Both professionals and individual investors can find the oil market quite complicated as there are occasionally huge price fluctuations daily. This article outlines the variables that drive the oil market and how to include oil in your investment strategy
What is Oil Trading?
Oil trading is buying and selling various forms of oil and oil-related assets to make a profit. Because oil is a limited resource, its price can fluctuate dramatically due to supply and demand swings. Because of its high volatility, it is popular among traders. Without owning any actual oil, you can trade CFDs on:
- the spot price of oil
- the prices of oil futures
- options contracts
Oil Spot Price
Oil spot prices are the costs of immediately buying or selling oil, or ‘on the spot,’ rather than at a later date. While futures prices reflect the market’s expectation of how much oil will be valued after the future expires, spot prices reflect its current worth.
Oil futures are contracts to exchange a specific amount of oil at a specific price on a specific date. It is traded on exchanges and reflects the demand for various types of oil. Oil futures are a popular method of oil purchases and sales and allow you to trade ups and downs. Companies use the future to lock oil at a favourable price and hedge them from adverse price changes. They’re also popular among speculative traders because there’s no need to deliver oil barrels — you just have to fulfil the contract, which may be done with cash. Brent Crude and West Texas Intermediate (WTI) are the two most prominent types and get traded on the Intercontinental Exchange (ICE) and the New York Mercantile Exchange (NYMEX), respectively. They serve as a benchmark for global oil pricing and economic health.
Oil options are similar to futures contracts in that you are not obligated to trade if you do not want to. They allow you to buy or sell a certain amount of oil at a specific price on a specific date, but you are not obligated to do so.The two types of options are:
- Calls – You might buy a call option if you think the market price of oil will rise.
- Puts – You’d buy a put if you felt it was going to fall.
If you want to take opposite positions, you can sell call and put options. In quiet markets, selling options can yield revenue because you obtain its value outside of your trade. However, you must exercise caution, as this is your maximum profit, and if the market swings against you, you might lose a lot more.
What Causes the Price of Oil to Fluctuate?
The price of oil gets determined by the supply and demand relationship. When oil demand exceeds supply, the price of oil will rise. Oil prices will decline if demand falls and supply floods the market.
Many factors might influence oil supply and demand, and we’ve listed five of the
most frequent ones here.
The Organization of Petroleum Exporting Countries (OPEC) produces a significant portion of the world’s oil supply. They set levels of production to meet global demand by increasing and reducing oil prices. OPEC and its allies agreed to reduce production rates to stabilize prices during the Covid-19 pandemic. However, disagreement with Russia, a non-OPEC country but a prominent exporter, caused the oil price to plummet dramatically.
There will be a surplus of oil if demand declines but supply continues, which will be diverted into storage facilities. However, the amount of oil that may be kept is limited. Concerns about excess oil will affect market pricing as these tanks fill up.For example, traders’ concerns about tightening oil-storage capacity due to the coronavirus prompted crude oil futures to plummet in April 2020. The oil price was negative at one point for the first time.
The State of the Global Economy
The oil demand grows in economic growth to address industries such as transport, energy, pharmaceuticals, and manufacturing. If demand exceeds supply, then oil prices will rise. But if there is a period of recession in the economy, oil consumption will decrease and, if production continues, will lead to lower oil prices. Oil traders often utilize economic data to assess an economy’s health – such as GDP and stats on employment.
The Search for Alternative Sources of Energy
Energy corporations are under increasing pressure to develop new ways to generate power as climate change becomes a more prominent topic in global discussions. Alternative energy sources, such as solar, wind, and hydroelectric, may reduce oil demand.
Location and Quality
One of the significant challenges facing the oil market is the scarcity of high-quality sweet crude, which many refineries, notably in the USA, need to fulfil strict environmental regulations. For this reason, it still needs to import oil, despite increasing oil production in the United States. The refining capacity of each country is varied. For example, a considerable amount of light crude oil is produced in the United States, which it can export. In the meantime, it imports other types of oil to achieve maximum production on a refining basis.
There are also variances in the manufacture of oil for sale. Brent Crude is an oil producer from the North Sea between the Shetland Islands and Norway, whereas West Texas Intermediate is from US oilfields, notably Texas, Louisiana, and North Dakota. They are both sweet and light, making them perfect for gasoline refinement.
When it comes to oil markets, investors have a wide range of possibilities. The energy sector has something for everybody, from indirect exposure via an energy-related stock to more direct involvement in a commodity-linked ETF. Investors should conduct their own research or get advice from a financial advisor before making any investment.