Introduction to Crude Oil Markets

Oil Trading, where to start

When it comes to commodities trading, investors distinguish between soft commodities and hard commodities. While all commodities are fungible, there are differences between them. Oil falls into the category known as hard commodities – those commodities that need to be mined, drilled or extracted from the ground. Such is the significance of oil in the global markets that it has assumed the moniker of Black Gold. Oil is particularly useful once it has been refined into other products like gasoline. Hard commodities are part and parcel of industrial processes, and as such they are of particular interest to investors. Oil is particularly important in the production of most every chemical product including medicines, paints, detergents and plastics. Its widespread usage in the generation of heat, fuelling aircraft and vehicles and machinery is undeniable. Consider for a moment that oil is used in textiles, functional clothing, CDs/DVDs, furniture and other uses. Industrialized countries such as Eurozone nations, Japan, the U.S., Canada and China are heavily reliant on oil and this is why the price of oil so heavily impacts the economies of these countries. Towards the end of 2014, we witnessed a downturn in the price of oil which saw price slashed in half from over $100 per barrel to under $50 per barrel. As such, gasoline prices across the U.S. dropped below $2 per gallon, effectively injecting $450 million per day back into the U.S. economy to drive up retail sales throughout the holiday shopping season. Oil prices are highly volatile and dependent on supply, global demand, geopolitical uncertainty and a host of other economic criteria. We will explore the importance of this commodity as it affects trading activity around the world.

The Power Players in the Crude Oil Markets

While OPEC generally controls a substantial portion of the oil supply, the U.S. is the world's largest oil producer – overtaking Saudi Arabia and Russia. The rich shale oil fields in U.S. states including Texas and North Dakota have uncovered vast resources of oil. However, the U.S. is still a net importer of crude oil with up to 8 million barrels per day being imported during 2014. Global oil prices are mainly attached to the Brent crude oil variety while U.S. oil is known as WTI crude oil (West Texas Intermediate). The prices of both these oil benchmarks typically run in the same direction, although Brent crude oil historically trades at a premium is priced above WTI crude oil on the markets.

What affects on Oil Trading activity

OPEC is dominated by Saudi Arabia, Qatar, the United Arab Emirates and Kuwait. Saudi Arabia is the most important decision maker in OPEC. This group of oil-rich nations controls a substantial portion of global oil supply, and as such can manipulate prices. The more oil supplied, all other things constant the lower the price and vice versa. During the recent oil price slump, OPEC made a decision not to reduce supply in order to protect its market share. This hurt the price of oil and those OPEC member countries that have high costs of operation. In 2014 and 2015, OPEC insisted that equilibrium would best be achieved by allowing the markets to bottom out on their own and re-establish equilibrium without cutting supply. The price of oil is highly volatile, and is particularly hard-hit by geopolitical uncertainty, Mideast turmoil and decisions made by OPEC. Crude Oil trading predominantly takes place in the futures market, used by producers and merchants to hedge costs and traders to speculate on the direction of prices.

The USD and the Price of OIL

As news breaks of improvements in a country's GDP, oil consumption might also increase. There is a positive correlation between oil demand and GDP. The simple reason behind this is that as industry increases and expands, so too does the demand for oil and its related products. It should be borne in mind that oil contracts are denominated in U.S. dollars. Higher oil prices increase the demand for the U.S. dollar as the number of transactions for oil contracts increases. The relationship between the U.S. dollar and the price of oil is interesting. As the U.S. dollar weakens against a basket of currencies – as is evident in the U.S. dollar index – the price of oil likely increases. Various studies have been conducted over the years, notably the Granger causality, which shows that there is an inverse relationship between the price of Brent crude oil and the U.S. dollar exchange rate. For every 1% weakening of the USD, Brent crude oil tends to rise by 2.1%. This is because as the dollar weakens (oil is denominated in dollars) other countries can afford to buy more of this commodity and other commodities which increases the demand for oil (denominated in USD) – and the price. When the dollar is performing below expectations, investors tend to flock to commodities like gold which are also denominated in USD. They are a better store of value than traditional currencies. You can enjoy tremendous trading potential by closely following important news from the oil market as it affects oil trade. This commodity is one of the most important tradable assets on the market and the price and availability of crude oil has far-reaching implications for the global economy.