Understanding the features of the oil trade
What is oil?
Oil is the most popular mineral in the world market. Not only gasoline is made from oil, but also clothes, household chemicals, cellophane, paints, bitumen, asphalt, about a thousand types of lubricants, tiles, fertilizers, cosmetics, and plastic. Everything else is made of 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. In Baghdad of the 7th century, tar was used for the construction of roads. On the basis of oil, the “Greek fire” was invented, famous for the fact that when trying to extinguish it with water, it flared up even more. Some species of whales were saved from extermination by the advent of kerosene, a product of oil distillation, which replaced whale oil in lighting lamps. Then, in the 19th century, the oil found its mass use, first in kerosene lamps and in the form of lubricants for the growing industry, later in the form of naval fuel oil and, of course, diesel and gasoline internal combustion engines.
Since the invention of the internal combustion engine, a boom in oil demand has begun. Since then, world oil production has been increasing, and prices have been rising. Oil as a source of energy has become comparable in value to gold in the financial sector, so they began to call it “black gold”. Oil, like gold, provoked “oil fevers” where it was found.
According to the Global Energy Statistical Yearbook 2018, 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 for a reason.
Why is it still a “barrel”?
Typically, the price of oil is determined 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 oil was produced in small volumes, it was transported and sold in barrels and wineskins of various volumes. In the second half of the 19th century, the demand for oil increased, and there was not enough capacity. Oil prices were indicated per barrel, and barrels could be of various sizes (used before beer, fish, molasses or turpentine oil), which was inconvenient. Finally, in 1866, oil producers from Pennsylvania, USA, decided to establish a standard oil container. Such a container was a 42-gallon barrel or a barrel in translation from English. Since then, an oil barrel equals 42 US gallons or about 159 liters. Although oil is now mainly transported by pipelines, tankers, and 55-gallon barrels, oil is still measured in oil barrels.
Where is oil traded?
Oil is traded on commodity exchanges, mostly using futures contracts. Many forex brokers bring their clients to other markets as well (other than foreign exchange) in order to allow them to diversify their investment portfolios, and offer CFDs for trading. When concluding such kind of contracts, there is no supply of raw materials – the broker and the client conclude an agreement that at the time the transaction is closed, the mutual settlement will be based on the correctness of the client’s forecast. Oil is almost the only raw material asset available for margin trading with any forex broker.
There are about 200 grades of oil in the world, each consisting of a mixture of crude oil from several fields. So, for example, Brent grade is a mixture of oil from fields in the North Sea, and Urals grade is a mixture of oil from fields in the Urals and Volga region. The main properties of the variety are the density of oil and its sulfur content. Some types of oil, such as Brent (according to the first letters of the field horizons – Broom, Rannoch, Etive, Ness, and Tarbert ), WTI (West Texas Intermediate) and Dubai Crude are called marker, or reference – 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.
Read more about the main marker grades of oil
- Brent (UKOIL, Brent Crude) is a marker grade of oil produced in the North Sea since 1970. This variety has become a marker due to the reliability of supply. Since the 1980s, Brent has been decisive for the pricing of many types of oil. In particular, in the early 2010s, he determined the price of 70% of all grades of oil in the world.
- WTI (West Texas Intermediate) is a marker grade of oil produced in Texas. It is mainly used for 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, in particular, because of the higher shipping costs from the USA, but in 2011 the situation changed, and now WTI costs $ 10-20 cheaper than Brent. Until now, the reasons for such a coup have not been clarified.
- Dubai Crude is a marker grade of 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 Gulf, which is available at any time.
Why is oil trading in dollars?
After the president of the United States canceled the gold supply to the dollar in 1971, after which the dollar devalued 17% against gold over 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 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 oil for US dollars. So, by 1980, 80% of world 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 trade had already taken place in dollars.
Forex oil: what determines the price?
The oil rate depends on many factors, the main reason for the price movement historically was either its oversupply or a shortage in the world market. Until the 1972-73, the price of 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 OPEC was established, 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 advent 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. And so it happened. OPEC began to really influence the market in the early 1970s. So, in 1973, OAPEC (Organization of Arab Countries – Oil Exporters – it includes the majority of OPEC members) reduced the volume of oil production, reacting to the support of Israel by many Western countries in its conflict with Syria and Egypt. The price of a barrel of oil rose from $ 2.59 to $ 11.65, and the global energy crisis has become 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 reduces oil production quotas for the participating countries, which means OPEC affects oil prices, although it does not establish them.
In addition to OPEC, “black gold” prices are influenced by various factors, such as:
- Weather conditions in oil production areas;
- OPEC oil production decisions;
- Volumes of oil supplies by countries not members of OPEC;
- Political factors. Due to the economic course chosen by the President of Venezuela, Nicolas Maduro, and political sanctions, oil production and refining in the country fell into decay. Venezuela produces about 750,000 barrels per day, with normal production volumes before the political crisis of 2 – 2.5 million barrels per day;
- The growth of the global economy. In the period from 2002-2003 to 2008, oil rose from $ 20 to $ 130, which was caused by rapid economic growth in the world and the ensuing shortage of money;
- Current supply and demand. So, in 2014 there was an excess of oil in the world. The price of Brent crude oil fell from $ 113 per barrel in June to $ 55 in December, and by January 2016, oil fell to $ 30 per barrel;
- Cost of oil production in future fields. The cost of producing a barrel of oil in some hard-to-reach fields can reach $ 80-90;
- Budgets of oil-exporting countries. The budgets of oil-exporting countries for the next year usually include the cost of oil, acceptable for these countries, to balance the budget.
When trading in oil, it is worth considering these fundamental factors.
Forex Oil Trading
Oil can also be traded on the Forex market. Trading here occurs with contracts for price differences, or 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. Novice traders can hardly afford to spend so much on their first steps in the world of trading. LiteForex presents two main marker grades of oil – Brent and WTI with high liquidity and volatility. The oil market lends itself well to fundamental analysis (the analyst can also be read without leaving the trading platform), and the LiteForex terminal has all the necessary tools for technical analysis. In addition, a daily technical analysis of oil (and not only) is published on the blog.