Most valuable resource in the world

Crude oil is the primary source of energy in the world.

It is black gold or the “blood” of world economies. As much as 80% of a barrel of crude is refined into gasoline, jet fuel and distillate fuels such as diesel and heating oils. The rest is processed into petrochemical feedstocks, waxes, lubricating oils, asphalt and other by-products that make their way into thousands of everyday products such as vitamin capsules, tyres and plastics.

Since the start of COVID-19, oil prices have plunged. Demand has shrivelled because of pandemic lockdowns and travel restrictions. Of late, prices have partially rebounded. If you are wondering whether it is a good time to enter the oil market, read on as we explain why we think oil should be in every trader’s portfolio!

Main benchmarks: Brent Crude and West Texas Intermediate (WTI)

Brent Crude and WTI are the two primary benchmarks for the highest-quality refined oil products. They are the most widely used markers by oil traders.

Accounting for two-thirds of the world’s crude contracts, Brent Crude – also known as Brent North Sea Crude – is the most widely used benchmark for African, European and Middle Eastern oil markets. Brent Crude refers to oil from four fields in the North Sea: Brent, Forties, Oseberg and Ekofisk. This oil is ideal for refining diesel fuel and gasoline.

West Texas Intermediate (WTI) is oil extracted from the wells in the United States (US). It is the main benchmark for the US oil market. WTI has less sulphur content, making it lighter and sweeter than Brent oil and easier for refining. It is produced in landlocked areas which makes transportation difficult and is commonly used for gasoline refining.

What affects oil prices?

Crude oil is the most talked-about commodity. While Brent Crude and WTI are often correlated, various factors such as geopolitical developments, supply, demand, production and delivery may affect oil prices differently and widen the price differential. The Global Financial Crisis in 2008 caused WTI oil prices to fall from a high of US$147.27 in July 2008 to a low of US$33 in February 2009.

Oil prices are determined by marginable futures contracts which are subject to speculation and hedging by hedge funds and commodity traders. In fact, less than 5% of futures contracts is fulfilled by physical settlement or delivery of the commodity. [1] This means that oil prices can increase or decrease quickly without any change in real demand and supply.

 

Why invest in oil?

Reason 1: High Liquidity Crude has always been one of the most highly-traded commodities in terms of volume and open interest.

• Volume is the total number of traded contracts
• Open interest is the total number of open long and short positions in the market

Why is liquidity important? Trading in low-liquidity commodities like exotic metals may result in wild price swings and high losses in slippage. The higher the volume and open interest, the lesser the slippage.

Liquidity is important for all assets, particularly commodities. Liquidity assures you that there is a market for you to buy and sell easily. It attracts traders and investors to a market.

2020 is one of the most volatile years for crude-oil trading due to COVID-19. Brent Crude hit a high of US$70.25 in January 2020 and went as low as US$9.12 in April 2020.

Reason 2: Pent-up Demand for Oil

With the UK being the first country to approve the use of COVID-19 vaccines [2], the outlook for the global travel industry has started to look positive. As early as March 2021, pent-up demand for both domestic and global travel could be a powerful catalyst for refineries and airlines to restart oil hedging to lock in future prices. International travel is expected to pick up as borders gradually reopen. It is widely perceived that ‘peak oil’ [3] is not here yet. Pent-up travel demand from a widespread success of COVID-19 vaccinations may further increase crude-oil volatility. This makes it an even more compelling trading tool!

Reason 3: Portfolio Diversification

The 11-year bull run in equities could be losing steam. Equity markets have been sluggish with generally lower volatility in the past three months than the beginning of the year. They seem to be heading into a multi-year sideway range while stock fundamentals try to catch up with their technically higher prices.

Crude oil, being the most liquid commodity and historically more volatile than the S&P 500, can potentially boost your trading profits and assist you in portfolio diversification.

1) Petroleum stocks 

Alternatively, you can trade and invest in listed petroleum companies such as Sinopec, Royal Dutch Shell, ExxonMobil and Chevron, to name a few. While you are not directly trading on oil, oil prices are correlated to the earnings of these companies. Shell, one of the world’s largest oil companies, reported in June 2020 that the low price of oil this year could reduce the value of its assets by up to US$22bn. [4]

References: 1. https://www.thebalance.com/taking-delivery-of-commodities-via-the-futures-market-4118366 2. https://www.cnbc.com/2020/12/02/uk-approves-pfizer-biontech-coronavirus-vaccine-for-use.html 3. Peak oil refers to the hypothetical point at which global crude oil production will hit its maximum rate, after which production will start to decline. 4. https://www.bbc.com/news/business-53233702

Disclaimer

We do not base our recommendations entirely on the above quantitative return bands. We consider qualitative factors like (but not limited to) a stock`s risk reward profile, market sentiment, recent rate of share price appreciation, presence or absence of stock price catalysts, and speculative undertones surrounding the stock, before making our final recommendation
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