Frequent fluctuations in oil prices have made many people think about ways to buy and sell oil and potentially make some profit for themselves. But does that mean that you need to buy and hoard oil barrels to be able to sell them when the prices rise? Well, no, since you can be trading oil via futures trading, which allows traders to buy and sell oil at a future date at a pre-specified price.
Such contracts do not involve physical possession of oil. Another way to get involved with trading oil is to invest in exchange traded funds or ETFs that are traded on exchanges, just like stocks. Buying Contracts for Difference or CFDs is another way of venturing into oil trading. Here are some important things that one needs to know before trading oil.
Oil and its Types
An important thing to know about oil trading is that oil can be of different types, some are light, others are heavy and, therefore, priced differently. But then, how do you trade oil? This is possible through the setting of benchmarks as a price reference for all types of oil. The most popular benchmarks for oil trading are the Brent and the WTI or ‘West Texas Intermediate’. These two varieties of oil are in high demand.
While Brent refers to the North Sea oil, WTI (also called light sweet crude oil) originates in the US Permian Basin and is available in abundance. The price of the two varieties differs because of their different supply levels. While US oil production has risen, with advancements in shale and fracking technology, Brent drilling has undergone a decline in recent years.
Oil prices can be spot prices or futures prices, wherein spot prices refer to the current market price for the immediate delivery of oil. Futures contracts refer to contracts calling for the sale of oil on a future date, at a specific price. Futures contracts allow both the buyer and the seller to safeguard themselves against the risk of price changes.
Trading crude oil futures can be done on the New York Mercantile Exchange (NYMEX) and Tokyo Commodity Exchange (TOCOM). The prices of NYMEX Light Sweet Crude Oil futures and Brent crude futures are quoted in dollars and cents per barrel and are traded in lot sizes of 1,000 barrels (42,000 gallons). The prices of TOCOM Crude Oil futures are quoted in yen per kiloliter and are traded in lot sizes of 50 kiloliters (13,210 gallons).
Factors Driving Oil Prices
As with all other commodities, the demand and supply for oil are the primary factors driving its price. Increased demand means higher prices and increased supply means lower prices. While the demand for oil continues to increase, supply is determined by several factors. Often oil producers restrict the supply of oil to maintain prices, while political changes, wars and other factors may lead to uncertainty about supplies at a particular time, leading to changes in price.
The price of oil is also linked to the value of the US dollar and thus any change in the value of the US dollar has an impact on oil prices. Overall market sentiment also plays a key role in driving oil prices. If the traders believe that the oil supply is going to fall, even though it may not, prices may shoot up.
Traders also need to know that oil prices are highly volatile and therefore, oil trading involves a lot of risk.