Investing in crude oil -- what to keep in mind

Crude oil is essential to many worldwide sectors. It is the force that propels most vehicles, powers industry, and generates electricity. Because of the importance of oil to humanity, it has become a precious resource for many businesses and nations. Crude oil, along with its derivatives, is amongst the most widely traded commodities in the world.

But how can you invest in the most popular trading instrument? Continue reading as we discuss what crude oil is, how you can invest in it, and the factors that determine its price.

What is crude oil, and how can you invest in it?

Crude oil is a natural resource extracted from the earth and refined to make goods like jet fuel, gasoline, and other petroleum products. It is a tradeable commodity all over the world, both in spot markets and derivatives markets. 

Changes in crude oil prices can have repercussions on the global economy. Rising oil prices result in higher gas prices at the pump, higher transportation expenses, and higher producer input costs.

Crude oil prices are primarily determined by supply and demand in the sense that prices are lowered by excess supply and declining demand and vice versa. Geopolitical developments or severe weather that affects oil-producing countries might also influence how variations in supply and demand are perceived.

Traders can invest in crude oil in futures and spot contracts. The spot contract price indicates the current market value for oil. The futures contract price, on the other hand, shows the price buyers are prepared to pay for oil on a delivery date established in the future.

What do crude oil futures work? 

An oil futures contract is a contract to buy or sell a specific number of barrels of oil at a specific price on a specific date. When purchasing futures, a contract is formed between buyer and seller and protected with a margin payment equal to a percentage of the contract's entire value.

Crude oil futures provide individual traders with a simple and accessible approach to engage in one of the world's most significant commodities markets. Furthermore, crude oil futures contracts can be used to hedge the price risk of a wide range of energy companies, from exploration and extraction to refiners. 

Refiners choose light, sweet crude because of its low sulfur level and reasonably high yields of gas, diesel, heating oil, and jet fuel. Crude oil futures can also be used by businesses that consume large amounts of energy goods to hedge against price swings.

There are two major oil contracts traded by the oil market participants globally. The West Texas Intermediate (WTI) crude is North America's benchmark for oil futures. It trades on the New York

Mercantile Exchange. The benchmark for Europe, the Middle East and Africa is the North Sea Brent

Crude that trades on the Intercontinental Exchange.

Factors affecting crude oil

Economic Growth:

China and India are among the top consumers of crude oil. These are developing nations, and due to their expanding infrastructure and industries, they have a high demand for this commodity. However, these nations must import most of the crude oil needed. Crude is both an essential component of a nation's development and an inescapable cost. Despite having established economies, even European nations and industrialized nations like the USA, UK, and Australia place a high priority on their energy security.

OPEC Actions:

The Organisation of Petroleum Exporting Countries (OPEC), is made up of a few nations from the Middle East and a few from Africa. The cartel is in charge of roughly 80% of the proven oil reserves and 45% of the world's proven oil output. Since they have control over global oil production and supply, any decision they take on oil supply and demand dynamics impacts global crude oil prices. 

Wars and Unrest:

A few additional factors, such as natural disasters impairing oil production or supply globally, also impact crude oil prices. The ongoing conflict between Russia and Ukraine is another issue that the globe is now dealing with, influencing crude oil prices. The battle has disrupted the supply chains of industries worldwide, significantly contributing to the steep rise in crude oil prices.

What determines crude oil prices? 

Demand and Supply:

Like the price of any other commodity, the price of crude oil is greatly influenced by the dynamics of supply and demand. The demand for crude oil is high, but when it exceeds the total supply, the price of crude oil rises. Additionally, when the market is oversupplied with crude oil and demand is low, crude oil prices fall, thereby increasing consumption.

Market Speculators:

Crude oil is a widely traded commodity worldwide, and traders, brokers, and the prices of the commodity on the futures market all have a significant impact on crude oil prices. Crude oil's open market prices are mostly determined by its forward market pricing and the mood of the market. The brokers and speculators profit from market mood and seize trade chances, which further affect the price of crude oil worldwide.

Production Costs:

The nations with the highest global oil reserves control the majority of the world's crude oil production. Few nations have been able to use their output more effectively while maintaining a lower reserve-to-production ratio. On the other hand, due to high production rates, a few countries are currently experiencing decreasing reserves. Crude's supply on the market is affected by changes in overall output, which influences its prices.

Conclusion

Crude oil trading involves a small initial commitment and offers the greatest potential for profit growth due to increased leverage. However, oil futures are very liquid and highly volatile, making it difficult to predict price swings. Therefore, if you are a beginner, it's preferable to start trading with industry experts, such as Sharekhan, first and then gradually branch out on your own. If you choose a smaller broker, you might want to speak with them, asking if they provide commodities brokerage services and are connected to the MCX or NCDEX.

FAQs

Q. Is crude oil a good investment?

Crude oil is one of the world's most demanded and used commodities. It could be traded with a very low margin requirement. The demand for energy is constantly rising globally; hence, the demand for crude oil will also increase over time.

Q. Can you make money from crude oil?

Considering its unique position in the global economic and political systems, crude oil trading has the potential to give high returns. Short-term traders can profit from the volatility in crude oil prices.

Q. How do I start crude oil trading?

To start trading in crude oil, all you need is a Demat or a trading account with an authorized broker, such as Sharekhan.