World of Oil Derivatives: A Guide to Financial Oil Trading in a Modern Age by Greg Newman

World of Oil Derivatives: A Guide to Financial Oil Trading in a Modern Age by Greg Newman

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INTRODUCTION
History of Oil and Oil Trading

The story of oil begins in prehistory; indigenous people in many regions
of the world were aware of this black stuff which seeped out of the ground.
For much of its life, it has been treated as a nuisance – nasty viscous stuff
which sticks to your feet. It was useful as an early antibiotic and disinfectant;
it was used to waterproof boats.
Oil grew to be the vitally important commodity it is today in the early
1800s in the United States of America (US) when it was discovered that
although it was a poor substitute for whale oil for lighting – it is too smoky
and smelly – it could be distilled into a lighter product which burnt cleanly
and didn’t smell too bad: kerosene. Kerosene lamps became the primary
light source after dark – before coal gas was piped into cities and towns.
Of course, the invention of the internal combustion engine catapulted
oil to stardom. When Henry Ford adopted the internal combustion engine for
his mass-produced vehicles, a ready supply of distilled oil (gasoline) was
essential. Interestingly, Ford could have chosen to power his Model T with
electricity, but lead–acid batteries were far too heavy. Ladies didn’t like
internal combustion engines: they were too noisy and smelly, and you had to
start them with a cranking handle, but gasoline’s unbeatable energy density
won – and does to this day.
After that, oil-driven engines were everywhere: in cars, lorries and
ships – Churchill had the British Navy convert its warships from coal to

oilburning – and oil was used for electricity generation. So there was a growing
demand for oil and its products, first in the US and quickly spreading
through the rest of the world.
Because Rockefeller pioneered the vertical integration of oil production
– oilfield drilling, transporting by rail, refining and distribution – it became
widely available throughout the country and, therefore, the energy provider
of choice. Demand soared. New oilfields were discovered, and everyone
rushed to exploit them. An entire industry was created, the giants of which
are around today: Standard Oil, Chevron, Texaco and others; the British
joined in to exploit oilfields in Russia, Iran, the Middle East and Asia (with
the help of US oil companies).
You can read this fascinating story in books like The Prize and other
books I will reference later. But, for now, the main point is that around 1850,
oil went from not being even a footnote in human history to the most
important commodity in the world. It wasn’t just useful – to industry, to
transport and later, increasingly to pharmaceuticals and plastics – it was
vital. It became a source of great wealth and embedded in politics. Buying
and selling oil became a sophisticated and growing market, which I have
more to say about in the next chapter.
Politics dominated the oil business in all its forms as demand grew
meteorically, spurred first by the world wars and then by consumer demand
in the years of reconstruction and plenty that followed. Throughout this
period, big US oil companies monopolised the technology, pricing and, to a
great extent, availability. The market for buying and selling was the domain
of these oil majors and specialist brokers who traded on long-term bespoke
contracts.
Then, countries outside the US that supplied oil to the industrial world
began to want more control over their major national asset. When the
Organization of the Petroleum Exporting Countries (OPEC) refused to sell
oil to the US in the wake of the Arab–Israeli war of 1967, old certainties
began to weaken. The world wanted ever more oil, and as a result of these
weakening certainties, independent traders saw the opportunity for a ‘spot’
market to supply oil without the traditional suppliers and their contracts.
This market made it possible to trade oil for instant delivery between any
two parties. But to develop fully, this market had to provide several
assurances: the creditworthiness of the participants, the grade and quality of
the oil product and the logistics of delivery and payment. And that, for us, is
where the oil market became interesting.
The Physical Oil Market
What is Oil?
Crude oil is a dark, viscous, foul-smelling liquid found in underground
deposits in many parts of the world, though it was in western Pennsylvania
in the US that it was first commercially exploited. In its natural form, it is

World of Oil Derivatives: A Guide to Financial Oil Trading in a Modern Age by Greg Newman