Investing in Oil and the Energy Markets
Dealing in oil and energy markets may seem like an unusual investment to make, but oil is a commodity that tends to have fairly volatile prices and, as compared with precious metals, has a much more direct-use feature about it. It is a necessity for all car owners, airlines, and for a large part of the industrialised world. Unlike gold or silver, for example, that are bought to hold or to be admired for their ornamental qualities, oil is most commonly bought, in the end, to be burned!
Oil is traded on the futures exchanges and you can buy or sell at given prices for forward months as well as at the current time. Rather than go out and buy hundreds or thousands of barrels of oil and storing it, you can buy oil on paper or online by using an electronic traded fund (ETF) or by spread betting on the price of oil. An ETF can be bought outright and is the equivalent of buying the actual oil, mimicking all its price moves. Spread betting is more for retail investors, and this entails taking a position in the market either up or down and getting paid out if the move goes your way by an amount equivalent to the amount per dollar of the underlying security that you have wagered.
Both of these approaches give you an equivalent experience of buying and selling the actual commodity without having to get into the logistic or other concerns with the physical underlying instrument. It is these financial instruments that airlines and other industries use to hedge against price rises or to dispose of stockpiles in the market.
Oil prices have moved from less than US$40 per barrel to a high of US$147 a few years ago and have now settled in the US$90 to US$100 range at least for the time being. As a long-term buy and hold commodity it may not prove to be a fruitful investment due to the amount of two-way price volatility that sees prices moving down as much as they move up. However, as a trading instrument, crude oil futures can provide a handsome return on a week-to-week basis or even as a day trading play.
There are two main types of oil that are quoted on the exchanges, and these are UK Brent crude and US crude. Brent Crude is a more pure sort of oil that requires less refining, and so is priced higher in the market. The difference between the prices of the two main oil products is called the spread and this can tell you a lot about refining costs and also the supply at the refiners or of any shortages of refining capacity. As such this can have an effect on the underlying price of crude oil since if there is a backlog at refineries then there will be a glut of crude. Even if this is only temporary it could certainly affect prices in the near term.
The EIA in the United states releases stockpile and inventory reports for crude oil, natural gas and other oil products that serves to provide market participants with a guide as to how much oil is in the system at both the wholesale and the retail ends of the market. This data is normally released on Wednesday afternoons US time, and, depending on the sensitivity of the market, can produce large moves in the price of oil, either up or down.
You might think that oil would be significantly more expensive than it is even at current fairy historical high levels, especially give the world’s reliance on it, but there is the supply side to consider. Oil producers are producing a lot of oil and in some ways want to keep it affordable otherwise there is the possibility that if prices were significantly higher, much more money would go into the research of oil free energy, such as electric cars etc. Oil producers are keen to ensure that we don’t wean ourselves off the “black gold” too early.
Currently pricing and supply is in part governed by OPEC who oversees supply of several oil producing nations and by doing so affects prices. An overseeing body such as OPEC would not normally be so welcome in other financial markets but it seems to be in place for oil and is one of the things to keep an eye on. That said, it rarely intervenes dramatically in the market, and often only brings in supply cuts or supply increases when prices hit extreme lows or highs.
Natural gas futures can also be volatile but seem to move in a more seasonal fashion, with this commodity being used in the winter months across Europe, Russia and the US for heating. Much is open to interpretation since the amount of natural gas produced at any given time is usually with known factors in place including seasonal changes.
Still, an unexpectedly harsh winter or an unusually long and hot summer may well push natural gas futures prices around and although these price movements are hard to predict, they are nonetheless usually slow to emerge, so you can often jump into the market slightly late and still catch a large part of the move thereafter. Since the prices are often traded for future dates you may find yourself trading winter month prices in the spring or summer and so this makes the supply forecasts much more important.
By going back further down the chain and checking the status of things like capital expenditure on exploration and the fortunes of, for example, companies that supply natural gas producers with their equipment you can often see some trends in place early. The same goes for oil in many respects, so by thinking out of the box you can give yourself an edge in the market.