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Trading Oil

For decades, commodity trading in petroleum products was a club for only the big guns. At 42 gallons per barrel, and a minimum contract size of 1,000 barrels, the prospect of delivering oil was only for professionals. But several changes have occurred in the last few years to alter the scene.

Oil prices remained stable for decades until the explosion of the mid-70s. Political and technological changes resulted in shortages, uncertainty and rising prices. Since then prices have risen to over $70 per barrel and are expected to rise from mid-2006 to mid-2007 and then decline slightly for the following two years.

No one can predict oil prices with certainty, but there are several large scale factors that make reasonable projection possible.

Demand is rising, and is likely to continue for at least the next few years and probably longer. India and China are both experiencing substantial technological and cultural changes. India in particular is embracing more elements of a free-market economy than it ever has and the trend shows no signs of being reversed, or reversible.

Western technology and business methods are bringing India into the 21st century very rapidly. Along with that comes an increase in demand for energy, primarily oil-based, in order to build new homes, office buildings, manufacturing plants and more. Large segments of what was once a largely rural economy are seeing the effects. That leads to even more demand.

Demand isn't enough, of course. An individual can want anything. But India's ability to buy those goods is increasing. With an inexpensive, highly educated work force India is becoming the central focus for outsourcing for Information Technology, electronics manufacturing, communications and more. Those 21st century businesses are expected to continue to expand for at least the next decade. Just as one indication, broadband adoption is growing rapidly in India.

China now has the largest mobile phone use in the world, and the second largest Internet population. Demand for energy is increasing there and is expected to continue for the next decade at least. Though ostensibly ruled by the Communist Party, social forces are eroding its effectiveness. No one can know whether repression will ease or increase, but the flow of information is difficult to block even for a dictatorship.

As social changes continue, business is increasing in China. Energy demand is up. New buildings, manufacturing plants and infrastructure is constantly being built. All those require energy, primarily oil-based.

At the same time demand is rising, supply rates have becoming static or declined. Temporary refinery loss, such as that due to hurricanes, can be recovered in a few months to a year. But North Sea oil production peaked in 2000 and has been tapering off slowly. Until or unless political changes occur that release the large known reserves in Alaska, substantial new sources are unlikely to come into play. No new sources are expected to come online anywhere in the world.

Technology is leaning more toward developing other forms of energy, though they are not expected to be on the market for more than ten years. Fuel-cell powered cars, which would account for only 7% of gasoline use anyway, won't be in everyone's driveway for some years to come.

Political pressures to forbid nuclear power, at least in the U.S., are not expected to change. The waste disposal problem is still a political football with no solution in sight.

Finally, new forms of oil trading mechanisms are evolving to allow the average investor to participate in this once-exclusive club.

E-mini futures on the Chicago Mercantile Exchange, for example, allow for trading contracts half the traditional size, 500 barrels. Futures and options on NYMEX (New York Mercantile Exchange), though still at the 1,000 barrel size require less than 5% investment, putting them within reach of all. Commodities pools and funds (such as those from Pimco and Oppenheimer), which allow investing fractional amounts, are becoming more popular.

The risk/reward balance was never more favorable for the average investor to investigate oil commodity trading.