How to Invest in Oil Futures

UTC by Osaemezu Ogwu · 12 min read
How to Invest in Oil Futures
Photo: Depositphotos

We’ve outlined all you need to know about oil as an investment, oil futures, and provided you with the tips that should guide you to make a successful trade.

Oil futures have gained popularity over the years, and if you’re looking to dive into the market, it’s best to have a good understanding of how the oil sector works. And even better, know how to buy oil futures to begin your first trade.

Oil as an Investment or Crude Oil Fundamentals

Crude oil is described as a raw material whose refinery leads to the creation of several products. Some of these products include diesel, gasoline, and a wide range of petrochemicals. The process of refining oil often requires around 3 oil barrels to aid in the production of 2 and 1 barrel of unleaded gas and heating oil respectively.

There are various grades of oil and among these is the Light sweet oil. The latter ranks in the top as a major traded grade and it can be tied to several reasons. For starters, it is quite easy to purify this oil to create other products. This grade is also traded on NYMEX. Another popular grade traded in London is the Brent Blend Crude. The latter has garnered interest over the years. When it comes to the major producers of oil, three countries including the US rank at the top. A popular benchmark used in ascertaining oil prices is Brent.

Oil is actively being traded on exchanges. And its rise and fall in price can have an impact on commodities like natural gas. This effect is also evident in the prices of stocks and fiat.

In line with that, the popularity of crude oil as an investment vehicle can be tied to the activeness of its market. It can be traded as a futures contract and it is available to traders worldwide. Like most markets, the price of oil is unstable and it can change even with a piece of breaking news.

Investing in Oil

All in all, you can invest directly or indirectly in crude oil. Let’s take a closer look at each:

Direct Investments in Oil

Buying oil futures or options is a direct investment in oil. Futures contracts are an agreement to purchase a certain quantity of an asset at a particular price and time in the future. Options contracts allow the buyer or seller to exchange oil at a specified date in the future. Either of these investments can be carried out on a commodities exchange.

Indirect Investment in Oil

There are also indirect investments in oil. This is made possible by investing in energy-based ETFs. There’s the ALPS Clean Energy ETF (ACES), for instance, and Fidelity Select Natural Resources Port, an energy mutual fund. Either of these invests in companies that are tailored to the oil sector. The level of risk is also lower.

There is also a wide range of ETFs tailored to the oil sector. These are not limited to iShares Global Energy ETF (IXC), and Global X MLP & Energy Infrastructure ETF (MLPX). There’s also the VanEck Vectors Oil Refiners ETF, ProShares K-1 Free Crude Oil Strategy ETF (OILK), and First Trust Nasdaq Oil & Gas ETF (FTXN). The big idea is to invest in oil by owning shares in several oil companies.

Things to Remember When Investing in Oil Futures

Keep the following in mind when investing:

Specifications of Crude Oil Contract

Crude oil contracts have specifications that new and existing traders need to know.

Here’s an outline of these specs:

  • Symbol: CL
  • Exchange: NYMEX
  • Trading time: 6 pm to 5 pm Eastern Time
  • Contract size: A thousand barrels
  • Months: Monthly
  • Quote: Price for a barrel
  • Size: $0.01 for a barrel

Knowledge of the Market

While trading futures is profitable, there could also be losses. However, these losses can be curbed when a trader has a full understanding of the system. It is often advised that beginners should not venture into a trade of this type.

For starters, trading futures requires the trading of a commodity on the day it expires and at the agreed price. Further, holding a call and not taking delivery of the agreed oil barrels would mean canceling the trade prior to its expiration.

Tips on Oil Futures Trading

There are several tips that can guide you in trading oil futures. Some of these tips include:

  • In the process of trading and monitoring prices, keep in mind that the value of unleaded gas can impact that of oil.
  • It is important to pay close attention to economic indicators since this can help to determine future price movements.
  • The demand for crude oil futures is higher in summer and even winter. However, the reasons differ. In the summer, the demand is higher due to more driving and a higher need for crude oil. Hence, it helps to spike its value.
  • In winter, there is more need for heating oil and this leads to a rise in price. Accordingly, keep track of the Northeast’s weather. This is because it contributes significantly to the consumption of heating oil compared to other regions.
  • Keep track of the reduction or increase in oil prices by OPEC since it will impact on the demand and supply of crude oil globally.
  • You need to be aware of the market players in the futures market. There are hedgers, traders, and either of these is the major participants in the market. Asides from this group, there’s also the small traders and investors. This group has may impact less on the energy futures market, even though not in all markets.

The Volatility of the Crude Oil Futures Market

It should not come as a surprise that news may spring up overnight, thereby causing a major disparity in oil prices. These changes can be during the day or at night given that trading of these futures takes place at both times. Also, this price swing may occur despite the analysis or prediction of even the most advanced trader. Some news that may have an influence on the market includes economic reports, pandemic news, or even issues in the Middle East.

In line with that, a change in oil supply can also impact on the prices of these futures. There’s also the emotions of investors at play and mostly on the part of small investors who are day traders.

To that effect, issues in the Middle East, and other news may cause traders to act immediately based on the news. These traders may adjust their trading strategy thereby causing a fluctuation in price. What’s more, crude oil contracts, as well as, oil companies are sensitive to factors such as production, demand, supply, interest rate policies, and so much more.

Crude Oil Price Movements

In addition, the crude oil price movements can be tied to short or long positions by traders. In this case, a swift movement in price may cause investors who had sold to quickly buy back during price spikes. This long can either eat into their profit or lead to losses.

What’s more, a long is carried out by placing orders to buy. The heightened buys are carried out simultaneously as when speculators rush into the market to buy in as well. Nonetheless, investors who had sold will buy quickly since there is a higher risk involved in not re-entering a position.

In addition, a significant development that impacted on supply could mean shorters suffering a high loss. If that happens, it could lead to a margin call. The latter means more losses on the part of the individual. Besides the oil market is also impacted by psychological swings. There are often upwards or downward bias.

Over and above that, a person trading using trends can enhance their potential for profit. It is also worth noting that the price may trade in a range for a long time after a major move. That is why an investor who can spot out a range can take advantage of the opportunities to purchase at a low but sell high. There are investors who adopt the strategy or trading in a range until the price breakouts.

The point is, investors bidding can also have an impact on its price. As such, demand and supply are not the only factors that drive these prices. Wealthy investors are also active traders of oil futures. They may hold the futures for the short or long term.

However, investors who swing trade oil futures in the short-term are said to impact on the price swings in the short term. There are also opinions that their impact on the market is minimal.

Another factor that contributes to the price movement is the US dollar value. If the dollar value is high, the pressure is mounted on the price of oil. On the contrary, low dollar value aids in increasing oil prices. Coupled with that, if the economy and the stock market are growing, then so can the price of oil. Nonetheless, the economy can be stifled if these prices are overly too high. The trend may become a thing of worry for prices that are surging towards the psychological price point of $100 per barrel.

Day Trading

Day traders have made the oil markets their favorite trading ground. These investors look out for support and resistance, and also pivot points. The risk of trading is curbed by placing stop orders executed once the price attains a certain level. This means that the risks of swift movements up and down can be curbed with stop orders. To that effect, it is advisable for a trader to place stop orders to ensure that their risk is reduced to the minimum.

Oil Futures Trends

In 2014, oil entered a bearish market with prices falling. The price for a barrel was below $108 and this was on the NYMEX. However, there was a further decline to below $30 a barrel for the WTI Crude. In April 2020, the price for a barrel was around $28.

The recent decline is due to the price war with Russia vs. Saudi Arabia. The war brought about excess supply in the market. There’s the U.S. where the price of oil hit a 21 year low as a result of the coronavirus pandemic. The lockdown in countries worldwide caused a sharp fall in demand for the asset, which impacted negatively on its price. Much more, the fall in demand was met with more selloffs at lower prices.

The fall in the market was evident in some indexes like the Brent Crude index. The latter took quite the beating when it dumped on April 19, 2020, by 2.85% and a barrel of oil was priced at $27.28. And even worse, the Brent Crude index has crashed by almost 60% in the past year even though there has been some correction. The same decline was reported of the WTI which tanked by 21% and hitting as low as $15 for a barrel. The dump in price was not the last given that hours later, the WTI oil plunged to $11.33 per barrel.

Asides from the pandemic, another major reason for the fall in oil prices is the uncertainty lurking around the excess storage of oil. This caused an overflow of the oil reserves across the world thanks to the declining use of oil. Businesses being on lockdown for over a month meant lower demand for oil.

Risk of Investing in Crude Oil Futures

Investing in the oil sector can be profitable, but there are certain risks you need to be wary of. Some of these risks include:

Price Volatility

The price of commodities tends to fluctuate, which poses a risk to investors in the oil and gas sector. This level of volatility was at a heightened point between 2014 and 2015. And the reason was tied to the high-level supply of crude oil.

Oil Spillage

If you invest indirectly in oil by buying shares in an oil company, then there is a risk of oil spillage. In this case, an accident could lead to an oil spill. If that happens, it could lead to the company’s shares falling as well. An example is BP (Deepwater Horizon oil spill) whose shares tanked significantly after an oil spill about a decade ago.

Prior to the oil spill, its stock was sold at $60, however, it declined to $26.75, which made it about 55% decrement. Asides from the decline in its shares, BP faced a number of lawsuits due to the effects the oil spills caused. For instance, 4.9 million gallons were released into the Gulf of Mexico. The latter impacted marine life negatively.

Another case of an oil spill is with Exxon when there was an accident with its Valdez tanker in 1989. However, the event did not affect its stocks significantly. Having tanked by 3.9% after the oil spill into the water, its stock price corrected to levels it once traded at.

Dividend Cuts

Companies pay dividends to investors occasionally, and they are an incentive to investors. Nonetheless, it is possible for the company not to pay dividends if its revenue has declined. The low income may be as a result of making low earnings in product sales, thereby bringing about a need for a dividend cut.

There’s a real-life example of a company that cut its dividend and it turned out to hurt its stock price. The company is Seadrill and the cut occurred in 2014. When that happened, its stock dumped by 50%.

Conclusion

Now that you know how to buy oil futures and even make a direct or indirect investment, it becomes easy to invest in the oil market. However, be wary of the volatile nature of prices, which makes it needful to have a deep understanding before trading. There’s the stop order which can help you out, and the same can be said about sourcing for the latest news to ascertain future price movements.

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