Source: Unsplash (Zbynek Burival)

Oh no! Are oil prices up again?

You might have seen this in the news or heard about this in regular conversations among your peers.

Have you ever wondered why oil prices go up or down in the market?

Don’t worry, this article will detail 5 simple ways for you to understand how the crude oil market works.

#1 It’s Demand and Supply

You might have heard about this from an Economics 101 class that you attended in college or secondary school. Demand and supply ultimately determine the price of crude oil and how much of it is produced.

What is demand? When you want something, you are willing to pay for it. It’s great if it’s free but generally, you have to pay. The more you want it, the more you are willing to pay. Hence, higher demand equals higher price.

What about supply then? To produce something, you need to buy raw materials and invest in machinery. The lower the cost, the lower you can charge and the more you can produce.

Think of it this way, you made and sold 10 barrels of oil before this. If you managed to produce more barrels of oil at 20 and consumers only wanted 10 at the original price, you would have to reduce your prices to sell the 20 barrels. More supply equals lower prices.

Here’s a table to describe this.

	Impact On Crude Oil Prices
Higher Demand	Higher Prices as people are willing to pay more
Lower Demand	Lower Prices as people are paying less.
Higher Supply	Lower Prices as companies can produce at a cheaper cost or have to reduce prices to sell more.
Lower Supply	Higher prices as companies are producing at higher cost or consumers are paying higher due to limited supply.

#2 Higher economic activities generally mean more demand for crude oil

Crude oil is used in almost everything. You need it to drive and power your electricity at home. When you do more work, you tend to consume more crude oil.

This applies to companies also. The more they produce, the more electricity they consume. They also need oil to power their vehicles to transport things.

Hence, if the economy is doing well, crude oil prices go up due to higher demand. What does that look like in the real world?

You might have seen the word gross domestic product (GDP) being thrown around in the media. Yes, GDP measures how much work is being done in the country.

The higher the GDP, the more demand it has. Who is demanding crude oil then? In the world today, U.S., China, and Europe are the biggest economies in the world, so naturally, their GDP growth will primarily drive crude oil demand.

In 2020 during the pandemic, as these economies were not doing well, crude oil prices fell to reflect this.

The better the global economy does, the higher the demand for crude oil prices and hence, higher crude oil prices.

#3 The cheaper cost of producing crude oil means more supply

When you run a business producing crude oil, several factors could lead to lower costs for you.

For example, the drilling machinery and rigs to drill for oil are expensive, and so are the maintenance and engineering service costs that come with them.

You also need to hire engineers to run them, which are typically professionals that could cost quite a bit. Furthermore, you will also need to pay for transportation for ships to carry them halfway around the world.

These costs could decrease if you hire labor that is cheaper which many oil companies are starting to do.

They have been hiring engineers from Asia (lower pay because of currency differences) to work on oil projects worldwide.

#4 Decision by OPEC and the discovery of crude oil has an impact

OPEC or Organization of Petroleum Exporting Countries is a global body that consists of countries that produce and export oil to the world and makes decision on how much oil to produce.

It consists of countries such as Saudi Arabia, Iran, Iraq, Kuwait, Libya, Nigeria, Algeria, Angola, Congo, Guinea, Gabon, Libya, UAE, and Venezuela.

A decision to reduce oil production will increase oil prices as there is less supply and vice versa. On 2 June 2023, oil prices rose by 2.5% when Saudi Arabia decided to reduce its oil production.

Furthermore, a sudden discovery of crude oil could also lead to a decline in oil prices as supply increases. This was evident in the first half of the 2010s when the U.S. discovered large amounts of shale oil. By 2015, crude oil prices declined to US$35 per barrel from US$104 per barrel in August 2014.

#5 Movements in oil price is unpredictable and mainly driven by human emotions

I am going to make this clear. The previous 4 factors that were discussed are the fundamental drivers of the global crude oil market, but human emotions ultimately are the main driver.

Like the stock market, the crude oil market is driven by sentiments on what investors think of the market. Sometimes, it’s rational, sometimes, it’s not.

Sometimes, a big player might want to make some money by putting in a big order to buy crude oil, and hence, everyone follows only for the big player to sell at the peak and for everyone else to suffer.  Crude oil markets and commodity markets in general are rife with such manipulation.

Conclusion

There are many intricacies when it comes to understanding and investing in the global crude oil market. However, these 5 factors are the main things that you should keep a look out for if you want to dip your feet into the world of crude oil.