How safe is crude oil investment?

NEERAB PUDASAINI

There are many commodities on which we can invest. Oil trading is one of the sectors. Crude oil future trading is very novel for our commodity trading, but choosing the commodity for trade without proper knowledge can be a nightmare, as it has the gambling effect. There is both a chance of profit or loss in this trading because of the variation in price which occurs on a regular basis.

Oil is a most volatile commodity, so if we want to work it in our favor we must properly study the factors affecting it before trading; otherwise it will be just like gambling.

Future trading in crude oil began on the NYMEX platform in the year 1983, with the contract size of 42,000 gallons i.e. 1,000 US barrels. Today the margin needed to trade is about $ 9,788 (which may vary with the market fluctuation). In Nepal, MEX (Mercantile Exchange Nepal) started crude oil trading from the year 2008 with the contract size of 250 US barrels. According to them, they settle around 1,500 to 3,000 contracts of crude per month.

With the dream of earning enormous profits, most of the traders lose their money, because crude oil trading is not as simple as they think. Traders always have to keep a watch on every OPEC (Organization of Petroleum Exporting Countries) step, because it controls the price of oil. OPEC was formulated in the year 1960 with the intention of organizing and protecting the interests of oil producing countries.

The well known fact is that commodity price is governed by the demand and supply paradigm. If OPEC decided to cut the production of oil, then its demand would increase and vice versa. Likewise, during winter the demand increases. The recent adverse climate in different parts of US has led to a high demand resulting in crude oil price increase. The US dollar is another important factor to be considered before trading, because it changes the oil price on a daily basis. When the dollar goes up, oil prices go down, and vice versa. Some political experts even have gone on to say that the base currency issue is the main factor for the Iraq war.

Crude oil price is also dependent on the volatility of global equity market, mainly US, China, and European equity markets control oil prices. The US is the biggest consumer of crude oil, therefore, the demand volume of US also has an impact on its price. A global trader of crude oil always waits for the report of EIA (Energy Information Administration). EIA provides a weekly report on crude oil inventory of the US, and the market always reacts on this data. Therefore, the suggestion is to keep an eye on it.

Crude oil always moves with the US employment data or labor department report. If the unemployment rate increases, the price of crude oil goes down and vice versa. Besides, other factors like war, recession, and natural disasters are important factors which affect crude oil price. Therefore, all the factors in combination or alone can affect the price of crude oil.

During the 1970s, the price of oil and inflation was very interrelated, as oil price moves up or down, and inflation follows suit. We can say that oil is the major input to economy. If the input costs rise, it affects the economy. For example, if the price of oil rises, then it will cost the industry, and the industry will pass all of its cost to the end users, which leads to price rise and, thus, inflation. All this was seen during the 1970s, but after the 1980s, the oil and inflation started to deteriorate. During the Gulf War in the 1990s, crude oil price doubled in six month from $20 to $40 pr barrel, but the CPI (Consumer Price Index) remained stable from 134.6 to 137.9. With this historical data, we can say that the correlation between crude oil and inflation, has weakened significantly now.

The price of oil in 2011 has a very good chance of increasing because of its huge demand, particularly from fast moving economies like China and India. There is no sign of improvement in the US economy because of the recent FED announcement of pumping $600 billion into the financial market by buying US treasury bonds; the weakened US or USD will definitely lead to increase in the price of crude oil.

The recent BP oil spill issue has forced the government to restrict these forms of acquiring crude oil as it may lead to decrease in supply, which automatically increases the price of oil. The political imbalance of two super powers may affect the price of oil in 2011. Demand is yet another important factor for price rise and demand of oil is rising day by day. Recently, OPEC published its consumption forecast by 800,000 barrels a day for 2014, saying the signal for economic recovery are visible.

Apart from the fundamental indicators, there are technical indicators which should be considered before trading. Mainly, Bollinger band, volatility indicator, momentum indicator, RSI, and some other technical indicators must be studied. So, the suggestion is not to trade in any commodity without proper knowledge. Commodity trading is subject to market risks which makes studying both the technical and fundamental factors for each commodity essential before trading.

neerab@neerabpudasaini.com.np