The Volatility of Oil
Oil is a volatile stock in more ways than one and it is easy to get one's fingers burnt when it comes to investing in oil or gas. It is also easy to make fabulous amounts of money. So how do you make money with oil while retaining the use of your fingers?
The oil market is a complex one but the four principle factors that determine what the price of oil is going to be are supply, demand or consumption, the financial market, and governmental policies. Once upon a time it was easy. There was the supply of oil and there was the demand. If the supply exceeded the demand the price would be lower than if the demand exceeded the supply. Simple stuff. Nowadays it has become more complex. Financial markets such as future market pricing, and governmental policies designed to protect a countries oil supply have become the overriding factors that determine the price of oil. The price of oil is no longer solely dependent on the supply or the demand. It is dependent upon government regulation to some degree and very much so market buying and selling of future oil prices.
These days there is a much closer relationship between investment and the volatility of the oil price as speculators in the market jockey for the best profit margins in the buying and selling of oil futures. This despite increasing regulations set by the western countries to protect their oil interests and guarantee their supply.
"In today's world, oil-price dynamics are different than even 10 years ago," says Kenneth Medlock, an energy economist at the Baker Institute at Rice University in Houston.
But supply and demand is not totally forgotten. This can be affected not just by the world crude oil spouting out of the ground; the processing of it can also interfere with the demand. When we talk oil of course we are talking about black crude.
A barrel of crude oil from an oil well in the Far East, or even closer to home is simply thick black oil that has no use to anyone in its original form. It is composed of various elements such as carbon, hydrogen and sulphur. 'Sweet' oil is oil that has less sulphur. Both originate from the remains of fossilised flora and fauna. Animals and planets from millions of years ago. This output of oil is measured in barrels. A barrel of oil is equal to 158.987295 litres. To be of any use it has to be refined to produce the products we use today, petroleum, gasoline, diesel, kerosene as well as some plastics etc. This refining can take some time and is another point at which the price can be affected. For example, spring time is when most refineries are subject to maintenance and so production during those times slows down. The supply can back log, the demand outpace the capacity of the refinery and this affect the price flow through. So price increases can also occur when the world crude-oil market tightens and inventories are lowered.
The trading of oil in the financial market has a large bearing on the oil price. As well as speculators betting on the future price of oil some time down the track in the future, suppliers and oil companies also like to protect their future price by investing in the oil futures market. It can also affect how much oil the suppliers will release to the market. When the price is low they are more reluctant to release oil and would rather keep it until the price rises and they can sell it for a larger profit margin.
So investing on the price of liquefied fossilised tree trunks is somewhat of a guessing game unless you have a lot of experience in the financial markets and even then, it can be a wild hold on to your hat adventure.
An oil future is basically a contract between a buyer and a seller, to buy a specific amount of a commodity at a fixed price on a fixed date Once a contract has been set, a futures buyer would receive the specific number of agreed upon barrels of oil for the price stated in the future contract, regardless of the actual market price at the time of delivery.
So where does that leave us? Futures market speculation is a veritable minefield for the uninitiated and so not recommended. One is not investing in the price of oil so much as betting in a lottery where the high volume more experienced players have the best odds and the small inexperienced investor is the one often played for a sucker.
However, if one is eager to stick ones toe in the water, or oil in this case, probably the best option is to look at oil companies directly. Most oil companies are on the stock market and offer shares and with those shares hopefully come some dividends. As in any investment it is prudent to do some due diligence and look at such factors as past history, performance, balance sheet and so forth and, as always, consult with your financial advisor before making any investments in the share market.
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