Crude oil, or “black gold,” is one of the world's most precious commodities. Price changes in the commodity can affect the economic ecosystem at every level, from family budgets to corporate earnings to the nation's GDP. Indeed, sudden price drops or unexpected spikes can send global financial markets into a tizzy.

Crude oil prices change quickly in response to news cycles, policy changes, and fluctuations in the world's markets. Since 2014, oil prices have experienced a downward journey, falling from highs of around $105 per barrel. In February and March of 2020, crude prices accelerated their decline in reaction to the coronavirus pandemic and an expected sharp drop in demand for oil. In addition, major oil producers failed to come to an agreement on production cuts, exacerbating the problem. By mid-March 2020, the price of U.S. crude oil was fluctuating just around $30 per barrel. So, what causes these dramatic swings in the price of oil, and what can we expect going forward?

Supply

For several decades, the Organization of Petroleum Exporting Countries (OPEC) has been the elephant on the world's trading floors, with its oil-producing member nations working together to determine prices by boosting or reducing crude oil production. While OPEC's grip on the market has loosened some in past years, its decisions continue to play a dominant role. OPEC's every move is watched closely by governments, oil companies, speculators, hedgers, investors, traders, policymakers, and consumers.

Key Takeaways

  • Crude oil prices can vary greatly, with a price near $150 per barrel in 2014 and $30 in 2020.
  • Crude oil prices react to many variables, including economic news, overall supplies, and consumer demand.
  • OPEC is an international oil producing cartel that plays an important role in determining global oil supplies.
  • Economic growth and increased industrial production can drive up the demand for crude oil.
  • Key reports that affect crude oil prices in the short term are weekly inventory statistics from the American Petroleum Institute and U.S. Energy Information Administration.

OPEC's policies are affected, in turn, by geopolitical developments. Some of the world's top oil producers are politically unstable or at odds with the West (issues pertaining to terrorism or compliance with international laws, in particular, have been problematic). Some have faced sanctions by the U.S. and the United Nations.

In the past, supply disruptions triggered by political events have caused oil prices to shift drastically; the Iranian revolution, Iran-Iraq war, Arab oil embargo, and Persian Gulf wars have been especially notable. The Asian financial crisis and the global economic crisis of 2007-2008 also caused fluctuations. 

The supply crude oil is also determined by external factors, which might include weather patterns, exploration and production (E&P) costs, investments, and innovations. For example, thanks to advances in technology that allow companies to extract oil from rock—so-called shale oil—the United States became the world's largest producer of oil in 2018 and a major source of global oil supplies.

Demand

Strong economic growth and industrial production tend to boost the demand for oil—as reflected in changing demand patterns by non-OECD nations, which have grown rapidly in recent years. According to the U.S. Energy Information Administration,

“Oil consumption in the Organization for Economic Cooperation and Development (OECD) countries declined between 2000 and 2010, [while] non-OECD oil consumption increased more than 40%. China, India, and Saudi Arabia had the largest growth in oil consumption among the countries in the non-OECD during this period.” 

Other important factors that affect demand for oil include transportation (both commercial and personal), population growth, and seasonal changes. For instance, oil use increases during busy summer travel seasons and in the winters, when more heating fuel is consumed.

Derivatives and Reports

More and more, market participants are buying and selling crude oil, not in its physical form, but in the form of contracts. For example, airlines and oil producers use derivatives, like futures and options, to a hedge against swings in the price of oil, while speculators drive those prices upwards or downwards when there are waves of buying or selling amid incoming news.

Reports on production figures, spare capacity, target pricing, and investments can be a crucial factor in the setting of crude oil prices. Some of the most keenly followed reports are OPEC's monthly oil report, International Energy Agency (IEA) oil market report, and weekly inventory data from both the American Petroleum Institute (API) and the U.S. Energy Information Administration (EIA).

The Bottom Line

Oil has long been the engine of the world's economy, and even today—as the search for alternative energy sources gains ground—life without crude oil is hard to imagine. Carbon-based fuels are used in heavy and light manufacturing, in the production process (chemicals, textiles, detergents, and medicines), and in every sector of our transportation industries. For now, at least, oil companies and oil-rich nations will surely weather dips, deeper plunges, and sudden spikes in crude oil prices.