What should I know before investing in oil?
Exchange-traded oil, that is, oil on which it is possible to speculate online, is traded in the form of a barrel of crude oil. Refined products and oil companies are therefore not taken into account here.
It is traded daily on the spot or spot market in the form of futures contracts. These contracts are commitments to buy or sell a pre-determined quantity of barrels at a given date, usually 3 to 6 months. The price of this sale or purchase is obviously known in advance. These contracts are generally referred to as "paper barrels". It is these contracts that allow operators to hedge against the risk of excessive price fluctuations.
But if oil is so popular with investors, it is above all because of its high volatility and therefore its reactivity and strong movements that can occur in a short period of time.
Understanding oil prices before investing
Depending on the trading platform you are going to use or the investment products offered by your bank, you will have the opportunity to encounter two main types of crude oil. Indeed, crude oil quotation concerns two different main types of oil, WTI (West Texas Intermediate) which is the oil produced and stored in the United States, and Brent which is the North Sea crude. To this, you can add a few other, less well-known types of crude oil such as Dubai Light and Arabian Light.
These different oil quotations are classified according to their quality and therefore the simplicity of obtaining refined products such as petrol.
Oil is listed on two main spot and futures markets, namely the NYMEX (New York Mercantile Exchange) and the IPE (International Petroleum Exchange) which is based in London. The spot markets for refined or finished products, which are very numerous and generally located in direct proximity to the refining areas, will not be taken into account here. In Europe, one of the best known of these markets is the ARA (Amsterdam, Rotterdam Antwerp).
The history of oil prices shows a significant rise in prices since 2002 due to strong demand from emerging Asian countries such as China. The record for the WTI quotation is $150 per barrel and occurred in 2008.
The last few years have shown us that the oil market is a very volatile market that can go up or down. But then how is it possible to predict and therefore anticipate the future evolution of the oil market? There are two methods that allow you to best anticipate future trends in this market, depending on whether you wish to invest in the short term or the long term.
For long-term investment strategies, priority consideration will be given to the possibilities of supply and demand trends. Demand is primarily defined by the oil consumption of oil-importing and industrialised countries. Indeed, it is the industrial sector that consumes the most oil. As a result, periods of economic growth often tend to increase the demand for oil and thus push up the price per barrel. By analyzing the growth prospects of the industrialized countries, it is therefore possible to predict the trend in world demand in the coming years. On the other hand, it is also known that periods of crisis, such as the Covid pandemic of 2020, lead to a significant drop in demand. This type of event can therefore lead to a sharp drop in the price of a barrel. Here and because of the coronavirus, the price of crude oil has even temporarily gone into negative territory, as producers no longer have sufficient space to store the barrels produced.
As far as short-term strategies are concerned, the method to be used to anticipate the evolution of the oil market is quite different. It is of course based largely on technical analysis since oil is a speculative asset which is strongly affected by the psychological effects of the market. It is therefore necessary to know how investors will take their strategic positions in order to determine the future trend of the oil price. To do this, you will also use fundamental data known to have an almost immediate effect on the price per barrel. These include the weekly publication of US inventories on the economic calendar, the value of the US dollar against the euro, OPEC decisions and geopolitical news affecting oil exporting countries. While these events clearly impact the market, you should nevertheless take into account investors' anticipation of these publications before taking your positions. This anticipation can be useful in order to carry out interesting transactions when it is under control.
Whatever your investment horizon, it is therefore possible to anticipate the evolution of the oil market globally in order to set up efficient strategies and thanks to a good knowledge of the market. However, do not forget to secure your positions by placing stop orders at high and low levels that should not be exceeded.
How to invest in the oil sector?
There are several different ways to invest in the oil market. Indeed, you can both subscribe to a bank investment product allowing you to integrate crude oil into your portfolio through specific contracts such as ETFs or Warrants. But you can also choose to speculate on the price of a barrel of oil by using contracts offered by online brokers such as CFDs or Contracts for Difference. Finally, some investors choose to trade oil by trading on the shares of major companies in the industry.
Buying oil with ETFs
Investors who speculate on the stock market via a bank investment product frequently subscribe to investment products that include oil. However, there are not many products and vehicles that allow investors to invest in crude oil in this way, and they generally include other assets, including other commodities.
Oil ETFs seek to replicate the performance of a benchmark index linked to the price of crude oil, such as WTI (West Texas Intermediate) or Brent.
There are two types of oil ETF:
- Physical ETFs: These buy and store crude oil, which is rare and complex.
- Synthetic ETFs: These use derivative financial instruments, such as futures contracts,
Trading oil with CFDs
Oil trading with online brokers' CFDs is an alternative that does not involve buying barrels of oil and selling them, but taking positions on the rise or fall of the price of a barrel of WTI or Brent. In concrete terms, the aim here is to detect upward or downward movements in the price of this asset and to take a position on the anticipated trend with a more or less long horizon. The realised gain or loss is the difference between the opening and closing price of oil. Online trading, although accessible to individuals, is however a risky activity and should be reserved for investors who understand how the markets work and know how to set up good money management.
Finally, the third method to speculate on the oil market is to buy to speculate on shares of oil companies. Indeed, companies such as Total, BP, Royal Dutch Shell or Saudi Aramco are some examples of stocks that are strongly influenced by the evolution of the oil price and that can be an alternative to this investment. Here it is possible to buy these stocks through a traditional stock portfolio, i.e. with a securities account or a PEA for example, or to speculate on their price online using CFD contracts via the trading platforms of approved brokers.
Ultimately, the choice of one or other of these investment methods will depend largely on your investor profile, your knowledge of the market, your trading horizon and your risk aversion.
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Should you invest in oil on the upside or the downside?
Oil trading down: When and how?
As explained above, crude oil is a particularly volatile asset that follows successively downward and upward movements. However, while many investors choose to trade this asset upwards, it is also possible and sometimes even advisable to trade it downwards. To do so, it is of course first necessary to detect future bearish trends in the barrel. Several factors can influence a fall in barrel prices.
For example, it is known that the price of crude oil is directly influenced by the difference between supply and demand. Both can be analysed on the basis of certain identifiable data. We know that supply comes from the companies that extract the oil and that it is OPEC, the Organisation of Petroleum Exporting Countries, which regulates this market by setting up production quotas for each of its members. Thus, an OPEC decision will directly influence the world oil supply and thus have an indirect impact on the price of black gold. We know, for example, that when quotas are high and production is high, black gold prices tend to fall.
Another element likely to lead to a significant drop in crude oil prices concerns this time oil crises and shocks. This was particularly the case with the 2008 crisis when the global industry experienced a sharp slowdown in activity and thus a significant drop in crude oil consumption and demand. The barrel of oil then lost 100 dollars. In 2014, a decision by OPEC not to reduce production while demand was at half mast also led to a drop in the price of oil of almost 60% and set the stage for the oil crisis of 2015, which saw the price of a barrel fall to $27 in January 2016. Finally, even more recently, the coronavirus crisis that has almost stopped the industry's consumption worldwide due to containment has even led to negative prices for a barrel of crude oil.
Other factors can also lead to a drop in crude oil prices, such as the construction of new nuclear power plants in some oil-intensive countries or political decisions to reduce the use of fossil fuels in favour of green energy as part of a sustainable development policy. It is indeed interesting to note that the development of alternative energies could have a negative influence on the price of oil in the more or less long term.
Thus and when you anticipate a drop in the price of oil, be it in the short, medium or long term, you have the possibility to take a position on this downward movement by using specific contracts such as futures contracts or CFDs offered by online trading platforms or also ETFs and equities.
Oil trading on the rise: When and how?
Of course, the price of crude oil does not only move downwards and it is also possible to anticipate upward variations of this raw material. For this, it is also necessary to know the factors that will lead to a surge in the price of black gold.
Among these elements that strongly influence the price of oil is the fall of the US dollar. Indeed, it is in this currency that the price of black gold, like that of many other raw materials, is quoted. Thus and when the dollar is weak in relation to other currencies, this leads to an advantageous exchange rate for importers who increase their purchases. As a result, the price of oil starts to rise.
Similarly, any increase in the global demand for oil will have a positive effect on the price of oil. However, this demand is closely linked to the growth of certain economic powers or the development of emerging markets, as it is the industry that consumes the most oil for its production. This demand should also be compared with supply. Indeed, the production of the major oil-producing countries will have a direct effect on the price of crude oil. Attention must therefore be paid to the decisions of OPEC and Russia concerning production quotas. It is indeed frequent that in periods of low oil demand, OPEC or OPEC + decide to drastically reduce the production of each country in order to provoke an upward recovery in the price per barrel.
Finally, the geopolitical context of oil producing and importing countries will also influence the evolution of the price of black gold to a greater or lesser extent. Indeed, we know that armed conflicts and diplomatic tensions have an influence on this value and its evolution. Several events have thus provoked a surge in prices in the past, such as the Arab Spring or the nuclear projects of certain countries such as Iran. More generally, political instability, Islamic threats and attacks tend to create concern on the markets and fears of oil shortages and thus drive up the price of black gold.
If you expect oil prices to rise, there are a number of ways to speculate in this market, such as buying shares in major oil companies, taking an upward position on a barrel of crude oil through CFDs, or taking out a specific stock market contract.
Fundamental and technical analysis for oil trading
To trade oil in any way whatsoever, it is of course essential to know how to spot and anticipate future changes in this value as well as possible. To do this, it is essential to carry out two types of analysis of the price per barrel, namely a technical analysis and a fundamental analysis.
Fundamental analysis consists of studying the external elements that will influence the price of oil. These include :
- On the value of the US dollar
- Geo-political news from producer countries
- OPEC and OPEC+ decisions
- From the publication of US stocks
- Global economic growth
The technical analysis is based on a study of historical stock market oil charts. In particular, it enables the detection of price rise and fall signals using different indicators. Among the indicators most frequently used by investors in black gold are, for example, the MACD indicator, moving averages, pivot points, Bollinger Bands and technical support and resistance levels. The use of customisable charts is of course recommended here as they allow the display of several indicators simultaneously and therefore a faster reading of the signals.
These two types of analysis are of course to be used together and not separately and it is best to ensure that technical and fundamental signals point in the same direction before taking any decision and market position. You can of course test your strategies with a demo account before you start.
