oil ministers from the participating countries. These include comments from the respective oil ministers from Russia, Saudi Arabia, Kuwait and Venezuela to name a few.
Crude oil trading basics – The markets
Many people ask how to trade crude oil. But they don’t know that there are many different ways to do this. As you might have already guessed, we have talked about the extraction, refining, supply and demand and of course the U.S. dollar.
But firstly, we should mention that when you want to trade crude oil, you are in effect trading the raw material before it gets refined.
So if we talk of the general oil market, here are some of the ways you can gain exposure to crude oil.
- Oil stocks & ETF’s: By purchasing the shares of the oil companies or investing in an oil tracking ETF, you have the option to pick and choose what aspect of the crude oil market you want to gain exposure to. You can choose from either the oil exploration and drilling companies, to the refineries. While many of the big names in the oil industry are based in the U.S, their operations also span overseas.
- Crude oil CFD: CFD is a contract for different instrument. These are purely speculative instruments and by no means allow you to own the actual underlying asset. Oil CFD’s can be easily traded at leverage. One of the advantages being that you can day trade crude oil CFD’s and on leverage. This means that you don’t incur huge upfront costs. However, because oil CFDs are speculative instruments and leveraged, they are also risky.
- Crude oil Futures: Crude oil futures are exchange traded standardized instruments. Oil futures are primarily traded on a futures trading exchange and generally involves the producer and the consumer. However, another group, known as speculators also make up to be a major futures market participant. With the oil futures market, if you own the contract to delivery and are long, you can take delivery of the underlying asset. Day traders can also trade oil futures, especially the mini oil contracts.
- Crude oil derivatives: Besides oil futures, you can also trade OTC (over-the-counter) using oil derivatives such as options, swaps and forward. These OTC contracts are highly customized and is out of the reach from the common average individual. The oil derivatives are typically suited for large companies (either those involved in the oil markets) or those that have a significant sensitivity to oil prices (such as airlines).
Crude oil trading basics – Any benefits of trading crude oil?
Now that we have covered enough ground, the question that comes to mind is about whether there are any benefits of trading crude oil. I mean, why do you want to specifically want to trade crude oil when you can trade currencies, or other commodities like gold or even speculate cryptocurrencies.
Firstly, it can be a matter of personal choice After all, you might not just be trading crude oil but other assets too. If you are such a person, then trading crude oil can give you the diversification.
Because this is a resource that only seems to be getting limited as time goes by, there are a lot of dynamics at play. Although the world is now slowly turning towards renewable energy and getting more climate conscious, crude oil still has a long way to go.
The volatility in the oil markets provides for good crude oil day trading opportunities. Due to the different fundamentals that impact crude oil prices, this is a commodity that is quite unique.
If you are still interested in crude oil trading, then I shall conclude this crude oil trading basics guide with this light video to watch. It cites the 15 random and very interesting facts about Crude oil.