Crude Oil Overview

Updated on January 25, 2024
Article byRutan Bhattacharyya
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Crude Oil?

Crude oil, or simply crude, is a source of liquid fuel that one can extract via drilling. It serves as a core component for petroleum products, chemicals, plastics, and transport fuel. Moreover, it can help investors diversify their portfolios and mitigate financial risk.

Crude Oil

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Since the world heavily relies on this mixture of hydrocarbons occurring naturally, its price heavily depends on economic growth’s pace, impacting the demand prospects. Also, oil prices impact different commodities’ prices. Moreover, one must note that changes in the price of crude oil may trigger deflation or inflation. For instance, higher oil prices mean increased shipping and input costs.

Key Takeaways

  • Crude oil refers to a non-renewable fossil fuel that one can find in natural underground reservoirs. It is a base component for transporting fuel, petroleum, plastics, petroleum products, and chemicals. In addition, investors can opt for crude oil trading to diversify their portfolios.
  • Some popular models used to predict oil prices are time-series analysis, regression-based structural model, and Bayesian Autoregressive Model
  • There are various factors influencing oil prices. Some are alternative energy sources, market speculation, exogenous shocks, and OPEC oil countries.
  • Based on the sulfur content, crude has two categories — sour and sweet.

Crude Oil Explained

Crude oil refers to a liquid petroleum product that occurs naturally. It is a non-renewable resource found underground and is composed of different organic materials and organic deposits. This commodity serves as a leading fuel source all around the world.

Crude and its derivatives are traded worldwide in oil markets. One must refine this fuel source before utilizing it. After refining, it falls into the petroleum products category.

As noted above, crude prices have ripple effects via the broader economy. The demand and supply principles predominantly drive the prices. Shrinking demand and oversupply lower prices, short supply, and surging demand increase the prices, while natural disasters or geopolitical events impacting oil-producing countries drive the perceived supply and demand changes. Speculators investors can engage in crude oil trading through spot and futures markets and ETFs or exchange-traded funds.

There are different categories of crude. For example, the API, or American Petroleum Institute, developed API gravity, a measurement standard on the basis of density. It groups crude into two weight-based classifications. Also, certain organizations classify the commodity as a medium for the oils failing between light and heavy levels.

Based on the sulfur content utilized by the industry, crude is sour or sweet. Generally, sweet crude contains less than 1% sulfur. On the other hand, sour crude’s sulfur content is over 1%. Generally, sweet crude contains less than 1% sulfur. On the other hand, sour crude’s sulfur content is over 1%.

The four labels utilized to classify crude are as follows:

  • Sweet
  • Sour
  • Light
  • Heavy

Pricing crude involves measuring the spot price of different oil barrels. Two common ones are as follows:

  • Brent Blend:  This is the primary benchmark crude in Africa and Europe.  
  • West Texas Intermediate (WTI): This is America’s benchmark crude.

Sometimes, people also quote the basket price of the Organization of Petroleum Exporting Countries or OPEC.

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History

The development of crude took place during the industrial revolution. Moreover, the introduction of its industrial uses was in the 1800s. The global economy heavily relies on fossil fuels, such as crude. However, the demand for such resources often causes political unrest since only a few nations have control over the largest reservoirs.

Similar to any industry, demand, and supply heavily affect crude oil profitability and prices. Saudi Arabia, the U.S., and Russia are some of the largest oil producers worldwide.

In the late 1800s and early 1900s, the U.S. was a leading oil producer in the world. Organizations within that nation introduced new technology for producing gasoline and other useful products from oil. During the middle and the last few decades of the 1900s, oil production in the U.S. dropped drastically, and the country converted into an importer of energy. In 2021, net crude imports stood at the second-lowest yearly level since 1985.

One of America’s largest oil suppliers was OPEC. The organization comprised the world’s largest natural gas reserves and crude holders in terms of volume. Thus, the OPEC countries had significant economic leverage in the determination of supply and the price of crude oil in the late 1900s.

In the early 2000s, new technological development, specifically hydro-fracturing, established a second energy boom in the U.S., significantly decreasing the influence and importance of OPEC.

Heavy dependence on fossil fuels is the primary reason behind global warming. After all, the risks associated with oil drilling include ocean acidification and oil spills, which cause damage to the ecosystem.

Moreover, in the 21st century, many producers manufacture products that depend on alternative energy sources, such as electric vehicles, wind turbine-powered communities, and solar panel-powered homes.

Factors Affecting Crude Oil Prices

Let us look at some factors impacting crude prices.

#1 – OPEC Nations

OPEC (Organisation of the Petroleum Exporting Countries)is a cartel comprising 14 nations that export petroleum. Here cartel means that all these countries together regulate oil prices by increasing and decreasing the supply. In 2018, the nations agreed to restrict oil production to roughly 39 barrels daily, which was over 1/3rd of worldwide production.

That said, one must note that the influence of OPEC is reducing owing to the American fracking industry’s expansion.

#2 – Non-OPEC Oil Nations

Apart from the OPEC nations, the leading oil producers in the world include China, the U.S., and Canada. Together the non-OPEC countries produce approximately 53 million crude oil barrels each day.

#3 – The U.S. Dollar’s Strength

The exchange of oil occurs in U.S. dollars, which means that the dollar value has a significant effect on oil prices. For example, oil prices will decrease if the U.S. dollar strengthens, provided every other factor stays the same.

#4 – Market Speculation

The price of crude is set on futures markets. This means market speculation concerning future events can impact oil prices. For instance, if China decides to develop new nuclear power plants, oil demand will drop significantly. On the other hand, a rise in global fracking can lead to increased crude supply and more speculation in the market.

#4 – Exogenous Shocks

Events that are impossible for economics to control or explain, such as geopolitical instability, war, and natural disasters, can affect oil prices.

#5 – Alternative Energy Sources

A higher awareness of the benefits of renewable energy sources, for example, wind and solar, can decrease the world’s dependence on crude. Thus, with the supply remaining high, the oil demand will drop. This, in turn, will lead to a fall in oil prices.

How To Invest In Crude Oil Contracts?

There are many ways to allocate funds to oil commodities. Individuals can even purchase actual crude by the barrel. This commodity trades on the NYMEX or New York Mercantile Exchange as light sweet crude futures contracts. It trades on other exchanges worldwide too. Such contracts are agreements that deliver a certain quantity of the commodity at a specific price on a particular date.

Another way to purchase oil is by buying oil options, which are contracts that provide sellers or buyers with the right but not the obligation to trade the commodity on a certain date in the future. If individuals want to purchase options or futures directly in oil, they must trade them on commodities exchanges.

Besides oil futures and options, one more common way for individuals to gain exposure to crude is to invest in oil ETFs. One must note that individuals can also get indirect exposure to crude by allocating funds to different oil companies.

Forecasting Crude Oil Prices

Let us look at some models commonly used to predict oil prices.

#1 – Bayesian Autoregressive Model

Enhancing the standard regression-based model involves adding computations to measure the probability of the effect of specific anticipated events on oil. The majority of contemporary economists like utilizing the BVAR or Bayesian vector autoregressive model to estimate oil prices.

#2 – Time-Series Analysis

Economists also utilize time-series models, for example, autoregressive models and exponential smoothing models, to predict future oil prices. These models involve analyzing oil’s history at different points to extract meaningful stats and estimate future values based on the values previously observed.  

#4 – Regression-Based Structural Model

In this case, statistical computer programming computes the probabilities of specific behaviors on oil prices. These models have a strong predictive power. However, if the creators of such a model do not include one or multiple, it may fail.

#5 – Oil Futures Prices

The IMF or International Monetary Fund, and central banks primarily utilize the prices of oil futures contracts as their gauge. Individuals in crude futures set the prices by a couple of factors — demand and supply and market sentiment.

Frequently Asked Questions (FAQs)

1. How crude oil is extracted?

On land, one can drill oil using an apparatus known as a drilling rig or oil rig. In the case of offshore oil, people drill the crude from an oil platform. A lot of modern wells utilize air rotary drilling rigs, which have the capacity to operate 24 hours per day.

2. Does crude oil burn?

Crude is flammable. Moreover, one must note that it contains hydrogen sulfide gas, which is harmful. Oil wells may catch fire due to arson accidents or any natural event, such as lightning.

3. Will crude oil go up?

One cannot say for sure whether crude prices will increase or decrease as they depend on multiple factors, such as OPEC oil nations, exogenous shocks, etc. That said, individuals can use specific techniques like time-series analysis to estimate future price movements.

4. How crude oil is transported?

It is transported from wellheads to refineries via the use of tankers, barges, trucks, pipelines, and railroads. Among these, transporting through pipelines is the cheapest and safest way to transport crude and refined products.

This has been a guide to what is Crude Oil. We explain its history, factors affecting its prices, how to invest in and forecast crude oil contract prices. You can learn more about it from the following articles –

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