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.
Learn more about crude oil, the factors that impact prices, and how to invest in it if you decide that it’s right for your portfolio.
Key Takeaways
- Crude oil is a valuable resource that can be refined into petroleum products, including diesel fuel and gasoline.
- There are six types of crude oil: light/sweet, light/sour, medium/sweet, medium/sour, heavy/sweet, and heavy/sour.
- Crude oil prices are subject to geopolitical factors and events which affect supply and demand.
- 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.
Interestingly, a 42-gallon barrel of crude oil produces about 45 gallons of petroleum products because of a refining phenomenon called refinery processing gain.
Types of Crude Oil
Oil investors are generally concerned with the quality of the oil they are investing in and the location it comes from. This is because crude oil forms differently due to the geographical makeup of the locations. Oil prices are based on geopolitics, natural events, and organizational influences, which, in turn, dictate production, supply, and demand.
The oil industry and regulators use crude oil’s density and sulfur content to classify it into several categories. Oil can be grouped by sulfur content as either sweet or sour, or by density as either heavy or light. Using these two groups—and by creating a group in between—oil is classified into six classes by the industry and investors:
- Heavy/Sweet
- Heavy/Sour
- Medium/Sweet
- Medium Sour
- Light/Sweet
- Light/Sour
Heavy oils are used to make industrial products like asphalt and plastics. Medium oils have sulfur content that falls somewhere between heavy and light. Light oils are generally used in diesel, gasoline, and aviation fuel because they take less processing. Sour crude has more sulfur and carbon than light crude and requires more refining; thus, it incurs more costs.
The US Energy Information Administration has created a chart that demonstrates where most crude oils come from and the types in those areas.
US Energy Information Administration
For investing purposes, classification by geography, weight, and sulfur content is most important because these affect the price the most. However, some investors might be interested in the Environmental Protection Agency’s (EPA) classifications which are based on toxicity levels and changes in state.
EPA Classifications for Crude Oil
The EPA categorizes crude oil into four main types of crude oil: Class A, Class B, Class C, and Class D. These are important for learning more about general toxicity and physical state changes:
- Class A: Most refined products and many 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: These are waxy and oily in feel and are less toxic than Class A oils. They stick more firmly to surfaces than Class A oils. As temperatures rise, they are more likely to penetrate porous layers or surfaces.
- Class C: These are usually brown or black, have a similar density to water, and tend to sink. This type of oil doesn’t penetrate porous surfaces as quickly 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: These are residual oils, heavy crude oils, select high paraffin-based oils, and certain weathered oils. Typically, Class D oils are dark black or brown, and if they melt, they can coat surfaces, making cleaning up a spill very difficult. Class D crude oil is relatively nontoxic.
Factors That Impact Crude Oil Prices
West Texas Intermediate (WTI) is one of the most commonly traded crude oil blends, along with North Sea Brent. Historically, Brent and WTI crude oil prices have tracked each other closely, even though production levels can be different. Global events can cause pricing issues, however. For instance, in 2011, the two prices diverged because many significant events disturbed crude oil prices:
- The Arab Spring: Oil prices are dependent upon events in the Middle East. War in Libya disturbed the Organization of Petroleum Exporting Countries’ ability to maintain its oil supplies.
- Demand: Increasing demand from China and Middle Eastern countries caused a rise in prices.
- Bottlenecks in transportation: The US experienced a slowdown in crude oil transportation.
- The Debt Crisis: Europe was in the throes of a significant crisis dealing with countries that had taken on too much debt.
- Strategic petroleum releases: Members of the International Energy Agency released oil from their reserves to meet rising demand.
Note
Price differences can stem from various reasons, such as where the oil is produced, transportation costs, political and economic conditions in the regions where the oil is sold, and refining costs.
International Community Responses
Specific international events can influence crude oil prices also. For example, in early 2022, Russia invaded Ukraine. International responses to the unjustified invasion included bans on Russian oil and businesses, and private companies began removing their investments in the country.
The effects were quickly felt worldwide as crude oil prices soared. In April, Brent Crude was expected to climb from 2021’s $70.89 per barrel to $103.37 per barrel for 2022, while West Texas Intermediate was expected to rise from $68.21 to $97.96.
Financial Markets
When market participants buy and sell either physical quantities of crude oil or trade contracts for upcoming crude oil deliveries, their actions impact prices. The activities of banks, hedge funds, commodity trading advisors, oil producers, airlines, companies, and individual investors all play roles in pricing.
Note
Because oil benchmarks are usually priced in US dollars, oil prices can also fluctuate in response to variations in the value of the US dollar.
Other Factors
Other factors that can impact the price of crude oil include:
- US 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
- Import/export policy changes
How To Invest In Crude Oil
There are a few ways you can invest in and try to profit from price movement in crude oil markets.
ETFs
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 future exposures. They are both issued by the United States Commodity Fund (USCF).
Options
You can also invest in crude oil futures 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 losses and may help protect against adverse commodity price movements.
Futures
Crude oil futures are traded on the New York Mercantile Exchange (NYMEX) and the Chicago Mercantile Exchange (CME) and are the most actively traded futures contract for a physical commodity. They are popular because they have strong liquidity and price transparency. Crude oil futures give individual investors one way to invest in a vital commodity market. Be mindful, though—crude oil futures are leveraged, making them riskier than other investments.
Note
Options and futures can be confusing for new investors who have never traded 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
Future contracts are leveraged or “margined,” which means you may be liable for losses above your initial deposit. Know your risk tolerance, and gauge your experience and knowledge of different types of securities before investing any money.
Volatile Market
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) tumbled. At the start of February 2020, the price was $50.06 per barrel. On April 20, 2020, it closed at -$36.98 per barrel.
False Information
Some brokers and firms claim that crude oil investments soar during and after natural disasters. This claim has no real backing, and natural disasters don’t necessarily increase the 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 of purchasing commodity futures and options.
Frequently Asked Questions (FAQs)
How many types of crude oil are traded?
There are six different crude oil classifications, but more than 160 types can be traded. There are even more different investment types to choose from.
What are the four uses of crude oil?
There are actually five crude oil uses—transportation, industrial, residential, commercial, and electric power.
What crude oil is the best quality?
The easiest and cheapest oil to refine is light and sweet crude.
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.