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:
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
Going long on WTI
Oil trading examples
Going short on Brent oil
Your research suggests that the demand for oil in China will soon increase, and therefore, you expect that oil prices will rise. You buy 1 lot of WTI at $63.95, which equals to 100 barrels of oil, or $100 for every $1 movement in the price.
After some overnight news that new supply from US shale oil producers is coming to the market, your speculation proves to be incorrect. The price drops from to $63.95 to $62.20 and you decide to sell. Your loss is calculated by multiplying the difference between the opening and closing price with the US dollar value per increment, (63.95 - $62.20) x $100 = $175.
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.