Over the past several years, oil futures have gained popularity. Anyone looking to dive into this market should have a great understanding of how the oil industry works. Also, they should know how to purchase oil futures to execute their first trade.
Crude Oil Fundamentals
By description, crude oil is the raw material that is refined to produce several products used in the real world. Some of the products include gasoline, diesel, and a huge assortment of petrochemicals. The refining process mostly needs almost 3 oil barrels to help in the production of 2 and 1 barrel of unleaded gas and heating oil respectively.
Various grades of oil exist and among them is the Light sweet oil. This oil ranks in the top categories of the major traded grades of oil and it can be linked to several reasons. First, it is very easy to purify the oil which leads to the creation of other products. This grade of oil is also traded on NYMEX.
Another notable grade of oil that is traded in London is the Brent Blend Crude which has attracted a lot of interest over the years. Concerning oil production, the US and two other countries rank at the top. A major benchmark that is used to determine oil prices is Brent.
Today, oil is majorly traded on different exchanges around the world. Its rise and fall in price can sometimes have a major impact on commodities like natural gas. This effect that arises from changes in price is evident in the prices of stocks and fiat markets.
Based on that aspect, the popularity of crude oil as a real market investment vehicle can be linked to the activeness of its market. Moreover, it can be traded as a futures contract and it is readily available to traders globally. The price of oil is unstable and it can vary even with a small piece of breaking news.
In general, you can invest directly or indirectly in crude oil. Here is how you can do that:
Direct Investment In Oil
Purchasing oil futures or options is a direct investment in oil. Futures contracts are generally an agreement to purchase a specific amount of an asset at a particular price and time in the future. Options contracts enable the investor to exchange oil at a specified time and date in the future. Any of these investments can be done on a commodities exchange.
Indirect Investment In Oil
Indirect investments in oil also exist. It is possible through investing in energy-based ETFs. The ALPS Clean Energy ETF (ACES), for example, together with Fidelity Select Natural Resources Port which is an energy mutual fund are some of the platforms that investors use to invest indirectly in the oil market.
These ETFs invest in companies that are active in the oil sector. Using the indirect investment method also lowers the risks involved. Many ETFs exist which are designed to serve the oil industry.
Some of them include but not limited to the VanEck Vectors Oil Refiners ETF, First Trust Nasdaq Oil & Gas ETF (FTXN), iShares Global Energy ETF (IXC), ProShares K-1 Free Crude Oil Strategy ETF (OILK), and Global X MLP & Energy Infrastructure ETF (MLPX). The primary idea in this strategy is to invest in oil by owning shares in multiple oil companies.
What To Remember When Diving Into The Oil Futures Market
Whenever you want to join this market, here is what you will need to remember:
Specifications Of Crude Oil Contract
Crude oil contracts have various specifications that new and existing traders should know. Here is an outline of the specifications:
- Trading time: 6 pm to 5 pm Eastern Time
- Months: Monthly
- Quote: Price for a barrel
- Size: $0.01 for a barrel
- Symbol: CL
- Contract size: A thousand barrels
- Exchange: NYMEX
Market Knowledge And Understanding
Although trading futures is highly profitable, cases of losses also exist. Nonetheless, the losses can be mitigated or avoided when the trader knows how the system operates. Beginners should avoid venturing into a trade of this kind.
First, trading futures needs the trading of a commodity on the day that it expires and at an agreed price. Additionally, holding a call and not taking the delivery of agreed oil barrels would result in the cancellation of the trade before its expiration.
How To Trade In Oil Futures
Many tips exist that can be used to guide traders who decide to dive into trading oil futures. Some of the tips for profitable trading include:
- It is advisable to keenly review economic indicators because it can help in determining future price movements.
- Always remember that the value of unleaded gas can easily impact the value of oil while trading and monitoring prices.
- During winter, demand increases for heating oil which results in a rise in prices. Thus, ensure that you keep track of the Northeast’s weather. The weather significantly contributes to the consumption of lots of heating oil compared to the other regions.
- The demand for crude oil futures is higher during summer and even in winter. Nevertheless, the reasons differ. During summer, demand is higher as a result of more driving and an increasing need for crude oil. Therefore, it is responsible for the spike of its value.
- While trading, monitor any reduction or increase in oil prices by OPEC because it will eventually affect the demand and supply of crude oil worldwide.
- You will also need to familiarize yourself with the major market players in the futures market. Hedgers and traders exist in this market. Both of these categories of traders are the major participants in the market. Apart from the big players, there exists a group of small traders and investors. This group may have some impact on the energy futures market, even though it does not happen in all markets.
Volatility In The Crude Oil Futures Market
It is not surprising that news may come up overnight which may cause a huge disparity in oil prices. The changes can happen during the day or at night since the trading of these futures happens at both times. Additionally, the price swing may happen despite the in-depth analysis or prediction of even the most experienced trader.
Some of the news that may result in significant influence on the market includes the pandemic news, economic reports, or even issues in the Middle East. Based on that, any change in oil supply can also affect the prices of the futures. There is also the emotions from the investors at play and mainly on the part of the small investors who mostly are day traders.
In that connection, issues that come up in the Middle East and several other pieces of news may make traders act instantly based on that specific news. The traders may also adjust their trading strategy which, in turn, causes significant price fluctuations. Moreover, crude oil contracts and oil firms are sensitive to factors like demand, production, supply, interest rate policies, and much more.
Crude Oil Price Movements
The crude oil price movements can sometimes be connected to short or long positions by the traders. Thus, a rapid movement in price may make the investors who had sold to quickly buy back when the prices spike. This long may eat into their profit or cause losses.
Interestingly, a long is done by placing orders to buy. The increased buys are done concurrently when speculators rush into the market to buy in too. But, investors who had sold can quickly buy since there is a higher risk involved in not re-entering a market position.
Furthermore, a major development that affected supply may mean that the shorters are suffering a high loss. In case that happens, it could cause a margin call. That means more losses on the part of the individual. The oil market is also vulnerable to psychological swings which result in upwards and downwards bias.
Apart from that, any trader who is trading using trends can enhance their potential for profits. You should also note that the price may trade in a particular range for a long time after a major price movement. Thus, any investor who can spot out a range can benefit from the opportunities available to buy at low but sell at high.
Some investors use this trading method in a range and trend until the price breaks out. Hence, any investors bidding may also affect the price of oil markets. That means demand and supply are not the only factors that drive the prices. The wealthy investors are also majorly active traders of oil futures. They may decide to hold the future for the short or long term.
Nevertheless, investors who swing trade oil futures in the short-term are believed to affect and contribute to price swings in the short term. Also, there are opinions that their effect on the market is highly minimal.
The US dollar value is also another factor that majorly contributes to price movements. Whenever the dollar value is high, the pressure is mounted on the price of oil. On the other hand, low dollar value helps in increasing oil prices.
In the case that the economy and the stock market are growing, the price of oil can also rise. But, the economy can be significantly stifled if the prices are overly too high. The trend may become a worrying factor for prices that are increasing towards the psychological price point of $100 per barrel.
In most cases, the day traders have made the oil markets their favorite trading ground. These types of investors look out for support and resistance and several other pivot points. Trading risks are minimized by placing stop orders whenever the oil market price reaches a certain level.
Thus, any risks of rapid swings up and down can be controlled with the stop orders. By that effect, the traders need to set stop orders to guarantee that their risk is mitigated to the lowest levels.
Oil Futures Trends
Oil entered a bearish market in 2014 resulting in massive drops in oil prices. Price per barrel at that time was around $108 and that was on the NYMEX. Nonetheless, a major decline followed to below $30 a barrel for the WTI crude. The price per barrel was about $28 in April 2020.
The recent drop is a result of the price war that exists between Saudi Arabia and Russia. The war resulted in excess oil supply in the market. In the United States, the oil price hit a 21-year low due to the coronavirus pandemic. The lockdown in countries around the world resulted in an extensive drop in demand for the asset. That impacted negatively the price of oil.
The fall in demand resulted in more selloffs at lower prices. The massive fall in the market was seen in some of the indexes like the Brent Crude index. These indexes took a huge beating especially when dumping happened on April 19, 2020. Brent Crude index lost 2.85% when the price of an oil barrel was priced at $27.28.
It seems all gloomy for the Brent Crude index market that has lost about 60% in the last year although there has been some correction over time. That decline was reported of the WTI that lost about 21% and hit lows of $15 per barrel. The price dump was not the last since the WTI oil plunged to $11.33 per barrel hours later.
Apart from the COVID-19 pandemic, another significant reason for the drop in oil prices is the uncertainty that is looming around the excess storage of oil. This occurrence resulted in an overflow of the oil reserves throughout the world due to the falling use of oil in locked down economies.
Risks Involved In Crude Oil Futures Investment
Investing in the oil industry can be profitable if it is done correctly. However, there are various risks that traders must be wary of to avoid losing their investment. Some of the risks include:
Commodity prices tend to fluctuate depending on the market conditions. Volatility causes risks to investors in the oil and gas industry. The level of volatility was significantly high between 2014 and 2015 resulting from the high-level supply of crude oil.
If you decide to invest indirectly in oil through the purchase of shares in an oil company, there is a risk of oil spillage. In that scenario, an accident can result in an oil spill. If it happens, it could make the company’s shares fall considerably. One recent example is BP (Deepwater Horizon oil spill) whose shares plummeted considerably after an oil spill almost ten years ago.
Before that oil spill, the company’s stock was worth $60. But, after the spill, it dropped to $26.75 translating to a loss of 55%. Apart from the declines in shares, British Petroleum encountered multiple lawsuits as a result of the effects that the oil spills caused. For example, 4.9 million gallons were released into the Gulf of Mexico. That affected marine life in the area negatively.
Exxon also experienced an oil spill when an accident with its Valdez tanker happened in 1989. But, that event never affected the stock markets considerably. Having lost about 3.9% after the oil spill in the water, the stock value corrected to levels that it once traded at.
Oil companies pay dividends to investors at times which act as incentives to these investors. But, companies sometimes do not pay dividends whenever revenue has declined. Lower-income may arise from low earnings in product sales which bring about the need for a dividend cut.
Some companies have cut dividends and went away with it while others have cut the dividends and it hurt their stock price. One such company is Seadrill that cut dividends in 2014 resulting in a 50% drop in its stock price.
It is easy to invest in the oil futures market when one has the right information and expertise. Direct and indirect investment strategies are available. Nonetheless, the volatile nature of the prices may result in huge losses if a trader does not take time to understand the current conditions in the market before trading.
To help minimize losses in this market, stop orders are available. But, experts advise that investors should do thorough market research and read the news to determine the future price movements to minimize risks of losing their investments in the oil futures markets.