Crude oil is one of the life-blood commodities critical to the global economy. After refining it can be, and is, used to power cars, trucks, airplanes, and other vehicles. Other fractions are key energy sources for ships, heating and electricity – some even end up as asphalt.
As well as such energy uses petroleum and its products are used to manufacture plastics – largely being replaced with natural gas now – and any number of household items like detergents and paint. It is not, however, the multiple uses that make crude oil such a favored instrument for investors. Rather, that it is so important and intertwined with the global economy makes the price volatile. Where there are price changes it is possible to profit, after all.
Here we'll discuss various different ways to invest and trade in crude oil and how crude oil trading can be done with Contracts for Difference, CFDs, on Mitrade.
Crude oil comes in various different types, the two main differentiators being weight or viscosity (so, there are light and heavy crudes) and sulphur content (there are “sweet” or “sour” crude oils). Different regions tend to produce different types – the Orinoco Belt in Venezuela produces a very heavy, sour, oil, the North Sea a light and sweet, just as examples.
Oil then tends to get classified according to its source. This is both because of these types and as a guide to transport issues. The major classifications all have their own “benchmark” prices. So, we can have WCS (Western Canadian Select), Urals, OPEC Reference, Tapis, Bonny Light, Brent, WTI (West Texas Intermediate), Dubai Crude, and Isthmus.
Each different type, heavy or light, will produce different amounts of petroleum or ship bunker fuel – again, just an example among the many different products. Transport will also change. The events in Russia and sanctions have made Urals worth less than non-Russian oils. The US allowing the export of crude oil raised the relative price of WTI. Changes in gasoline demand with respect to ship fuel will change the value of heavy and light oils.
These benchmark and spot prices are therefore in constant movement in relation to each other. A universe of constantly trading prices is just what we desire as traders – it is price changes we desire to trade, after all.
USOIL price chart from mitrade▼
Brent Oil price chart from mitrade▼
The crude oil price remained relatively steady from the dawn of the oil age in the mid-19th century up to the 1970s. Of course, the value of the dollar changed over that time but the nominal crude price didn't very much. Then came the “Oil Price Shock” as oil producers realised their economic power. Since then we've had a highly volatile global crude oil price.
Crude Oil Prices - Historical Chart
The highest crude oil price does depend upon which benchmark we want to align with. The highest international price was $184.94 a barrel in July 2008. Because the US did not allow the export of crude at this time WTI, the main inside the US benchmark was much lower.
On 20 April 2020, WTI Crude futures dropped below $0. This was more a function of the futures contract delivery date and a lack of available storage than anything else. The following day Brent dropped below $20 a barrel – useful proof of the fact that different benchmarks for crude oil can have very different price movements.
We did, of course, have a significant reduction in economic activity during the coronavirus lockdowns. As these things work a reduction in economic activity leads to a reduction in demand for oil and thus lower prices across the board for crude oil. It's a global market and one in which supply is relatively inelastic – once you've started pumping from a well you don't stop doing so.
As a result of this, there was a price war going on between Russia and Saudi Arabia (really, all of OPEC, but Saudi is the swing producer here, the one that varies its production the most). Russia didn't want to reduce its production of crude oil, the state budget is based upon the tax collected. Saudi Arabia wished to punish Russia for not so curbing production and so continued to produce at the full rate, driving the price down.
This drove the global oil price down but as above, some benchmarks more than others. The specific April 20th issue was the maturity date of the US futures contract leading to considerable quantity suddenly becoming available. Yes, the price really did go negative, some producers had to pay to have their oil transported away.
Crude oil is the most actively traded commodity in the world which means there's certainly the liquidity to make trading easy. The price is also volatile – it changes often and a lot – and trading is about being on the right side of price changes. So, yes, there certainly is a possibility of usefully trading in crude oil.
Commodities can be much more risky than stock markets though and oil riskier than many other commodities. So there needs to be a careful consideration of risk appetite before entering the market.
It's only really possible to answer the question of whether to invest or trade in crude oil by considering the trading strategy of the individual investor. That singular calculation of an acceptable risk/reward ratio.
If you wish to invest in oil with little money then there are, essentially, two different ways.
It is possible to take a very small position, which will cost very little money. But a small position will also - whether we’re trading crude oil or anything else - also produce little profit when we get the position correct.
The other way is to use leverage. To borrow to increase the size of our position. Leverage can be done in several different ways. A future or option is leveraged so that price changes are magnified. Or it’s possible to specifically borrow money in order to buy stocks or an ETF - so-called “margin trading”. A Contract for Difference (CfD) provides yet another way. Because the trade is purely upon the immediate price then they entry fee into that trade is low, but obviously at a higher risk.
An Exchange Trade Fund is a company that sits between us, the investor or trader, and the underlying assets. ETFs exist for near every variation we might want to trade and oil-based ones run the whole spectrum. There are oil-based ETFs which hold stocks and shares of oil companies. We buy shares in the ETF and this gives us a portfolio of oil company stocks – rather like a mutual fund.
There are other ETFs that are in crude oil futures, some in options even. These, by design, are not for long-term holdings but for short-term speculations, possibly even only intraday.
The share or stock prices of Exxon (NYSE: XOM) or BP (LON: BP.) are clearly going to be influenced by the price of their major output, crude oil. So, it's possible to buy oil company shares as either an investment in or a trade upon the price of crude oil. As with all commodity-producing firms, there is an inherent leverage here, the share price will move more than the oil price.
Note that it is possible to invest – that is, take long-term positions – here and look for the income from the dividends as well as trade for price movements and capital gains.
A Master Limited Partnership is more like buying into a specific well or oil field. The difference between an MLP and simply buying corporate shares or stocks is more to do with the tax laws surrounding them than anything else. There is a variation here, where MLPs are commonly listed and available to individual investors, which is in the transportation, storage, and pipeline areas of the industry.
Hess Midstream (NYSE: HESM) for example collects, stores, and exports, but does not drill directly. The economics of this business are not particularly dependent upon the price of crude oil itself so while they are crude related they often don't move in tandem with the oil price.
As with any large commodity market, there are also futures markets in crude oil. These are the contracts which went negative on April 20th above on their delivery date – there's considerable risk with futures. There are futures contracts on most of the benchmarks, indeed that's what the different benchmarks are for. Brent and WTI particularly exist so as to have a standardized product and delivery point for, respectively, North Sea and Texas oil that futures contracts can be built upon.
When we talk about a “commodities exchange” this is normally what we mean, an exchange which trades commodities futures. A future is a contract drawn up now to agree to buy and sell, respectively, at a predetermined price at some future date. That future will then vary in value over the term of the contract depending upon what the underlying physical price of the same commodity is doing. The important risk factor to know about futures is that you can lose more than your starting position. That is, not only can you lose money you can lose more than you originally started with.
WTI is traded on the New York Mercantile Exchange (NYMEX) and Brent futures on the Intercontinental Exchange (ICE) London.
In theory, a CFD can be written on absolutely any price – of a stock or share, a future, an MLP, an oil benchmark. As a CFD is a derivative product all that is required is a willing market and a liquid underlying instrument. In practice, CFDs are in larger markets simply because that is what more people want there to be CFDs in. A CFD in more detail is simply a derivative trade upon the price of an instrument. As that underlying price changes – the share, future, benchmark – then the CFD creates a profit for one side of the bargain and a corresponding loss for the other side.
In this CFDs resemble futures but with some differences:
A CFD is on a one-to-one basis with the underlying financial instrument
A CFD has no expiry date – it's possible to allow the position to run as long as desired
CFDs can be very much smaller than futures or options – one single unit is possible in a CFD
The universe of CFDs can encompass any underlying which has a changeable price – even cryptocurrencies
CFDs are not traded through an exchange but over the counter (OTC) with a CFD broker
CFDs are not available to US residents – the SEC doesn't allow them.
Crude oil CFDs will suit traders who wish to speculate on the price of oil without owning any of the underlying assets. CFDs also allow substantial leverage. This allows the risk-tolerant to make short-term trades in a straightforward manner on the future direction of crude oil prices and oil-related instruments.
To go short is to be predicting a price fall in the instrument being traded, to go long is to assume a future price rise. CFDs allow speculation on price movements in either direction, which is just a matter of specifying the contract in the right way. This is not always true of other instruments – there can be difficulties in going short on stocks and shares for example.
A trader thinking that prices will decline will go short on oil, one who is predicting a rise will go long. The CFD broker will offer a price and a spread either way which is one of the advantages of the technique.
It is often possible to gain credit from the broker to maximize the effect of price movements. This is known as “leverage”. The concept is that borrowing to increase the size of the position is like a lever. As with real-world levers, this does increase the strength of the price movement – but it also increases losses as well as profits. Leverage in oil CFDs is entirely possible but needs to be considered properly as part of a risk management system.
Another use of CFDs is to hedge an exposure to the underlying. This is also as with futures – major market participants are those who own actual crude oil and wish to lay off the risk of their doing so. A trader with a position in oil shares, ETFs, even futures, might well back that position with a CFD operating the other way – long as opposed to short, or vice versa – in order to provide risk insurance to the main position.
Step 1: Open a Trading Account
To trade anything on Mitrade, obviously, you need a Mitrade account. You can open a Mitrade account here.
Step 2: Deposit funds
With CFD trading you do not pay the full cost of the position. However, as with futures, you must provide margin – the minimum amount to be able to open the trade. The funds you need to deposit will depend upon the position you want, any associated leverage, and so on. On Mitrade, just to give an example, a minimal position of 0.01 lit WTI oil would require a deposit of $5 to be able to open the position.
(place a buy order on mitrade)
Step 3: Place a buy or sell order
Or, in other terminology, place that short or long position. Which you do will depend upon your views of the crude oil market – is it going to rise or fall? You can do this through the mobile trading app or the online web trader.
Step 4: Track the CFD position, take profits, and stop losses
CFDs are derivatives and usually use leverage. Therefore prices can move quickly. It's necessary to regularly monitor prices and positions so as to be able to take profits and also stop losses as necessary.
There's a thought that CFDs are highly complex but this isn't, not really, quite true. What CFDs are is highly risky. The reason for this is that CFDs use leverage – that borrowing to increase the position size and so the exposure to price changes. The higher the leverage then the faster the price changes are multiplied and so the greater the risk.
Experienced traders and investors will find the maximal leverage highly useful and often profitable. The speed with which maximum leverage can change positions makes it important that inexperienced traders monitor their positions and create stop losses,
It's this, the leverage, which makes CFDs instruments that leave no room for misunderstandings or trading errors. The wrong position can be wiped out in its entirety. The use of leverage means that a trader can lose more than the initial capital put up for the trade. Inexperienced traders are advised – strongly – to practice in a demo account before using real – or their own – money.
Despite all of these risks, CFDs are a popular method of trading financial markets, crude oil and derivatives among them. The low barriers to entry and the ability to select the desired instrument make this so. For traders who are on the right side of their positions, there are potential profits. However, all traders need to be cautious and research each trade prior to entering into it, before the execution of it. Leverage both magnifies and multiplies, profits on the upside and also losses on the down.
One of the joys – and difficulties – of predicting the crude oil price is that near everything is important to it. Politics, interest rates, the state of the economy in general, war, inventories and, of course, what everyone else is doing in the same market. The following indicators are worth looking at when trading oil:
The Organisation of Oil Exporting Countries (OPEC)
Politics really matter to the oil price
The economy in general
Derivatives and reporting on oil
There are predictions of what the oil price is going to be in the future. The International Energy Authority (IEA), the International Monetary Fund (IMF), and the rest of the alphabet soup – OPEC, OECD, and so on – all try their hand at predictions a year and more out. This is less helpful than we might think. They're not right any more often than anyone else is one issue. Another is that even if we did believe their predictions then they would already be in price. The efficient markets hypothesis (EMH) tells us that.
The reality is that long-term predictions of the oil price don’t have a good record – simply because there are so many things that influence the crude oil price.
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