Time to get your hands dirty with the black stuff

The Crude Truth About Oil Trading: A Guide to Oil Markets

June 15 by Leonardo Siligato

So you want to get into oil trading?

Have crashing oil prices ever brought out the opportunist in you? Made you think, ‘If only I could buy some oil and profit when the price inevitably bounces back.’ Sort of like how you kept all your old comic books, hoping they’d be worth something one day!

Well, buying actual oil is one way to do it. But with oil trading, there’s no need to go stacking barrels of crude in the cellar. Before we go into that though, let’s start with the basics.

Is oil all the same?

Theoretically, yes. But in practice…no.

Oil is a commodity, a raw material whose value and characteristics don’t differ from barrel to barrel, regardless of producer.

 Same same…but different

But in fact, there are different types of oil. Some are light, others are heavy (high-density). Some are sweet – it simply means it contains less sulfur, so don’t try to get a taste of it! – while some are harsh (more sulfur).

It’s like red apples – you have the Fuji, the Pink Lady and so on. If you’re not into apples, they may all seem the same but they actually have different taste profiles and textures. This results in differences in price.

Similarly, light and sweet oils cost more than other types of oil. Why? Because it’s easier to refine them.

So how are these oils priced then?

the crude truth about oil trading

Shutterstock sheikh knows

The benchmarks

A benchmark is a crude oil that is used as a pricing reference. If the price is around $40 a barrel and you want to sell a similar oil for $100 – well, you’re not going to easily find buyers.

There are several benchmarks for oil. But the ones you hear quoted most in the news are Brent and WTI, which stands for West Texas Intermediate. They are both light, sweet and thus, in very high demand. Brent is the North Sea oil, while WTI is – as you may have guessed from its name – Texan. As WTI is better (lighter and sweeter) than its European counterpart, it is supposed to trade at a premium. But since 2010, the situation has flipped. It now costs a few bucks less than Brent since there’s a lot more of it in supply.

Although the prices of these two benchmarks differ by a few dollars, they generally move like synchronised dancers.

 Goddamn, they’re perfectly in sync!

When one rises, the other tends to go up as well. So when you hear about soaring or falling “oil prices”, they’re referring to all the major benchmarks. You know what they say, a rising tide lifts all boats. And they can also get capsized at the same time…

In short, the “oil price” is a simplification: there are several types of oil at varying prices. But for the same type of crude oil (let’s say WTI), there are two prices: spot price and futures price.

Types of contracts in oil trading

There are two types of contracts when it comes to oil trading: spot contracts and futures contracts.

If I were to sell you oil with a spot price, that means I’m charging you the current market price. Then I would have to immediately deliver the goods to you. Whereas a futures contract would see us locking in a price for a specified date in the future. It came about as a way for both buyer and seller to safeguard themselves from the risk of fluctuating prices. Think of it like pre-sale concert tickets. If you miss out on them, you might end up paying double on some ticket reselling marketplace next month…

Futures allow people who don’t want to take physical delivery of the goods to profit from changes in prices. So it lets everyone get involved with oil trading. Even if you’re the sort who’d rather store beer kegs than oil barrels in your cellar.

 

Now here’s where it gets interesting: the futures price is no guarantee of the actual price of oil once that delivery date comes. Some consider futures prices as a forecast for future spot prices. But there can be vast differences since there are many factors that may impact the price in between. Which brings us to the next question…

What makes the price of oil rise and fall?

  1. As with everything else in this world, it’s all about demand and supply. If demand goes up, so does the price. But if there’s more supply than demand, then the price falls. Oil has a gazillion uses so demand is pretty much constant. Supply, on the other hand, depends on many factors. Part of the role of OPEC (Organization of the Petroleum Exporting Countries) is to ensure stability in oil prices. When there’s a glut in oil depressing prices, the oil cartel typically cuts production since it’s in their interest to keep prices at higher levels.
  2. Geopolitical risks like political upheavals and wars. Especially if they happen to take place in oil-rich countries. This is because traders worry that such conflicts will limit supply but the impact on oil prices is usually short-term.
  3. The price of oil is also linked to the value of the US dollar. Oil is bought and sold internationally using those dead presidents. So when the dollar depreciates or loses value, oil becomes cheaper (since foreign buyers need less of their currencies to purchase dollars). This means they now have more money to purchase more oil, which will push up demand – along with prices.
  4. Finally, there’s market sentiment at play, which is arguably the second biggest driver of oil prices after supply and demand. You know how we talked about geopolitical risks above? Well, sometimes the oil price pops at the first whiff of a conflict, even if it doesn’t actually disrupt supply. Or the price might sink if traders believe OPEC is not going to reduce production in the future. Like the stock market, it’s all about fear and expectations, not the actual reality of the situation.

Oil traders every time OPEC fails to reach a deal

Why should I trade oil?

Um, because it’s more exciting than trading soybeans? For a trader, oil futures are super appealing for two reasons. Firstly, they’re very liquid. It means they’re traded at very high volume so you never have to worry about being unable to sell them. Also, it can be highly volatile because of all the variables affecting prices. This presents juicy opportunities for profits (and also losses, so watch out!)

How can I start oil trading?

You can invest in oil futures but a typical futures contract contains 1,000 barrels. At the current WTI price, that would set you back over $45,000.

An alternative is exchange-traded funds or ETFs, oil-based securities traded on an exchange much like shares. Buying one ETF will cost you about the same as a barrel of oil.

But the simplest and most affordable way to get into oil trading? (Without having to sell your car or prized comic books.) It’s with CFDs, or contracts for difference, on BUX. Trade US oil with BUX now!

Written by

Leonardo Siligato

Holds a degree in Economics and Finance from Bocconi University, where he also worked as a research assistant for a while. After several years at Italian national all-news radio station Radio 24, he now delivers financial news and articles at BUX. A mountain enthusiast, he could not have chosen a better place to pursue his passion than the Netherlands… Look him up on BUX: @Siligon_Valley

Disclaimer: All views, opinions or analysis expressed in articles are that of the author and do not represent the views of BUX. Neither BUX nor the author provide financial advice and these articles should not be construed as such.

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