Crude oil futures were created to provide some certainty in the market. Like a farmer harvesting crops, oil producers make a large upfront investment in a product which they will sell at a future unknown price. The futures market helps alleviate some of that uncertainty by setting a price now for future delivery of the product.
Certain industries rely on the futures markets to operate. Take a major consumer of oil, the airlines, they get through thousands of gallons of fuel every day. However, they will sell tickets for their flights weeks, or months beforehand. Without a futures market they would constantly be exposed to the risk of price fluctuations, never knowing if the price the seats were sold for will actually cover the cost of the fuel used.
Buying a futures contract clearly has risks and benefits. It is possible to overpay or underpay for crude oil, as the actual future spot price is unknown at the time of purchasing the contract.
However, overall, producers and consumers tend to overpay just as much as they underpay. The aim is not to make money on price fluctuations, what is important here is achieving price certainty.
- The current supply. Figures are produced weekly by both the International Energy Agency and the Energy Information Administration
- Estimated Future Supply. Various fundamental data such as the oil rig count, OPEC agreements, and political activity in oil producing nations, can affect future supply.
- Anticipated future demand. Various organisations publish the current demand for oil. Predicting future demand is a little more tricky, where fundamentals play a key role. For example, as China and India expand their reliance on fossil fuels, the US is reducing it’s dependence on oil for transportation.
There are a number of different types of oil. However the most widely traded futures market is for US crude oil (WTI). The contract is named CL, and traded on the CME-Nymex exchange.
To know which date the futures contract you are trading is, a letter and number are placed after CL. For example the 2017 December contract for CL is called CLZ17.
A full list of the contract dates can be found here
If the contract is not closed before expiry, then you will be liable for delivery of the crude oil, after expiry date. This is why it is always important to ‘rollover’ contracts before expiry. Rollover is the process of switching to the newest, most heavily traded contract, before the old contract expires.
All trading is complicated and involves a high degree of risk. Trading any market without a plan or structure is little more than gambling.
Although oil is heavily influenced by fundamental data, good or bad data does not necessarily mean the markets will go move in a predictable way. I have found the best way to trade crude oil is to focus on price action and see how the market is digesting the ever changing news and information that surrounds it.
If a piece of news indicates a drop in supply of oil (for instance the recent OPEC agreements capping production), then it can be argued the market will likely go up in the medium to long term. However, it is always important to look for price action to confirm that first. Find trends and confirmations of that bullish move, and then find the best risk/reward place to enter the market.