What Drives Oil Prices (And Why It Matters to You as a Trader)

Here’s a mistake I made a lot early in my career, and that I see many beginners making today:

You see something in the news that impacts oil production, like unrest in the Middle East, and you decide to long crude futures. Seems like a no-brainer with all that geopolitical tension.

Pretty much everyone is guilty of this: we see a headline, connect it to the price action, and suddenly we’ve got a trading thesis.

The truth is, the aggregate market prices these headlines in before you or I can act on them.

Oil prices are driven by an incredibly complex web of factors. And while understanding them is useful, there’s a massive gap between understanding oil fundamentals and actually trading profitably based on that understanding.

Let me explain.

It’s Just People Buying and Selling Stuff

Before we dive into the complexity, let’s strip this down to the basics.

At the end of the day, oil prices are determined by people buying and selling oil. That’s it.

Supply and demand.

If more people want to buy oil than sell it at a given price, the price goes up. If more people want to sell than buy, the price goes down.

Every single factor we’ll discuss – from OPEC decisions to geopolitical tensions to seasonal patterns – ultimately affects prices by changing how much people want to buy or sell.

This is important to remember because it’s easy to get lost in the weeds of complex analysis and forget this fundamental truth.

Supply-Side Factors: Who’s Selling the Oil?

Image from US Energy Information Administration

OPEC+ Production Decisions

OPEC and its allies (OPEC+) control roughly 40% of global oil production and 72% of proven reserves. When they decide to pump more oil or cut production, it matters – a lot.

Saudi Arabia plays a special role here as the “swing producer.” With spare capacity of 1.5-2 million barrels per day, they can ramp production up or down to influence prices.

Remember 2020? When COVID crashed demand, Saudi Arabia and Russia initially couldn’t agree on production cuts. Their brief price war sent oil plummeting to negative prices (yes, sellers were actually paying buyers to take oil off their hands).

U.S. Shale Production

The shale revolution transformed global oil markets. Unlike traditional oil projects that take years to develop, shale producers can ramp up or down relatively quickly in response to price changes.

Different shale basins have different break-even prices. The Permian might be profitable at $56/barrel, while the Midland Basin needs $66/barrel. This creates natural price floors; when prices drop below these levels, production eventually declines.

This dynamic has effectively capped oil price spikes since about 2014. When prices rise, U.S. producers drill more wells, increasing supply and eventually bringing prices back down.

Geopolitical Disruptions

Wars, sanctions, and political instability can suddenly remove significant oil supplies from the market.

The Russia-Ukraine conflict in 2022 pulled roughly 2 million barrels per day from global markets, sending Brent crude to $121/barrel. The 2011 Libyan civil war cut 1.5 million barrels daily, triggering a $15/barrel spike.

These disruptions create a “risk premium” – buyers are willing to pay more today because they fear supplies might be even tighter tomorrow.

Natural Disasters and Infrastructure

Hurricanes in the Gulf of Mexico, wildfires in Canada, pipeline attacks in the Middle East – all these events can suddenly choke off supply.

Hurricane Ida in 2021 shut down 95% of Gulf of Mexico production. In 2024, Canadian wildfires curtailed oil sands operations, trimming global supply by 0.8 million barrels per day.

Demand-Side Factors: Who’s Buying the Oil?

Economic Growth

Oil demand is tightly linked to economic activity. Strong GDP growth, especially in major consumers like China, the U.S., and India, increases demand for transportation fuels and petrochemicals.

The COVID pandemic showed this relationship in reverse. When economies shut down, oil demand collapsed, and so did prices.

Seasonal Patterns

Oil demand fluctuates predictably throughout the year. Summer “driving season” (June-August) boosts gasoline consumption. Winter increases heating oil demand in colder regions.

Refineries schedule maintenance during the “shoulder seasons” (spring and fall), temporarily reducing their purchases of crude oil.

These patterns create seasonal price movements that traders can potentially exploit.

Energy Transition

Long-term oil demand may also be influenced by the shift toward renewable energy, electric vehicles, and carbon policies.

The International Energy Agency estimates that renewable energy subsidies have diverted $1.3 trillion from fossil fuels since 2015, constraining future supply growth.

This creates a fascinating dynamic where oil companies are hesitant to invest in long-term projects, potentially setting up supply shortages if the energy transition happens slower than expected.

Financial Market Dynamics

Futures Markets and Speculation

A significant chunk of oil futures trading involves speculators, not physical buyers. These traders aren’t interested in taking delivery of actual oil; they’re betting on price movements.

This creates interesting market structures:

• Contango: Future prices exceed spot prices, encouraging storage (as seen in 2020)
• Backwardation: Spot prices exceed futures, indicating tight current supply

These structures influence physical oil flows and storage decisions, which then affect spot prices.

Currency Effects

Oil is priced in U.S. dollars, creating an inverse relationship between the dollar and oil prices. When the dollar strengthens, oil becomes more expensive for buyers using other currencies, potentially dampening demand.

Conversely, dollar devaluation (as during 2020-202) tends to lift oil prices.

Why You Probably Can’t Out-Predict the Market

Now here’s where this gets relevant for you as a trader.

Given all these complex, interacting factors, is it realistic for people like you and I to out-predict professional energy analysts, oil company strategists, and hedge fund researchers who do this full-time?

Markets are forward-expectations pricing machines. And the oil market is no exception. It’s constantly incorporating new information and adjusting prices based on what participants expect to happen.

Consider this: When OPEC announces a production cut, prices don’t wait until the physical barrels are removed from the market. They jump immediately as traders incorporate this new information into their expectations.

As a solo trader, you’re very unlikely to have information the market doesn’t already know, or analytical capabilities that surpass the professionals.

I learned this lesson the hard way. Early in my trading career, I spent hours building elaborate models to predict price movements based on reports and other publicly available data.

I was convinced I had an edge.

Spoiler alert: I didn’t. My predictions were no better than random guesses. The market had already priced in everything I knew, and then some.

Where Your Real Edge Might Be

So if you can’t out-predict the market, where’s your edge?

It’s in understanding and exploiting structural imbalances – places where natural buyers and sellers create supply/demand imbalances. As with most edges, these typically only play out on average.

We’ve explored these here, and we’ll revisit them briefly below.

Having said that, an understanding of the supply and demand dynamics can help you understand when a good edge might disappear.

Here’s a perfect example:

Every year, Pemex (Mexico’s state oil company) hedges its oil production by buying massive amounts of put options. This is a huge oil hedge, sometimes taking over a month to execute.

Typically, this would push option prices higher. Why? Because someone has to take the other side of these trades. Traders could step in and demand a premium for taking on this risk.

But one year, something interesting happened. Delta Airlines (DAL) stepped in as a natural seller of these puts. As a major fuel consumer, Delta benefits when oil prices fall, so selling puts aligned with their natural exposure.

The result? The usual risk premium disappeared because the risk found its natural home. The producer (Pemex) and consumer (Delta) transferred risk between themselves without needing the professional traders to step in.

This illustrates a crucial point: risk premiums arise when risk can’t be naturally diversified in the market. When natural counterparties meet, the premium vanishes.

Admittedly, this is a very niche trade, and not one that I did, and not one that I recommend non-professionals do either.

But it illustrates the point that as a trader, your job is to:

1. Identify situations where natural buyers and sellers create imbalances
2. Understand when these imbalances are likely to occur. Ideally, you’d also understand when they’re likely to disappear.
3. Position yourself accordingly

Exploitable Patterns in Oil Markets

Here are some specific patterns worth exploring:

Seasonal Refinery Maintenance

During spring and fall “turnaround” periods, refineries shut down for maintenance, reducing crude demand. This creates a predictable seasonal weakness in crude prices relative to products like gasoline.

Term Structure During Geopolitical Events

When geopolitical tensions spike, oil term structures often shift dramatically. The front end of the curve (near-term prices) typically rises more than the back end, creating steeper backwardation.

This isn’t because the market thinks the crisis will only affect near-term supply; it’s because institutional constraints and risk management practices force certain market participants to adjust their positions in predictable ways.

WTI-Brent Spread During Export Constraints

The spread between WTI (U.S. crude) and Brent (international benchmark) widens predictably when U.S. export infrastructure is constrained. This happened dramatically during 2011-2014 before export restrictions were lifted.

While that specific opportunity is gone, similar regional spreads still appear during pipeline outages, port congestion, or sudden regional supply/demand imbalances.

A Framework for Finding Your Edge

Rather than trying to predict oil prices directly, use your understanding of the market to:

1. Identify natural buyers and sellers: Who has to trade regardless of price? When do they typically trade?
2. Look for structural constraints: What physical, regulatory, or institutional factors create friction in the market?
3. Find recurring patterns: Which situations create predictable supply/demand imbalances that the market can’t easily resolve?
4. Start small: Instead of trying to trade “oil” broadly, focus on specific spreads, products, or time periods where you can find a genuine edge.

An Example from My Trading

US holidays create predictable demand for oil products such as gasoline. A good strategy for many years was to long USO (the US oil ETF) a few days before a holiday, essentially front running excess demand, and then shorting it a couple of days after as demand reverted.

This was an incredibly simple trade, and it did remarkably well when I traded it. It’s sparse (only has a position infrequently), so it’s a boring trade that requires some discipline. Perhaps that’s why the market didn’t fully absorb it.

Here’s a plot of the average returns to USO by days before or after a US holiday.

• D-5 is 5 days before the holiday
• D-4 is 4 days before the holiday
• etc
• D1 is one day after the holiday
• D2 is two days after the holiday
• etc

Image: Vojtko and Dujava, 2024

It shows higher returns on average before the holiday, and lower returns on average after.

I haven’t traded it for a couple of years as I’ve been busy with other things, but I suspect it still works. USO.

Bottom Line

Oil prices are driven by a complex web of supply and demand factors. Understanding these dynamics is valuable, but don’t fool yourself into thinking you can consistently predict price movements better than the market.

Instead, use your understanding to identify structural inefficiencies and recurring patterns where you might have a genuine edge.

Remember, you don’t need to predict oil prices to trade oil markets profitably. You just need to find pockets of inefficiency created by natural buyers and sellers doing what they need to do.