Crude oil is the world's most widely traded and used commodity. Oil and its derivatives still power the bulk of global transportation, and serve as cooking and heating sources in developing countries.
Because the world remains so reliant on crude oil, its price is heavily dependent on the pace of economic growth, which affects demand prospects. This relationship is a two-way street, because our dependence on petroleum products in transportation, chemicals and manufacturing means changes in the price of oil can also affect the pace of economic growth.
For example, in the early months of 2022, crude oil prices at seven-year highs above $90 per barrel were frequently described as an inflationary threat to growth. That's in stark contrast with crude's plunge in the spring of 2020 in response to the COVID-19 pandemic.
The price of April West Texas Intermediate crude oil futures that year fell to -$37 per barrel shortly before expiration, meaning that's how much traders were willing to pay to avoid having to take delivery of about 42 gallons of crude. Global travel and economic activity had dropped off dramatically at the time amid public health restrictions, and the resulting supply surplus strained crude oil storage capacity.
While the negative pricing didn't last long and illustrated some risks particular to futures markets, it showed just how dramatically oil market sentiment can swing in response to changes in economic fundamentals.
Below, we'll look in more detail at the key variables in the global oil markets.
- Crude oil prices can fluctuate widely and rapidly, ranging from negative territory in 2020 to more than $90 per barrel less than two years later.
- Crude oil prices react to many variables, including supply and demand prospects and the perceived risk of market disruptions.
- Economic growth can drive up the demand for crude oil, while slowdowns tend to lower demand and prices.
- OPEC+ is an international alliance of crude oil exporters that negotiates export quotas for members in an attempt to influence global supply.
- One reason crude oil prices can be volatile is that supply and demand are relatively inelastic, that is they're slow to respond to price signals, requiring bigger price moves to bring the market into balance.
In the spring of 2020, oil prices collapsed amid the COVID-19 pandemic and economic slowdown. OPEC and its allies agreed to historic production cuts to stabilize prices, but they still dropped to 20-year lows.
The Organization of Petroleum Exporting Countries (OPEC) has sought to influence global oil prices by limiting the supply of crude for decades, with varying degrees of success. In recent years, OPEC's power to set prices was undermined by the development of shale supply in the continental U.S., but reinforced by OPEC's alliance with Russia and other exporters under the OPEC+ umbrella. Governments, oil companies, and speculators, continue to pay close attention to every OPEC+ decision.
OPEC's policies may be affected, in turn, by geopolitical developments. Some of the world's top oil producers are politically unstable.
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.
Technological innovations and financial conditions can also influence crude oil supply levels by affecting production volumes and costs. For example, advances in hydraulic fracturing, or fracking, technology have vastly increased the supply of crude extracted from rock, with the so-called shale oil making the U.S. a net exporter of crude oil and related products for the first time since the 1940s in 2018.
Strong economic growth and industrial production tend to boost the demand for oil—as reflected in the increased demand from fast-growing developing nations 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 rather through futures and options contracts. For example, airlines and oil producers use derivatives like futures and options to hedge against swings in the price of crude, while speculators use the same securities in hopes of profiting from price moves in crude oil.
Such hedging instruments are important to many oil producers and consumers because oil prices can be so volatile. One reason oil prices are often volatile is that crude oil consumers are relatively slow to change their consumption in response to changes in the price of oil, and producers tend to be similarly slow in adjusting production. With supply and demand relatively inelastic, the price must move more to balance supply and demand at times of disruption for either.
Reports on production figures, spare capacity and investment can all affect crude oil prices in the short term, as can perceptions of the risks to supply and overall market sentiment. Some of the most closely followed reports are OPEC's monthly oil report, the International Energy Agency (IEA) oil market report, and weekly inventory data from both the U.S. Energy Information Administration (EIA) and the American Petroleum Institute (API).
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—it remains an essential commodity. Carbon-based fuels are widely used in transportation, heating and manufacturing.
While global growth plays a major role in setting oil prices, supply dynamics influenced by political developments as well as technological innovations in crude extraction and alternative energy sources are also important oil market factors.