Crude oil is heralded as the one of the top commodities to trade in India as it is perpetually in global demand. The rise and fall of crude oil prices have wide-ranging implications around the world. That is why be it among day traders or traders for the long-term, crude oil is a popular option in commodity markets across the board. India and China are the biggest consumers of crude oil all over the world. According to an annual fuel report by the International Energy Agency (IEA), India’s demand for crude oil is forecasted to equal China’s by 2024.
Crude oil futures are the most actively traded commodity in the world and offer greater liquidity due to high volume of trade. If you want to learn how to do commodity trading in oil or crude oil futures trading, this beginner’s guide is the right place to start.
What is Crude Oil?
Crude oil is naturally-occurring unrefined petroleum. It is a fossil fuel which comprises organic materials and hydrocarbon deposits. There are two reasons the demand for crude oil keeps growing:
- By refining crude oil, one can produce products that are high in demand such as fuels like gasoline, kerosene, and diesel. It is also used to manufacture steel, plastics and fertilisers.
- Crude oil is a non-renewable fossil fuel. Hence, it is limited and cannot be replaced once used.
Important features of crude oil market
Crude Oil is a highly volatile commodity and offers longer trending movements compared to other products. However, crude oil futures trading takes place mostly for speculation rather than delivery unless you own an oil company such as the IOC, ONGC, BPCL, etc.
In order to conduct commodity trading with oil prudently, it is important to familiarise oneself with certain features about the crude oil market that makes it unique:
- Crude oil is considered to be one of the most actively traded commodities in the world. Since crude oil is essential for the manufacture of a number of products, any change in its price reflects on the prices of these products as well.
- Oil prices are likely to fluctuate at a much higher rate than most other communities, thereby making the oil market a relatively volatile one. However, it is this volatility that opens up trading opportunities and makes it lucrative for day traders. The prices of crude oil as a commodity are influenced by the following essential factors:
- Like any other commodity, the price of crude oil is affected by the laws of supply and demand. Production costs, storage capacity, and interest rates all affect crude oil prices in decreasing capacity. Recently, a rare combination of oversupply and consistent demand has increased the pressure on the cost of oil.
- OPEC announcements: The Organisation of Petroleum Exporting Countries, or OPEC, is an organisation made up of the largest oil producing countries of the world. When the OPEC makes certain announcements, they can alter investor expectations and result in short-term changes in crude oil.
- The value of US Dollar: The US is one of the most important players in the global trading of crude oil. As a result, the overall value of crude oil is greatly impacted by the current value of the dollar.
- Political turmoil and natural disasters in oil-producing areas such as the Middle East as well as the oil supply routes also impact pricing.
How to Trade in Oil as a Commodity
With crude oil, the demand for immediate delivery is smaller when compared to future delivery. The logistics of transporting oil are complicated, hence, investors don’t intend to take on delivery if it is immediate. This is often why futures contracts are more common among end-users as well as investors. By entering a commodity futures contract, a trader agrees to buy or sell a specific amount of crude oil for a pre decided cost on a specific date. The concept of commodity trading can be best understood with an example.
Example 1 – Commodity trading for risk management or hedging
Assume that you are a farmer who grows wheat and you sell your produce in the market at Rs. 500 per quintal which fetches you a decent profit. You have thousands of tons of rice to sell and you want to be sure that you don’t suffer a loss if the price of wheat comes down unexpectedly. To safeguard yourself from losses, you can enter into a futures contract (buy a futures contract) to sell the wheat at Rs. 500 per quintal at a future date. This is called hedging.
Example 2 – Commodity trading for speculation
Now, assume that you are a trader who is interested in crude oil futures trading. You are bullish on crude oil (meaning you think that crude oil prices will increase in the future). One contract of crude oil is 100 barrels and it is priced at Rs. 2,50,000 (Rs. 2,500 per barrel); but you don’t have to pay the entire money to buy a futures contract. You have to pay a margin of 5% which comes at Rs. 12,500.
Imagine that crude oil prices increases to Rs. 2,550 per barrel. In that case, you earn a profit of Rs. 50 per barrel and make a total profit of Rs. 5,000 (Rs. 50 x 100) by investing just Rs. 12,500. Therefore, commodity trading provides a lot of leverage to traders. 20x in this example.
One can also profit from falling global crude oil prices in the commodity market. For example, you bought an oil futures contract with a strike price at Rs. 4520 on Dec 1 and by December 30 oil prices fell from Rs. 4520 to 4420 per barrel. But you can still sell the futures at Rs. 4520 and make a profit of Rs. 100 per barrel which amounts to a net profit of Rs. 10 lakh (10,000 barrels x 100) assuming the deal was for 10,000 barrels.
In order to trade oil futures, a trader has to find the appropriate exchange for the desired oil benchmark.
- Oil benchmarks: The benchmark for crude oil is the reference point that determines standards for buyers and sellers of oil. On a global level, the most important oil benchmarks are the West Texas Intermediate(WTI), Brent Blend, and Dubai Crude.
- Exchanges: Oil futures in India are traded on the Multi Commodity Exchange, also known as MCX. On MCX, crude oil is one of the most highly traded commodities. On an average, Rs 3000 crores of oil, equivalent to 8500 barrels, is traded on the exchange daily. In FY19, crude oil accounted for nearly 32% of the MCX’s turnover, which was nearly Rs. 66 lakh crores.
Crude oil contracts on the MCX
More than Rs. 3,000 crore of crude oil futures trading takes place in the MCX every day. It is the most actively traded commodity on the exchanges.
Two types of crude oil contracts are traded on the MCX:
Crude oil (Main)
- Price quote: Per barrel
- Lot size: 100 barrels Crude oil (Mini)
- Price quote: Per barrel
- Lot size: 10 barrels
Crude oil mini is more popular with traders because the lot size is less, hence the margin money required is also minimal.
Can retail investors go for commodity trading in oil
Definitely, it requires minimal investment and you have maximum opportunities to earn higher profits due to higher leverage. However, oil futures are not only highly liquid they are also highly volatile and it’s hard to foresee price movements.
If your broker offers commodity broking service and is affiliated with MCX or NCDEX, you can consult them for crude oil futures trading. Initially, it’s better to start with experts and gradually start trading on your own.