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Crude oil, referred to as the "mother of all commodities" and the "lifeblood of all industrialized countries," is a crucial resource for economic development worldwide. Despite attempts to reduce petroleum usage and search for alternative green energy sources, crude oil remains a vital commodity with immense significance.

The correlation between rising oil prices and inflation may raise questions for some. This article delves into the framework of crude oil analysis.

1. Why analyzing crude oil may be important?

2. What factors can impact crude oil prices?

   ○Commodity attributes impact on oil supply

   ○Geopolitics and unexpected events can impact oil supply

   ○Financial attributes impact on financial assets

   ○Extreme Weather Impacts the Oil Industry

Crude oil is closely related to economic indicators due to its presence in various parts of the real economy.

While crude oil can drive economic development in countries, price fluctuations may affect economic stability and monetary policies.

For instance, energy accounts for a 7% weight in the consumer price index (CPI) as of 2023. Although not a significant percentage, the high volatility can influence monthly data changes. Similarly, gasoline consumption plays a critical role in driving changes in new retail sales.

A sharp increase in oil prices may indicate forthcoming upward trends in both inflation and consumer data. Unexpected spikes in inflation may result in central banks raising interest rates.

In the latter part of this article, we will explore how crude oil's commodity, political, and financial attributes impact its price.

1. Commodity attributes impact on oil supply

Crude oil is a fossil fuel that can be refined into various products, including gasoline, diesel, liquefied petroleum gas, among others.

Which countries in the world produce crude oil?

Understanding which countries produce crude oil is crucial when analyzing the commodity.

As a non-renewable resource, countries with abundant reserves have pricing power over crude oil. Therefore, in 1960, the world's largest oil and natural gas reserve countries established an organization known as the Organization of the Petroleum Exporting Countries (OPEC).

OPEC's mission is to coordinate and unify the petroleum policies of its member countries to maintain market stability. This implies that OPEC has the power to dominate global crude oil supply and determine oil prices. As of 2023, the organization has 13 member countries, accounting for approximately 40% of global oil production and 60% of the global oil market.

To ensure sustainable development, OPEC maintains a fixed amount of idle capacity. In reality, OPEC's annual production only represents a small fraction of these countries' reserves. In order to keep crude oil prices high and maintain a stable income, OPEC may proactively reduce its production from time to time.

Saudi Arabia is currently the largest producer and exporter among OPEC countries. In 2021, Saudi Arabia represented 34% of OPEC's crude oil production, more than twice that of Iraq, the second-largest producer in the organization. This explains why we frequently hear news reports of Saudi Arabia representing OPEC in decision-making.

Oil production capacity and pricing are often highly contested issues as oil is a vital commodity for economic growth.

Non-OPEC countries are developing technologies to break the global crude oil supply pattern and compete for dominance in oil production. In 2022, the top five oil producers were the United States, Saudi Arabia, Russia, Canada and China, all countries except for Saudi Arabia are non-OPEC countries.

The US has the world's largest shale oil reserves, increasing production efficiency and reducing reliance on foreign oil imports.

The introduction of shale oil disrupted the previously OPEC-dominated pricing and suppressed international oil prices for an extended period, leading to the establishment of OPEC+ through an agreement between OPEC and ten other oil-producing nations.

What is the difference between OPEC and OPEC+?

OPEC+ was established in 2016 and expanded beyond OPEC's membership, including countries such as Russia, Azerbaijan, and Kazakhstan.

In summary, both OPEC and OPEC+ aim to maintain stability in the international oil market. However, with the inclusion of these countries, OPEC+ has a higher oil supply and proven reserves, OPEC+ has become the driving force behind many of the developments in the global oil markets over recent years.

Which countries are the primary consumers of crude oil?

Now let's take a look at the demand side of crude oil. Crude oil is a crucial fuel source for global industries and vehicles, and as "a nation on wheels", the US is both the largest producer and consumer of crude oil. In the 21st century, emerging economies such as China have experienced rapid growth, leading to an increased demand for crude oil due to their infrastructure development and industrial expansion needs.

The gross domestic product (GDP), which measures economic growth, is highly related to global crude oil consumption. Moreover, major consumer countries such as the United States and China account for over half of the world's total consumption, and their GDP is often highly correlated with crude oil consumption trends.

Crude oil inventories are essential for maintaining the supply-demand balance

The oil crisis in 1973 caused a massive disruption in the global supply of oil. To address the unpredictability of oil supply and demand, the Organisation for Economic Co-operation and Development (OECD) established the International Energy Agency (IEA) in 1974.

The mission of the IEA is to maintain substantial petroleum reserves to address unexpected disruptions in the oil supply. The IEA has 31 member countries, and its inventory is primarily located in the United States, Europe, Japan, and South Korea.

Note: The OECD was founded on December 14, 1960, by 18 European countries, the United States and Canada. The organization now has 38 member countries responsible for discussing and developing economic and social policies. It regularly publishes economic reports, statistical databases, analyses, and forecasts regarding global economic growth prospects.

Confused between IEA and EIA?

The US Energy Information Administration (EIA) has significantly different responsibilities compared to the international government organization IEA. The EIA collects, analyzes, and publishes US energy information weekly. Its reports provide information on weekly petroleum supply, crude oil, and refined product inventory levels, reflecting the current supply-demand situation of crude oil. Therefore, EIA data can impact oil prices, commodity futures markets, and even the US dollar index.

In addition to the EIA, the American Petroleum Institute (API) also regularly releases data on US crude oil inventory and refining operations.

How does the supply and demand relationship affect oil prices?

Crude oil, like most commodities, is affected by supply and demand. When there is more supply than demand at a given level, the market price decreases. Conversely, when there is limited supply and high demand, crude oil prices can surge.

Until now, the global oil market has been a seller's market. As a well-known cartel, OPEC+ member countries have a strong incentive to keep oil prices as high as possible. Despite having the world's highest oil reserves, OPEC+ often controls global crude oil supplies through production cuts or supply restrictions for their interests.

Note: A cartel, also known as a monopolistic interest group, is an independent enterprise or organization that controls supply or manipulates prices.

OPEC+'s statements can temporarily affect oil prices by changing expectations. For example, in the latter half of 2022, oil prices dropped from $120 within three months to around $90 due to concerns about a global economic downturn. OPEC+ declared production cuts in October 2022 to elevate oil prices, and soon after, benchmark Brent crude oil prices surged past $93 per barrel.

Similarly, crude oil inventories can provide insight into the supply-demand relationship in the market. When petroleum inventories increase, it can be seen as a signal that the market supply is sufficient or demand has decreased, putting pressure on oil prices to fall. Conversely, a decrease in inventory may indicate increased demand, and prices may rise sharply.

For example, US commercial crude oil inventories have had a significant negative correlation with West Texas Intermediate (WTI) crude oil prices.

2. Geopolitics and unexpected events can impact oil supply

Crude oil is the most closely linked to geopolitics and international relations commodity compared to other commodities. In the case of geopolitical conflicts between major oil-producing countries and consumers, it can lead to a decrease in supply, causing oil prices to soar. Similarly, any indication of improved relations, particularly in oil-producing regions, may cause oil prices to decrease as geopolitical tensions can drive them up by making it difficult for oil production and exports.

Two large-scale global oil crises occurred due to oil embargoes leading to supply disruptions. During these periods, world oil market prices skyrocketed, significantly impacting countries that rely on oil and causing their economies to slow down noticeably.

3. Financial attributes impact on financial assets

Crude oil is a speculative asset that individual investors can trade by buying spot or futures contracts. The oil market participants closely monitor two main oil contracts: West Texas Intermediate (WTI) and Brent crude oil.

The differences between WTI and Brent crude oil are:

● WTI crude oil futures pricing mainly takes place in the US, while Brent crude oil futures pricing mainly takes place in Europe. Asia-Pacific regions such as China and India primarily price based on Dubai crude oil.

● Due to the developed financial markets in the US, WTI crude oil has better liquidity and transparency, making it the leader in global commodity futures trading volumes. On the other hand, Brent crude oil has broader coverage as it can be transported by sea to various parts of the world. Currently, over three-quarters of global crude oil transactions use Brent crude oil as a benchmark price.

From a correlation perspective, crude oil is closely linked to various financial assets, and we will analyze these connections:

1. Other commodities

Crude oil prices have a positive correlation with other commodity prices. When crude oil futures prices rise, other commodity prices tend to rise as well. Commodity investment considers crude oil as significant due to its highest proportion in the asset management scale of commodity indexes.

2. US Dollar Index

As crude oil is priced in US dollars, the WTI crude oil prices usually have a significant negative correlation with the trend of the US dollar. The "petrodollar system" means that countries buying and producing crude oil trade through the US dollar. If the US adopts an expansionary monetary policy, causing the US dollar to depreciate, but crude oil's value remains the same, it would require more US dollars to purchase a barrel of oil, thereby pushing up crude oil prices. However, in recent years, the correlation between crude oil and the US dollar has been weakening due to various factors affecting oil prices.

3. Stock Market

Overall, there is a weak correlation between oil prices and the stock market. Thus, it is difficult for analysts to predict how oil prices will affect the stock market. However, the transportation and oil sector of the stock market is closely related to spot crude oil prices as fuel is the primary input cost for transportation companies. When oil prices are high, some investors may explore the possibility of taking bearish positions in transportation companies.

4. US Treasury Bonds

Similarly, WTI crude oil prices usually have a significant negative correlation with US Treasury bonds. For example, if oil prices rise rapidly in September 2023, it could have a sustained impact on US inflation, which could force the Fed to raise interest rates again. This concern could cause the yield on US Treasury bonds to increase. Rates and prices are inversely related, so we can see that the prices of ten-year Treasury main contracts exhibit a volatile downward trend.

5. Market Expectations

Crude oil and inflation expectations have a significant positive correlation. Therefore, it is important to understand the trend of crude oil when analyzing the decisions of the Fed. If crude oil prices go up, inflation expectations may also rise. If this happens during a rate-hike cycle, the Fed may increase the probability of raising interest rates.

Indicators Investors Can Pay Attention to

Crude oil's characteristic of having "inelastic demand and elastic supply" makes it challenging to forecast its price. However, investors can observe crude oil prices by combining related indicators such as: commodity, political, financial, and weather conditions. Here are some relatively important indicators for reference:

To track economic indicators in moomoo：

4. Extreme Weather Impacts the Oil Industry

Crude oil is also affected by unexpected events such as extreme weather and natural disasters. Here are three examples:

● Hurricanes and storms can cause severe damage to offshore drilling platforms, refineries, and pipelines, leading to price increases.

● Heat waves and droughts can also affect the oil industry. For instance, prolonged hot weather may reduce hydropower generation, leading to power outages. This could impact the refining and transportation of oil, resulting in a decrease in supply and an increase in prices.

● Winter storms can impact the oil industry in various ways. As temperatures drop, there is an increase in demand for heating oil and natural gas, leading to increased demand.

Investors can prepare in advance for potential disruptions caused by extreme weather by monitoring weather patterns.

Summary

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