By Noble Drakoln

Crude oil is a naturally-occurring substance found in certain rock formations in the earth. To extract the maximum value from crude, it needs to be refined into petroleum products. The best-known of these is gasoline, or petrol. Others include liquefied petroleum gas (LPG), naphtha, kerosene, gas oil and fuel oil.

Oil wells are used to release the oil from within the earth. Some of the earliest developed oil wells were drilled in China using bamboo poles. These oil wells were developed in 347 A.D. for the sole purpose of providing enough fuel to create a thriving salt industry. By the 1950s, crude oil became a global energy source, which in effect killed the whaling industry by making whale oil obsolete.

In the crude oil industry, there are oil names (such as Brent Light Crude Oil and Bonny Light) and there are oil types (such as light, heavy, sweet and sour). Light oil has a low density viscosity, while heavy oil is of higher density. Sweet oil has less sulfur, and sour oil has excessive sulfur. The world market prefers light, sweet crude oil, largely because it requires less refinement and production time before going to market. (Find out how to stay on top of data reports that could cause volatility in these markets in Become An Oil And Gas Futures Detective.)

A sample commodity futures contract for crude oil is shown in the following table.

Crude Oil Contract Specifications
Ticker Symbol Open Outcry: CL (NYMEX)
Contract Size 1,000 U.S. barrels (42,000 gallons)
Deliverable Grades Specific domestic crudes with 0.42% sulfur by weight or less, not less than 37 degrees API gravity nor more than 42 degrees API gravity. The following domestic crude streams are deliverable: West Texas Intermediate, Low Sweet Mix, New Mexican Sweet, North Texas Sweet, Oklahoma Sweet and South Texas Sweet.
Specific foreign crudes of not less than 34 degrees API nor more than 42 degrees API. The following foreign streams are deliverable: U.K. Brent, for which the seller shall receive a 30 cent per barrel discount below the final settlement price; Norwegian Oseberg Blend is delivered at a 55 cents–per–barrel discount; Nigerian Bonny Light, Qua Iboe, and Colombian Cusiana are delivered at 15 cent premiums.
Contract Months All months
Trading Hours NYMEX Open Outcry: Monday-Friday 9am-2:30pm EST
eCBOT Electronic: Sunday-Friday 6pm-5:15pm CST
Last Trading Day Trading terminates at the close of business on the third business day prior to the 25th calendar day of the month preceding the delivery month. If the 25th calendar day of the month is a non-business day, trading shall cease on the third business day prior to the business day preceding the 25th calendar day.
Last Delivery Day All deliveries are ratable over the course of the month and must be initiated on or after the first calendar day and completed by the last calendar day of the delivery month.
Price Quote Dollars and cents per barrel.
Tick Size NYMEX: 1 cent per barrel ($10.00 per contract)

Daily Price Limit
(Not applicable in electronic markets)
  1. $10 per barrel ($10,000 per contract) for all months. If any contract is traded, bid or offered at the limit for five minutes, trading is halted for five minutes.
  2. When trading resumes, the limit is expanded by $10 per barrel in either direction. If another halt were triggered, the market would continue to be expanded by $10 per barrel in either direction after each successive five-minute trading halt.
  3. There will be no maximum price fluctuation limits during any one trading session.

Understanding Crude Oil Contracts
Like every commodity, crude oil has its own ticker symbol, contract value and margin requirements. To successfully trade a commodity, you must be aware of these key components and understand how to use them to calculate your potential profits and loss.

For instance, if you choose to buy or sell a crude oil futures contract, you will see a ticker tape handle that looks like this:

CL8K @ 105.52

This is just like saying "Crude Oil (CL) 2008 (8) May (K) at $105.52/barrel (105.52)." A trader buys or sells a crude oil contract according to this type of quotation.

Depending on the quoted price, the value of a commodities contract is based on the current price of the market multiplied by the actual value of the contract itself. In this instance, the crude oil contract equals the equivalent of 1,000 barrels multiplied by our hypothetical price of $105.52, as in:

$105.52 x 1,000 barrels = $105,520

Commodities are traded based on margin, and the margin changes based on market volatility and the current face value of the contract. To trade a crude oil contract on the New York Mercantile Exchange (NYMEX) a trader may be required to maintain a margin of $8,775, which is approximately 8% of the face value. The margin amount will change in different market conditions, but the amount of leverage provided by the futures markets makes it attractive for investors looking to gain exposure to oil prices.

Calculating a Change in Price
Because commodity contracts are customized, every price movement has its own distinct value. In a crude oil contract, a one-cent move is equal to $10. When determining NYMEX's crude oil profit and loss figures, you calculate the difference between the contract price and the exit price, and then multiply the result by $10. For example, if prices move from $105.52 to $110.83, you multiply the difference, which is $5.31, by $10 to yield a contract value change of $5,310.

- Buy Sell Total Value
Crude Oil Contract Price (1 cent move = $10) $105.52
$110.83 531 cents or $5,310


Crude Oil Exchanges
Futures contracts for crude oil are traded at the New York Mercantile Exchange (NYMEX), Intercontinental Exchange (ICE), Dubai Mercantile Exchange (DME), Multi Commodity Exchange (MCX), India's National Commodity and Derivatives Exchange (NCDEX) and the Tokyo Commodity Exchange (TOCOM).

Facts About Production
One barrel of crude oil is the equivalent of 42 U.S. gallons. After the barrel of oil is refined, it yields approximately 20 gallons of motor gasoline and seven gallons of diesel. With an additional 17 gallons of petroleum byproducts, such as propane, ammonia and plastic materials, the total refining process has a net gain of two gallons - 42 gallons go in; 44 gallons come out.

As mentioned, the types of crude oil are light/ heavy and sweet/ sour. Lighter, sweeter crude is in more demand globally, but is becoming increasingly difficult to access. This has caused many investors on Wall Street to question how much oil is actually being pumped from reserves versus how much oil is being used. Emerging economies in both China and India have added to this intense debate.

In 2004, annual worldwide oil consumption was 30 billion barrels. This would not have been controversial, except that new discoveries during the same time had fallen to eight billion barrels. By 2005, worldwide demand for oil had reached 31 billion barrels, leaving worldwide emergency stockpiles nearly depleted for 37 days. While Saudi Arabia, Russia, and the U.S. are the top oil producing countries in the world, they are having more difficulty meeting demands.

Currently, 62% of the world's accessible oil can be found in the Middle East, centered around five countries: Saudi Arabia, United Arab Emirates, Qatar, Iraq and Kuwait. The fact that a protracted war on terror in Iraq has halted production to a fraction of what it used to be is important to take into consideration. Also understand that Qatar shares a natural gas field with Iran, considered by the U.S. as part of the axis of evil, so two out of the five Middle East countries are not producing at full capacity. (When the price of oil goes up, don't worry about how much gas is going to cost; get even by making a play on the Canadian dollar. Find out how in Canada's Commodity Currency: Oil And The Loonie.)

Factors That Influence Crude Oil's Price
The price is influenced by the following factors:

  • For the past 50 years, the price of crude oil has been denominated in U.S. dollars. With the fluctuation in the value of the U.S. dollar and the prominence that newer currencies such as the euro are gaining, OPEC is considering switching crude oil from a U.S. dollar quotation system to either the euro or to a basket of multiple currencies. This could have an adverse affect on oil prices in the short run.
  • In 1956, geophysicist M. King Hubbert made the dire prediction that oil would reach a peak production level, flatten out, and eventually decline - following a bell curve pattern of distribution. Eventually, the world would deplete all of the available oil. The peak, as calculated by Hubbert, was alleged to have been hit in 1970. Since then, peak oil predictions have been readjusted to account for current usage versus what is being pumped from the ground. (For more on this phenomenon, see Peak Oil: What To Do When The Wells Run Dry.)
  • Alternative methods of oil development are gaining prominence. Oil shale and tar sands are becoming viable oil producing sources. As the price of technology begins to decrease, these sources become more accessible to refiners. Methods for turning methane and coal into oil substitutes, first discovered in the 1930s and during WWII, are being explored again. All of these alternatives have the opportunity to upset crude oil prices.
  • Global warming is considered an unintended consequence of using petroleum-based products. This has led to an aggressive move to develop green energy sources such as electric cars, fuel cells, ethanol, liquid natural gas and others, in the hope that they can potentially reduce the world's reliance on crude oil. As these technologies become more common in the marketplace, they have the ability to displace crude oil.
Conclusion
Crude oil is a commodity that the 21st century inherited from the 19th century, with all of its benefits and drawbacks. Of all of the traded commodities, it has the broadest impact. How the world interacts with the crude oil industry in the years to come will have a wide-reaching impact on the environment, the global economy and our daily lives.


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