CRUDE OIL BASICS EXPLAINED AND WHAT MOVES PRICES

What is crude oil?

Crude oil is a naturally occurring, unrefined petroleum product composed primarily of hydrocarbon deposits and other organic materials. A key raw material used in the production of fuel (such as petrol, diesel, and jet fuel), plastics, synthetic materials, and chemicals, crude oil plays a crucial role in the global economy.

Crude oil is extracted from the earth through drilling and is subsequently refined into usable products. It exists in a liquid form in underground reservoirs, sedimentary rocks, and tar sands. Depending on its composition, origin, and processing complexity, crude oil is often classified into different grades such as Brent Crude, West Texas Intermediate (WTI), and Dubai Crude, which serve as pricing benchmarks in oil trading.

Globally, crude oil is measured in barrels (approximately 159 litres), and transactions typically occur on international commodities markets. As a highly liquid global asset, it is frequently subject to speculation, geopolitical influences, and economic cycles.

Besides its industrial function, crude oil pricing influences inflation rates, energy costs, and even interest rate decisions by central banks. It is, therefore, closely monitored by traders, policymakers, and analysts for signals about economic trends and geopolitical sentiment.

Here are the main types of crude oil:

• Brent Crude: Derived from the North Sea, a global price benchmark used for oil pricing in Europe and Africa.
• West Texas Intermediate (WTI): A lighter, sweeter oil sourced mainly in the U.S., used as a benchmark for North American pricing.
• Dubai/Oman Crude: Heavier and more sour, often used for pricing oil exported from the Middle East to Asia.

The differences in physical characteristics such as 'light' or 'heavy' and 'sweet' or 'sour' impact how efficiently oil can be refined and thus its market value. Lighter, sweeter crudes are typically more valuable as they produce higher yields of gasoline and diesel.

Crude oil is not only one of the most significant commodities but also among the most politically sensitive. A variety of global actors and national governments have vested interests in oil revenue, production, and pricing structures. This makes crude oil both an economic and strategic resource, often at the centre of international negotiations and conflicts.

Understanding crude oil basics provides a vital foundation for analysing energy markets, crafting energy policies, and making informed decisions in commodities trading and investment strategy.

What drives oil supply and demand?

The price of crude oil is fundamentally driven by supply and demand dynamics, just like other commodities. However, due to its pivotal role in modern economies and its widespread use across various sectors, even small shifts in supply or demand can lead to substantial price volatility.

Supply Factors Affecting Oil Prices

1. Production Levels: The oil output from producing countries—particularly members of the Organisation of the Petroleum Exporting Countries (OPEC) and leading non-OPEC producers such as the United States and Russia—can significantly influence global supply.

• When producers increase output, supply rises, potentially pushing prices down.
• Conversely, production cuts can constrain supply and raise prices.

2. Spare Capacity and Inventory: The availability of stored crude and unused production capacity acts as a buffer during supply disruptions. Lower inventories tend to tighten supply, increasing prices.

3. Technological Advances: Innovations in extraction methods—such as hydraulic fracturing and deepwater drilling—can enhance supply by making previously inaccessible reserves economically viable.

4. Natural Disasters and Operational Disruptions: Events such as hurricanes, earthquakes, or technical failures at refineries and rigs can derail supply chains and limit production temporarily.

Demand Drivers in the Oil Market

1. Global Economic Growth: Expanding economies typically require more energy for transport, manufacturing, and electricity production, pushing up demand for oil. On the other hand, a global recession reduces demand.

2. Seasonal Consumption: Seasonal variation impacts demand. For example:

• Summer increases petrol use due to higher travel volumes in the Northern Hemisphere.
• Winter sees more heating oil use, especially in colder regions.

3. Fuel Efficiency and Alternatives: Improvements in vehicle fuel economy, growth in electric vehicle adoption, and policies encouraging renewable energy can curb oil demand growth over time.

4. Industrial and Aviation Sectors: The health of industrial production and the level of global air travel are significant demand indicators. A spike in airline activity or industrial output can significantly ramp up crude consumption.

OPEC and Market Balancing

OPEC plays a critical role in balancing global supply and demand. Through coordinated production targets, member nations influence oil prices to manageable levels to protect their economies from harmful price volatility. The OPEC+ agreement, which includes Russia and other non-OPEC producers, has further extended this coordination in recent years.

Understanding the interplay of supply and demand offers a crucial lens into oil price forecasting. Investors, economists, and policymakers constantly evaluate inventories, economic indicators, and production quotas to estimate future price movements. While market fundamentals remain the core pricing determinant, they often intersect with external shocks and policy decisions that can accelerate or reverse market trends unexpectedly.

Geopolitical influences on oil markets

Geopolitics has long been a dominant force in shaping the supply, investment climate, and pricing outlook of crude oil. Given the concentration of reserves in politically sensitive regions and the strategic importance of energy for national security, oil markets are often highly reactive to geopolitical developments.

Key Geopolitical Factors Affecting Oil Prices

1. Regional Conflicts: Military conflicts or civil unrest in oil-producing regions—particularly in the Middle East—can disrupt production and transportation channels. For example, tensions between Iran and Saudi Arabia or conflict in Libya and Iraq have historically caused oil price spikes due to feared or real supply losses.

2. Sanctions and Trade Policies: Economic sanctions imposed on major producers—such as Iran, Venezuela, or Russia—can restrict their ability to export oil. This limitation reduces global supply and tightens market conditions. In 2022, Western sanctions on Russia following its invasion of Ukraine significantly transformed global oil flows and led to major price volatility.

3. Strategic Reserves and Government Intervention: Nations may release crude from strategic petroleum reserves (SPRs) to soften price spikes or supply disruptions. For example, coordinated SPR releases among major economies can temporarily ease market tightness, though they tend to have short-term impact unless accompanied by increased production.

4. Maritime Chokepoints: A large share of global oil trade passes through narrow waterways such as the Strait of Hormuz, the Suez Canal, and the Strait of Malacca. Blockades or threats in these regions can trigger fears of supply chain interruption and drive prices higher.

5. Political Decisions and Alliances: Oil alliances and national policy shifts can influence supply behaviour. For example, OPEC+ decisions often reflect both market dynamics and diplomatic negotiations. Energy policy transitions, subsidies, and international climate agreements also play a growing role in guiding long-term investor sentiment.

Market Sensitivity and Price Reactions

Geopolitical tensions rarely need to result in actual supply disruption to affect the market. Even the perception of risk—whether through diplomatic rhetoric, missile attacks near oilfields, or coups in producing nations—can impact futures contracts and investor positioning. The high reliance on oil in transport, chemicals, and power implies that national interests are fundamentally tied to oil access and pricing stability.

Furthermore, the interconnectedness of global energy markets means that trouble in one region often affects global supply chains. A conflict in Nigeria can reduce European supply; sanctions on Iran may shift Asian delivery schedules; a Russian export ban may reroute North American trade flows.

Energy security is increasingly coming to the forefront of governmental agendas, especially in light of climate change and energy transition pressures. Diversification of supply sources, increased storage capabilities, and long-term energy partnerships are key tools used by nations to hedge against geopolitical volatility in the oil sector.

In summary, geopolitics acts as a powerful multiplier of price pressures in crude oil markets. While supply and demand establish the foundation, political events often catalyse or distort normal market functions, making oil a uniquely sensitive and strategic commodity in the world economy.