4 Major Factors about Oil as a Commodity

Gold and oil are the two most popular commodities to invest in. When an investor first gets into the commodities market, these two essential items are often the first he or she must understand. While gold is essentially a form of currency, oil is a very unique commodity because of the implications of oil prices on the market as a whole. Understanding oil as a commodity means learning not only about how it trades, but also how it is controlled by various individuals.

#1 Oil Markets have Two Sides

First, it is essential to understand there are two sides to the oil market. The first side is the crude oil market, where the commodity is actually mined and refined. The second side is the consumer market, where the commodity is actually sold as gasoline, heating oil or other resources. An investor can take part in either side of the market, but commodities traders are usually referring to crude oil in their day-to-day discussions. When you are talking about the price of oil on a given day, you are talking about the price of a barrel of crude oil and not a gallon of gasoline.

#2 Oil is a Hard Commodity

A hard commodity is something that is mined or extracted instead of grown. Hard commodities tend to be in limited supply, though some commodities break this mold. Hard commodities cannot spoil over time, and they always have some innate value. Gold, silver, oil and cotton are all hard commodities; cotton is one of the hard commodities that can be grown and produced. Soft commodities are marked by their ability to spoil or go bad. Grain, tomatoes, soy and orange juice are soft commodities. Since oil is a hard commodity, it can be held for long periods of time and released at an opportune moment, unlike soft commodities.

#3 Oil is a Controlled Commodity

The oil market can be manipulated by the ability to hold crude oil instead of releasing it to the market. If too much oil is released, the price of oil can drop to a level that makes the business less profitable. If not enough is released, the price may be too high to capture full profits. This is a complicated example of the simple laws of supply and demand. With oil, the supply can physically be held to try to reach the optimal point in the supply and demand curve.

#4 Oil Prices are Politically Motivated

Owing to generations of conflict in oil-rich nations and the world's dependence on oil for daily operations, the price of oil is a politically charged figure. Oil producing countries can decide to hold the commodity not just to set an optimal price, but to produce a political or economic outcome unfavorable to another country. So, even if it may make sense to release more or less oil from a purely financial perspective, these individuals can and do manipulate the market for other reasons. Relying on a supply and demand model rarely works in terms of crude oil prices due to this X factor.

blog comments powered by Disqus