Bear Market Trader | What drives oil? Financial Markets.
Know how financial markets have an affect on crude oil prices.

What drives oil? Financial Markets.

Points to be taken from this read


Before and after world eco­nom­ic slow­down, there were observ­able increas­es in cor­re­la­tions between com­mod­i­ty prices.

There is a neg­a­tive cor­re­la­tion between the USD and crude oil.

Stocks and crude oil prices tend to move in the same direc­tion dur­ing finan­cial crises and recovery.

Bond prices and inter­est rates move in oppo­site direc­tions. U.S. Trea­sury bond prices and crude oil prices would tend to move in oppo­site direc­tions in times of chang­ing eco­nom­ic conditions. 

Inverse rela­tion­ship between the exchange val­ue of the dol­lar rel­a­tive to oth­er cur­ren­cies and crude oil prices.




Most of the infor­ma­tion here comes from the U.S. Ener­gy Infor­ma­tion Administration’s web­site (EIA) and some from Wikipedia. I am not pre­tend­ing to come up with all this infor­ma­tion myself. The only thing I did was go through the infor­ma­tion and put togeth­er pieces of it to make it eas­i­er to under­stand and access for myself. This, I want to share with you and I hope it ben­e­fits you in some way. All the praise goes to the good peo­ple that put this up on the EIA and Wikipedia website.

Please go over to these respec­tive web­sites for a lot more information:

EIA on the bal­ance of ‘What dri­ves Crude Oil?’ finan­cial markets


Keep­ing it simple

As I tried explain­ing in the dis­claimer this post is just going to be the sum­ma­riza­tion of ‘facts’ I have found on the inter­net. Sort of like a cheat sheet for any­thing on the finan­cial mar­kets that are involved with crude oil. Above you can find the sources for the infor­ma­tion list­ed here so head on over and look up more details if you wish.


So here it goes…


Mar­ket participants

  • Mar­ket par­tic­i­pants not only buy and sell phys­i­cal quan­ti­ties of oil, but also trade con­tracts for the future deliv­ery of oil and oth­er ener­gy derivatives. 
  • One of the roles of futures mar­kets is price dis­cov­ery, and as such, these mar­kets play a role in influ­enc­ing oil prices.
  • Oil mar­ket trad­ing activ­i­ty involves a range of par­tic­i­pants with vary­ing moti­va­tions, even with­in indi­vid­ual participants. 
    • Some, such as oil pro­duc­ers and air­lines, have a sig­nif­i­cant com­mer­cial expo­sure to changes in the price of oil and petro­le­um-based fuels, and may seek to hedge their risk by buy­ing and sell­ing ener­gy deriv­a­tives. For exam­ple, an air­line may want to buy futures or options in order to avoid the pos­si­bil­i­ty that its future fuel costs will rise above a cer­tain lev­el, while an oil pro­duc­er may want to sell futures in order to lock in a price for its future output.
  • Banks, hedge funds, com­mod­i­ty trad­ing advi­sors, and oth­er mon­ey man­agers-who often do not have inter­ests in trad­ing phys­i­cal oil-are also active in the mar­ket for ener­gy deriv­a­tives to try to prof­it from changes in prices. 
    • In recent years, investors have also shown inter­est in adding ener­gy and oth­er com­modi­ties as alter­na­tives to equi­ty and bond invest­ments to diver­si­fy their port­fo­lios or to hedge infla­tion risks. 
  • Every trans­ac­tion must involve both a buy­er and a sell­er, and the desired “long” buy­er and “short” sell­er posi­tions of those with direct com­mer­cial inter­ests in the oil mar­ket do not nec­es­sar­i­ly equal one another. 
    • Banks, hedge funds, and oth­er “non-com­mer­cial” investors can add liq­uid­i­ty to futures and deriv­a­tive mar­kets by tak­ing the oth­er side of trans­ac­tions with com­mer­cial participants. 
    • On the oth­er hand, con­cerns have been raised that non-com­mer­cial com­mod­i­ty trad­ing and invest­ment may “use up” liq­uid­i­ty and ampli­fy price move­ments, par­tic­u­lar­ly at times when momen­tum is run­ning strong­ly in a par­tic­u­lar direction.


High­er inter­est in commodities

  • Activ­i­ty in com­mod­i­ty exchange con­tracts has risen in recent years. One mea­sure of activ­i­ty in futures mar­kets is open inter­est on exchanges, which indi­cates the num­ber of con­tracts in a trad­ing ses­sion that have not been set­tled or closed. 
    • Open inter­est (click here to find out what it is) on exchange-trad­ed crude oil futures con­tracts increased sub­stan­tial­ly over the past decade, as mea­sured by the New York Mer­can­tile Exchange (NYMEX)  , the main com­modi­ties exchange for ener­gy prod­ucts in the Unit­ed States. 
    • Both com­mer­cial par­tic­i­pants (those that have a direct inter­est in phys­i­cal oil pro­duc­tion, con­sump­tion, or trade) and non-com­mer­cial investors (mon­ey man­agers and funds that are inter­est­ed in trad­ing con­tracts for invest­ment and diver­si­fi­ca­tion pur­pos­es) have shown increased trad­ing activity. 
      • Care must be tak­en in inter­pret­ing these data, how­ev­er, because the vast major­i­ty of posi­tions are held in the less trans­par­ent over-the-counter (OTC) mar­ket rather than on exchanges. 
      • In addi­tion to futures con­tracts, anoth­er way for mar­ket par­tic­i­pants to invest in crude oil is through the buy­ing and sell­ing of options contracts. 
      • Options allow for invest­ment expo­sure with lim­it­ed poten­tial for loss­es and pro­vide an insur­ance-like instru­ment against adverse com­mod­i­ty price movements.


Activ­i­ty publications

  • The Com­mod­i­ty Futures Trad­ing Com­mis­sion pub­lish­es a week­ly activ­i­ty report on oil trad­ing that occurs on exchanges (e.g., NYMEX), the Com­mit­ment of Traders Report .
    • In this report, the activ­i­ties of mul­ti­ple trad­ing cat­e­gories are detailed, includ­ing phys­i­cal par­tic­i­pants (pro­duc­ers, mer­chants, proces­sors, and end users), mon­ey man­agers (usu­al­ly hedge funds or oth­er sophis­ti­cat­ed traders), and swap deal­ers (tra­di­tion­al­ly invest­ment banks or com­mod­i­ty broker/dealers).
      • On a net basis (sub­tract­ing short posi­tions from long posi­tions), phys­i­cal par­tic­i­pants tend to be net short while traders in the mon­ey man­agers cat­e­go­ry tend to be net long.


  • Dur­ing the world finan­cial cri­sis that occurred in the lat­ter half of 2008 and 2009, mar­kets saw a dra­mat­ic increase in the cor­re­la­tion between crude oil and oth­er com­modi­ties as demand decreased for raw materials. 
  • How­ev­er, both before and after the world eco­nom­ic slow­down, there were observ­able increas­es in the cor­re­la­tions between com­mod­i­ty prices. At the same time as this rise in cor­re­la­tions was a rise in inter­est in gen­er­al com­mod­i­ty exposure. 
  • A grow­ing num­ber of investors have gained expo­sure to com­modi­ties by invest­ing in index funds-mar­ket instru­ments that pro­vide expo­sure to bas­kets of commodities. 
  • These index funds usu­al­ly estab­lish shares of var­i­ous ener­gy and oth­er com­modi­ties to pro­vide diver­si­ty across a range of commodities. 
  • Also, exchange trad­ed funds (ETFs)-which can be bought and sold through­out the day like indi­vid­ual com­mon stocks-are an increas­ing­ly pop­u­lar means for investors, includ­ing indi­vid­u­als, to gain expo­sure to com­modi­ties as an asset class.


Com­plex matters

  • Cor­re­la­tion is not the same as cau­sa­tion, how­ev­er, and the rela­tion­ship between crude oil and oth­er finan­cial mar­kets is complex. 
  • Even with observed move­ments in cor­re­la­tion lev­els, influ­ences between crude oil price changes and changes in val­ues of oth­er asset class­es are unclear. 
    • For exam­ple, it is pos­si­ble that high cor­re­la­tions are due to more pri­ma­ry rela­tion­ships with a third com­mon fac­tor, such as eco­nom­ic growth expectations.
    • Anoth­er com­pli­cat­ing fac­tor is that these rela­tion­ships and their strength vary over time. Ana­lysts con­tin­ue to work to bet­ter under­stand the con­nec­tions between these markets.


Index funds

  • Most index funds are “long only” funds whose val­ue will increase only when the prices of the under­ly­ing com­modi­ties rise. 
    • Investors in such instru­ments expect com­mod­i­ty prices to rise; mon­ey is lost if the val­ues of the under­ly­ing com­modi­ties in the index decrease. 
    • Many of the man­agers of index-style invest­ments do not trade the indi­vid­ual com­po­nents of an index on a dai­ly basis; instead, they buy and hold these invest­ments over peri­ods of months or years, 
      • rolling con­tracts for­ward to avoid phys­i­cal delivery.


Addi­tion­al info

  • Some mar­ket observers believe that increased trad­ing activ­i­ty by investors and long-only index funds in oil mar­kets has had a sig­nif­i­cant impact on the ener­gy price for­ma­tion process. 
    • Although a grow­ing body of research by aca­d­e­mics and secu­ri­ties mar­ket ana­lysts exam­ines this issue, no defin­i­tive con­clu­sion either prov­ing or dis­prov­ing a causal link­age between non-com­mer­cial trad­ing and large ener­gy price swings over the past few years has been reached.
    • Because the vast major­i­ty of posi­tions are held in the less trans­par­ent OTC deriv­a­tives mar­ket, how­ev­er, analy­sis that relies only on read­i­ly avail­able data from the trans­par­ent por­tion of the mar­ket may offer only lim­it­ed insights. 
  • Addi­tion­al data and analy­sis are need­ed to bet­ter under­stand the rela­tion­ship between ener­gy deriv­a­tives trad­ing and price move­ments. In addi­tion, the glob­al nature of trade in ener­gy-relat­ed deriv­a­tives adds to the chal­lenges of ana­lyz­ing trad­ing activity.


Oth­er finan­cial markets

  • Pri­or to 2007, stocks, bonds, and exchange rates showed only infre­quent, fleet­ing cor­re­la­tions to oil futures prices. 
  • In con­trast, the price of crude oil showed pos­i­tive cor­re­la­tions with stocks from 2008–2010.
  • Neg­a­tive cor­re­la­tions with the val­ue of the U.S. dol­lar dur­ing most of late-2007 to the present.
  • And more irreg­u­lar but often neg­a­tive cor­re­la­tions with bond prices dur­ing 2008–2010.
  • For each asset class, there are finan­cial, phys­i­cal, and com­mon under­ly­ing eco­nom­ic fac­tors-such as the eco­nom­ic down­turn and recov­ery-that could be influ­enc­ing these more sig­nif­i­cant correlations. 
    • Finan­cial fac­tors include devel­op­ments such as the grow­ing inter­est over the last decade in crude oil as an invest­ment asset. 
    • This invest­ment inter­est has altered the finan­cial mon­ey flow into and out of commodities. 
    • Phys­i­cal crude oil mar­kets can also be influ­enced by out­side factors. 
    • Exchange rates and eco­nom­ic fac­tors play a role in crude oil pro­duc­tion and con­sump­tion, pos­si­bly lead­ing to price correlations.



  • Stocks have tra­di­tion­al­ly been the largest invest­ment mar­ket. Eco­nom­ic con­di­tions can cause prices for stocks and com­modi­ties, includ­ing oil, to move high­er or low­er together. 
  • As macro­eco­nom­ic con­di­tions improve (or wors­en), earn­ings for com­pa­nies increase (or decrease) 
  • and demand for com­modi­ties as raw mate­ri­als rise (or fall) as well. 
  • Eco­nom­ic expec­ta­tions are one pos­si­ble rea­son why a pos­i­tive cor­re­la­tion was observed dur­ing 2008–2010 between the S&P 500, a bench­mark for stock mar­kets, and crude oil, one of the most heav­i­ly trad­ed com­modi­ties in the world.
  • In addi­tion, there were sig­nif­i­cant changes in the lev­el and appetite for risk dur­ing 2008–2010.
  • Over the past decade, crude oil has shown sim­i­lar risk/return char­ac­ter­is­tics to stocks. As a result, dur­ing peri­ods where risks were ris­ing sig­nif­i­cant­ly (dur­ing the finan­cial cri­sis) and then abat­ing (dur­ing recov­ery), stocks and prices for crude oil and oth­er com­modi­ties could tend to move in the same direction.



  • As eco­nom­ic con­di­tions improve (or wors­en), inter­est rates on gov­ern­ment bonds will tend to rise (or fall). 
  • Since bond prices and inter­est rates move in oppo­site direc­tions, U.S. Trea­sury bond prices and the price of crude oil would also tend to move in oppo­site direc­tions in times of sig­nif­i­cant­ly chang­ing eco­nom­ic conditions.
  • In addi­tion, bonds, the sec­ond-largest invest­ment mar­ket, are often viewed as low­er-risk invest­ments than stocks, albeit with low­er aver­age returns. 
  • As an asset class, bonds are gen­er­al­ly less volatile and car­ry a low­er chance of los­ing principal. 
    • U.S. Trea­sury bonds, in par­tic­u­lar, are usu­al­ly con­sid­ered a risk­less investment. 
    • As investors become wor­ried about future returns in high­er risk assets, such as stocks and com­modi­ties, they tend to increase allo­ca­tions to bonds in their portfolios.



  • Sev­er­al hypothe­ses have been offered that tend to sup­port an inverse rela­tion­ship between the exchange val­ue of the dol­lar rel­a­tive to oth­er cur­ren­cies and crude oil prices. 
    • The first is sim­ply that because oil bench­marks are tra­di­tion­al­ly priced in U.S. dol­lars, a depre­ci­a­tion of the dol­lar decreas­es the effec­tive price of oil out­side the Unit­ed States. 
    • This decreased cost may increase con­sumers’ demand for oil, adding upward pres­sure to prices.
  • A sec­ond poten­tial rea­son is that U.S. dol­lar depre­ci­a­tion will decrease the effec­tive prof­its of non‑U.S. pro­duc­ers, when con­vert­ed into for­eign currencies. 
    • To coun­ter­act this, these coun­tries may tar­get high­er dol­lar prices of oil to main­tain real rev­enue, bud­get lev­els, and pur­chas­ing pow­er in world markets. 
    • Dol­lar depre­ci­a­tion also reduces the returns on dol­lar-denom­i­nat­ed assets, when mea­sured in for­eign cur­ren­cies, which may increase the attrac­tive­ness of for­eign invest­ing in com­modi­ties like oil. 
      • Com­mod­i­ty invest­ment may also become more attrac­tive to U.S. investors as a hedge against infla­tion if dol­lar depre­ci­a­tion tends to increase expec­ta­tions of greater inflation.
  • Final­ly, a rise in oil prices also expands the U.S. trade imbal­ance, which can put addi­tion­al down­ward pres­sures on the dol­lar, again yield­ing a neg­a­tive cor­re­la­tion albeit with cau­sa­tion going in the reverse direction. 
  • Despite these many pos­si­ble expla­na­tions, the actu­al cor­re­la­tion between oil prices and exchange rates has not been sta­ble over time, and was close to zero for more than half of the last decade.



Thanks for reading


I hope this post helps to make the role of the finan­cial mar­kets in rela­tion to oil prices more clear.


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