Introduction to the history of oil
From the beginning of time, human societies have relied on nature as a source of nourishment, heat, and power. We have harnessed the burning of fossil fuels to extend our reach all the way back to the discovery of fire itself. Even renewable sources of energy are not just a modern preoccupation. The ancient world explored a variety of techniques to make the most of the energy available to them, including the use of passive solar to heat south-facing homes, or the harnessing of wind and water in mills.
But it was only until the large-scale exploitation of single fossil fuel sources that human society began to assume its modern form. The British empire and industrial revolution it set in motion was dependent on its abundant resources of coal. Its successor, the American empire, would rise to prominence thanks to a different natural resource. The century that was to follow would be one powered by oil.
The Science of oil
We’re used to thinking of petroleum as a black liquid and natural gas as a completely different substance, but the truth is that the term petroleum actually refers to both, as well as to a host of finished products that are made from the raw material. Petroleum is a mixture of hydrocarbons within the earth that can take liquid, gas, or solid form. The form they assume when reaching the surface depends on the unique characteristics of the deposit being mined. Generally, oil deposits will also contain some natural gas, and some (though not all) gas wells will also bring up liquid fuels.
Oil wells tend to produce mostly liquid crude. But due to the pressure at the surface being lower than underground, some of the natural gas contained in the mixture brought to the surface will inevitably come out of solution and be recovered as a gas. In a gas well the opposite can occur, due to the well being hotter beneath the surface, heavier hydrocarbons can condense out of the gas as they are brought up. This liquid is referred to as natural gas condensate, or natural gasoline, as it naturally contains the types of hydrocarbons usually distilled at the boiling range of petrol.
The main thing to keep in mind is that petroleum is the collective term used to describe mixtures of a great number of different hydrocarbons all containing different ratios of carbon, hydrogen, nitrogen, oxygen, sulphur and metals (in that order). These deposits are captured when large quantities of biological organisms are buried under sedimentary rock and subjected to intense pressures and temperatures.
Crude Oil in the Ancient World
The word petroleum comes from mediaeval Latin. It literally means “rock oil,” from the conjunction of the Latin “petra” for rock and “oleum” for oil. Its use is frequently attributed to the 16th century German mineralogist Georg Bauer, although some contend that it may have originated earlier with the Persian philosopher Aviccena.
Crude oil is very much the fuel of our modern age, its extraction, refinement and use to power heavy machinery was only perfected in the past hundred or so years. Despite this, it was also familiar to the ancients due to the way oil deposits can often find their way to the surface without having to be mined.
It actually has a more than five thousand year history of use, with the ancient Assyrians, Sumerians and Babylonians all thought to have gathered crude oil, bitumen and asphalt from sites on the bank of the Euphrates river. According to Herodotus, the very walls and towers of Babylon used asphalt in their construction. The ancient Egyptians are said to have employed it in medicine. Persian chemists distilled the crude material, where it was used, among other things, to turn their arrows into incendiary weapons.
The ancient Chinese also had an extensive history of use for the substance. The I-Ching, one of the oldest Chinese writings, mentions oil in its crude form. The Chinese are also credited for being the first to record the use of crude oil as a fuel substance, as far back as the 4th century BCE.
Naturally occurring sites where crude oil rises to the surface are known as oil seeps. They are very common in North America, with the Native Americans also thought to have taken advantage of the black stuff for its various medicinal purposes.
Just as in the ancient world, oil has a history of use in the mediaeval and modern world in medicine and as a sealing material in construction. However, it wouldn’t be until the 19th century that oil consumption would really turn the corner.
The industrial revolution started with coal, but would reach new heights in the age of oil. Oil proved to be a superior fuel in every way. Its higher calorific value and lower carbon-to-hydrogen content make it a more powerful and cleaner burning fuel. Its liquid form also makes it easier to transport than gas.
The development of the internal combustion engine and its mass use in automobiles, the conversion of ship engines, and aviation developments during WWI further accelerated the worldwide demand for this new source of power. Add to this a plethora of new uses in plastics, solvents, adhesives, fertilisers and pesticides, which led to a constellation of new industries all dependent on crude oil as their primary material.
The US Oil Boom
In our introduction to gold, we highlighted gold’s central role in the US rising to prominence as the global superpower. In an unrelated sequence of events that proved to be equally auspicious, crude oil would become another major commodity that helped catapult the United States to the centre of global affairs.
A significant oil discovery at Oil Creek, Pennsylvania in the mid 1800s led to the completion of the first ever well drilled specifically for oil. Funded by American entrepreneur Edwin. L Drake, it laid the blueprint for a US oil industry that would see the discovery of oil fields across fourteen states by the end of the century. For a large stretch of both the 19th and 20th centuries the United States would be the world’s leading oil producer. Even after its oil production peaked in the 1970s, its foreign policy would go on to be largely influenced by the need for securing reliable sources of oil.
Elsewhere, large oil deposits discovered in Venezuela in the early 1900s would eventually see the South American nation becoming the world’s second largest global producer. Thousands of miles away, the British would initially strike oil in Persia, then compete with other nations in the aftermath of the Great Wars in order to control areas where crude oil deposits were thought to exist. After WWII, the United States would enter into an alliance with Saudi Arabia, guaranteeing the security and modernisation of the country in exchange for access to its oil reserves.
The British control of Iranian oil through the Anglo-Iranian Oil Company (originally the Anglo-Persian Oil Company) would last for 37 years but would come to an abrupt end when Prime Minister Mohammad Mossadeq nationalised the country’s oil. In response, the US and the UK led a coup d’état in 1953 to oust Mossadeq and keep the black liquid flowing westward.
In the 1950s and 1960s, vast deposits of oil and natural gas were also discovered in Siberia, which pushed the Soviets to invest in its exploitation. The black stuff was cheap and plentiful during this period, remaining below $3 per barrel despite surging demand. This dynamic, along with crude oil’s multiple advantages over coal, would see oil overtaking coal as the world’s primary energy source.
OPEC was formed as a counterbalance to US dominance in global oil markets. At the time, the United States was both the world’s largest producer and consumer of oil. Prior to OPEC, the global market in crude oil was dominated by a group of multinational oil companies (known as the seven sisters) the majority of which were headquartered in the United States. OPEC was conceived of as a way for emerging oil producers such as Venezuela and the Middle-East to organise in order to counteract the centralisation of power that had been occurring up to that point.
Founded in 1960 in Baghdad, the original OPEC member states were Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. The names of those five founding members alone should give one pause. The first two have been embroiled in some form of conflict with the West for many decades. The third was invaded by the second in 1990, leading to the first Gulf War, and fifteen of the nineteen terrorists involved in the 9/11 attacks were from the fourth. Oil markets are deeply rooted in geopolitical conflict because in the 20th century possessing oil meant physical, economic, and political dominance.
Today, there are a total of 13 OPEC member nations plus a further 11 oil-rich non-member states that regularly attend OPEC meetings.
As we saw in our introduction to Gold, the 1970s was a period of great upheaval. This is no less true when looking at the oil markets. In 1972, (a year after the Nixon shock) the US reached its peak in oil production, leading to the world’s largest oil consumer having to start importing oil in order to meet its ever increasing needs.
Meanwhile, as the British empire continued to contract following WWII, the United Kingdom started to withdraw from the Middle-East, leaving Iran and Saudi Arabia (both of which were armed by the West) to assume the role of keeping the region secure. This was to be a short-lived arrangement. In the aftermath of the Arab-Israeli war of 1973 between Israel and Egypt, Syria and Jordan, OPEC would use the oil of its member nations as a political tool for the first time in its history.
Between 1973 and 1974, OPEC would initiate production cuts and impose an oil embargo against the United States and other industrialised nations that had supported Israel. Where a previous embargo in response to the Arab-Israeli 6-Day War of 1967 had failed, this time a perfect storm of extraneous factors, including the Nixon shock, currency devaluations and coal-miner strikes in the United Kingdom contributed to massive disruptions in global trade.
This event saw the post-WWII boom coming to an end as nations were forced to institute energy rationing. In the US, the pumps would be closed on Sundays, limits were imposed on how much fuel could be purchased and citizens were assigned different days to fill up according to their licence plate numbers. In the UK, a 3-day work week was instituted, and in Europe a number of countries banned Sunday driving.
The embargo was a traumatic experience for the West. A global recession followed in which both unemployment and inflation surged at the same time (stagflation). The world we live in today has been massively shaped by the OPEC embargo, including the subsequent exploration of nuclear and hydro-electric alternatives as well as the perennial conflicts we have seen in the Middle-East since then. North sea oil is another direct consequence of the
OPEC embargo as oil companies found themselves exploring new offshore sites to make up for the oil that was not finding its way onto global markets as a result of the OPEC embargo.
The Iranian revolution took place in the late 1970s, leading to the Shah being replaced by an anti-Western Islamic republic. Oil production fell precipitously, leading to a second oil crisis. Tensions between Iran and Iraq led to eight years of war, which set the stage for the arming of Iraq by the West, which would eventually conclude in the Gulf Wars of the 1990’s and early 2000s. During this period, non-OPEC production begins to exceed that of OPEC nations.
In the late 1970s, the Soviet Union would enter the fray, becoming the largest producer of oil in the world. This would last beyond the fall of the Soviet Union into the early 1990s. The United States would also expand its own capacity by turning its attention to its Alaskan oil fields.
A notable development in contemporary oil markets has been the exploration of unconventional oil deposits. These are extracted using methods other than traditional oil and gas wells and have been relied on increasingly in recent years as conventional oil reserves dwindle or are interrupted by geopolitical conflicts. This technological development has changed the balance of power in oil markets for the first time in many years.
Oil shales and tar sands are considered unconventional oil deposits due to being both harder and more expensive to extract than conventional wells. An interesting dynamic of this type of oil is that it can only be profitable when oil trades at a higher price per barrel (above $60), which is why it has emerged as a solution to rising oil prices and growing demand.
In fact, the shale oil revolution has led to the United States unexpectedly reemerging as the world’s largest crude oil producer. The US reclaimed this title in 2014 when it became the world’s leading producer of crude for the first time since US oil production peaked back in the 1970s. Shale or “tight” oil exploration has led to the US not only meeting its own oil needs, but also starting to export its oil abroad once again.
In recent years, OPEC has moved to stifle the explosion of unconventional oil by flooding the market with its own cheaper-to-produce oil, dropping the global price and thus making unconventional oil barely profitable or even outrightly unprofitable at certain times.
Crude oil trading
Crude oil was originally transported in 42-gallon barrels. Owing to this historical quirk it is still priced by the barrel, with each still equalling 42 gallons, or around 159 litres of the underlying oil. Aside from the spot markets that facilitate the trade of physical crude oil, it also trades on a variety of derivatives markets including futures, options, and CFDs.
Oil investors are divided into two broad camps; commercial investors and non-commercial investors. Commercial investors are those participants whose businesses are directly exposed to the changing prices of crude oil and its various by-products. Oil refiners and airlines belong to this category as the price of crude oil significantly affects their bottom line.
Non-commercial investors are all the parties that seek to profit from the price fluctuations of the market without their core business being reliant on the underlying commodity. Banks, hedge funds, money managers and individual traders all fit into this category.
Crude oil trades around the clock, six days per week from Sunday to Friday. Just as in the trading of gold, its combination of participants, venues, and derivatives markets allows for a reliable reference price to be available throughout most of the trading week.
Crude oil varies significantly in its hydrocarbon composition from site to site, which means that there are multiple reference grades all trading side by side throughout the day. The most popular of these grades are West Texas Intermediate, Brent Blend and Dubai Crude.
West Texas Intermediate is a blend of crude oils that do not originate from any specific wells but simply meet the WTI light sweet grade standard. By contrast, Brent Blend and Dubai Crude refer to crude oils sourced from North Sea and Dubai oil fields, respectively.
Crude oils are graded according to their lightness and sweetness. Lightness refers to the gravity of the oil, a reading higher than 10 means the oil is lighter than water and thus floats on top of it. A reading lower than 10 denotes the opposite. Sweetness, on the other hand, refers to the oil’s sulphur content. Sweet oils are low in sulphur, making them ideal for the production of low-sulphur fuels like petrol and diesel.
West Texas intermediate is both light and sweet. Brent, though not as light or sweet as WTI, is still considered a high quality crude. Dubai crude is heavier than either Brent or WTI, with a higher sulphur content, earning it the classification of “sour.”
Economic Indicators for oil trading
As we’ve explored throughout this article, crude oil prices are determined by a wide variety of supply and demand dynamics that touch almost every area of the global economy. From the costs associated with the extracting and refining of hydrocarbons, to the demand dynamics of economies that require them at different rates depending on whether they are expanding or contracting.
Furthermore, a host of geopolitical factors can influence supply, such as sanctions and embargoes, or more kinetic conflicts such as the ones we’ve seen in the Middle-East and North-Africa. Traders interested in this most crucial of commodities will need to pay close attention to all of the above factors and more.
One of the regular features of every oil trader’s calendar are the inventory reports, the most important of which are the weekly updates released by the U.S Energy Information Administration (EIA). These detailed reports provide a comprehensive breakdown of US inventories and refinery capacity, which clues traders in to whether demand is beginning to outstrip supply or vice versa.
In addition to these, closely monitoring OPEC meetings helps oil traders better understand the broader dynamics of global supply as OPEC members are known to coordinate their production quotas in order to meet specific price targets.
Beyond all of the above, a healthy understanding of market cycles and inflation can also be extremely useful to crude oil traders as these inform the broader macro-economic trends that largely determine the demand for oil.
To learn more about how to become an oil trader, feel free to browse our growing education centre, which features a variety of content on the trading of commodities.
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