In the extraordinary times that we live in today, oil trading 21 seems a weird subject to be discussing. Yet headlines such as oil down 21% are becoming centre page news. Although oil has been under pressure for some time due to the laws of supply and demand, it took a Black swan event to truly make it drop.
At it simplest form it is profiteering from the difference in the price of oil. This can be achieved by going long or short. When going long you are positioned for the price to go up. If going short, you will profit if the price goes down. In a more complex form, there are traders who will seek to profit from short-term events, such as the demand around the US driving season. Both BP and Shell have teams of traders looking to profit from these movements. Finally some traders will even place oil in a tanker and park it somewhere in a quiet part of an ocean. They are waiting for a favourable opportunity in the oil price, so as to the discharge this cargo of oil in a port or country, which is happy to pay more than the current asking price.
If you are trading in the oil market you will have to understand a key relationship between the demand for oil and its effect on the price. The more someone requests something, the more you can charge for it. In a growing economy, the oil price tends to be high (relative to norms) as oil powers machinery. Yet if there is a high demand for oil whilst it is being over-produced, you will have too much supply for the demand.
This was a situation we were in before Saudi Arabia, the world’s dominant producer, started a price war with Russia and the US shale producers. Although supply and demand is the key to understand oil price movements, it is useful to know what can influence it.
Economic expansion is the obvious one, but others to consider are war (no market likes instability), a huge entrant (US shale?), reduced output (Venezuela?) or the rise of electric as a source of energy. The reasons are many and far between, and in any given week the main driver of the price can switch between the above reasons and more!
One of the best times to find an opportunity to profit is in times of distress. When there are distressed sellers, you are able to get assets on the cheap. This means you reap a reward sooner, as you are under paid in the first place. Although the rise of renewable energy through electric cars or wind farms is clear, it is too early to write off oil.
Major developing economies in the far east are still dependent on oil, as the cost of implementing cleaner energy is still too much for them. The developing financial crisis will also mean that some larger economies will put off this investment expense. This makes buying oil and holding on to it until after the crisis has past an attractive option. After all, oil in the $30s has historically happened in crises, not in expanding economic times!
The subtitle may appear a bold statement, but today’s oil price is not influenced by one major event, but two! Initially the oil price was dropping because of the perceived reduced demand a recession would cause. But now Saudi Arabia has declared war on US shale gas producers and Russia. Geopolitical risk is a perpetual one for any trader, even for retail Forex traders. This means we could have a situation where economic growth eventually reappears, but the oil price is kept artificially low by Saudi Arabia increasing production whilst offering oil at an incredibly low price.
Investing in oil can be remarkably simple through buying an ETF which tracks its price or through a spread bet. You can choose between Brent Crude or West Texas Intermediate although Brent crude is seen as more relevant. Today’s instability should provide a good entry point to profit over the long-term, once the virus passes over and economic growth returns!