Shales in the Middle Permian Lucaogou Formation have been considered as one of the most important unconventional reservoirs in NW China, due to their excellent shale oil and tight oil potential. Based on the data of previous organic geochemical studies, the overall evolution of the ecosystem in the lake, water conditions and organic matter sources have been outlined. Here we present the results of the mineralogical and organic-petrological examinations and the Rock-Eval pyrolysis, on samples of a fine-grained, mixed carbonate-clastic sedimentary succession from the Santanghu Basin, providing new detailed insights into paleoenvironmental evolution and lake level changes. In addition, shale oil potential was further evaluated on this oil-prone shale. Analytical results from a total of 196 shale samples from the second member of the Lucaogou Formation, collected from one newly drilled core, indicate algal/microbial sources of organic matter, classified by Rock-Eval pyrolysis as type I kerogen. Samples characterized by lower hydrogen index (HI) values (type II kerogen) contain increased contributions of terrigenous organic matter, evidenced by enhanced inertinite and vitrinite contents. Vertical variations in mineralogical and bulk geochemical composition reflect an evolution from a saline, anoxic to a deep, freshwater lake. Two environmental changes subdivided the sequence into three units. The boundary between the lower Unit I and the middle Unit II is characterized by the drastic decrease of smectite and K feldspar contents and a sharp increase in total organic carbon (TOC) content. The upper Unit III is distinguished by high TOC/S ratios. Based on variations in petrography and carbon isotopes of hopanes, the middle Unit II can be further subdivided into two parts reflecting changes in water level of the lake. All the periods of high-water level are characterized by higher lamalginite contents ( > 40 vol%) and higher HI values than those obtained from sediments deposited during periods of shallower water levels. Deposition in a shallow lake is evidenced by increased dolomite and decreased lamaginite contents. Lake level fluctuations, indicated by mineralogical and geochemical parameters, are associated with changes in organic matter sources, leading to the great variability in mineral content, organic petrography and hydrocarbon generation potential. High TOC and brittle minerals contents, micro-nanopores system and large thickness of the shale show that the Lucaogou Formation holds a significant shale oil potential in areas where oil window maturity is reached.