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How to trade oil

Learn everything you need to know about speculating on the oil markets

 

Trading oil

Used in manufacturing, transportation as well as energy generation and with a supply that is variable and limited, oil has a dramatic effect on the global economy, making it one of the fastest moving markets.
 
Traders who don’t understand the unique characteristics of the oil market often fail to take full advantage of the trading opportunities that exist in this volatile market.
 

  

What are the types of oil traded?

Oil is a natural resource obtained from oil reserves deep underground. It forms from the sedimentation of plant and animal carcasses or fossils for over millions of years under the cover of sand and rock layers.
 
Oil producing countries include the US, the Scandinavian countries (North Sea) and OPEC countries (Organization of Petroleum Exporting Countries) countries such as Saudi Arabia and Iran.
 
There are two types of oil used as benchmarks in oil pricing: WTI and Brent oil.
 

1. WTI
WTI stands for “West Texas Intermediate,” which is crude oil obtained and produced in the U.S. It is also referred to as “Texas light sweet”. It is “light” because it is less dense compared to most OPEC crude and it is “sweet” because it has lower sulfur content.
 

2. Brent crude
Also referred to as simply “Brent,” Brent oil is the oil obtained and produced in the North Sea. Brent is also described as light and sweet like the WTI oil.

 

WTI & Brent Oil price correlation

WTI was traditionally more expensive than Brent, but as oil drilling and fracking technology advanced, West Texas Intermediate now tends to be cheaper. This is also known as the US shale revolution, because the decrease in oil production costs also decreased the US dependence on oil imports.
 

The prices of both types of oils are highly correlated, but if one of them depreciates and the other appreciates, a pricing anomaly may occur. For example, in February 2011, the spread between the WTI and Brent prices reached more than 15 USD (WTI traded at 85 USD/barrel and Brent traded at 103 USD/barrel).

 

 

WTI - Brent Oil price correlation 2011 - 2017



WTI’s depreciation was caused by the increasing oil surplus in interior North America at the time and Brent’s appreciation was caused by the civil unrest that existed that time in Egypt and the Middle East.
 

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What drives the oil prices?

Oil is one of the most heavily traded global commodities with no shortage of news causing the oil market to move on a daily basis.
 
Here are the key factors that affect the price of oil:
 

  1. Extraction and refining

The extraction and refining processes of crude oil are very costly. Since oil reserves are located deep underground, it takes a considerable effort to extract crude oil from the ground. Any technological advancement or setback in the extraction process has direct effect in the price of oil.

 
  1. Consumption and demand

The leading oil consumer nation is the U.S., followed by Japan, China and industrial European countries Like Germany and the U.K. These nations place high demands on crude oil for their industrial and economic functions and therefore their industrial needs can affect the global oil prices.

 
  1. Accessibility and supply

Accessibility, no matter how much the supply, can be influenced by political and economic factors. The increase in inflation, unemployment and poverty rates can cause the consumption rate to decrease by rendering the product inaccessible or unaffordable for those affected. Political unrest and insurgencies can also lead to cutbacks in oil imports and hijacking of imported commodities.

 
  1. Natural disasters and accidents

Natural disasters like earthquakes and storms are unpredictable events and the damages they cause on affected drill sites and refineries can impede and delay the production rate of oil. Fire and mechanical malfunctions or breakdowns also cause production delays during the recovery period. The delays these circumstances can cause will result in decreased oil supply and thus increase the price.

 


Key oil reports to follow

There are two oil reports that you should acquaint yourself with and regularly refer to.

 
  1. DOE Oil Inventory

The Department of Energy Oil Inventory report is released every Wednesday and measures the stockpile of oil in the U.S. Since the U.S. is the largest oil consuming nation, it is important for oil traders to regularly check their demand rates by referring to the amount of stock left in their oil inventory.

 
  1. OPEC Oil Market Report

The second oil report you should study is the OPEC monthly and annual reports. These reports provide insight on the production targets of OPEC countries. Their production targets and quotas reflect the current levels of supply and demand of oil in the world market.

 


Oil trading examples

 
Going long on WTI

Your research suggests that the demand for oil in China will soon increase and therefore you expect the oil prices to rise. You buy 1 lot of WTI at $56.95, which equals to $100 for every $1 movement in the price.

 

Your speculation proves to be correct. The price jumps to $61.95 and you decide to sell. Your profit is calculated by multiplying the difference between the opening and closing price with the Dollar value per increment, (61.95 - $56.95) x $100 = $500.

 
 
Going short on Brent oil

Despite attempts by OPEC to reduce oil market surplus and boost the global price of oil, your analysis suggests that the US shale oil industry will grow its supply and therefore you expect the price of Brent oil to fall.

 

You sell 2 lots of Brent oil at $52.50, which equals to $200 for every $1 movement in the price. A week later, the market is trading at $49.50 and you decide to close the position. Your profit is (52.350 – 49.50) x $200 = $600.

 

Oil is the most important energy commodity but far from the only one. Natural gas is another key commodity market widely used for trading diversification.

 

 

 
  • To understand the unique characteristics of the natural gas market, go to

  • How to trade gas






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