Reviewed by Cierra Murry
Oil is the crown jewel of commodities. It’s used in many ways, from making plastics and asphalt to processing fuel. Price changes in oil ripple through the entire economy, since it is essential to the production, distribution, and delivery of most of the physical products we use.
As a result, the oil industry is an economic powerhouse, and changes in oil prices are closely watched by governments, corporations, investors, and consumers.
Many variables affect oil prices, but the key driver is the basic principle of supply and demand. The big question is: What affects the supply and demand of oil?
Key Takeaways
- Supply and demand based on global economic conditions and geopolitical tensions significantly impact oil prices.
- The United States, Saudi Arabia, and Russia are the top three oil producers globally, producing nearly 44 million barrels per day in 2023.
- OPEC, a cartel of oil-producing countries, retains the power to determine oil supply and prices but to a lesser degree than in the past.
Supply and Demand
Oil consumption consists of hundreds of millions of people and businesses collectively influencing supply and demand for oil-based products and, therefore, their prices.
Levels of oil production also affect oil prices, particularly in countries that produce large amounts of crude oil.
The United States is the largest oil producer in the world, outpacing the country that most assume to be the largest producer: Saudi Arabia. The U.S. surpassed Saudi Arabia as the world’s largest oil producer in 2018. The main driver was the surge in shale fracking in Texas and North Dakota.
That may change. Saudi Arabia and its OPEC partners have announced they will step up oil production in 2025 after several years of relatively low output.
The U.S. produced more than 22% of the world’s oil supply as of 2023, compared with 11% each for Saudi Arabia and Russia.
Top 10 Oil Producers
After the U.S., Saudi Arabia, and Russia, the world’s top 10 oil producers are Canada, China, Iraq, Brazil, the United Arab Emirates, Iran, and Kuwait.
Capacity and Reserves
The nations that produce the most oil and the countries that are most commonly identified with an abundance of oil aren’t necessarily the same. There is an important distinction between oil production and oil reserves.
Types of Reserves
Typically, oil reserves are categorized as proven reserves (90%+ chance that oil can be extracted), probable reserves (50%+ case that oil can be extracted), and possible reserves (at least a 10% probability that the quantities recovered will equal or exceed the sum of estimates proved plus possible reserves).
Determining the type of oil reserves countries have can help determine where future oil supplies will come from and the ability of future supply to meet demand.
Countries with Reserves
Venezuela has been identified as the leader on the list of largest oil reserves by country, with reserves estimated at more than 303 billion barrels. However, most of that oil is offshore or deep underground, making it difficult and expensive to reach. It is also dense oil, which makes it harder to refine into usable products such as gasoline.
Saudi Arabia has the second-largest reserves, with 267 billion barrels.
As for the United States, its proven reserves are less impressive than its current capacity. The U.S. had 55 billion barrels in reserve by 2024.
Pumping, Refining, and Distribution
Basic supply and demand theory states that when more of a product is produced, it should sell for less.
It’s a symbiotic dance. More was produced because it became more economically efficient (or no less economically efficient) to do so. For example, if an oil well stimulation technique was invented that could double an oil field’s output for only a small incremental cost, with demand staying static, prices should fall.
Oil Extraction
Technological developments have impacted production and the costs of extracting oil from the ground.
Oil production in North America has surged, with fields in North Dakota and Alberta as fruitful as ever.
Also, new supply has been added due to advancements in shale fracking. Fracking refers to hydraulic fracturing, in which fractures in rock formations are created by injecting fluid into the cracks to force them to open. Petroleum or natural gas can then be extracted from subterranean wells.
Note
The U.S. consumed 20.25 million barrels per day of oil in 2023 while producing about 21.91 million barrels per day, meaning the U.S. is a net exporter of oil.
Refining and Distribution
Despite the increase in oil production, crude oil prices have remained volatile. That has a ripple effect on the prices of most products, given the reliance on oil for production, shipping, and delivery of physical products.
The problem with the basic supply and demand theory is that distribution and refinement haven’t always kept up with production.
For example, the United States does not build refineries often. The newest refinery with significant capacity came online in Garyville, Louisiana, in 1977.
Important
There were 130 refineries in operation in the U.S. as of 2023. So, even though there is a large supply of oil, the ability to refine it and get it to market is limited, which affects the supply that is available for consumption.
OPEC and Oil Prices
Then there’s the power of the cartels. The Organization of the Petroleum Exporting Countries (OPEC) was founded in the 1960s. Although the organization’s charter doesn’t state this explicitly, they fix prices.
By restricting production, OPEC can force oil prices to rise and thereby enjoy greater profits than if its member countries had each sold on the world market at the going rate.
Geopolitical Tensions and Oil Prices
The oil industry is a global game and what happens in the world impacts the price of oil, especially since a many of the world’s biggest oil producers are in politically unstable areas.
Regions Susceptible to Tensions
Geopolitical tensions are associated with many oil-producing countries, particularly in the Middle East. Saudi Arabia, Iraq, Iran, Kuwait, and Libya all fall into this region.
Other countries have added to the uncertainty of oil supply, impacting prices. For example, Russia has been a nefarious player in global politics, suffering sanctions from the U.S. and the European Union, among others, as a result.
Russia and Ukraine Tensions
Russia’s aggressive moves on Ukraine offer a recent timeline of the impact of geopolitics on oil prices.
Tensions that began in late 2021 and escalated in early 2022 led to a 35% surge in the price of West Texas Intermediate (WTI), the “sweet crude” oil that is a global benchmark.
In mid-December 2021, Russian officials demanded that Ukraine be precluded from joining the North Atlantic Treaty Organization (NATO) and that NATO forces be withdrawn from Eastern Europe. The U.S. and NATO refused, and these tensions again roiled energy markets.
In early 2022, Russia began military operations in Ukraine, which centered around the separatist regions in the east and other targets within the country. WTI oil prices spiked from $74.32 on Dec. 15, 2021, to $100, while Brent crude shot up to more than $105 during intraday trading in early 2022.
What Is the Supply and Demand for Oil?
The U.S. Energy Information Administration forecasts world oil production in 2023 to be 101.55 million barrels per day (mb/d), with world consumption reaching 101.58 mb/d.
How Does Oil Affect Overall Economic Supply and Demand?
The world relies on oil not only for fuel but for use in making plastics, chemicals, clothing, and much more. Moreover, its price gyrations directly affect manufacturers, shippers, and distributors of virtually all physical goods.
When oil prices rise and fall, there is generally a corresponding rise or fall in the costs to produce goods and services. When oil prices rise, costs for production and transportation rise, which decreases supply at a given price.
If oil prices fall, production and transportation costs fall, so more can be produced at a given price.
Demand increases or decreases in response to these supply fluctuations.
How Does Supply and Demand Effect Gas Prices?
Generally, if the oil supply increases, prices at the pump respond by going down. As supply decreases, demand increases and so do prices.
Where Are the Cheapest and Most Expensive Gas Prices in the U.S.?
The national average price per gallon of regular gas was $3.07 as of November 2024, according to the American Automobile Association. Consumers in most states paid less than that.
The highest gas prices can be found in Hawaii, at $4.57, and California, not far behind at $4.46.
Bargain gas can be found in Oklahoma, at an average of $2.57, and Texas, at $2.65.
The Bottom Line
The law of supply and demand drives oil prices. But oil prices drive the economy, influencing the cost of doing business and the prices of most consumer goods.