How the Crude Oil Market Works

Crude Oil Supply

On June 1, 1973, Leon Mill spray paints a sign outside his Phillips 66 station in Perkasie, Pa., to let his customers know he is out of gas.
On June 1, 1973, Leon Mill spray paints a sign outside his Phillips 66 station in Perkasie, Pa., to let his customers know he is out of gas.
AP Photo

We really depend on crude oil in modern society, but where exactly does it come from? Oil is made of compressed hydrocarbons, the remains of prehistoric animals and plants placed under extreme pressures and temperatures in the Earth's crust. Hydrocarbons take many forms, including coal, natural gas, crude oil and even diamonds [source: Energy Information Administration].

We can find oil supplies just about everywhere in the world, but some areas are more abundant than others. Countries in the Middle East, including Saudi Arabia, Iraq, Iran and others, have massive supplies of oil and are the world's leading oil exporters.

Other countries have strong supplies, including Russia, Venezuela and even the United States. The oil found in Texas in the early 20th century resulted in a significant economic boom for that region. In fact, North America is currently the world's second-largest oil producer [source: Energy Information Administration].

Groups like OPEC -- the Organization of the Petroleum Exporting Countries -- monitor their oil supply and can ration it out as they see fit, which sways the supply and price of oil. This is what led to the "gas crisis" of the 1970s: the Middle Eastern members of OPEC decided to "punish" Western nations for their support of Israel in the war in which the latter was attacked by Syria and Egypt. They imposed an oil embargo, and the result was a drastic upswing in oil prices. A severe recession ensued where gas prices in the U.S. rose from 30 cents per gallon (about 7 cents per liter) to about $1.20 per gallon (about 32 cents per liter) at the height of the crisis [source: Trumbore]. Geopolitical crisis', especially in volatile places like the Middle East, can have a big effect on gas prices in the United States.

Another thing to remember about crude oil and fossil fuels is that they are a non-renewable source of energy. This means that the world is slowly but surely running out of its supply of oil, and once it's gone, it's gone. After all, we can't wait around another few million years for animals to fossilize and become liquefied, can we?

While it's tough to know just how much oil is left in the world, more and more governments and businesses are looking into sources of renewable energy. This includes sources we can never really run out of, including wind, solar power and even heat from deep inside the Earth's core, just to name a few.

As our crude oil supplies dwindle, we know the short supply will make the demand increase -- and the cost will go along with it.

Up next, we'll examine how oil is traded in commodities markets, and how people make money by betting on its future price.