Oil prices are currently in the spotlight. This time, it is not just traders that are keeping a close eye on the price of the commodity. A spike in fuel prices is worrying consumers and prompting governments to act. There is talk that U.S. President Joe Biden might visit Saudi Arabia soon, another sign that the pressure on governments to contain rising prices is growing.
What factors are driving oil prices higher? And how can retail traders potentially profit from price movements in the oil trading market?
Oil prices were always extremely volatile, and not an asset for faint-hearted traders. However, the commodity has seen an unprecedented level of volatility in the past two years. It started with the COVID-19 pandemic when oil prices even went into negative territory and panic was widespread.
Oil prices then went into a phase of steady recovery and eventually reached a new multi-year high in October 2021, driven by hopes that the worst is behind us and that we will see a rebound of the global economy.
The next shock came in February 2022 when Russia attacked Ukraine. Volatility has remained at elevated levels since then.
What factors are driving oil prices now?
- China´s strict COVID-19 measures led to concerns about a slowdown of the world´s biggest economy, and lower oil demand. Oil traders are showing more optimism now that China is gradually opening. A sharp rebound in oil demand from China could push prices even higher, as it is unlikely major producers would adjust their production fast enough to respond to this. However, it remains to be seen how quick the Chinese economy can recover from the shock of the harsh zero-COVID rules.
- The European Union is working hard to free itself from its dependence on fossil fuels from Russia. The EU recently agreed to a partial embargo of Russian oil imports and is planning to have a full ban eventually in place. A full embargo could take time, but there is little doubt that the recent events represent a new world order for the energy market.
- Geopolitical tensions are unlikely to abate soon, which could keep oil prices volatile.
- OPEC+ is another important factor. The organization recently agreed to increase its oil production starting from July in response to the global energy shortages. However, the move only caused a temporary decline in oil prices, as it will only slightly make up for the deficit in the market. What could be next? The U.S. might try to encourage Gulf states to ramp up production further. OPEC might also decide to exempt Russia from its oil production quotas, allowing other producers to increase their output.
Most retail traders trade oil in the form of CFDs (contracts for difference), including cash and futures, which means they are not buying the underlying asset (a physical barrel of oil) but simply speculating on whether the price of oil in the open market is going to rise or fall.
While there are many different oil benchmarks, most of the prices are pegged to one of the primary benchmarks: WTI and Brent Crude.
Brent Crude oil: An estimated 60% of the world’s traded oil is priced off Brent, making it the most widely used marker and one of the major benchmarks for oil in the Middle East, Europe and Africa. Brent crude oil is obtained from four oil fields (Brent, Forties, Oseberg and Ekofisk) in the North Sea, which makes it more convenient to transport. Crude from this region is considered ‘light’ and ‘sweet’.
WTI: WTI oil is the main benchmark for oil consumed in the USA and is extracted from wells in America. As these oil fields are landlocked, transporting WTI oil is relatively expensive compared to Brent.
CFDs offer several advantages over futures contracts. Margin requirements are far lower, allowing traders to trade oil without putting up a significant amount of capital. Leverage of up to 100:1 can be used, although leverage is always a double-edged sword. Trading costs are generally lower, and there is more flexibility compared to the standardized futures contracts.
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