The Basics of Oil Trade
Updated: May 17, 2020
Crude oil is oil in its most basic form which is then further refined to produce gasoline, heating oil, jet fuel and a vast array of other petrochemical products that come in many different grades. The most common raw product is the ‘Light Sweet Crude Oil’ that is traded at the New York Mercantile Exchange. The other grade of oil that is traded in London is called the Brent Blend Crude. This grade is one of the other widely used benchmarks for the determination of the oil prices.
Crude Oil is one of the most traded commodities. It is also one of the most volatile commodities to trade and there are fluctuations in the prices even at the slightest hint of a change. Oil is the commodity that is most favoured by the day traders owing to its active and fluid nature.
The different grades of Oils are traded in different markets. For instance, the West Texas Intermediate (WTI) is the crude oil that is dug from the wells in the United States. The WTI is traded under the CL ticker which is on the Chicago Mercantile Exchange. The New York Mercantile Exchange’s Middle Eastern Crude is known as the Dubai and the Oman Oil. The Brent Blend Crude is the standard that is widely accepted around the world and is utilized by around 2/3rd of the oil trade that takes place around the world.
The Oil prices depend on demand, the supply is then relative to the demand of the oil around the world. The Oil Futures Contracts are agreements that are binding in nature and give individuals the right to purchase a barrel of oil at a predefined price that is set at a given predefined date in the future.
There are two types of traders who trade oil:
The shipping industry is one of the industries that would hedge oil futures to prevent any risk of future fluctuations in the price of oil. These are the companies that actually buy the oil from the market. Another example of a market hedger would be airline companies that would also buy oil futures to be secure against future potential rising prices.
Speculators are those who attempt to predict the direction of the pricing and have no actual intention in buying the product. In a statement published by the Chicago Mercantile Exchange, the majority of the oil futures are bought by the speculators versus the purchasers who actually take possession of the commodity are less than 3%;
As mentioned before the Oil Market is an active one with high velocity and volume of trading. This makes Market Sentiment another factor that makes the oil markets very volatile. The mere belief that the demand of oil will increase can increase the oil prices dramatically. Conversely, the belief that the oil demand will decrease in the future could lead to the drastic fall in the price of the commodity and lead to the selling of more and more oil futures.
Economics of Oil Pricing goes beyond the regular market forces of demand and supply as there are a variety of other factors that determine the price of oil per barrel and is impossible to assume that they all remain constant over the period of time. There is a large supply of the crude oil as it is economically viable for the companies to maintain a high level of production. This fact makes oil refineries the primary places that actually determine the global price of oil. The imbalance in production and the imbalance of the oil is what regulates the prices of oil in other countries. The production of oil may be high but the rate of the refinement of the oil simply cannot keep up due to how tedious the entire process is. Crude Oil in its raw form is something that cannot be consumed by machineries. The oil needs to be refined into its by-products for its efficient consumption.
40% of the global supply of oil is produced by OPEC. The OPEC is the Organization of the Petroleum Exporting Countries. The members of OPEC are Saudi Arabia, Iran, Indonesia, Venezuela, Iraq, Libya, Algeria, Nigeria, United Arab Emirates, Ecuador, Kuwait, Gabon and Angola. OPEC was founded in 1960 to primarily fix the oil and the price of gas. Considering the organization dominates the production level of oil they have a significant control over the price. Restricting the production of oil is one of the primary tools in their arsenal to manipulate the prices and the markets of oil around the world. There were times in the 70s and the 80s that OPEC would force the rise in the price to enjoy greater profits. This oligopolistic structure also allows OPEC to enjoy supernormal and is yet another factor determining oil trade.
Therefore there are a vast array of factors that come into play while determining the production rate of oil and thus making it impossible to pinpoint a conclusive determinant of oil prices in the global market. Making oil trade a practice of recurring occurrence yet one of the most perilous commodities to trade.
Author : Aviral Bhardwaj