What is a commodity?
A commodity is a food, metal or other fixed physical substance that investors buy or sell, usually through futures contracts. Agricultural products, metals, petroleum, foreign currencies, and financial instruments such as Treasury bills and bonds are commodities. Petroleum (crude oil) is the world's most actively traded commodity.
What are spot and futures markets?
A spot market is one in which commodities are traded for near-term delivery - within a month for oil markets. A futures market is one in which a commodity is traded for delivery on a specified future date, which could be months or years away. Major fuel users, such as airlines and trucking companies, often buy oil in futures markets to guarantee the cost of the fuel they will use.
What are the benchmark crude oils?
Grades of crude oil are determined by their specific gravity and sulphur content. There are so many different varieties and grades of crude oil that buyers and sellers refer to a limited number, which are called reference or benchmark crude oils. Other varieties are then priced at a discount or premium relative to the benchmark. Brent blend crude oil pumped from the North Sea is generally accepted to be the world benchmark. According to the International Petroleum Exchange, Brent is used to price two-thirds of the world's internationally traded crude oil supplies. In the Persian Gulf, Dubai crude is used as a benchmark to price sales of other regional crude oils to Asia. In the United States, the benchmark is West Texas Intermediate (WTI). This means that crude oil imports into the United States are usually priced in relation to WTI. The Organization of Petroleum Exporting Countries (OPEC), a cartel of some of the world's leading producers, has its own reference, known as the OPEC basket, which is an average of seven crude oils. Six of the crude oils included in the OPEC basket are pumped by member countries, and the seventh is from Mexico. In practice, however, price differences are not large.
The Q&A segment was largely adapted from: the FAQ on Chicago Board of Trade web site, www.cbot.com/cbot/pub/page/0,3181,1065,00.html, and BBC News online, Oil Markets Explained, http://news.bbc.co.uk/2/hi/business/904748.stm.