Oil is the most-traded non-financial commodity in the world. 86 million barrels of oil are produced every single day, which makes it one of the better commodity markets to trade particularly given that the price of crude tends to trend and can be a good momentum play. Oil is also one of the more specialised markets you can speculate on since it is driven by both technical and fundamental factors. Of course, as with many markets, oil traders will be split between those who trade on fundamentals, those who trade technicals and those who use both.
Oil and gas is a typically volatile sector, which tends to suffer at any prospect of a slowdown in the global economy. However, in the longer term the demand will keep growing and the reality is that supply is limited.
With in excess of 86 million barrels produced every day, for stock market traders that wish to speculate on the oil price the profit possibilities are large – and equally so is the loss potential. Although the Dow Theory states that ‘the market discounts all news’ any oil trader will have one eye firmly on the fundamental scene as we have seen of late, geopolitical, economic or regulatory events have a swift and direct effect on oil prices. Traders who study the fundamentals will keep a close eye on energy supply and demand, although these are immensely complex in themselves. One only has to see how the oil price moved up sharply last year as the USA and Iran appeared to be on the verge of hostilities in the Straits of Hormuz.
“Crude Oil. Easy. Deep, liquid markets. Exchange traded, with masses of futures contracts giving reference prices almost round the clock, from Singapore to London and on to New York.”
Supply side factors to take into account include oil discovery and geopolitical risks in major producer regions of the Middle East, West Africa and Latin America, and keep a record as to how much crude is currently stored in the USA via crude oil inventory data figures published every Wednesday by the USA Dept. of Energy. Traders will also keep track of any news from the Organisation of the Petroleum Exporting Countries. The demand side is influenced by the world economy, in particular the United States and the value of the USA dollar. Most commodities are priced in dollars so a weak dollar will make the commodity more attractive for foreign buyers.
Likewise, favourable economic news like improvements in industrial production or manufacturing are likely to have a positive impact on oil prices as traders speculate that there will be increased demand for oil in the future. In contrast, negative news like rises in unemployment figures will put pressure on oil prices.
Oil Event Calendar
- Department of Energy (DOE) release weekly stock figures every Wednesday at 10.30 NY time (Thursday at 11:00 if a public holiday in the week). Stats show the change from the previous week fro Crude (WTI), Gasoline and Distillates.
- The American Petroleum Institute (APIL) also release weekly stock figures every Tuesday at 16:00 NY time but these are largely ignored by the industry.
- The main other economic event which has the most direct effect on the price of oil is the US Non Farm Payroll (NFP).
What is important when absorbing the information from weekly/monthly reports into your trading strategy is to take heed of the market’s perception of the figures. example – it is not a good idea to buy WTI on a draw in Crude stocks on the weekly DOE stats if the market was expecting a larger draw. It is important to assess the impact of stats against current market news. Example: it will be foolish to sell BRN on a bearish IEA report if civil war has just kicked off in Saudi Arabia.
While the volatility seen among oil and gas stocks is unwelcome to many investors, many spread betters and short-term traders see it as an opportunity. Oil trading is perhaps best illustrated by an example. There are two main oil markets traded on world exchanges. The first one is West Texas Intermediate (WTI) oil which is extracted in the USA for local consumption, and the other being Brent crude, which is sourced in the North Sea and which serves as the global benchmark for the physical trading of oil. If you are looking to trade short-term (days or few weeks), you might be better off to utilise the daily contracts which have tight spreads and can usually be rolled over for a small overnight financing fee. Longer term monthly future oil contracts are also available for those who wish to target longer-term moves. The minimum spread trade is usually £1 per one-cent move in the cost of a barrel with typical initial margins of about 2% of the effective exposure or £200.
Let’s assume the following scenario: Spreadex is quoting the North American oil futures market commonly referred to as the West Texas Intermediate (WTI) at $90.69 and $90.75 a barrel, mirroring the price of a WTI oil contract for delivery in March. The 6-point difference between the bid and offer prices represents the spread. You think the price is going to rise further so you buy at $90.75, putting up £2 for every cent, or point, the contract rises. Spreadex has a deposit factor of 200 for this market so you need £412 as initial margin to be able to open this position [the extra £12 to cover the spread (six points x £2)]. Should the price continue rising to reach $95 a barrel in March, you would make a gain of £850 – the 425-point rise [9500 – 9075] multiplied by £2. But if it were to fall to $88.00, you would stand to lose £550 – the 275-point drop multiplied by £2.
If you want exposure to crude – buy crude – it’s very easy to buy a mini or 2 pound/dollars per point spread betting and if investors cannot be bothered to look into what spreadbetting is or have a phobia about the credit worthiness of a spread betting provider and somehow think Goldman is a safer bet – then they fully deserve what they will get and what is coming. Alternatively, if you prefer not to speculate on the underlying commodity directly you would spread bet on oil shares – like say, instead of buying oil directly you could go long on BP, Shell (RDSB), Tullow Oil (TLW) or Premier Oil (PMO) which would in most senses be a bet that the oil prices will continue rising. Likewise companies like Deere and Co or Syngenta offer exposure to rising agricultural demand. With gold or oil, you can also acquire exposure by investing in gold mining companies and the oil exploration and production sector which would represent highly geared ways of playing the commodity prices since stock prices are fundamentally leveraged meaning that such companies like mining stock tend to move more dramatically than the commodities the company produces (up or down).
But if you are are used to spread betting equities, why not use this type of bet to play commodity prices? For example an upbet on BP is effectively an upbet on the oil price. Likewise, BHP Billiton is mainly a mining operation but the business has expanded into oil and gas and has proven oil reserves – although here you need to take into account the geographical risk since the company is highly dependent on China where it has a lot of contracts for iron ore, and, if growth was to slow, that would impact the price. Meanwhile companies such as Deere and Co or Syngenta offer exposure to rising agricultural demand. Traders and investors need to think about their own risk appetite before trading such stocks. If you’re looking to make a profit on these, you need to follow the market closely because the share price of some stocks will swing on the basis of reports regarding findings. So sure, you’ll still need to keep your wits about you, watch your bet sizes and use stop losses to limit any fallout. Here of course you also have to factor company specific risk such as management and production record, but for spread betters who want some exposure to commodities without playing the market directly this could be the best bet.
“However, beware that with Oil being so volatile, that IMHO its only really a day trade on spread bets. Market volatility is rife and oil prices can rise or fall significantly in a single day. To put it into perspective the oil price can rise and drop by over $7 dollars in a day or more, depending on geopolitics. Even a 1 point bet could see swings of £700 or so either way. Spread betting the Oil futures price is not much good unless you have a well funded financial spread betting account though. The price movements in a few hours can empty small accounts quite easily. Potential for mega bucks, but also mega losses. And in that respect spread betting is exactly that, betting. An art, not a science. I learnt the hard way. Stick to 1 point bets if you are really tempted.”
If spread betting volatile commodities like oil make sure you are betting a stake size that you’re comfortable with – things can go ugly if a very volatile market like oil moves against you while daily swings of $2 or so are quite common. The utilisation of stops is also sensible so as to close bets automatically should the oil price move against you. I’ve also just spent a few hours trying to get my head around junior oilers. It’s an attractive sector from the finite oil point of view but has the potential to send investors to the poor house like no other sector. Scanning down through ShareScope the charts are an absolute nightmare to try trading or investing.
Here’s one interesting perspective from a trader: Oil/fuel prices have an interesting relationship with economic growth – logically, higher prices mean a squeezed consumer and higher production costs. But in reality, the relationship is positive, especially on the way up. Oil prices head higher in anticipation of economic growth, just like the stock market, and a chart between the DOW and CRUD (ETF oil) shows that on the way up (2009 onwards) the two move with high correlation.
Another interesting strategy revolves around trading the price differential between the West Texas Intermediate and Brent oil contracts widening or contracting; the gap between the two prices having swung up and down by as much as $19 in 2012. This is often referred to as pairs trading. Pairs trading is about going long in one market and taking a short trade in another market so as to profit from changes in the relative prices between the two. Essentially currencies are traded in pairs but this also applies to individual shares and commodities.
One pairs trade that is attracting increasing interest is trading the differential between US crude oil and UK crude oil. Before the Arab Revolution began in Dec 2010, the West Texas Intermediate and Brent crude largely traded in a tight range, normally within one or two dollars in price from each other. However, over the next two years, the political unrest in the Middle East increased risk and attached a risk premium on UK crude, while increasing American production has kept USA prices lower.
Because of this, UK crude oil has been prone to lead when political unrest spread (UK crude has tended to rise faster) while US crude has tended to lead when political tensions calm down (UK crude falls faster). If a spread trader believes there is something coming that could affect the price differential between the West Texas Intermediate and Brent crude, he/she could pair two future contracts of the two oil commodities (say trade December UK crude oil against December USA crude oil).
Oil Spread Betting
Question: Oil. I know that it seems to trade between certain ranges so if its trading at $80 a barrel, I could acquire some and hold onto it until it rises back up to $100 a barrel. Then I would exit and wait for it to go down again. I’m sufficiently patient to wait for a while, but what I’d like to avoid is a situation where I’m leveraged as this could result in wipe-out if I buy it at $80 and it goes down to $60 before rising again.
Answer: Open a financial spread betting account with, say, IG Index and don’t use leverage then! That way you don’t risk a margin call or getting closed out if the market moves against you. Note that if your target price is $80/barrel, IG would quote that as 8000.00 with a minimum position of £1/point so you’d still need to deposit £8k in at £1/point to be exposed without leverage. Otherwise another possibility is to buy £1/point of crude at 8000.00 and put a stop loss order at 4000.00, then hope that crude doesn’t drop to $40/barrel…
Note: If starting out try doing £1pp on Oil contracts… that’s probably a good starting amount because you get to ‘feel’ the volatility, and when you become good with it, you can crack it up a notch, perhaps £3pp. Even on £3pp on a catching $4/b movement is 400 points : £1200 profit! That can happen in less than a day, or more likely over 3 to 5 days… worth trading only at key times…
P.S. Look at the lifecycle of an oil explorer and understand that oil explorers are high risk and consume large amounts of cash to keep them going! You can hedge your bets by finding oil producers as well. In practice I rarely use stops with oilers. For a start if they are not Guaranteed Stop Losses (for which you pay more through the spread) stops are practically useless with volatile oil shares. By the time the spread betting company decides to implement them you have already lost most of your dosh. They also tend to manipulate prices early in the trading day so you can often find yourself stopped out on a share at 8am which is comfortably higher at 9am. That said I don’t think spread-betting is that much more risky than outright share ownership as long as you diversify your portfolio and keep an eye on your total exposure.