Crude oil futures are the most popular and most actively traded energy contract on the commodity market. In fact, crude oil futures are the global benchmark for the energy market. The contract is highly liquid and, at the same time, has the kind of volatility that attracts both traders and investors.
Trading crude oil futures can be a profitable venture if you master the market and learn the factors that affect crude oil prices. But futures are leveraged instruments, which may not be appropriate for risk-averse investors, as price changes can happen in a dramatic fashion — in a matter of minutes.
|Crude Oil Futures Contract Specifications|
1,000 U.S. barrels which is 42,000 gallons
Sunday-Friday 5:00p.m. - 4:00p.m. CST
Last Trading Day
Trading ends at the close of business on the third business day before the 25th calendar day of the month prior to the delivery month
What You Need to Know About Crude Oil
Crude oil is unrefined petroleum, which occurs naturally in the ground and composed of hydrocarbon and other organic materials. It is formed from fossil deposits millions of years ago and can be processed into various useful products through a process known as fractional distillation. Here are some facts you should know about crude oil:
Evidence suggests that crude oil has been used in one form or another since ancient times, especially in Babylon, Persia, and China. But it rose in importance with the development of the internal combustion engine during the industrial revolution in the 19th century.
The first modern oil refinery could be traced to the works of James Young in 1851 in Scotland and Ignacy Łukasiewicz in 1856 in Austria. Today, the world is very much dependent on crude oil as a source of energy, despite the campaign for green energy.
Over 75 million barrels of crude oil are produced in the world every day, and most of them come from these countries: Russia, Saudi Arabia, USA, Iraq, Iran, China, Canada, United Arab Emirates, Kuwait, and Brazil. Depending on the density and sulfur content, crude oil produced by these countries are classified into West Texas Intermediate (WTI), Brent Crude, Dubai Crude, and the Urals.
Crude oil is about the most useful commodity in the world. It is processed through fractional distillation to get a wide range of useful products, including gasoline, diesel, aviation fuel, heating oil, kerosene, petroleum naphtha, asphalt base, liquefied petroleum gas, and fuel oils.
Apart from being a major source of the global energy supply, products from crude oil are used in the manufacture of many consumer products, such as plastics, cosmetics, fertilizers, pesticides, synthetic textiles, computer hardware, etc.
What Are Crude Oil Futures?
Crude oil futures are standardized contracts that trade on commodity exchanges, and their values reflect the anticipated price of crude oil in the future. A crude oil futures contract is an agreement to make or take delivery of a specified quantity of crude oil on a specified future date, at a predetermined price.
Crude oil futures started trading on the NYMEX in1983. The contract specifications normally state the quantity, grade, date of delivery, contract units, and currency denomination. Commodity exchanges have clearinghouses, who guarantee the contracts by acting as the middle person between buyers and sellers.
The contract trades on margin, meaning that only a small percentage of the total worth is deposited to trade it. Throughout the life of the contract, the clearinghouse marks the contract to market, so the daily differences in price are settled at the end of each trading day. Traders in winning positions have their profits added to their accounts while those in losing positions have their accounts debited.
At expiration, the seller provides the exchange with the specified quantity of crude oil and gets settled, while the buyer balances the exchange and takes delivery of the commodity. The settlement process can be quite complicated, which is why traders, who are not interested in the physical crude, try to avoid it.
In fact, most of the traders in the crude oil futures market are not interested in the physical commodity, and they avoid the process via any of these two ways:
Offsetting position before expiration
Speculative traders, short-term traders close their positions before the contract expires in order to avoid the final settlement and delivery process.
Rolling over to the next contract period
Long-term traders and hedgers tend to swap their expiring contracts with another contract with a further expiration date by simultaneously closing the current position and opening a new one in a contract with a further expiration date.
If, in any way, a trader unknowingly leaves his position until the contract expires but still wants to avoid the delivery process, he can retender the crude to the exchange. It will cost him a couple of hundred dollars per contract though.
How Do Crude Oil Futures Contracts Trade?
Unlike forward contracts, which trade over the counter, crude oil futures contracts trade on commodity exchanges and are standardized. Here are the key features of crude oil contracts.
Exchanges where crude oil futures contracts trade
Crude oil futures trade on several popular commodity exchanges around the world, including the Tokyo Commodity Exchange (TOCOM), the International Petroleum Exchange (IPE) London, which is now a subsidiary of the Intercontinental Exchange (ICE), and the New York Mercantile Exchange (NYMEX), a member of the Chicago Mercantile Exchange (CME) Group.
The exchanges offer contracts on the different types of crude oil, such as the Brent, Middle East Sour Crude and WTI. But the WTI is most popular in the American market.
Margins and leverage
A crude oil futures trader is required to have a certain minimum amount in his account to be able to trade a crude oil contract. This minimum amount is known as the margin, and its value depends on the exchange, type of contract (a full contract or mini contract), contract expiration, and the market situation.
The margin requirements for the full crude oil contract on the NYMEX is $4,000 for the December 2019 contract, $3,975 for the February 2020 contract, and $3,925 for the March 2020 contract. Leverage, which is inversely related to the margin also varies accordingly.
On the CME and ICE, one full contract of crude oil settles for 1,000 barrels or 4,200 gallons of the commodity, and the price quotation is in the U.S. dollar and cents per barrel. The minimum price fluctuation is one cent per barrel or $10 per contract. On the TOCOM, crude oil futures prices are quoted in yen per kiloliter and are traded in lot sizes of 50 kiloliters or 13,210 gallons.
Apart from the standard full contract, the CME also offers the E-mini crude oil futures contract, which settles for 500 barrels or 2,100 gallons of crude oil.
For the WTI contracts on the CME Group, monthly contracts are listed for the current year and the next 10 calendar years, with two additional contract months. Following the termination of trading in the December contract of the current year, monthly contract for a new calendar year and two additional contact months are added.
Trading terminates three business days before the 25th calendar day of the month prior to the delivery month. If the 25th calendar day is not a business day, trading terminates on the third day prior to the last business day preceding the 25th calendar day.
At expiration, the contracts are settled by physical delivery, and the delivery procedure is as follows:
- The commodity is delivered no earlier than the first calendar day of the delivery month and no later than the last calendar day of the delivery month.
- The seller is obligated to ensure that its crude oil receipts, including each specific foreign crude oil stream, if applicable, are available to begin flowing ratably in Cushing, Oklahoma by the first day of the delivery month, in accordance with generally accepted pipeline scheduling practices.
- The seller shall provide the buyer with all the paperwork, including the pipeline ticket, any other quantitative certificates, and all appropriate documents upon receipt of payment. The seller shall provide preliminary confirmation of the title transfer, by telex or other means, at the time of delivery.
On the ICE, however, the WTI crude oil futures contract is cash-settled against the prevailing market price for US light sweet crude. It is a price in USD per barrel equal to the penultimate settlement price for WTI crude futures as made public by NYMEX for the month of production, in accordance with the 2005 ISDA Commodity Definitions.
Why Trade Crude Oil Futures?
The reasons for trading crude oil futures vary among traders, but most of them fall under controlling price risk, inflation hedge, portfolio diversification, and speculation.
Managing price risk
Crude oil producers can sell crude oil futures contracts to secure their profit at the current price and protect their businesses from severe price fluctuations in the future. For example, say crude oil is trading at $67.00 per barrel, and it costs Company X, an oil-producing company, $40.00 to produce one barrel of crude. If Company X is concerned that the price of crude may decline in the future, they may approach the futures market and sell enough crude oil contracts that cover their anticipated production volume. Assuming crude oil price falls to $50 per barrel when the contract expires, Company X must have preserved $17 per barrel for themselves.
Similarly, crude oil refiners can buy crude oil contracts to secure a stable supply of crude they need in their factories. If there is a shortage of supply in the future and the price rises, they won’t have to worry about their crude oil supply because they had already secured a contract at a cheaper price.
While fiat currencies lose their purchasing power when there is rising inflation, commodity prices tend to rise during hyperinflationary periods, and crude oil is not an exception. As a result, some investors buy the commodity to protect their wealth against inflation.
Fund managers and institutional investors always try to diversify their portfolio across several asset classes, and crude oil futures are one of those derivatives with enough liquidity to absorb their huge orders. These investors understand that by spreading their investments across many asset classes, they’re reducing their exposure to market risks.
The majority of individual traders in the crude oil futures market trade for speculative purposes. They are not interested in the crude oil per se; their only interest is to benefit from the daily fluctuations in oil prices.
Crude Oil Futures Trading Strategies
Being the most liquid contract of the energy futures contracts, the crude oil futures markets easily swallows big order without hesitation. Including the fact that there are many edges to be found on the market, it’s one of our favorite markets to trade. And as always, we have quite a lot of trading strategies trading the market simultaneously to achieve better diversification.
If you’re interested in getting edges for a variety of futures markets, we recommend that you have a look at our edge membership. As a member, you’ll get new edges delivered every month!
Factors Affecting Crude Oil Futures Prices
Crude oil prices are affected by a lot of factors, and these are some of them:
Supply disruptions: Disruptions in oil supply can push the prices up. Many of the countries in the Middle East are among the top crude oil producers in the world, and some of them often experience adverse political situations, such as wars, terrorism, and international sanctions. Apart from the political events, oil supply disruptions can be caused by the Organization of Petroleum Exporting Countries (OPEC) if they intensional decide to reduce output to push crude prices up.
Shale oil production: The US has turned from being the biggest crude oil importer to one of the top 10 exporters of oil, all thanks to the shale oil boom which started in 2010. The oversupply caused by the increase in U.S. output is one of the main reasons for the 2015 severe decline in oil prices, which lasted until OPEC decided to cut output and help crude prices recover above $50 per barrel.
Shifting demand: With the emergence of improved technologies, we now have cars that are more fuel-efficient. Some even run entirely on battery or solar energy. All these, coupled with the push for renewable sources of energy, will affect the demand for crude oil.
Global warming and changing policies: The issue of climate change and global warming has become a major talking point in recent times, and governments around the world are making policies to reduce the use of fossil fuels. This will reduce the demand for crude oil and can affect prices.
Energy reports: Traders closely monitor the U.S. Energy Information Administration (EIA) Weekly Energy Stocks report. The report is released around 10:30 a.m. ET every Wednesday, and it details the crude oil inventories in the US. Other keenly followed reports are the OPEC Monthly Oil Market Report, American Petroleum Institute (API) Inventory Report, Monthly Energy Review, International Energy Agency (IEA) Oil Market Report, Annual Energy Outlook, Short-Term Energy Outlook, and International Energy Outlook.
Crude Oil Futures Seasonality
Here is a seasonal chart of the crude oil spot price, found at cxoadvisory.com
Crude oil is one of the most important commodities on our planet. It touches every aspect of the global economy — energy production, transportation, and even consumer goods. The CME Group, ICE, and TOCOM offer crude oil futures contracts.