Understanding Oil Prices: A Beginner's Guide

The Number That Moves the World#

When you fill up your car, you're participating in the world's largest commodity market. Oil trades in volumes that dwarf gold, copper, and agricultural commodities combined. The price you pay connects to trading floors in New York and London, to decisions made in Riyadh and Moscow, to weather patterns in the Gulf of Mexico, and to economic growth in Shanghai. Understanding how this system works is essential for anyone who wants to make sense of energy news—and their own household budget.

The price of crude oil isn't set by any single entity. It emerges from the continuous interaction of buyers and sellers around the world, each with different motivations, different information, and different time horizons. What results is a price discovery mechanism of remarkable sophistication—and notorious volatility.

The Benchmarks: Brent and WTI#

Not all oil is the same. Different grades have different chemical compositions, different sulfur content, and different market characteristics. To create a common reference point, the oil industry has developed benchmarks—standardized contracts that serve as the basis for pricing crude worldwide.

Brent Crude is the dominant international benchmark, referenced in pricing for roughly 80% of global oil trade. Despite its name—derived from the Brent oil field in the North Sea—Brent pricing has evolved far beyond that depleted field. Today, "Brent" refers to a basket of crudes from the North Sea region, traded primarily on the Intercontinental Exchange in London. When news headlines mention "oil prices," they're usually talking about Brent.

West Texas Intermediate serves as the primary benchmark for North American crude. WTI represents high-quality, low-sulfur oil delivered to storage facilities in Cushing, Oklahoma—a small town that functions as the continent's oil crossroads, where pipelines from dozens of directions converge. WTI typically trades at a slight discount to Brent, reflecting the landlocked nature of American production and occasional infrastructure bottlenecks that trap oil in the continent's interior.

Canadian oil, particularly heavy crude from the oil sands, prices off these benchmarks but typically at a discount. Western Canadian Select, the main Canadian benchmark, can trade $15-25 below WTI due to its heavier composition and the transportation costs required to reach refineries. This discount represents billions in lost value for Canadian producers—a direct consequence of infrastructure limitations that prevent access to global markets.

Who Sets the Price?#

The trading ecosystem includes players with fundamentally different objectives.

Producers—national oil companies, independent operators, integrated majors—need to sell their output and manage price risk. When a company invests billions in a new project, it often locks in future prices through forward contracts, sacrificing some upside potential in exchange for certainty that the investment will be profitable.

Refineries are the buyers of crude and sellers of gasoline, diesel, and other products. They profit from the "crack spread"—the difference between crude input costs and product output prices. When that margin narrows, refineries may cut throughput, reducing crude demand. When it widens, refineries run at maximum capacity.

Traders and speculators provide liquidity, taking positions based on their views of future supply and demand. Critics sometimes blame speculators for price volatility, but research suggests their role is primarily to absorb risk that producers and consumers want to shed. Without speculators willing to take the other side of hedging trades, markets would be less liquid and more volatile.

Hedge funds and financial investors increasingly treat oil as an asset class, allocating portions of portfolios based on macroeconomic views or diversification strategies. Their buying and selling can amplify price movements, particularly when algorithms respond to the same signals simultaneously.

Consumer country governments participate through strategic reserves, buying when prices are low to build buffers against future disruptions, and occasionally releasing stockpiles to dampen price spikes. The United States' Strategic Petroleum Reserve holds about 400 million barrels; releases in 2022 were explicitly designed to moderate prices following Russia's invasion of Ukraine.

What Moves Prices?#

Oil prices respond to supply, demand, and the expectations of both—though sorting out which factor drove any particular price movement can be surprisingly difficult.

On the supply side, OPEC+ decisions carry the most immediate impact. When the cartel announces production cuts, prices typically rise; when it increases quotas, they fall. But implementation matters as much as announcements—member countries frequently produce above their quotas when prices are high and enforcement is lax.

American shale production has transformed supply dynamics over the past decade. Unlike conventional projects that take years to develop, shale wells can ramp up within months when prices rise and shut in quickly when they fall. This responsiveness creates a soft ceiling on prices: when oil rises above $70-80 per barrel, shale production surges, adding supply that eventually pushes prices back down.

Geopolitical disruptions create sudden supply fears. Attacks on Saudi facilities, sanctions on Iran or Venezuela, pipeline sabotage in Nigeria, hurricanes in the Gulf of Mexico—any event that threatens production can spike prices instantly, even before actual supply is lost. Sometimes the fear premium dissipates quickly; sometimes it becomes embedded in sustained higher prices.

Demand factors move more slowly but can be more consequential over time. Global economic growth is the primary driver—when China booms, oil demand rises; when recession hits, it falls. Transportation activity, industrial production, and even weather (which affects heating and cooling demand) all influence how much oil the world consumes.

Financial factors add another layer. Oil is priced in dollars, so when the dollar strengthens, oil becomes more expensive for buyers using other currencies, reducing demand and pressuring prices down. Interest rates affect the cost of holding inventory and the attractiveness of oil as a financial asset. Even stock market movements can influence oil as investors adjust their overall risk appetite.

Why Such Volatility?#

Oil prices are notoriously volatile—far more than most commodities. The reasons are structural.

Supply is inelastic in the short term. When demand rises unexpectedly, producers can't instantly increase output. Drilling new wells, building pipelines, and expanding refining capacity takes years. In the meantime, prices must rise enough to destroy some demand, which can require dramatic price spikes.

Demand is equally inelastic in the short term. When prices spike, consumers can't immediately switch to alternatives. They might drive less at the margins, but they still need to heat their homes and get to work. Industrial processes designed for petroleum can't switch fuels overnight. This means that small supply disruptions can cause large price movements.

Inventory provides only a limited buffer. Storing oil is expensive—it requires tanks, safety measures, and capital tied up in barrels sitting idle. As a result, the world maintains relatively small inventories compared to consumption. When those inventories draw down, the market has little cushion against disruptions.

Concentrated production amplifies geopolitical risk. A handful of countries and a few key chokepoints—the Strait of Hormuz, the Suez Canal, the Strait of Malacca—control a disproportionate share of global oil flows. Disruptions at these points can remove millions of barrels from the market instantly.

The 2020 price collapse illustrated these dynamics in extremes. When COVID lockdowns eliminated demand overnight, supply couldn't adjust quickly enough. Storage filled. Prices crashed. At one point, WTI futures briefly traded negative—producers were paying buyers to take oil off their hands because they had nowhere to put it. Within two years, prices had surged above $100 as demand recovered faster than supply.

From Crude to Pump#

When crude oil prices move, consumers expect gasoline prices to follow—and they do, but imperfectly and with delays that often generate suspicion of price gouging.

The price you pay at the pump reflects multiple components. Crude oil itself accounts for about 55% of the retail gasoline price in North America. Refining costs and profits add roughly 15%—this varies significantly based on refinery utilization, seasonal fuel specifications, and regional capacity. Distribution and marketing—the cost of getting refined products to gas stations and the retailers' margins—contributes about 10%. And taxes, which vary enormously by jurisdiction, account for the remaining 20% or so.

These components don't move in lockstep. Crude prices can fall while refining margins rise, keeping retail prices elevated. Local supply disruptions—a refinery outage, a pipeline problem—can push regional prices far above what crude movements would suggest. Seasonal regulations requiring cleaner-burning summer gasoline blends create predictable springtime price increases that have nothing to do with crude markets.

The "rockets and feathers" phenomenon frustrates consumers: gas prices seem to rise immediately when crude spikes but fall only slowly when crude drops. Research suggests this pattern is real but smaller than popular perception. Part of the explanation is psychological—we notice price increases more than decreases. Part is structural—retailers adjust prices slowly because changing prices has costs, and they'd rather wait to see if crude movements persist before passing them through.

Reading the Headlines#

When oil price news crosses your screen, knowing what the numbers actually mean helps separate signal from noise.

Spot prices represent what buyers pay for immediate delivery. Futures prices reflect contracts for delivery at specified future dates. The relationship between them tells a story. When futures prices exceed spot prices—a condition called contango—the market expects prices to rise, or at least that storage costs make it profitable to buy now and sell later. When spot prices exceed futures—backwardation—the market is tight, and buyers are willing to pay a premium for immediate delivery.

Daily price movements, even dramatic ones, often reflect trading flows and speculative repositioning more than fundamental changes in supply and demand. Weekly and monthly trends are more meaningful. The most important signal is sustained movements that suggest structural changes in market balance.

Be skeptical of simple explanations. "Oil rose because of Middle East tensions" may be true on a given day, but the same tensions often exist without moving prices. Market participants are constantly reassessing probabilities—prices reflect the weighted average of many possible futures, not a single narrative.

What It Means for You#

For consumers, oil price volatility is an unavoidable feature of modern life. Hedging is difficult at the individual level—you can't lock in future gasoline prices the way airlines lock in jet fuel. What you can control is exposure: more efficient vehicles, housing choices that reduce commuting, and financial buffers that can absorb temporary price spikes.

For Canadians specifically, oil prices carry a dual significance. When prices rise, gasoline costs more—but so do the revenues that fund Alberta's budget, the royalties that support provincial programs, and the investment that creates high-paying jobs. When prices fall, consumers save at the pump—but communities that depend on energy production suffer.

Understanding this complexity is the first step toward thinking clearly about energy policy. Oil isn't just a cost; it's an asset. How Canada manages that asset—developing it efficiently, getting fair value in global markets, using revenues wisely—matters far more than any individual price movement.

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Key Takeaways#

Oil prices emerge from global markets where producers, refiners, traders, and governments interact continuously. Brent Crude and WTI serve as the primary benchmarks, with Canadian heavy oil trading at a discount due to quality differences and infrastructure constraints. Prices respond to supply factors like OPEC+ decisions and shale production, demand factors like economic growth and transportation activity, and financial factors like dollar strength and inventory levels. Structural inelasticity in both supply and demand, combined with concentrated production and limited storage, creates inherent volatility. Retail gasoline prices reflect multiple components beyond crude, including refining, distribution, and taxes—which is why pump prices don't perfectly track crude movements.