What Is Crude Oil?

Crude Oil Explained

Oil rig with workers
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Crude oil is a liquid fuel source located underground and extracted through drilling. Oil is used for transportation, heating and electricity generation, varied petroleum products, and plastics.

Here are the types of crude oil and how they affect individual investors, consumers, the broader economy.

Definition of Crude Oil and Its Uses

Oil is called a fossil fuel because it is made up of ancient fossils. The oil we use today came from water-based plants and animals that lived before even dinosaurs existed. Oil is a fossil fuel made up of hydrocarbons left behind by animals and plants millions of years ago.

Over millions of years, the remains of these plants and animals were crushed and heated between layers of rocks and sand until they became underground pools of oil. We call this oil "crude oil" because it is not yet refined for use. Crude oil is both a fuel and a base for products. Oil can fuel jets, cars, heaters, and generators.

Crude oil can be used to create petroleum products like tar, asphalt, paraffin wax, and lubricating oils. It can also be used to create products that aren't typically associated with petroleum. Perfume, fertilizer, and computers are all made with crude oil. It's the base for plastics, so anything with plastic is made with crude oil.

Oil is a nonrenewable resource. It will take millions of years for new oil to be created when the world's current supply is depleted.

In 2020, the United States produced 4.1 billion barrels of crude oil. Each barrel produces roughly 45 gallons worth of petroleum products. Gasoline is the most commonly produced petroleum product, and about 19.4 gallons of gas is produced from each barrel of crude oil.

What Are the Impacts of Crude Oil Use?

Modern society depends on oil to function. Without it, there is no economic activity. The demand for oil and the dependency on it has many impacts worldwide. The impacts vary from the pollution it creates to the money it helps make.

Broad Economic Impacts

Crude oil is used in nearly every industry for something. Rising costs affect the cost of products and services, so the cost of living goes up. Some 26% of all energy used in the U.S. in 2020 was used in the transportation sector, so higher crude oil prices impact any industry that involves transportation.

Higher oil prices increase prices of other fuels like gasoline, home heating oil, and natural gas. In 2020, the cost of crude oil made up 43% of the price of gasoline. Federal and state taxes made up 22% of the price paid at the pump, followed by refining costs and profits, and finally by distribution and marketing costs.

Oil prices also play a major role in prices paid for industrial processes and residential living. Higher oil prices effectively increase the cost of everything you buy, and this creates inflation.

Climate Concerns

Burning oil releases carbon dioxide that remains in the Earth's atmosphere. These molecules act as a blanket over the Earth, capturing the solar heat that bounces off the Earth's surface. This is known as the "greenhouse effect."

Since the Industrial Revolution of the late 1800s, the excessive burning of oil has had a pronounced effect on the climate. The amount of carbon dioxide in the atmosphere has increased some 48% above levels found before 1850. That's a larger increase than the Earth experienced in the 20,000 years leading up to 1850.

This global warming contributes to extreme weather patterns. It both increases the likelihood that extreme weather events will occur and the intensity of these events. This includes heat waves, droughts, and destructive wildfires. A warmer environment also increases ocean levels, exposing more areas to erosion. Warmer air increases the speed of hurricane winds and evaporates more water that can fuel stormy weather.

Types of Crude Oil

There are many different types of crude oil. The American Petroleum Institute (API) created a measurement standard based on density, called API gravity, that groups crude types into two weight classifications.

Some companies also classify crudes as medium for oil that falls in between heavy and light levels. For example, ExxonMobil has a medium class of crude oils.

There are two classifications for sulfur content used by the industry as well. Crude oil is sweet or sour based on the percentage of sulfur it contains. Sweet crude generally has less than 1% sulfur, while sour crude has a sulfur content of greater than 1%.

You'll see four labels used to classify crude oil:

  • Light
  • Heavy
  • Sweet
  • Sour

The classifications are then combined and used to label the weight and sulfur content of crude oil. For instance, you might see light sweet crude or medium sweet crude used to define an oil.

How Is Crude Oil Priced?

Crude oil prices measure the spot price of various barrels of oil, the most common of which are West Texas Intermediate, Brent Blend, or the Dubai Mercantile Exchange. The basket price of the Organization of Petroleum Exporting Countries (OPEC) and the futures price of the New York Mercantile Exchange are also sometimes quoted.

West Texas Intermediate

This is the benchmark crude oil in the Americas. WTI crude oil is called "light, sweet" crude oil quality because it is lightweight and has low sulfur content. These properties make it excellent for making gasoline.

WTI is the main oil pricing benchmark for North American oil.

Brent Blend

Brent Blend is refined in Northwest Europe and is the primary benchmark for crude oils in Europe and Africa. It's a combination of crude oil from more than a dozen different oil fields in the North Sea. It is less “light” and “sweet” than WTI but still excellent for making gasoline.

Dubai/Oman

Prices for oil produced in the Middle East are benchmarked to the Oman Crude Oil Futures Contract listed on the Dubai Mercantile Exchange (DME). Most of the oil listed on the DME is exported throughout Asia. Oman crude is listed as a medium sour crude.

Other Pricing Information

WTI sells at close to a $3.00–$4.00 per barrel discount to Brent. The difference is the increased supply of WTI from U.S. shale oil producers. Prices for other crude oils in these two continents are often priced as a differential to Brent, i.e., Brent minus $0.50. 

The OPEC basket price is an average of the prices of oil from Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, UAE, Ecuador, Qatar, and Venezuela. OPEC uses the price of this basket to monitor world oil market conditions.

The New York Mercantile Exchange futures price for crude oil is reported in almost every major U.S. news outlet. It is the value of 1,000 barrels of oil at some agreed-upon time in the future. The oil is commonly WTI. In this way, the NYMEX forecasts what oil traders think the WTI spot price will be in the future. But the futures price follows the spot price pretty closely since the oil traders can’t know about sudden disruptions to the oil supply.

What It Means for Investors and Consumers

Consumers and investors view oil in different ways. Investors are also consumers, but their investing side enjoys rising oil prices much more than their consumer side does. Consumers that only use oil for transportation dread rising oil prices.

Investors

There are many ways to invest in oil, but it's not for the faint-hearted. Oil prices are so volatile that they are difficult to predict.

Crude oil futures are agreements to buy or sell oil at a specific date in the future at a particular price. Businesses use them to fix the price of oil they need for the future. Traders never take possession but simply sell the futures contract before the expiration date.

Oil exchange-traded funds are easier to invest in than oil futures. They follow the prices of oil futures, but they are just as volatile. Some oil ETFs follow the stocks of oil companies. Their prices are affected by both oil prices and the stock market. Even if oil prices are rising, the ETF prices could fall if investors pull funds from the oil companies' stocks.

Some traders only trade on the daily price changes of the oil contracts, making small amounts of money on changes throughout the day.

Consumers

Crude oil prices affect consumers because it takes oil to get them the products and services they need. For example, higher transportation costs result in higher food prices at the grocery store in your neighborhood.

You'll also pay more for gas to get to work or take the kids to practice. Higher oil prices mean that you'll have less money to pay for other expenses or luxury items.

Key Takeaways

  • Crude oil is a base component of transport fuel, plastics, chemicals, and petroleum products.
  • Brent, West Texas Intermediate, and DME Oman are the most used benchmarks for crude oil.
  • Oil prices affect the prices of most other commodities. As such, movements in oil prices can trigger inflation or deflation.