Understanding Crude Oil Trading

What is crude oil?

Crude oil is the most popular fossil fuel in the world market. Not only gasoline(diesel) is made from crude oil, but also clothes, household chemicals, cellophane, paints, asphalt, about a thousand types of lubricants, tiles, fertilizers, cosmetics, and plastic. Everything else is made from plastic.

Oil has been known to mankind since at least the seventh millennium BC. In ancient Babylon, bitumen was used in the construction of buildings and the sealing of ships. It is believed that it was also used in the construction of the Hanging Gardens of Babylon. Baghdad of the 7th century used tar for road construction. On the basis of crude oil, the “Greek fire” was invented, famous for the fact that when trying to extinguish it with water, it flared up even more. Some types of whales were saved from extermination by the advent of kerosene, a crude oil distillation product that replaced whale oil in lamps. Then, in the 19th century, crude oil found mass use, first in kerosene lamps and in the form of lubricating compounds for the growing industry, later in the form of naval fuel and, of course, diesel and gasoline internal combustion engines.

Since the invention of the internal combustion engine, a boom in crude oil demand has begun. Since then, world crude oil production has been increasing, and prices have been rising. Crude oil as a source of energy has become comparable in value to gold in the financial sector leading to the new name for it – “black gold”. oil, like gold, provoked its “rushes” in the places where it was found.

According to the Global Energy Statistical Yearbook 2018, crude oil is the most demanded energy resource in the world, which is why oil instruments are one of the most actively traded in the financial markets.

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Why do we use the term “barrel”?

Typically, the price of crude oil is counted in US dollars per barrel. We are used to hearing the word “barrel”, but how much is a barrel, and what is it all about?

While crude oil was produced in small volumes, it was transported and sold in barrels of various volumes. In the second half of the 19th century, the demand for crude oil increased while there was not enough containers. Crude oil prices were indicated per barrel, and barrels could be of various sizes (used before for beer, fish, molasses or turpentine oil), which was inconvenient. Finally, in 1866, oil producers from Pennsylvania, USA, decided to establish a standard crude oil container. The choice fell on a 42-gallon barrel. Since then, one oil barrel equals 42 US gallons, or about 159 liters. Although crude oil is now mainly transported by pipelines, tankers and 55 gallon barrels, it is still measured in barrels.

Where do I trade it?

Crude oil is traded on commodity exchanges, mostly using futures contracts. Many forex brokers bring their clients also to other markets (in addition to foreign exchange) in order to allow them to diversify their investment portfolios, and offer CFDs for trading. When buying something this way, there is no supply of raw materials – the broker and the client arrange an agreement that at the time of closing the transaction will be settled based on the accuracy of the client’s forecast. Crude oil is perhaps the only raw material asset available for margin trading with any forex broker.

There are about 200 types of crude oil in the world, each consisting of a mixture of crude oil from several oil fields. So, for example, Brent is a mixture of crude oil from oil fields in the North Sea, and Urals is a mixture from oil fields in the Ural region and Volga region. The main properties of any variety are density and sulfur content. Some types, such as Brent (according to the first letters of the oil fields – Broom, Rannoch, Etive, Ness and Tarbert), WTI (West Texas Intermediate – WTI) and Dubai Crude are called benchmark crude, or marker crude – they have a constant composition and sufficient liquidity in the commodity market. Quotes for these grades are used to determine oil prices in the rest of the world.

More about the main marker grades of crude oil:

• Brent (UKOIL, Brent Crude) is a marker crude oil produced in the North Sea since 1970. This variety has become a marker crude due to the reliability of supply. Since the 1980s, Brent has been decisive for the pricing of many types of crude oil. In particular, in the early 2010s, it determined the price of 70% of all crude oil in the world.
• WTI (West Texas Intermediate) is a marker crude oil produced in Texas. It is mainly used in the production of gasoline, and is in high demand in China and the USA. The composition is close to Brent. For a long time it cost more than Brent because of the higher shipping costs from the USA, but in 2011 the situation changed, and now WTI costs $10-20 cheaper than Brent. The reasons for such a drastic change have not yet been clarified.
• Dubai Crude is a marker crude oil produced in Dubai. It became a marker due to the reliability of supply. It is one of the few grades of oil produced in the Persian Gulf area which is available at any time.

Why is crude oil trading in dollars?

After the President of the United States stopped the backing of the dollar with gold in 1971, the dollar devalued against gold by 17% in two years. Then, in 1974, William Simon, the U.S. Treasury secretary under the Nixon administration, reached an agreement with Saudi Arabia that it would sell crude oil in dollars and invest these dollars in the American economy, and for that would receive military assistance and protection of oil fields. Following the example of Saudi Arabia, in 1975, all OPEC member countries began selling crude oil for US dollars. So, by 1980, 80% of the world’s oil was sold for dollars. This situation did not last long, however, it occurred precisely at the time of reformatting the oil market for exchange trading, where all trading had already been in dollars.

Crude oil on Forex: what determines the price?

The oil rate depends on many factors. Historically,the main reason for the price movement was either its oversupply or a shortage in the world market. Until 1972-73, oil was cheap; its price charts were not even similar to the charts of other commodities, which fluctuated throughout the year and especially during the world wars. In 1960, in Baghdad, the Organization of Petroleum Exporting Countries (OPEC) was founded, on the initiative of five oil producing countries: Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.

Before the creation of OPEC, the oil market was controlled by seven multinational corporations that kept the oil price at a stable low level of 1.5–3 US dollars per barrel, which was beneficial for the western countries where these companies came from. The so-called “seven sisters” included: British Petroleum, Exxon, Gulf Oil, Mobil, Royal Dutch Shell, Chevron and Texaco. With the arrival of OPEC, the situation in the oil market has changed. OPEC countries, for which, in most cases, oil was (and is) the main source of income, it was more profitable to raise the price of oil artificially and earn many times more. This is what happened. OPEC began to really influence the market in the early 1970s. So, in 1973, OAPEC (Organization of Arab Petroleum Exporting Countries – it includes the majority of OPEC members) reduced oil production in response to the support of Israel by many Western countries in its conflict with Syria and Egypt. The price per barrel of oil rose from $2.59 to $11.65 and the global energy crisis became the largest in history. As a result of this crisis, many countries began to create strategic oil reserves. In the US, such stocks make up a 3-month import volume.

Now, according to OPEC, the organization controls about 2/3 of all world oil reserves. Of course, the price will rise if OPEC cuts oil production quotas for the member countries, which means OPEC affects oil prices, although it does not establish them.

Apart from OPEC, the prices of “black gold” are affected by multiple factors, such as:

• Weather in the oil production areas;
• OPEC decisions on oil production;
• Production volumes of non-OPEC countries;
• Political factors. Because of the economic decision made by the current President of Venezuela, Nicolas Maduro, and political sanctions, oil production and refining have declined drastically. Venezuela produces 750,000 barrels per day, while the usual production volumes before the political crisis were at the level of 2-2,5 mln barrels per day;
• Global economy growth. In the period from 2002-2003 to 2008 oil increased in price from $20 to $130, this was due to vigorous economic growth and subsequent lack of money.
• Current supply and demand. In 2014, there was an oversupply of oil in the world. Brent price decreased from $113 per barrel in June to $55 per barrel in December, in January 2016 the price decreased to $30 per barrel;
• Production costs on the future oil fields. The cost of production of a barrel of crude oil might reach $80-90 on the oil fields difficult to access;
• Budgets of exporting countries. Often, the crude oil price that is acceptable for an exporting country is already budgeted in for a better balancing;

It is necessary to take into account these fundamental factors.

Trading crude oil in the Forex market

Oil can also be traded in the Forex market. Trading is being done with CFDs (contract for difference), and you can start trading with even a minimal deposit. This is an important point, since the commodity exchange has a high threshold for a minimum purchase of oil – 10 barrels, and this, at the moment, is more than $600. Beginners can hardly afford to spend so much on their first steps in the world of trading. LiteForex presents two main marker crudes – Brent and WTI, which have high liquidity and volatility. The oil market can be very well analysed fundamentally (analyses can also be read without leaving the trading platform). LiteForex terminal has all the necessary tools for technical analysis as well. In addition, a daily technical analysis and forecast for oil (and not only) is published on the LiteForex blog.

I wish you profitable trading!

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