Trading in Commodity Oil: A Beginner’s Guide

Crude oil is one of the most traded commodities in the world, and every major commodity exchange offers crude oil future contracts.

The world economy relies heavily on the distribution of crude oil since it is a driving factor for economic growth. Oil accounts for 3% of the world’s GDP, being crucial for transportation, operating machinery and producing fertilisers, plastics, medicines, chemicals and even solar panels. It is an actively traded commodity with high liquidity as it is traded in most countries.

In this blog, we will discuss trading in oil as a commodity, the various factors which determine its price along with a few of  its  contract particulars.

What Is Crude Oil?

Before learning how to invest in oil, it is essential to know what crude oil is. Crude oil is a specific type of fossil fuel which comprises decomposed organic matter and hydrocarbon. It is a naturally-formed unrefined petroleum product.

High-demand products such as gasoline, kerosene, diesel, etc., can be produced upon refining crude oil. It is a non-renewable fossil fuel, and hence, it is limited in supply.

There are various grades of crude oil available in the market. Brent and WTI (West Texas Intermediate) are the two most popular grades. There are numerous exchanges which trade in these variants of crude oil.

Factors Affecting the Crude Oil Market

Crude oil is a highly volatile commodity with more frequent and considerable price movements than other commodities. Crude oil trading rarely occurs with delivery unless the individual contesting in the contract owns a large oil corporation. So, crude oil trading happens mostly with price speculation.

Oil is an essential commodity since manufacturing a wide array of products is dependent upon it. any change in oil prices is therefore reflected in the prices of these oil dependent products as well.

To learn how to trade in oil commodities, it is vital to get familiar with the features and factors that affect crude oil price movements. 

The significant factors that affect the prices of crude oil are illustrated below.

• Supply and Demand: Similar to other commodities, the laws of supply and demand are responsible for the price movements of crude oil. Off late, limited oil supply and never-before-seen demand have pushed oil prices to very high levels.
• OPEC Dominance: Most countries import crude oil since oil reserves are concentrated in only a few regions. The demand for oil is endless, while the supply of oil is provided by only a few countries. These oil-producing countries are segmented into two categories given below.

1. Organization of Petroleum Exporting Countries (OPEC): This includes Qatar, Kuwait, UAE, Saudi Arabia, Iran, Iraq, Venezuela, etc.
2. Non-OPEC Countries: Includes Russia, Brazil, Canada, etc.

OPEC accounts for about 80% of the world’s proven oil reserves. Therefore, the decisions that OPEC takes in their meetings regarding oil prices and supply severely affect the commodity’s price.

• Availability of Alternatives: Since crude oil is a non-renewable substance, alternatives to it are constantly being searched for. For example, the USA was once one of the largest importers of crude oil. However, as American shale became cheaper and more accessible, the demand for crude oil reduced significantly, causing the crude oil crash from 2014 – 2016.
• Geopolitical Situations Around the World: Emerging economies such as India and China are some of the largest importers of oil. Fractures in economic growth can severely affect crude oil prices. political turmoil in significant oil-producing regions such as the Middle East impacts oil prices as well.
• Value of the US Dollar: Crude oil is traded using the US Dollar all across the world. Hence, the change in the value of the US Dollar can affect global oil prices as well.

How Crude Oil Is Traded in India

Crude oil trading in India has been more prevalent in recent times. In the crude oil trade, the demand for immediate delivery is much lower than the demand for future delivery. This is primarily due to the complex logistics process for oil transport. Hence, future contracts are a popular investment choice for crude oil.

For trading in oil futures, it is essential to find appropriate exchanges and oil benchmarks.

• Exchanges: One can trade oil futures on the MCX (Multi Commodity Exchange of India). Around ₹3,000 crore of oil is traded daily on the MCX, and in FY19, 32% of MCX’s turnover was based on crude oil.
• Oil Benchmarks: Benchmarks for crude oil are reference points which determine the standards of the oil. There are three crucial oil benchmarks on the global level, which are WTI (West Texas Intermediate), Brent crude and Dubai crude. In India, derivatives of crude oil are based on the WTI grade, with the benchmark being the price of NYMEX WTI.

Crude oil futures contracts have been present in India ever since the inception of commodity trades. However, options on futures of crude oil were introduced recently in May 2018 and have ever since become widely popular among traders. Options trades have exceeded futures trading in FY21-22.

Options have an edge over futures since they provide the right to buy and sell the contracts without any obligations. They require a premium payment, unlike futures which require an initial margin amount.

MCX Crude Oil and Natural Gas Contract Specifications

Crude oil derivatives worth more than ₹3,000 crore are traded on the MCX every day, making it one of the most popular commodities. Crude oil and natural gas can be traded in the form of futures and options with  specifications and  instances of which is provided below.

Table 1: Futures Contract Specifications

*MMBTU – Million Metric British Thermal Units

*’Crude Oil Mini’ contracts have a lot size of 10 barrels. The rest of the specifications remain the same as crude oil futures.

Table 2: Options Contract Specifications

*Source: MCX

Final Word

Oil is one of the most widely traded commodities as a result of its importance in the global economy. Global supply and demand play a crucial role in deciding the price of crude oil. It is very difficult to predict oil prices or the direction of changes due to the excess volatility of the commodity.

The price movements of energy products such as crude oil are derived from global benchmark contracts traded at NYMEX. Futures contracts and options are great ways for novice traders to participate in trading in oil as a commodity.

Frequently Asked Questions