What Is Crude Oil and How Can You Invest?

What Is Crude Oil?

Crude oil, or petroleum, is a hydrocarbon formed by the decay of large amounts of dead organisms such as plants, algae, and bacteria packed under layers of sand and mud over millions of years. Crude is found underground, onshore, and offshore between layers of sand and mud that have hardened into sediment.

The liquid can be extracted in a variety of ways. The traditional method is by drilling and capping the flow with a wellhead. Another (often controversial) method is fracking—reaching into areas horizontally where drilling would be difficult to access. This process involves pumping high-pressure freshwater, sand, and chemicals into the sediment to release bits of crude oil and then extracting the mixture for aboveground processing.

Like natural gas and coal, crude is a non-renewable fossil fuel that releases carbon dioxide into the atmosphere when ignited by fire and is a source of concern when it comes to climate change.

Crude oil is split into two categories based on its sulfur content: sweet and sour. It is also broken down into two categories based on density: light and heavy. Crude with lower sulfuric content would be classified as sweet and fetch a price higher than sour because low sulfuric content makes refining and processing the crude into petroleum products, such as gasoline and diesel, easier. The ideal crude mixture is light sweet, which is usually the type used for West Texas Intermediate (WTI), the American oil quality benchmark, and Brent, a benchmark widely used in Europe.

Another differentiation for crude oil is what is known as total acid number (TAN): the higher the acidity, the stronger the metal pipes required at refineries for processing to reduce corrosion.

Which Countries Have the Most Oil?

The largest petroleum reserves can be found in Venezuela, Saudi Arabia, Canada, Iran, Iraq, and Russia. Some countries with the largest reserves are part of a league known as the Organization of the Petroleum Exporting Countries (OPEC), which controls almost 80 percent of the world’s proven oil reserves. Together, the group of 13 nations seeks to regulate crude oil production (and consequently pricing), and their influence has geopolitical impacts, especially in countries such as the U.S. and China that have high oil demand.

While the U.S. has proven oil reserves equivalent to Libya’s, it is one of the world’s top producers and exporters, and the WTI contract serves as an important benchmark and reference rate in global trading. While most of the proven reserves are located in remote land areas, exploration continues offshore, where vast amounts of petroleum are yet to be discovered.

What Products Can Be Derived From a Barrel of Crude Oil?

A 42-gallon barrel typically yields 45 gallons of petroleum products, including gasoline, diesel, jet fuel, heavy fuel oil, and liquefied petroleum gas. Other products and distillates can be used as feedstock in the manufacturing of plastics or various industrial chemicals such as asphalt and lubricating oil.

Which specific petroleum products crude oil gets refined into depends on demand. In the U.S., gasoline demand is higher than in other countries where diesel is higher in demand and is produced more. Heavy crude oil would produce smaller quantities of gasoline and diesel and is better suited for products such as asphalt.

Petroleum products are typically stored at facilities near refineries in tanks. From there, they are shipped to other locations via pipeline, trains, trucks, or ships. 

How Can You Trade Crude Oil?

Crude oil can be traded in the commodities futures markets via global exchanges such as the New York Mercantile Exchange (NYMEX), which is operated by the CME Group of Chicago. The benchmark crude oil traded on NYMEX is West Texas Intermediate (WTI), which is typically light-sweet crude. Its name originates from the western region of Texas, which produces the most petroleum among the 50 states, and it serves as the benchmark for all crudes in the U.S.

There are more than 100 grades of crude oil traded in markets today. Among major benchmarks, Brent is used for Atlantic basin crude oils. Its name originated from the Brent oil field in the North Sea, where light sweet crude was first extracted in 1976. Dubai crude is often used as a benchmark for Middle Eastern oil, which is typically sour and tends to be heavy.

Unlike other instruments of trading, crude oil is a physical commodity, and placing an order means taking delivery. Aside from the price of the contract, separate payments must also be accounted for delivery and storage.

Crude oil on NYMEX is priced in dollars and cents per barrel, and each futures contract involves trading for 1,000 barrels. So, if a one-month forward contract of crude oil is priced at $75 a barrel, that means buying the contract at $75,000. On NYMEX, almost 1.2 million contracts are traded daily. Like with other commodities trading on futures markets, the closer the contract for delivery by month, the more expensive it becomes. Spot contracts mean crude oil is for immediate delivery.

There are also derivatives to crude futures, namely crude oil swaps, which serve as a hedge against price volatility.

Can Individual Investors Trade Crude Oil?

Futures trading on crude oil is typically relegated to dealers and brokers who have the resources and contacts to take delivery and store large amounts of crude oil. For those who can’t receive and store crude oil, one of the best alternatives is investing by proxy in publicly traded companies that engage in the exploration and production of crude oil. Their revenues and eventual bottom lines are dependent on pricing from the futures markets. A rise in crude futures means higher prices on crude sold in commodities markets, translating into higher prices of crude sold by oil producers.

Some of the biggest U.S. companies in oil exploration and production whose shares trade on U.S. stock exchanges are ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX), and Marathon Petroleum (NYSE: MPC). The world’s two biggest oil producers, Saudi Aramco and Royal Dutch Shell, have American depositary receipts (ADRs) that can be bought and sold on the New York Stock Exchange.

For those reluctant to trade individual stocks, oil exchange-traded funds (ETFs) and mutual funds are also popular.

Frequently Asked Questions (FAQs)

The following are answers to some of the most common questions investors ask about crude oil and its market.

Is Crude Oil Traded 24/7?

On the CME, trading on NYMEX WTI takes place from Sunday, 6 p.m. ET to Friday, 5 p.m. The most active times of trading are the pit sessions on NYMEX WTI from 9 a.m to 2:30 p.m. ET.

Can You Day Trade Oil?

Some online brokers such as Charles Schwab allow investors to trade crude oil futures on NYMEX during the exchange’s hours of trading operations. Schwab also offers fractional trading in Brent futures 24 hours a day.

What Is the Best Time to Trade Oil?

NYMEX pit trading hours are from 9 a.m. to 2:30 p.m. ET, Monday through Friday, and that makes trading during those hours ideal since prices tend to fluctuate less in the off hours.

How Can I Invest in Oil With Little Money?

Fractional shares in publicly traded companies like ExxonMobil are available for investing on online brokers. Schwab, for example, limits investment in oil-related companies to those that are part of the S&P 500. Some platforms allow for fractional trading in oil futures. Other emerging forms of investment such as Small US Crude Oil Futures allow individual investors access to the U.S. crude oil futures market.

What’s the Difference Between Investing in Oil Futures and Oil ETFs?

Oil is a physical commodity, and if you’re investing in futures, you’re typically trading for delivery on those contracts of thousands of barrels. Oil futures are one area of speculation among individual investors, and one method of trading involves selling futures contracts before expiration to avoid taking delivery. However, an investor can also avoid taking delivery via cash settlement, which means the investor is credited or debited the difference between the purchase price and final price.

Crude oil ETFs follow prices in the futures markets. The ProShares K-1 Free Crude Oil Strategy ETF, for example, tracks a Bloomberg index of crude oil futures contracts rather than on-the-spot price.

What Factors Cause Changes in Crude Oil Prices? How Much Does Crude Oil Price Vary?

Crude oil prices are dependent on supply and demand, making it a highly speculative form of investment. Oil prices briefly went negative during April 2020, at the start of the COVID-19 pandemic in the U.S. on the view that decreased activity would lead to an oversupply. Conversely, oil reached its highest prices, more than $145 a barrel, in July 2008, when demand was seen as high amid a stagnation in global production, but dropped by more than half in the months afterward as speculation eased.

Why Is Crude Oil Called Black Gold?

In the U.S., crude oil was first discovered in the mid-19th century, and demand started to pick up toward the late 1800s, making landowners—as well as those associated with oil’s production—very wealthy. The first part of its name is derived from oil’s color, coming out of the earth as black liquid, and the second part references its high value.

What Is the Difference Between Upstream and Downstream Operations?

Upstream refers to the exploration and production of crude oil, while downstream refers to the distribution and retail of crude oil’s refined products, such as selling gasoline and diesel at filling stations.

What Are the Impacts of Crude Oil on Climate Change? Is It a Renewable Resource?

Gasoline, diesel, kerosene, and jet fuel are among the most prolific petroleum products refined from crude oil, and their use emits carbon dioxide, which has been linked to global warming. Crude is a non-renewable resource, and when all reserves are exhausted, there’s no way to make more of them occur naturally.

Are There Alternatives to Using Crude Oil?

Renewable energy sources are on the rise. Solar, wind, geothermal, and hydropower are alternative sources of energy that have grown in popularity as concern about climate change has increased. Nuclear energy is also another alternative source.