Crude oil prices are determined by worldwide supply and demand. On the demand side of the equation, world economic growth is the biggest factor. Growing economies require energy, and oil accounts for over 35% of the world’s total energy consumption.
One of the major factors on the supply side is the Organization of the Petroleum Exporting Countries (OPEC), which can have significant influence on prices by setting production limits on its members, who together produce more than 40% of the world’s crude oil. OPEC countries have essentially all of the world’s spare oil production capacity, and possess about two-thirds of the world’s estimated crude oil reserves.
World Crude Oil Price Since 1970
The prices shown below are for Saudi Light crude oil from 1970-1974 and the U.S. Imported Refiner Acquisition Cost of crude oil from 1975 to present.
Source: Energy Information Administration, EIA World Oil Price Chronology: 1970-2009 (March 2009).
Disruptions in supply caused by natural and political events can also significantly affect prices. When the difference between production capacity and demand is very small, even the possibility of a supply disruption can cause oil prices to increase. Rapid and large oil price increases occurred in response to crude oil shortages caused by the Arab oil embargo in 1973, the Iranian revolution in 1979, the Iran/Iraq war in 1980, and the Persian Gulf conflict in 1990. Hurricanes in the Gulf of Mexico have also caused oil prices to spike.
Buyers and Sellers at a Global Auction
Crude oil and petroleum product prices are the result of thousands of transactions taking place simultaneously around the world, at all levels of the distribution chain from crude oil producer to individual consumer. Oil markets are essentially a global auction — the highest bidder will “win” the available supply.
Like any auction, however, the bidder doesn't want to pay too much. When markets are "strong" or “tight” (when demand is high and/or available supply is low), the bidder must be willing to pay a higher premium. When markets are "weak" or “loose” (demand is low and/or available supply is high), a bidder may choose not to outbid competitors, waiting instead for later, possibly lower-priced supplies.
There Are Different Types of Oil Market Transactions and Prices
Contract arrangements in the oil market cover the majority of oil that changes hands. Oil is also sold in spot transactions, meaning an “on the spot” purchase of a single shipment for immediate delivery at the current market price.
Oil is also traded in the futures markets. A futures contract is a standardized contract to buy or sell a specified commodity of standardized quality at a certain date in the future. If oil producers wish to sell oil in the future, they can ensure their ability to do so, and ensure the price they will receive, by selling a futures contract today. Alternatively, if oil consumers will need to buy oil in the future, they can be sure of being able to do so, and be sure about what they will be paying, by buying a futures contract today. In addition to producers and consumers, futures contracts are also bought and sold by market participants who do not produce oil or consume oil. Speculators buy and sell futures contracts in anticipation of price changes, hoping to profit from those changes.
Changes in Prices Send Signals to the Market
Prices in spot markets send a clear signal about the supply/demand balance. Rising prices indicate that more supply is needed, and falling prices indicate that there is too much supply for the prevailing demand level. Furthermore, while most oil flows under contract, its price varies with spot markets. Futures markets also provide information about the physical supply/demand balance as well as the market's expectations.
Source: Energy Information Administration, Annual Energy Outlook 2009, March 2009
Seasonal changes in demand can influence the supply/demand balance for oil, and thus the market price. Other things being equal, crude oil markets tend to be stronger in the fourth quarter of the year (the high-demand quarter on a global basis, where demand is boosted both by cold weather and by inventory building) and weaker in the late winter as global demand for oil falls with warmer weather.
Long-Term Outlook for Crude Oil Prices
Despite the recent economic downturn, growing demand for energy — particularly in China, India, and other developing countries — and efforts by many countries to limit access to oil resources in their territories that are relatively easy to develop is projected to lead to rising oil prices over the long term. However, oil price projections are highly uncertain, and EIA considers the implications of a wide range of price scenarios in developing its long-run outlook.1
1. The low and high oil price paths are not intended to provide lower and upper bounds for future oil prices but rather to allow the analysis of possible future world oil market conditions that differ significantly from those assumed in the reference case. See the Annual Energy Outlook, Trends in Economic Activity for more information.