There’s a scene in The Social Network, Aaron Sorkin’s film about the origins of Facebook, where Mark Zuckerberg tells a story about his friend and Facebook cofounder, Eduardo Saverin. Saverin made $300,000 in a single summer betting on oil futures—he had an uncanny ability to predict weather patterns and the related spikes and fall-offs in demand for oil.
I’m not a moonlighting meteorologist, but like many investors I do try to keep tabs on crude oil, perhaps more than on any other commodity. To put it simply, the global economy runs on energy, and a third of the world’s energy needs are supplied by crude oil; oil pulls more weight than any other energy source.
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What Do Oil Prices Tell Us?
Let’s begin with the most obvious relationships—gasoline and other fuel prices. When crude oil goes high, you can expect fuel to follow suit. Higher fuel costs are a drag on consumer spending and an added cost for businesses. Airlines, trucking, and other transportation companies are particularly affected.
Imagine how a spike or drop in crude oil prices might impact the fate of a stock like the FedEx Corporation (NYSE: FDX). If you can anticipate a steep drop-off in oil prices, then you may be able to also anticipate a major reduction in FedEx shipping costs, which might in turn boost profits and drive the stock price higher.
The effects of oil prices run a lot broader and deeper than those on transportation-intensive industries. Power generation, home heating, and industrial production of plastics are some of the others that are also directly affected by changes in the price of crude.
Is All Crude Oil the Same?
Attributes such as density and sulfur content separate the different types of crude oil available on the market.
West Texas Intermediate
One of the most high-quality crudes is known as West Texas Intermediate, or WTI. The lightness and low sulfur content of WTI makes it one of the best for producing gasoline. Among commodities traders, you will often hear WTI referred to as “light, sweet crude oil.”
Brent blend, or Brent crude, is crude oil sourced from sites quite far away from Texas. Brent crude comes from Africa, Europe, and the Middle East.
The price of Brent crude is perhaps the most significant oil price on the market, as it is representative of roughly two-thirds of all crude oil production. Brent crude is light, but not as light as WTI, and Brent has a slightly higher sulfur percentage.
Brent crude can be used to create normal gasoline, but it is particularly well-suited to the production of heavier diesel fuels.
Shale oil is crude oil found and excavated from between layers of shale beneath the surface of the earth. Recent advancements in excavation have led to a boom in shale oil production that, for a period of time, lowered the price of crude oil across the board. The shale boom has slowed in recent months.
How Investors Bet On (or Against) Oil
Oil commodities are among the most actively traded of all commodities worldwide. Commodities futures traders seek to anticipate oil price swings, and they purchase futures contracts accordingly.
Like Eduardo Saverin, many players in the crude futures market look to predict weather trends. A colder winter will often translate into higher demand for heating oil, which, like gasoline, is one of crude oil’s main byproducts. Similarly, a summer season in a strong economy with swarms of vacationers traveling by car will raise demand for gasoline, and thus crude.
Perhaps part of what makes the crude oil commodities trade so popular are the frequently volatile politics surrounding oil production. One of the largest producers in the Americas—Venezuela—is plagued by extreme civil, political, and economic turmoil.
The country’s immensely unpopular autocratic president, Nicolas Maduro, in a bid to consolidate political power, recently appointed an active general to oversee the country’s state oil company. Meanwhile, the powerful OPEC oil cartel (the Organization of Petroleum Exporting Countries) has a history of intentionally limiting production so as to secure economic or political advantages for its fourteen member nations.
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Had you invested at twenty dollars a barrel in 1988, you would have just barely covered your investment twice over (a 200 percent return) after a period of nearly three decades. Countless stocks have dwarfed this rate of return over the same time period, all while paying dividends and possibly splitting a time or two.
Direct plays on oil are best left to the futures market and short-term investing schemes.
Nevertheless, it is important even for longer-term buy-and-holders to develop knowledge of the interrelationships and correlations that bind oil to the greater economy.
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This article is a part of our ongoing series that explores a different stock or fund each week. The information contained herein should not be construed as ‘financial advice’ and is presented as the opinion of the author.
ClydeBank Media does not offer financial investment services and has no ties to any of the funds presented in this list. Please see our full financial disclaimer regarding the information contained within this stock analysis. Always consult your financial adviser before making investment decisions.