What Moves the Price of Oil: Supply, Demand and the Risk Premium

Oil is unusual among traded assets in that the forces setting its price are relatively few and can be named individually. There is no equivalent of a company earnings surprise. There is supply, demand, the cost of storage, and the probability that something breaks.

That does not make oil easy to forecast — it is famously hard — but it does make the mechanics legible.

The two benchmarks

Almost every oil price quoted in the news is one of two contracts.

Brent crude is a light, low-sulphur blend produced in the North Sea. Because it is loaded onto ships, it can reach any market, and it therefore serves as the reference for the majority of internationally traded crude.

West Texas Intermediate is a slightly lighter US grade delivered inland at Cushing, Oklahoma. Being landlocked, it has historically traded at a discount to Brent whenever US pipeline or export capacity was constrained.

The spread between them is itself informative: a widening discount for WTI usually indicates a US supply glut or an export bottleneck rather than anything global.

Supply: the three sources that matter

OPEC and its partners. The producer group coordinates output targets, and because several members hold spare capacity that can be brought online in weeks, it can influence price in a way no single company can. Announcements of cuts or increases move the market immediately. Compliance with those announcements moves it again, more slowly, as actual export data arrives.

US shale. Shale production changed the structure of the market. A conventional offshore field takes years to develop, so supply is unresponsive to price in the short run. A shale well can be drilled and completed in months, and existing wells can be shut in and restarted. That gives the US a fast-responding supply base which acts as a soft ceiling: when prices rise far enough to make drilling attractive, output follows and caps the rally.

Everyone else. Non-OPEC, non-US production — Brazil, Canada, Norway, Guyana — responds to price on multi-year timescales and provides the slow-moving baseline.

Demand: slower and more predictable than it looks

Oil demand is dominated by transport and industry, and it tracks global economic activity closely. Because of that, it moves slowly and forecasts are revised in small increments.

The exceptions are what matter:

• Recessions. Industrial slowdowns cut demand quickly and visibly.
• China. For two decades the largest source of demand growth; the direction of Chinese industrial activity is a first-order input.
• Seasonality. Northern hemisphere driving season lifts gasoline demand in summer; heating oil lifts distillate demand in winter.
• Structural change. Vehicle electrification reduces the growth rate of oil demand rather than the level, at least so far. Petrochemical demand continues to grow.

Because demand is price-inelastic in the short run — people still commute when fuel is expensive — small supply changes can produce large price moves.

Inventories: the market talking to itself

Inventory data is the closest thing to a real-time balance sheet for the oil market. If stocks are drawing down, the market is consuming more than it is producing. If they are building, the opposite.

The US Energy Information Administration publishes weekly figures, and they routinely move the price on release. Traders watch:

• Crude inventories against the five-year seasonal average, not against zero.
• Gasoline and distillate stocks, which say more about end demand.
• Cushing stocks specifically, because that is where WTI is delivered.
• Refinery utilisation, which determines how quickly crude is converted into products.

The risk premium

Oil is produced disproportionately in regions where supply can be interrupted by conflict, sanctions or infrastructure attack. Traders therefore price in a probability-weighted allowance for disruption — the geopolitical risk premium.

This premium behaves differently from ordinary supply and demand. It appears within minutes of a headline, is often large, and frequently unwinds just as fast if the feared disruption does not materialise. A useful discipline is to separate what has actually happened to physical barrels from what the market fears might happen. Historically, most risk premiums have decayed without a barrel being lost.

Chokepoints matter more than country risk in the abstract. A substantial share of seaborne crude passes through a small number of straits, and threats to those routes affect the entire market rather than one supplier.

The futures curve

Oil trades primarily through futures, and the shape of the curve carries a signal.

Shape	Definition	Usually means
Contango	Future prices above spot	Oversupply; storage is profitable
Backwardation	Future prices below spot	Tight supply; buyers want barrels now

Deep contango has historically coincided with gluts severe enough that traders hired tankers purely as floating storage. Sustained backwardation indicates physical scarcity. The curve often turns before the spot price does, which is why it is worth watching alongside the headline number.

Why oil reaches the rest of the economy

Oil enters the cost base of nearly everything: freight, aviation, agriculture through fertiliser, plastics, and household energy. A sustained move therefore shows up in headline inflation within weeks and in unrelated goods prices within months.

This creates a genuine policy problem. An oil-driven inflation spike is a supply shock, and raising interest rates does not increase the oil supply — it only reduces demand across the whole economy. Central banks generally try to look through the first-round effect while watching for signs it is feeding into wages and broader expectations. Whether they succeed is one of the harder judgements in macroeconomics.

What to watch

• OPEC meeting outcomes and, more importantly, subsequent export data.
• EIA weekly inventories, against seasonal norms.
• The Brent futures curve for physical tightness.
• US rig counts as a lagging indicator of shale response.
• Chinese industrial and import data for the demand side.
• The dollar, since oil is priced in dollars and a stronger dollar raises the cost for buyers using other currencies.

The bottom line

Oil prices are set by a tight physical market where small imbalances produce large moves, overlaid with a risk premium that reflects fear rather than barrels. Most forecasts fail because they assume the risk premium persists or that supply will not respond. Both assumptions have a poor record.

This article is educational and is not financial advice. Commodity markets are volatile and leveraged commodity trading carries a high risk of loss.