Trading the Oil Price

Crude oil is the raw material that when refined is used to produce diesel, gasoline, heating oil, jet fuel and many other petrochemicals.
Oil prices having been surging by a combination of supply shortages, rising geopolitical tensions over the Iraq war and Iran's nuclear programme and increasing investment/speculation in the commodity. In the past century for instance a number of people have made a fortune and generated enormous wealth from oil; case in point the great billionaire J. Paul Getty
Between 1998 and 2008 oil climbed from $10 a barrel to nearly $150 a barrel. The oil price rose from $85.42 in January 22nd 2008 to $147.27 in July 11th 2008; at which time a number of industry experts predicted that it would eventually hit $200 a barrel. However, the credit crunch and consequent cycle of wealth destruction had a dramatic effect on the price of oil which fell to a low $32.40 on 19th December 2008 as demand for oil faltered. Oil has since recovered to $70. Those wild fluctuations offer opportunities to the discerning speculator.
Huge oil wells still remain untapped in countries like Canada / Alaska but the extraction of this oil is only economically viable at the much higher oil prices we have seen in 2008.
Interest in spread betting on oil has been rising strongly particularly when the commodity is at its most volatile. For instance last year IG has seen more than 32,000 trades with a total market exposure of more than £1bn.

Unless you are very rich and have a brokerage account which gives you the right to trade futures it is best to use a spread betting provider to trade oil. Each futures contract gives exposure to 1,000 barrels of US light crude and with oil trading at $100 this equates to a total of $100,000. Spread betting allows you to trade oil on low margin. But, not only that; a spread bet has the advantage that the underlying mid-price of the commodity is tracked.
In the short-term the price of oil is impacted by the release of weekly US oil inventory figures each Wednesday at 3.30pm. Every week the Energy Information Administration (EIA) publishes Crude Oil Inventory numbers which gives us an insight into what future demand for oil will be. Commercial firms report their stock levels to the EIA on a weekly basis, but the Energy Information Administration (http://www.eia.doe.gov/ ) still has to make some estimates to deduce the final number of stock numbers of barrels of crude oil. You can see the most recent Crude Oil Inventories report here. The amount of oil commercial firms have in inventory directly impacts the price of oil in a predictable manner so this report is closely scrutinized by traders. Unexpected shortages of inventories can lead to a short burst in the price of oil. However, in general the oil market tends to be affected by quite a number of variables ranging from the the stability of Nigeria's political system to North Korean's missile testing programme.
Note that oil is not viable for production of electricity. It was back in the 70's and 80's but since then it has not been able to come near gas or coal. Crude is currently $12.33 per million BTU and gas is £4.20 per MBTU. So crude would have to fall to $25 ish to become a viable alternative electricity generation. Nuclear and windpower are not commercially viable in their own right and actually cost more than oil if you factor in the capital costs. Nuclear is still and always has been the most expensive with coal the cheapest. It's all about politics. Crude is now dependent on cars, home heating and chemical industries and so is a supply and demand commodity currently being propped up by speculators in bulk storage. Imo peak gas is far more important than peak oil.
The famous (or infamous) OPEC (Organisation for Petroleum Exporting Countries); a cartel of twelve countries Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela also has sizable influence here. Headquartered in Vienna the Cartel controls 42% of all oil produced worldwide and the Opec's main goal is the safeguarding of the cartel's self-interests - individually as member states and collectively as a cartel. The cartel aims to stabilise the price of oil balancing the interests of the producing nations and the necessity of securing a regular supply of petroleum to consuming nations at an acceptable return to investors who invest their capital in the oil industry. The OPEC also issues a monthly oil market report and a number of other releases which also impact the oil market so are eagerly awaited by oil speculators globally.
The longer-term chart of the cost of a barrel of crude oil reveals a rising but increasingly volatile trend that has seen the price move up from around $30 in the latter half of 2003 to over $100 in the first quarter of 2008. Today it is not unusual to see swings of 2 to 3 per cent in a day in the price of brent crude oil.
In general, energy and metal markets are leading indicators of inflation, so the financial community watches them very closely and it is useful to keep an eye on them. Oil has an inverse correlation with the dollar. There is also a high historical correlation between the price of crude oil and the price of gold. Generally, the price of an ounce of gold is 10 times the price of a barrel of oil. Partly, this is because mining gold is an energy intensive process and the cost to mine an ounce of gold will increase as the price of oil increases and also because they are both commodities and often affected by the same economic stimuli So buying gold is one way for a speculator to bet on the price of oil going up.
The Norwegian Krona is heavily dependent on the price of oil and the currency weakened substantially against the USA dollar when the oil price was under severe downward pressure. You can use this link in the exchange rates to take a view on the oil price although in such instances you also have to regard any other fundamentals that might affect the currency pair.
When trading oil be prepared for quite a lot more volatility than you would see trading say the FTSE index. If you're the sort of person who monitors their portfolio every day, could you stomach watching your holding wobbling by up to 5% every day? If you're faint hearted, it may not be for you.

Legitimate reasons why you might want to invest in Oil:

To hedge the cost of fuel.
Maybe you believe a rising oil price could hurt stocks.
Because you think a rising oil price could hurt stocks.
You believe inflation is a threat, so want to buy real assets.

Crude Oil Spread Betting

Traditionally, it was not straightforward for a retail investor to gain direct exposure to NYMEX Crude or BRENT Crude and trading oil stocks or ETFs provided indirect routes to exposure to the oil price. Spread betting and CFDs changed all this as they allow you to gain pure exposure to the oil price without the currency risk. And they also allow you to short the oil price...
Most spread betting providers quote prices for the two main oil futures contracts - the US Light Sweet Crude contract which tracks the value of West Texas Intermediate (WTI) and Brent Crude - both of which are traded round-the-clock from Monday morning to Friday evening. Both are also priced from the corresponding futures contracts and you need to be aware that the underlying futures are monthly contracts which are prone to be volatile when the expiry date approaches.
US light sweet crude oil started trading on the New York Mercantile Exchange (NYMEX) in 1983. Each contract giving exposure to 1,000 barrels and the pit trading session runs from 3pm to 7.30pm although futures can still be traded electronically on Globex round-the-clock.
Brent crude futures are traded from 2am to 10pm on the International Petroleum Exchange. Brent Crude accounts for two-thirds of the world's traded oil and liquidity starts to build in this contract at 10am, which is when the old pit trading session used to begin.
Capital Spreads offers exposure via spread betting on the price of the 'West Texas Intermediate' (WTI) futures contract which is traded on the New York Mercantile Exchange (NYMEX) and is the most popular grade of crude oil that is traded.
Most providers define a tick size as a 1c move in the cost of a barrel of oil and the minimum bet is typically £1 or £2 a point, with an initial margin requirement of 200 to 400 times the stake (depending on which provider you use).
So with oil trading at $45 a minimum stake of £1 would equate an exposure of $4500. For someone who has bought at $45 and closed his position at $56 would be sitting on a profit of around £1100 (assuming a £1 stake).
Most spread bets tend to be short or medium term. This is partly because the liquidity in the futures market tends to be concentrated in the first two months.
You can either open a daily rolling contract which comes with a spread of around 6 to 7 points or place a spreadbet on the monthly futures (usually the COMEX two-month futures contracts) - the latter which of course is more suitable for taking medium-term trades.
If you are an intraday oil spread trader make sure to keep an eye on the expiry of futures contracts as prices tend to fluctuate considerably during such times
Be careful about buying oil on excessive strength (i.e. don't get caught up in the hype). Always try to buy on weakness.
Crude Oil is very volatile and may be subject to gaps exceeding 50 points when the weekly inventories data are released or when the futures contracts expiry date approaches. So beware of delays of executions (look for another provider if your current one starts delaying your trades) as this would be just like giving away the control of the position - if you intend to day trade oil you really need instant executions to handle the volatility and leverage. You may also want to consider take out a guaranteed stop (which comes at an additional charge...) to avoid slippage.
Note also that you can use spread betting to trade on oil companies' stock prices - from the Exxons, Shells and BPs of this world to the smaller exploration outfits, drilling as the famouse Getty did over 50 years ago for that next 20,000-barrels-a-day oil field and the opportunity to make serious money.
Conversely if you believe that the oil price has peaked and is about to retreat an obvious play would be the airline companies. For instance Airline Ryanair was recently making up to 7% of the total revenues on equities spread betting on paddypower due to a fall in the price of crude oil.
To conclude Oil is a good commodity to trade. It gets both ample press and is easy to trade, it is also a highly liquid market and although it moves a lot you are able to get out anytime as it's virtually a 24-hour market. Remember that oil is more volatile than the FTSE and even the foreign exchange markets so it is essential that you make use of stop losses.

Trading Oil Futures and Oil ETCs

Other ways to trade Oil is to trade in shares in oil production companies or oil futures. Futures are however not for the faint-hearted or beginners as futures trading requires careful risk management and a disciplined approach. An oil futures contract is nothing more than a bet on what the price of oil will be at some time in the future. Each contract is for 1000 barrels of oil and requires the trader to place an initial margin set by the exchange, currently $12,000. At a price of $136 per barrel of light sweet crude, that $12,000 initial margin covers a position of $136,000.

If you bought a future at $136, say, and the price moved to $140 within the specified time (giving a contract value of $140,000), you would sell a future with the same expiry to close the position and pocket $4000, a return of 33% on your initial margin. Likewise, if you sold a future at $136 and the price moved to $132, you would buy a matching contract to close the position and pocket $4000. Of course, those returns would be losses if the price moved against you.

Exchange Traded Commodities also provide a simple way to get exposure to Oil. You can even bet on a falling oil price by shorting an oil ETC. The risk with Exchange Traded Commodities is that they are only as secure as the company that backs them (as in the AIG crisis with the collapse of the Lehman Brothers in 2008). Also, most ETCs only use financial instruments to get exposure so they are not directly buying the physical oil and thus it is not guaranteed that an oil ETF will closely follow the oil price. This is because an oil ETF works by buying and selling futures contracts as opposed to storing the physical commodity which means that the underlying oil price may not always be tracked as futures prices do not perfectly mirror the oil price. For instance should future prices rise too sharply above the spot price, commodity producers are likely to sell at the futures price while delaying their production back from the current markets, pushing them back into balance (this is referred to as 'contango').

Other than that you can invest directly in oil explorers and oil producers but this is risky and requires different skill sets. For instance for explorers you need to balance probable versus proven reserves and evaluate the cost of extraction. Some keen investors even scan through seismic and drilling reports to try to find something even the analysts have missed.

We can grow trees and plants (which oil is originally from) so why can't we make Oil?

Is it too energy intensive? Is much chemistry being done in this field? Do we have any chemists left?

We can make oil, fuels and chemicals from trees and plants. It's trivial chemistry to convert vegetable oil into high quality diesel fuel - it's so easy you can do it in your garage. There are many businesses around that will collect waste oil and fat from restaurants and food processing factories and sell the resultant biodiesel.

You can easily ferment cereal crops or sugar crops into alcohol - this has been done for thousands of years for beverages, but there's nothing to stop you refining the alcohol so that it reaches fuel grade. The pure ethanol can be mixed with petrol and used in standard cars.

The problem with both of these is scale - the amount of oil based fuels used is astonishing. The amount of land required to produce that fuel would be vast. The other problem is that Western agriculture, particularly in the US, is very heavily dependent on fertilizers and mechanization. Fertilizer is made from hydrogen, which is made from gas. The farm equipment and transport all use diesel. Then you need a lot of energy to run your processing plant (particularly if you are making alcohol).

In the US, the manufacture of ethanol from corn is highly subsidised. This has prompted enormous demand for corn, and has sent prices sky rocketing. There is also controversy because the conversion of corn to ethanol is very energy intensive, and some academics suggest that given the inefficient farming methods used, there is only a borderline energy gain; i.e. for every 10 barrels of oil saved because of the ethanol produced; the farmers and processors used 8 barrels equivalent of gas, oil and electricity to get there; not to mention the loss of prime arable land for food production.

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