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How to trade crude oil: a quick guide
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Crude oil is often considered one of the most important commodities in the global economy, perhaps because it is a non-renewable resource. This means that it is impossible to naturally replace crude oil at the same rate that it is consumed. If you are beginning to consider trading crude oil for the first time, you should start by understanding what factors drive this limited resource.
Here are some of the main influences that can affect the price of crude oil:
- OPEC+ production and supply policies: The Organization of the Petroleum Exporting Countries (OPEC+) is an organization made up of 13 oil-exporting nations that enables the co-operation of oil-producing countries in order to influence the global oil market. OPEC+ member countries must agree on how much oil to produce, which affects the price of oil, as an increased supply means an increase in revenue.
- Supply and demand: The fundamental principle of supply and demand plays a significant role in determining crude oil prices. Increased demand for crude oil (such as when there is a cut in oil supply) immediately creates a rise in the price.
- Geopolitical events: Crude oil prices are usually thrown into the spotlight whenever there are geopolitical conflicts, such as war or an international pandemic. Political tensions and uncertainties between countries add a non-quantifiable risk premium, as refinery disruptions can affect supply and production from OPEC+ producers.
- Economic growth given its impact on global demand: While geopolitical events may have a short-term positive or negative impact, crude ultimately depends on global economic activity to drive demand. In addition, population growth, a rising middle class using more energy and urbanisation are also important factors.
- Inventory levels: A high level of inventories, either from already produced crude oil held in storage on land or at sea, or spare capacity held in the ground by producers, will help make the market less volatile given the ability to mitigate any short-term disruptions, while the opposite may increase price fluctuations.
- Speculation and market risk sentiment: Like other commodities, crude oil prices can be influenced by investor sentiment and speculative trading in commodity markets. Factors such as geopolitical tensions, trade disputes, and macroeconomic policy decisions can affect investor perceptions and lead to price fluctuations.
So how can you actually trade this popular commodity? Here are a few ways:
- Crude ETFs/ETCs: Tracking the prices of either WTI or Brent crude oil.
- Energy sector ETFs: Tracking a basket of major energy companies operating in exploration, refining and other energy related services.
- Crude oil futures, CFDs and options: Trading crude oil futures in WTI or Brent, contracts for difference (CFDs), or options involves higher risk due to leverage. While these products offer opportunities for speculation, they also require careful risk management to mitigate potential losses. The WTI and Brent crude oil futures both have a contract size of 1000 barrels, and with a current price around USD 90 per barrel, a contract value of USD 90,000. Being a leveraged product, the buyer or seller of a futures contract has to provide around USD 7,000 as collateral per contract, leaving the owner of the position highly exposed to losses without proper risk management. CFDs track the futures price with the main difference being the ability to trade smaller quantities than the 1000-barrel futures contract.
Now that you understand the factors that influence the price of crude oil, and the ways to trade it, you need to figure out if it’s a commodity that is right for you. The only way to do that is to consider your tolerance for risk, and time horizon, as well as your personal financial goals. Before making any investment, always be sure to keep yourself well informed with the latest market news and insights.
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