Oil Trading 101

Reviewed: October 22, 2014
By FinanceWeb

Investing in oil stocks is a complex situation. Oil prices and stocks rise and fall in wide swings, with periods of extreme fluctuation. Many factors drive crude oil and oil stock prices. Oil comes from many sources, and some that are less stable than others. Pricing is left to each seller’s determination, although members of the Organization of Petroleum Exporting Countries or OPEC, adhere to the group’s guidelines on price and production levels. Prices also depend on the nature of the oil with low sulfur, or sweet crude getting a higher price than high sulfur, heavy oils because of lower refining costs. Benchmark oils are a shorthand for standard prices; the major benchmarks are the light, sweet West Texas Intermediate, the Brent Blend of European oils from the North Sea, and the light, sour Dubai crude.

Setting the Price of Oil

The price of oil depends in large part on the economics of supply and demand. Oil is critical energy source for the leading economies and a major component in vital industries. The overall demand has risen consistently over many decades. Today, the global production is about 90 million barrels. While the supply of oil is considered finite, it has expanded through advances in recovery including oil shale, hydraulic fracturing, and tar sands However, the available supply of oil is vulnerable to events such as hostilities and political changes. Currently, prices are falling due to lower demand and large supplies including the United States, which has reached new highs in crude production.

News and Events

Many sources of oil are controlled by governments. An abrupt change in government or the outbreak of hostilities can interrupt the process of moving crude oil into commerce and create shortages. News of such events, after the fact or in anticipation, can cause sharp price increases. Buyers will sometimes hedge their supply exposures by attempting to purchase more fuels.

Speculation and Prices

One vehicle for purchasing oil assets is through oil futures contracts. Based on the price of oil at a specified date, the holder will either realize a profit or loss on the difference between the futures price and the actual price. Based on market conditions, holders can sell for a profit. Oil speculation can affect the price of oil, and particularly during periods of short supply. Some experts suggest this activity can raise prices or distort the market by creating artificial upward movement.

Oil Investment Options

Investors can acquire oil stocks on the stock exchanges by purchase through stock brokers. Oil stocks are often among the better performers for long-term success and payment of dividends. Backed by strong assets, investors select these high-value stocks in a balanced portfolio. Investors can enter the oil markets through mutual funds that include oil or a broader selection of energy issues based on oil. There are a significant number of mutual funds that focus on oil and energy stocks. Indexed funds can follow a group of stocks that have substantial amounts of oil and energy stocks. One can invest more directly in the price of oil through Exchange Traded Funds. Based on a group or basket of stocks, investors trade these funds like stocks. Some ETFs focus narrowly on oil or more broadly on oil and energy. They provide a method for buying and selling over short periods and in large or small amounts, and for as little as one share.

Socially Conscious Investing

Some investment funds exclude investments associated with particular environmental and social issues. For example, some have policies that exclude oil and tobacco stocks due to health and environmental concerns. As a new investor, it is important to notice policies and exclusions when selecting mutual funds or managed investments. Rather than avoiding, some investors actively use positions as shareholders to urge change. In the current research for vaccines to fight Ebola Hemorrhagic Fever, tobacco plants have preliminary showings of usefulness. Similarly, crude oil contributes uses without environmental impacts such as in advanced materials.