If you are short on oil by function of your business model, you profit if oil prices decrease, and lose money if they increase. Oil distributors, who buy oil now to sell (deliver) at a future date, are short in this manner, since the inventory they hold is sold now so the price increasing throughout the period of delivery is profit they didn’t capture via selling at a lower price earlier.
Meanwhile, if you are long on oil by function of your business model, you profit if oil prices increase and lose money if they decrease. Take oil producers, who produce oil and sell it at a predetermined price and date—if the price of oil increases during that timeframe, they lose out on the marginal profits they could made merely by holding the oil and selling at spot prices later.
Whether long or short, companies hedge their bets in the oil markets by investing in assets that move against their inherent position. So, an oil distributor (short) will buy long futures contracts or purchase call options, while an oil producer (long) will go short on oil, or buy put options. That way, any gain or loss experienced is counterweighted—theoretically being the “perfect hedge” and removing all risk of price volatility.
To learn more, consider reading about PADD Districts, the Why WTI and Brent are Crude Oils, and Why There are Price Differences Among Crude Oils, and my Oil & Gas Terms Guide.
Conceptual Credit: Robert Kaufmann
