- Oil trading can be done in different ways:
- For futures contracts concluded on the commodity exchange
- Under contracts concluded on the so-called over-the-counter market
- Under direct long-term contracts between a producer and a consumer of oil
The largest volumes of oil are traded on two stock exchanges:
- New York Mercantile Exchange (NYMEX)
- London Intercontinental Exchange (ICE)
Less significant volumes are also traded on the exchanges of Tokyo, Shanghai, Dubai.
Unlike the stock exchange, the over-the-counter oil market does not have any specific location. In fact, the OTC market is a network of brokers from all over the world who, through various types of communication, communicate with each other and conclude deals to buy or sell oil.
If on the exchange market the volumes of traded oil are standardized and usually amount to 1000 barrels in one contract, then on the over-the-counter market you can buy or sell any volumes. It can be two railroad oil tanks or one oil tanker with delivery anywhere in the world.
Oil prices, which are formed in exchange trading, are widely known and are often mentioned in news reports. Oil prices that form in the OTC market are much less known, but, nevertheless, they are also carefully monitored and published by special agencies (for example, the Platts news agency, widely known in narrow circles).
Crude oil produced in different fields has different physical and chemical properties. It is logical that the price of oil from different fields will be different. As a rule, oil is supplied to the world market not from a single field, but in the form of a mixture from several fields in a certain region. Each such mixture (variety) has its own trade name. For example, Brent crude is a blend of crude oil from 15 fields in the North Sea. The Russian grade the Urals is a mixture of crude oil from fields in Western Siberia and oil from fields in the Volga-Ural region. There are a great many such types of oil in the world. Only the main ones, not counting local species, are about 200 varieties.
OIL TRADING ON THE EXCHANGE
Many people dream of trading oil on the stock exchange. And it is possible. Oil trading takes place from the comfort of your home, from any part of the world. Through the Internet, you earn by buying and selling oil. You can buy oil from your broker, he provides access to the exchange. There, it is allowed to purchase 10, 100, 1000, and more barrels of oil. The very essence of oil exchange trading is that you buy on the difference in the rate of oil. You can earn both on a decrease in the exchange rate and on an increase. You buy oil at the lowest price and then sell it at the highest price.
The unit of measure for volume is the barrel. An American oil barrel is equal to 42 gallons or 158.988 liters. Curiously, the barrel is also used for other liquids, but it only holds 31.5 gallons. Oil exchange trading is carried out in lots. Each lot is equal to 100 barrels. Compared to the actual purchase of oil, the electronic purchase has much less cost and complexity. In real life, you would need a very large amount of money, find a transport, a warehouse, and then also find a buyer. Everything is easier and faster on the stock exchange. You save time by replenishing your capital.
WHAT IS NECESSARY FOR OIL TRADING?
What does it take to trade oil? To begin with, you must open your trading account with a firm that allows you to enter the exchange. After this action, you can start trading oil on the exchange immediately. If you have no work experience, you have the option of trading on a demo account. This is an account that is provided without investing real money. There are several ways to trade oil on the exchange:
- Under a contract that can only be concluded on the OTC market;
- Under a long-term contract between a producer and a buyer of oil;
- For accepted futures contracts on the exchange.
What is the difference between oil trading on the exchange and over-the-counter markets?
The exchange market has established rules, for example, in one oil trading contract, there is a standard 1000 barrels. On the OTC market, you can buy and sell oil in any size, which is much more convenient. The exchange market has a specific location, which cannot be said about the over-the-counter market. Oil is traded in dollars, why? There are several reasons. The oil itself has already become a currency. And, as everyone knows, every currency is tied to dollars. Therefore, the change in oil prices affects the weakening or strengthening of the dollar. The dollar is preferable for the company, it is the most convenient currency. The dollar has the lowest currency exchange commission. Just one currency makes it easy to compare prices. The factors that affect the price of oil are almost the same as those that affect the currency. Namely, political factors and financial,
Since there are so many grades of oil, it is easiest for buyers and sellers to negotiate the price of a certain grade of oil by correlating this grade with one or more benchmarks. These benchmarks are the highly liquid West Texas Intermediate (WTI), Brent, and Dubai / Oman, traded on the stock exchange, called marker grades. Since the competition in the process of exchange trading is close to ideal, oil prices formed as a result of trading on the exchange are considered to be the most objective.
The price of a particular grade of oil is determined, as a rule, with a discount (less often with a premium) to one or several marker grades. The exact formula for calculating the price is described in the sale/purchase contract and takes into account the properties of this oil grade (the main ones are oil density, sulfur content), and transportation costs.
The first practice of pegging the price of the sold oil to the current market price was introduced by the Mexican company PEMEX in 1986. Later, this practice has spread widely throughout the world and has now become the main one in determining the price of sold oil. Although some long-term contracts between a producer and a consumer of oil still sometimes prescribe a specific price for oil, this practice is a thing of the past. Almost all contracts now contain a formula linking the price of the oil sold to the current market price.
Oil and US dollar
In world practice, it turned out that oil is traded in US dollars. And there are several objective reasons for this.
One reason is that oil itself has now become, in fact, a currency of its own. At least from a financial point of view. And, as you know, all currencies are primarily correlated with the US dollar. Euro to a dollar, ruble to a dollar, oil to a dollar. Therefore, by the way, the change in the price of oil reflects not only the change in the ratio of supply and demand in the oil market but also the weakening or strengthening of the dollar as a currency.
Another reason is that when selling/buying oil in dollars, the costs of companies for transferring money from one currency to another are minimized. It is much easier and cheaper to convert your local currency into dollars once or vice versa than to convert rubles into dollars, then into euros, then into yuan, etc. The dollar is preferable for companies as it is the most liquid and convenient currency with low commissions when converting from one currency to another. In addition, denominated oils in one currency (dollar) make it easier to compare prices and conduct arbitrage transactions if the price is somewhere too high (undervalued).
Thus, common sense and economic reality have led to the fact that oil is traded in US dollars, and not in any other currency.