How to trade on Kalshi's WTI oil markets.
Key terms
Oil trading: Buying and selling different types of oil and oil-linked assets.
Spot price: The price an asset settles at, for immediate delivery.
Supply: The willingness of sellers to offer a given quantity of a good for a given price.
Demand: The willingness of consumers to purchase a given amount of a good at a given price.
WTI oil: West Texas Intermediate oil, the main oil benchmark for North America.
Benchmark: A standard that is used to compare investment vehicles' performances.
Takeaways
‘West Texas Intermediate’ (WTI) oil is the main oil benchmark for North America.
Supply and demand, and expectations thereof, are the main drivers of oil's price.
The costs of oil extraction and production are also important considerations for its price.
Oil traders are segmented into two main camps: speculators who trade on price movements, and hedgers who limit their risk.
Both geopolitical and macroeconomic factors are important areas of research to find an edge in oil trading.
The use of oil, specifically in fuels, continues to propel it as a high-demand commodity around the globe. As an extension of its popularity, investors began oil trading. “Oil trading”, in this sense, is the buying and selling of different types of oil and oil-linked assets with the aim of making a profit. Oil is a finite resource, so its price fluctuates substantially with supply and demand changes. This volatility makes it extremely popular among traders.There are three ways you can trade oil: spot prices, futures, and options. In this post, we'll deep dive into spot prices.
What is oil spot price?
Oil spot prices represent the cost of buying or selling oil immediately. “Think on the spot,” instead of a set date in the future. While futures prices reflect how much the markets believe oil will be worth when the future expires, spot prices show how much it is worth right now. WTI oil is priced daily, so its spot price reflects its real-time value in the market.
How is the spot price determined?
Oil has a longstanding role as a high-demand global commodity. This popularity comes from the possibility that major fluctuations in price can have a significant economic impact. The two primary factors that impact the price of oil are:
Supply and demand: The concept of supply and demand is directly correlated to most commodities' prices. That is because as demand increases, or supply decreases, the price is expected to go up. As demand decreases, or supply increases, the price should go down.
Cost of production: The cost to create a barrel of oil, which can be impacted by the price of minerals used in refinement and distillation and a variety of other factors, is directly correlated with the price of the commodity.
WTI oil
West Texas Intermediate (WTI) crude oil is a specific grade of crude oil and one of the main three benchmarks in oil pricing, along with Brent and Dubai Crude. WTI is the underlying commodity of the New York Mercantile Exchange's (NYMEX) oil futures contract and is considered a high-quality oil that is easily refined. WTI is the main oil benchmark for North America as it is sourced from the United States, primarily from Texas.The use of benchmarks in the oil market is crucial, because the benchmark sets the context. In the oil market, benchmarks serve as a reference price for buyers and sellers of crude oil. When watching or reading the news, the price of oil is typically quoted from an oil benchmark.Benchmarks are not unique to the oil market though, and also cited across markets. For example, indices serve as another example in the equities market. If you want to see how your portfolio is performing in the current market, you can use the S&P 500's return over the same time period as the benchmark to assess your performance.
How to trade WTI oil
Like any market, oil trading requires research and investment sizing. Basic supply and demand theory states that the more a product is produced, the more cheaply it should sell. It's an inverse relationship. For example, if an engineer invented a technique that could double an oil field's output for only a small incremental cost, such as fracking, then the prices should fall.This is where oil trading gets interesting. Because oil is such a hot commodity, distribution and refinement may not always be caught up with production. As a result, there is a substantial demand and need for more oil, but fundamentally not enough supply because distribution networks cannot substantiate the demand. For example, the reason America does not have an overwhelming supply of cheap oil is because refineries are organized specifically for this problem. Reports cite that refineries operate at 90% of capacity in order to try and always supply the 10% when need be (NPR 2022).
Geopolitical forces impacting oil prices
Beyond distribution networks for oil, there is also the problem of producer cartels. Probably the single biggest influencer of oil prices is OPEC+. This organization is made up of 13 countries: Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, United Arab Emirates, and Venezuela. Collectively, OPEC controls 40% of the world's supply of oil (in 2022).OPEC+ was originally founded in order to fix oil and gas prices. By restricting production, OPEC+ could force prices to rise. This forceful strategy would thus allow member countries to profit and each sell on the world market at the going rate.