Investing in the oil market can be confusing for some investors. Like most commodities, you are not investing in a company, but rather a physical product. However, oil trading and investing often takes the form of you investing in a company that manufactures, drills for, or is in some way involved in the production or refinement of oil.
Alternatively, some investors invest in the future of oil, called “oil futures trading.” The price fluctuations of oil are tied to various market forces (i.e. supply and demand), so you must become familiar with those driving forces if you want to be successful.
What Drives The Price Of Oil?
Supply is one factor that drives the price of oil. On that supply side, the U.S. pumped 8.7 million barrels of oil per day in 2014. Worldwide oil reserves, however, top 1.64 trillion bbl. While OPEC nations are well-known for their oil reserves, they’re currently unable to pump much more than they already do right now.
The U.S. is a major producer at the moment, but there are smaller nations with proveable reserves, meaning that future investment may rely heavily on supplies obtained in the the U.S., as well as emerging markets like Nigeria.
OPEC, the Organization of Petroleum Exporting Countries, and the International Energy Agency have estimated that the demand for oil will continue at 86 to 87 million barrels of oil per day, but that these figures are likely to rise in the future as emerging economies come online and industrialize.
Some smaller countries are enticing consumers with fuel subsidies, and roughly one-quarter of the demand today comes from countries that provide those subsidies. However, because subsidies represent either central bank debt (bonds), or taxpayer dollars, subsidized oil may also cause oil producers to sell at a loss, especially if those oil producers are domestic.
In the long-term, demand needs to be stabilized by incentivising oil producers to produce more oil, but they will only do that if they can turn a profit. In that sense, supply and demand drive each other, albeit in different ways.
Risks You Face
Oil trading and investing is not a risk-free proposition. Even though almost everyone on the planet uses oil in some way, shape, or form, the price of oil can, and does fluctuate, often.
One of the inherent problems with oil is the lack of high-quality oil, sometimes called “sweet crude.” This is the type of oil that refineries often need to meet strict environmental and pollution-related regulatory requirements. Sweet crude is oil with a low sulphur content, and is the preferred type of oil in just about every refining application. As an investor, or if you’re involved in oil trading, your oil investment could suffer losses if oil producers cannot find and refine enough of this type of oil.
Even when oil prospecting companies are able to find crude oil, another risk you face is speculation. Speculation pressures run outside of the normal supply/demand dynamics.
Speculation, including oil futures trading, is a special type of oil trading that some investors engage in whereby investors hold oil futures contracts and other oil-linked investments for very short timeframes with the hope of bidding up, or bidding down, the short-term price of oil so that they may profit.
While the long-term investor in oil shouldn’t worry about this, it can cause dramatic price swings in the oil market in the short-term