Once removed from the ground, crude oil is refined into useful petroleum products such as diesel fuel and gasoline. Because of how valuable crude-oil-based products are, investing in crude oil is common. Keep reading to better understand what crude oil is, the factors that impact crude oil prices, and how to invest in it if you decide that it’s right for your portfolio.
- Crude oil is a valuable resource that can be refined into petroleum products, including diesel fuel and gasoline.
- There are four types of crude oil: Class A, Class B, Class C, and Class D.
- You can invest in crude oil through exchange-traded funds (ETFs), options, and futures.
What Is Crude Oil?
Crude oil is a mixture of hydrocarbons formed from plant and animal remains that lived in a marine environment millions of years ago. Over the course of those millions of years, the remains were covered by layers of rock, sand, and silt. A combination of pressure and heat from the layers turned those remains into crude oil.
Because it dates back millions of years, crude oil is known as a "fossil fuel."
Petroleum products are made from crude oil, coal, natural gas, or biomass. Examples of petroleum products are gasoline, jet fuel, waxes, asphalt, and lubricating oil. A 42-gallon barrel of crude oil can become about 45 gallons of petroleum products, according to the U.S. Energy Information Administration (EIA).
Types of Crude Oil
There are four main types of crude oil: Class A, Class B, Class C, and Class D.
While many in the petroleum industry characterize crude oil by its geographical source (like West Texas Intermediate), this is not a helpful classification scheme when it comes to learning more about a crude oil’s general toxicity, physical state, and any changes that occur over time and due to weathering. The ABCD classification scheme is much more useful when it comes to events such as oil spills, where it’s necessary to know details about the type of crude oil involved.
The following classifications apply to spilled oils.
Class A: Light and Volatile Oils
Class A crude oils are highly fluid, tend to be clear, and can spread at a rapid rate across both water and solid surfaces. This type of crude oil has a strong smell, high evaporation rate, and is typically flammable.
Most refined products and a lot of high-quality, light crude oils are included in Class A. Despite how valuable they are, Class A oils can be extremely toxic to humans, animals, and other organisms.
Class B: Non-Sticky Oils
Class B oils are waxy and oily in feel and are less toxic than Class A oils. They stick more firmly to surfaces than Class A oils. Heavy paraffin-based oils are considered to be Class B oils and as temperatures rise, they are more likely to penetrate porous layers or surfaces.
Class C: Heavy and Sticky Oils
Class C oils include residual fuel oils and medium to heavy crude oils. They’re usually brown or black in color, have a similar density to water and tend to sink. This type of oil doesn’t penetrate porous surfaces as easily as other types of crude oil. In the event of evaporation or weathering of volatiles in a Class C oil, it may produce solid or tarry Class D oil. Even though Class C crude oil is less toxic, it can still harm wildlife.
Class D: Nonfluid Oils
Residual oils, heavy crude oils, select high paraffin-based oils, and certain weathered oils are Class D oils. Typically, Class D oils are dark black or brown and if they melt, they can coat surfaces, which makes cleaning up a spill very difficult. Class D crude oil is relatively nontoxic.
Factors That Impact Crude Oil Prices
Crude oil prices ebb and flow. For example, West Texas Intermediate (WTI) is the first most commonly traded crude oil blend, followed by North Sea Brent. Historically, Brent and WTI crude oil prices have tracked each other closely, even though their levels can be different. That was up until 2011, though, when the two prices diverged.
Price differences can stem from a variety of reasons, such as where the oil is produced, transportation costs, political and economic conditions in the regions where the oil is sold, and the ease of refining the oil.
When it comes to the WTI and Brent price divergence in 2011, many believe that it was caused by a bottleneck in transportation that has narrowed and eased over the years, causing price fluctuations.
To help make educated guesses about future price movement, it may help to keep an eye on the broader energy market and sector ETFs, and to understand the different factors that drive crude oil prices. In addition to the previously mentioned factors, there are two factors that may be easy to track.
When market participants buy and sell either physical quantities of crude oil or trade contracts for upcoming deliveries of crude oil, their actions impact prices. The actions of banks, hedge funds, commodity trading advisors, oil producers, airlines, companies, and individual investors all play roles in pricing.
Some suspect there is an inverse relationship between the exchange value of the U.S. dollar relative to crude oil prices. Because oil benchmarks are usually priced in U.S. dollars, when the value of the U.S. dollar decreases or increases, oil prices may be affected.
Other factors that can impact the price of crude oil include:
- U.S. Energy Information Administration (EIA) weekly reports
- American Petroleum Institute (API) weekly reports
- Organization of the Petroleum Exporting Countries (OPEC) meetings
- Refinery capacity reports
- Gross domestic product (GDP) reports
- Natural gas inventory reports
- Weather events
- World events
- Import/export policy changes
How to Invest in Crude Oil
There are a few ways someone can invest in and try to profit from price movement in crude oil markets.
There are two popular crude oil ETFs that investors can consider adding to their portfolios:
- United States 12-Month Oil Fund (USL)
- United States Oil Fund (USO)
Both of these ETFs represent different underlying futures exposures. They are both issued by the United States Commodity Fund (USCF).
You can also invest in crude oil options, which are contracts that give you the right to buy or sell securities at a fixed price. Investing in crude oil options limits your potential for loss, and may help provide protection against adverse commodity price movements.
Crude oil futures are included in the New York Mercantile Exchange (NYMEX) and are the most actively traded futures contract that exists for a physical commodity. They are so popular because they have strong liquidity and price transparency. Crude oil futures give individual investors one way to invest in an extremely important commodity market. Be mindful though—crude oil futures are leveraged, which makes them riskier than other investments.
Options and futures can be confusing for new investors who may have never traded either before. If you are new to options or futures trading, work with a financial or investment advisor or broker to ensure you make the smartest move with your money.
Risk and Limitations of Crude Oil Trading
Before investing in crude oil, it’s important to understand the risks that come along with this market.
Risk of Loss
Futures contracts are leveraged, or “margined,” which means you may be liable for losses in excess of your initial deposit. Know your risk tolerance, and gauge your experience and knowledge of different types of securities before investing any money.
The crude oil market is not particularly stable and over time, oil prices have fluctuated significantly. For example, during the 2020 recession, the price of West Texas Intermediate (WTI) took a dive. At the start of February 2020, the price was $50.11 per barrel. On April 20, 2020, it closed at -$37.63 per barrel.
False Promises Run Rampant
There is a lot of bad advice out there surrounding the oil market. For example, many may make claims that crude oil investments will soar during and after natural disasters. This claim has no real backing, and natural disasters don’t necessarily increase chances of profiting in commodity futures or options trades based on crude oil. Also be wary of any claims that you can predetermine or fix the risks that come with purchasing commodity futures and options.
Frequently Asked Questions (FAQs)
How is crude oil refined?
Crude oil is refined into petroleum products such as gasoline at petroleum refineries. The refining process breaks down crude oil into different components through a three-part process involving separation, conversion, and treatment. Those components then are reconfigured into new products.
When does the crude oil futures market open and close?
Crude oil futures can be traded Sunday through Friday from 6 p.m. until 5 p.m. EST.
When do oil futures contracts expire?
Oil futures contracts expire on the third business day before the 25th calendar day of the month that precedes the delivery month. If the 25th falls on a non-business day, then trading will cease on the third business day before the business day that precedes the 25th calendar day.
How many barrels of oil are in a futures contract?
There are 1,000 barrels of oil in a crude oil futures contract.
The Balance does not provide tax, investment, or financial services or advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.