# Crude Oil: Definition, Importance for Investors, and Market Impact

## What Is Crude Oil?

Crude oil is a naturally occurring liquid made from hydrocarbons and organic materials, formed from ancient plants and animals. These organisms were covered by layers of sand, silt, and rock, subject to heat and pressure, and eventually turned into a type of fossil fuel that is refined into usable products, including gasoline, diesel, liquefied petroleum gases, and feedstock for the petrochemical industry.

Crude oil is a [nonrenewable resource](https://www.investopedia.com/terms/n/nonrenewableresource.asp), which means that it can’t be replaced naturally at the rate we consume it and is, therefore, a limited resource.

### Key Takeaways

*   Crude oil is a naturally occurring petroleum product refined into energy and industrial products, making it a crucial global commodity.  
    
*   As a nonrenewable resource, crude oil's limited supply contributes to its significant influence on global economics and politics.  
    
*   Investors can engage with crude oil through futures and spot contracts, using these instruments to hedge or diversify their portfolios.  
    
*   Global events and technological developments heavily influence crude oil prices, affecting economies worldwide.  
    
*   OPEC, consisting of major oil-exporting countries, has historically held considerable sway over crude oil supply and pricing.

![Crude Oil](https://www.investopedia.com/thmb/rmJiXH93Nkj1SJ3l6hxFmlS3m3A=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/crude-oil.asp-final-v2-bde7b6b001af49d4a7ada6cabfb693d4.png)

*— Investopedia / NoNo Flores*

## How Crude Oil Is Extracted and Refined

Crude oil is typically obtained through drilling, where it is usually found alongside other resources, such as natural gas (which is lighter and therefore sits above the crude oil) and saline water (which is denser and sinks below). Once extracted, crude oil is refined into products like gasoline, kerosene, and asphalt for consumers.

Crude oil is one of the world’s most important commodities, and its price can have ripple effects through the broader economy. When oil prices rise, gasoline costs more, shipping becomes pricier, and production costs increase. Crude oil prices are driven mainly by the principles of [supply and demand](https://www.investopedia.com/ask/answers/040915/how-does-law-supply-and-demand-affect-oil-industry.asp). Prices drop when supply exceeds demand, and they climb when demand is high but supply is short. Changes in perceived supply and demand can result from geopolitical events or natural disasters in oil-rich nations.

Investors and speculators can trade oil via [futures markets](https://www.investopedia.com/terms/f/futuresmarket.asp), [spot markets](https://www.investopedia.com/terms/s/spotmarket.asp), or [exchange-traded funds (ETFs)](https://www.investopedia.com/terms/e/etf.asp).

### The Evolution of Crude Oil in the Global Market

Although fossil fuels such as coal have been harvested for centuries, crude oil was first discovered and developed during the [Industrial Revolution](https://www.investopedia.com/terms/i/industrial-revolution.asp), and its industrial uses were developed in the 19th century. Newly invented machines revolutionized the way we do work, and they depended on these resources to run.

Today, the world’s economy is largely dependent on fossil fuels such as crude oil, and the demand for these resources often sparks political unrest, as a small number of countries control the largest reservoirs. Like any industry, [supply and demand](https://www.investopedia.com/terms/l/law-of-supply-demand.asp) heavily affect the prices and profitability of crude oil. The United States, Saudi Arabia, and Russia are the leading producers of oil in the world.

In the late 19th and early 20th centuries, the U.S. was one of the world’s leading oil producers, and U.S. companies developed the technology to make oil into useful products like gasoline. During the middle and last decades of the 20th century, U.S. oil production fell dramatically, and the U.S. became an energy importer. In 2021, however, crude oil net imports were at the second-lowest annual level since 1985.

Its major supplier was the [Organization of the Petroleum Exporting Countries (OPEC)](https://www.investopedia.com/terms/o/opec.asp), founded in 1960, which consists of the world’s largest (by volume) holders of crude oil and natural gas reserves. As such, the OPEC nations had a great deal of economic leverage in determining supply, and therefore the price, of oil in the late 20th century.

 In the early 21st century, new technology like fracking led to a U.S. energy boom, reducing OPEC's influence. Reliance on fossil fuels is a major cause of global warming, which has become a significant issue. Risks surrounding oil drilling include oil spills and ocean acidification, which damage the ecosystem. In the 21st century, more products use alternative energy like electric cars, solar homes, and wind-powered communities.

> **Fast Fact**
>
> Oil is often called “black gold,” yet crude oil has a range of viscosity and can vary in color from black to yellow depending on its hydrocarbon composition. Distillation, the process by which oil is heated and separated into different components, is the first stage in refining.

## Distinguishing Crude Oil from Petroleum Products

Petroleum, from the Latin for 'rock oil,' is often used interchangeably with crude oil. Essentially, petroleum is a more general word that refers to crude oil, the raw, unprocessed oil that is extracted out of the ground, and other petroleum products formed from refined crude oil.

Petroleum products cover everything that a refinery produces from crude oil or natural gas. These products include diesel, gasoline, fuel oil, and more.  

## Strategies for Investing in Crude Oil

Investors may purchase two types of oil contracts: spot contracts and [futures contracts](https://www.investopedia.com/terms/f/futurescontract.asp). To the individual investor, oil can be a speculative asset, a portfolio diversifier, or a hedge against related positions.

Large financial institutions and energy companies can also invest in oil and gas production through the use of [volumetric production payments (VPPs)](https://www.investopedia.com/terms/v/volumetric-production-payment.asp), which allow oil and gas companies to monetize their fields or proven orders.

### Understanding Spot Contracts in Oil Trading

The price of the spot contract reflects the [current market price](https://www.investopedia.com/terms/c/currentprice.asp) for oil, whereas the futures price reflects the price that buyers are willing to pay for oil on a [delivery date](https://www.investopedia.com/terms/d/deliverydate.asp) set at some point in the future.

The futures price is no guarantee that oil will actually hit that price in the current market when that date comes. It is just the price that, at the time of the contract, purchasers of oil are anticipating. The actual price of oil on that date depends on many factors.

Most [commodity](https://www.investopedia.com/terms/c/commodity.asp) contracts that are bought and sold on the spot markets take effect immediately: Money is exchanged, and the purchaser accepts delivery of the goods. In the case of oil, the demand for immediate delivery vs. future delivery is limited, in no small part due to the logistics of transporting oil.

Investors, of course, don’t intend to take delivery of commodities at all (although there have been cases of investor errors that have resulted in unexpected deliveries), so futures contracts are more commonly used by traders and investors.

### An Introduction to Oil Futures Contracts

An oil futures contract is an agreement to buy or sell a certain number of barrels of oil at a predetermined price, on a predetermined date. When futures are purchased, a contract between buyer and seller is signed and secured with a [margin](https://www.investopedia.com/terms/m/margin.asp) payment that covers a percentage of the total value of the contract.

End-users of oil purchase on the futures market to lock in a price; investors buy futures essentially as a gamble on what the price will actually be down the road, and they profit if they guess correctly. Typically, they will liquidate or roll over their futures holdings before they would have to take delivery.

There are two major oil contracts that are closely watched by oil market participants. In North America, the benchmark for oil futures is [West Texas Intermediate (WTI)](https://www.investopedia.com/terms/w/wti.asp) crude, which trades on the [New York Mercantile Exchange (NYMEX)](https://www.investopedia.com/terms/n/nymex.asp). In Europe, Africa, and the Middle East, the benchmark is [North Sea Brent Crude](https://www.investopedia.com/terms/n/northseabrentcrude.asp), which trades on the [Intercontinental Exchange (ICE)](https://www.investopedia.com/terms/i/intercontinentalexchange.asp).

While the two contracts move somewhat in unison, WTI is more sensitive to American economic developments, and Brent responds more to those in other countries.

> **Fast Fact**
>
> There are multiple futures contracts open at once, with most trading in the front-month contract (the nearest futures contract). For this reason, the front month is also known as the most active contract.

### Comparing Spot and Futures Oil Prices

Futures prices for crude oil can be higher, lower, or equal to spot prices. The price difference between the spot market and the futures market says something about the overall state of the oil market and expectations for it. If the futures prices are higher than the spot prices, this usually means that purchasers expect the market will improve, so they are willing to pay a [premium](https://www.investopedia.com/terms/p/premium.asp) for oil to be delivered at a future date. If the futures prices are lower than the spot prices, this means that buyers expect the market to deteriorate.

“Backwardation” and “contango” are two terms used to describe the relationship between expected future spot prices and actual futures prices. When a market is in [contango](https://www.investopedia.com/terms/c/contango.asp), the futures price is above the expected spot price. When a market is in normal [backwardation](https://www.investopedia.com/terms/b/backwardation.asp), the futures price is below the expected future spot price. The prices of different futures contracts can also vary depending on their projected delivery dates.

## Methods for Predicting Oil Price Fluctuations

Predicting crude oil prices is challenging because they are [volatile](https://www.investopedia.com/terms/v/volatility.asp) and depend on many factors. They use a range of forecasting tools and depend on time to confirm or disprove their predictions. The five models used most often are:

1.  **Oil futures prices**: [Central banks](https://www.investopedia.com/terms/c/centralbank.asp) and the [International Monetary Fund (IMF)](https://www.investopedia.com/terms/i/imf.asp) mainly use oil futures contract prices as their gauge. Traders in crude oil futures set prices by two factors: supply and demand, and market sentiment. However, futures prices can be a poor predictor, because they tend to add too much [variance](https://www.investopedia.com/terms/v/variance.asp) to the current price of oil.
2.  **Regression-based structural models**: Statistical computer programming calculates the probabilities of certain behaviors on the price of oil. For instance, mathematicians may consider forces such as events in OPEC member nations, [inventory](https://www.investopedia.com/terms/i/inventory.asp) levels, [production costs](https://www.investopedia.com/ask/answers/012715/what-causes-oil-prices-fluctuate.asp), or consumption levels. Regression-based models have strong predictive power, but their creators may fail to include one or more factors, or unexpected variables may step in to cause these regression-based models to fail.
3.  **Time-series analysis**: Some economists use time-series models, such as exponential smoothing models and autoregressive models, which include the categories of [ARIMA (autoregressive integrated moving average)](https://www.investopedia.com/terms/a/autoregressive-integrated-moving-average-arima.asp) and [ARCH (autoregressive conditional heteroskedasticity)](https://www.investopedia.com/terms/a/autoregressive-conditional-heteroskedasticity.asp)/[GARCH (generalized autoregressive conditional heteroskedasticity)](https://www.investopedia.com/terms/g/generalalizedautogregressiveconditionalheteroskedasticity.asp), to correct for the limitations of oil futures prices. These models analyze the history of oil at various points in time to extract meaningful statistics and predict future values based on previously observed values. Time-series analysis sometimes errs, but it usually produces more accurate results when economists apply it to shorter time spans.
5.  **Bayesian autoregressive models**: One way to improve upon the standard regression-based model is by adding calculations to gauge the probability of the impact of certain predicted events on oil. Most contemporary economists like to use the [Bayesian](https://www.investopedia.com/articles/financial-theory/09/bayesian-methods-financial-modeling.asp) vector [autoregressive (BVAR)](https://www.investopedia.com/terms/a/autoregressive.asp) model for predicting oil prices.
6.  **Dynamic stochastic general equilibrium graphs**: Dynamic stochastic general equilibrium (DSGE) models use [macroeconomic](https://www.investopedia.com/terms/m/macroeconomics.asp) principles to explain complex economic phenomena—in this case, oil prices. DSGE models sometimes work, but their success depends on events and policies remaining unchanged, as DSGE calculations are based on historical observations.

Each mathematical model is time-dependent, and some models work better at one time than another. Because no one model alone offers a reliably accurate prediction, economists often use a [weighted](https://www.investopedia.com/terms/w/weighted.asp) combination of them all to get the most accurate answer. In 2014, for instance, the [European Central Bank (ECB)](https://www.investopedia.com/terms/e/europeancentralbank.asp) used a four-model combination to predict the course of oil prices to generate a more accurate forecast. There have been times, however, when the ECB has used fewer or more models to capture the best results. Even so, unforeseen factors like natural disasters, political events, or social upheavals can derail the most careful of calculations.

## Key Resources for Oil Market Insights

Because crude oil prices constantly change and are typically more volatile than stock or currency prices, it is crucial for successful investors and traders to have good information sources that report on the many factors that can influence oil prices. Many websites report crude oil news, but only a few broadcast the breaking news and current prices. The following three offer current information.

1.  **MarketWatch**: MarketWatch provides a wide range of business news, personal finance information, real-time commentary, investment tools, and data. Despite covering all aspects of financial markets, it tends to be among the first to break stories, putting out headlines as soon as news hits. These headlines can be found at the top right of its home page under the “Latest” tab. MarketWatch also provides details when necessary, posting stories, sometimes only a paragraph or two, to elaborate on its headlines, and updating them throughout the day. The site provides current oil price information, stories detailing oil’s price path—including [premarket](https://www.investopedia.com/terms/p/premarket.asp) and [closing bell](https://www.investopedia.com/terms/c/closingbell.asp) commentary—and multiple feature articles. The site has an active link on [its landing page](https://www.marketwatch.com/) showing the price of WTI oil. Within most articles, MarketWatch also includes an active link to the price of oil, so when you read an article, the price quote included is current. In addition, MarketWatch offers a more in-depth analysis of the economic news driving oil prices.
3.  **Reuters Commodities Page**: The Reuters news service has a [commodity-specific portion of its website](https://www.reuters.com/markets/commodities/energy/) that releases breaking oil news, background stories, and current prices. It also offers more recent in-depth stories on, and analysis of, the sector as a whole, including price-driving sector updates, and it is good at releasing any imperative news as it is made public. Reuters also publishes frequent pieces detailing oil’s price movements and the factors behind those movements.
4.  **CNBC**: CNBC.com has a [web page dedicated to oil news](https://www.cnbc.com/oil/). During U.S. market hours, it publishes relevant oil-specific pieces. This works out to be about every hour when you look at its main page. CNBC frequently updates its articles when there is a price movement in oil, but it does not provide a live feed to oil prices like MarketWatch does. It makes up for this, though, by providing a good breadth of oil sector stories, including all major price movers and price-driving developments.

## How Do You Invest in Crude Oil?

To an investor, crude oil can be a [speculative](https://www.investopedia.com/terms/s/speculation.asp) asset, a [portfolio diversifier](https://www.investopedia.com/terms/d/diversification.asp), or a [hedge](https://www.investopedia.com/terms/h/hedge.asp) against related positions. There are two ways to invest in crude oil: futures contracts and spot contracts. The price of the spot contract reflects the current market price for oil, whereas the futures price reflects the price that buyers are willing to pay for oil on a delivery date set at some point in the future.

## What Can Spot and Futures Crude Oil Prices Tell an Investor?

The basis, or differences, between oil futures contracts and the spot (cash) market can be indicative of the near-term expectations of oil supply and demand. When futures prices are trading higher than the spot (known as contango), it suggests that traders are willing to pay a premium for oil to be delivered at a future date and that expectations are [bullish](https://www.investopedia.com/terms/b/bull.asp). When futures are trading below the spot (known as backwardation), it can be a [bearish](https://www.investopedia.com/terms/b/bear.asp) signal.

## How Can I Follow the Crude Oil Industry?

Crude oil prices and related market news are available online, often for free. For example, [MarketWatch](https://www.marketwatch.com/) provides up-to-date price quotes, headlines, and commentary. The site has an active link on its landing page showing the price of crude. The Reuters news service is another free site with a [commodity-specific portion](https://www.reuters.com/markets/commodities/energy/) that shows current prices. CNBC.com, too, has a [page dedicated to oil-specific news](https://www.cnbc.com/oil) and recent developments.

## What Countries Are Members of OPEC?

According to its statutes, OPEC membership is open to any country that is a substantial exporter of oil and shares the ideals of the organization. After the five founding members, OPEC grew by 11 additional member countries over time. They are, in order of joining, as follows:

*   Iran (1960)
*   Iraq (1960)
*   Kuwait (1960)
*   Saudi Arabia (1960)
*   Venezuela (1960)
*   Qatar (1961)
*   Indonesia (1962)
*   Libya (1962)
*   United Arab Emirates (1967)
*   Algeria (1969)
*   Nigeria (1971)
*   Ecuador (1973)
*   Gabon (1975)
*   Angola (2007)
*   Equatorial Guinea (2017)
*   Congo (2018)

Ecuador withdrew from the organization on Jan. 1, 2020. Qatar terminated its membership on Jan. 1, 2019, and Indonesia suspended its membership on Nov. 30, 2016. Angola has been the latest country to withdraw from OPEC, as of January 2024. Thus, as of 2024, the organization consists of 12 states.

## The Bottom Line

Crude oil, a [vital and finite resource](https://www.investopedia.com/ask/answers/030915/what-percentage-global-economy-comprised-oil-gas-drilling-sector.asp), plays a pivotal role in the global economy as the primary source of energy production and a key raw material for products like gasoline, diesel, and plastics. It is traded globally as a commodity, influenced heavily by supply-demand principles and geopolitical factors.

While the environmental impact of oil extraction and consumption is a concern, its importance persists as nations and industries depend on it for energy. Investors engage with crude oil through futures and spot markets to hedge, diversify portfolios, or speculate on price fluctuations. Despite its environmental controversies, crude oil's [significant role in energy production](https://www.investopedia.com/terms/o/oil-initially-in-place.asp) and economic activities underscores its indispensable status.

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