The Modern Oil Market: Trading the World’s Most Valuable Commodity
Why Is the Supply and Demand of Crude Oil So Important in Geopolitics?
If you’re interested in keeping up with world economic news, you’ll often hear talk of the price of oil changing in response to global events.
When it’s presented as a simple statement in this fashion, it’s easy to think of crude as a single, homogeneous product — however, there are dozens of categories of crude oil traded on the energy market, each with their own distinctive properties.
As a general rule, the lower density and ‘sweeter’ the oil — that is, the lower its sulphur content — the easier is for refiners to turn it into gasoline for power stations and vehicles, and therefore the more valuable it is considered.
The source of the oil is also a factor in need of consideration, as the more logistically tricky it is to transport, the more the consumer will have to pay for delivery; for this reason, oil extracted at sea is often seen as preferable to land-based sources, which are dependent on pipelines with finite capacities.
Understanding the Different Types of Crude Oil
Being a natural resource, crude oil products from different sources vary considerably in terms of their intrinsic characteristics; Energy Intelligence Group’s 2011 handbook identified more than 190 distinct major crude streams and blends from different geographical regions around the world.
Most notably, different types of oil contain different levels of sulphur, which dictate how much processing is needed to turn it into energy products such as gasoline; ‘sweet crude’ is the most coveted type in this regard, which is defined by a sulphur content under 5%.
With such apparent variance in the compositional makeup (and availability) of different types of oil, buyers and speculators need benchmarks that allow them properly assess to value of the product they are being offered.
Accordingly, the three most widely known forms — West Texas Intermediate (WTI), Brent and Dubai (or Oman) — are often used as pricing examples for all other crude variants to follow.
Keep in mind that the laws of supply and demand mean the value and asking price of these benchmark categories is always changing, and types that once commanded a high price may gradually become discounted (and vice versa).
Here’s a brief overview of the big three categories:
West Texas Intermediate (WTI)
WTI crude is mainly extracted from wells in the Midwestern and Gulf Coast vicinities of the US and transported via pipelines to Cushing, Oklahoma, a small town that has become America’s primary crude trading hub due to the famous Cushing Oil Field.
The primary benchmark for oil products consumed in the US, WTI oil is characterised by a composition that is very sweet and low density with a remarkably low (approximately 0.24%) sulphur content. It also has an API gravity of around 39.6 and specific gravity in the region of 0.827, all of which make it ideal for gasoline production and it is commonly sought after by refiners for this purpose.
Despite its useful characteristics, a drawback with WTI crude is that its supplies are landlocked — with most drilling taking place in land — making it awkward and costly to ship around the globe.
From a geopolitical perspective, however, the fact most WTI crude is consumed domestically (ie. within the US itself) makes its price and overall stability less sensitive to international tensions than other major crude types.
Further reading: https://www.investopedia.com/terms/w/wti.asp
Brent
The leading global price benchmark for Atlantic basin oils, the term ‘Brent’ covers crude from four separate North Sea locations: the titular Brent field, along with the nearby Forties, Oseberg and Ekofisk fields.
Brent is the category of crude most commonly used as a value marker around the world — with an estimated two-thirds of all oil contracts making reference to it when determining price — in addition to being the primary oil benchmark for European countries.
Like WTI, crude from these regions is light and sweet — though often less so than WTI — with a sulphur content of around 0.37%, making it useful for producing diesel and similar middle distillates.
The fact it’s extracted at sea also makes it easy to transport worldwide when required; for this reason, it generally trades at a higher price than US oils, fetching around $4 per barrel in normal market conditions, compared with $2.50 for WTI.
Further reading: https://www.dailyfx.com/crude-oil/wti-vs-brent.html
Dubai/Oman
A Middle Eastern crude oil that is somewhat heavier, this ‘basket’ product comprises crude from the Dubai, Abu Dhabi or Oman areas and is sometimes used as a benchmark for slightly lower grade oils.
Classified as ‘sour’ in contrast with the above sweeter variants, Dubai crude has an average sulphur content of 2% and a specific gravity around 0.871.
Dubai/Oman crude is commonly relied upon as a value reference point for oil from the Persian Gulf intended for delivery to the Asian market, where it is traded on the Tokyo Commodity Exchange (TOCOM).
Indeed, Dubai oil is especially prominent in the region as it is one of the few Persian Gulf crudes available immediately, and it is usually traded in JPY as its main exchange unit as opposed to the USD.
Further reading: https://www.forbes.com/sites/rrapier/2020/01/07/how-much-oil-do-we-import-from-the-middle-east/#5fede13021c6
In addition to these three major benchmarks, there is also another major indicator known as the OPEC Reference Basket (ORB), which is a weighted price average of petroleum blends originating from a cooperative group of nations known as OPEC.
Never heard of it? Let’s take a further look:
OPEC: A Brief Historical Overview
The Organization of the Petroleum Exporting Countries (OPEC) was established in September 1960 in Baghdad, Iraq, and has been headquartered in Vienna, Austria, since 1965.
Primarily centred around the Middle East and Africa with some South American input, the group was set up by five original members — Iran, Iraq, Kuwait, Saudi Arabia and Venezuela — and currently comprises a total of 13 nations. Presently, the collective includes its founders along with Algeria, Angola, Equatorial Guinea, Gabon, Libya, Nigeria, Republic of Congo and the UAE; former participant Ecuador withdrew on 1st January 2020 due to ongoing internal financial turmoil.
A major force in the international oil market, OPEC was collectively responsible for an estimated 44% of all oil production worldwide in 2018, and is said to possess more than 80% of the world’s global ‘proven’ oil reserves.
The official stated mission of the organisation is to keep oil prices stable through closely coordinating production and exportation policies at an international level — although critics suggest this close collaboration has instead led to production rates being purposefully manipulated for the member states’ financial and political benefit, much to the chagrin of outside nations.
In response, the US and other countries elected to gradually outflank OPEC by upping production at home via the controversial process of fracking, leading to a decrease in oil prices worldwide; OPEC responded by cutting their own production in 2017 to encourage an increase in prices, and later collaborated with Russia to cut production further in the early months of 2020.
Unsurprisingly, this sustained global instability in the levels of supply and demand has led to a lucrative global trading market for the commodity, which we’ll examine below.
How Is Energy Traded as a Commodity?
Ever since the energy shortage and price surge crises that affected the West throughout the 1970s, crude oil has typically been traded through the ‘crude futures’ contract market, which differs from the standard ‘spot market’ model in that these agreements pertain to the price of the product for a fixed, future time period, as opposed to the real-time current price.
The crude futures market was initially devised to alleviate the risks associated with sudden price fluctuations, allowing government buyers and refiners alike to ‘lock-in’ the price of a commodity — which is fixed in line with a specified benchmark crude type — for months or years at a time. Therefore, if the price of the product should increase in the interim, the buyer effectively becomes better off and isn’t liable to pay the newly inflated rate.
Different exchange markets are specialised to deal with certain types of crude, normally those native to their specific region; for example, WTI (being US-based) is primarily sold on the New York Mercantile Exchange, while Brent futures can be purchased on ICE Futures Europe.
These futures contracts outline both the drilling location and quality of the oil, and many are settled via cash payments — though physical delivery of the goods is also permitted in some cases.
In addition, there is also the opportunity to invest in derivative call options related to the various benchmarks known as ‘crude options’, which enable traders to purchase a set number of barrels at a pre-agreed price if and when the value of that particular product rises to a certain point.
Further reading: https://www.fool.com/investing/2016/07/12/what-are-crude-oil-futures-and-how-do-they-work.aspx
Can You Trade Crude Oil Speculatively?
Much like the practice of Contracts for Difference (CFD) trading on the currency exchange market, speculators commonly take advantage of the fast-moving energy market by betting on the price fluctuations caused by varying levels of supply and demand for specific oils.
For instance, all major oil exchanges allow investors to speculate on the future spread between two given benchmarks, which enables them to use their knowledge of each category’s fundamental attributes — and surrounding geopolitical events — to make educated guesses as to how the price differential is likely to behave.
This type of speculative activity is especially common during periods when one benchmark experiences an intense amount of volatility; the NYMEX, as a good example, noted record trading volumes between 2011–2013, when an oversupply of US crude oil led to a sharp drop in WTI prices relative to its Brent counterpart.
