The role of speculation in oil markets: What have we learned so far
TL;DR: The authors found that the existing evidence is not supportive of an important role of speculation in driving the spot price of oil after 2003, and there is strong evidence that the co-movement between spot and futures prices reflects common economic fundamentals rather than the financialization of oil futures markets.
Abstract: A popular view is that the surge in the price of oil during 2003-08 cannot be explained by economic fundamentals, but was caused by the increased financialization of oil futures markets, which in turn allowed speculation to become a major determinant of the spot price of oil. This interpretation has been driving policy efforts to regulate oil futures markets. This survey reviews the evidence supporting this view. We identify six strands in the literature corresponding to different empirical methodologies and discuss to what extent each approach sheds light on the role of speculation. We find that the existing evidence is not supportive of an important role of speculation in driving the spot price of oil after 2003. Instead, there is strong evidence that the co-movement between spot and futures prices reflects common economic fundamentals rather than the financialization of oil futures markets.(This abstract was borrowed from another version of this item.)
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TL;DR: The authors developed a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to flow demand and flow supply.
Abstract: SUMMARY
We develop a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to flow demand and flow supply. The speculative component of the real price of oil is identified with the help of data on oil inventories. Our estimates rule out explanations of the 2003–2008 oil price surge based on unexpectedly diminishing oil supplies and based on speculative trading. Instead, this surge was caused by unexpected increases in world oil consumption driven by the global business cycle. There is evidence, however, that speculative demand shifts played an important role during earlier oil price shock episodes including 1979, 1986 and 1990. Our analysis implies that additional regulation of oil markets would not have prevented the 2003–2008 oil price surge. We also show that, even after accounting for the role of inventories in smoothing oil consumption, our estimate of the short-run price elasticity of oil demand is much higher than traditional estimates from dynamic models that do not account for for the endogeneity of the price of oil. Copyright © 2013 John Wiley & Sons, Ltd.
1,156 citations
TL;DR: The authors argue that financialization has substantially changed commodity markets through risk sharing and information discovery in commodity markets, and they argue that the financialization can substantially change commodity markets by changing the mechanisms of risk sharing, information discovery, and information exchange.
371 citations
TL;DR: This paper analyzed how institutional investors entering commodity futures markets, referred to as the financialization of commodities, affect commodity prices and found that all commodity futures prices, volatilities, and correlations go up with financialization, but more so for index futures than for nonindex futures.
Abstract: We analyze how institutional investors entering commodity futures markets, referred to as the financialization of commodities, affect commodity prices. Institutional investors care about their performance relative to a commodity index. We find that all commodity futures prices, volatilities, and correlations go up with financialization, but more so for index futures than for nonindex futures. The equity-commodity correlations also increase. We demonstrate how financial markets transmit shocks not only to futures prices but also to commodity spot prices and inventories. Spot prices go up with financialization, and shocks to any index commodity spill over to all storable commodity prices.
341 citations
TL;DR: This paper showed that the real price of oil is endogenous with respect to economic fundamentals and that oil price shocks do not occur ceteris paribus and that one must explicitly account for the demand and supply shocks underlying oil prices when studying their transmission to the domestic economy.
Abstract: Research on oil markets conducted during the last decade has challenged long-held beliefs about the causes and consequences of oil price shocks. As the empirical and theoretical models used by economists have evolved, so has our understanding of the determinants of oil price shocks and of the interaction between oil markets and the global economy. Some of the key insights are that the real price of oil is endogenous with respect to economic fundamentals and that oil price shocks do not occur ceteris paribus. As a result, one must explicitly account for the demand and supply shocks underlying oil price shocks when studying their transmission to the domestic economy. Disentangling cause and effect in the relationship between oil prices and the economy requires structural models of the global economy including the oil market.
263 citations
TL;DR: In this paper, the authors explore how the use of two alternative proxies for global crude oil inventories affects the empirical evidence for speculation and conclude that current policy efforts aimed at tightening the regulation of oil derivatives markets cannot be expected to lower the real price of oil in the physical market.
262 citations
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TL;DR: In this article, the cross spectrum between two variables can be decomposed into two parts, each relating to a single causal arm of a feedback situation, and measures of causal lag and causal strength can then be constructed.
Abstract: There occurs on some occasions a difficulty in deciding the direction of causality between two related variables and also whether or not feedback is occurring. Testable definitions of causality and feedback are proposed and illustrated by use of simple two-variable models. The important problem of apparent instantaneous causality is discussed and it is suggested that the problem often arises due to slowness in recording information or because a sufficiently wide class of possible causal variables has not been used. It can be shown that the cross spectrum between two variables can be decomposed into two parts, each relating to a single causal arm of a feedback situation. Measures of causal lag and causal strength can then be constructed. A generalisation of this result with the partial cross spectrum is suggested.
16,349 citations
TL;DR: In this article, a discussion is confined in scope to absolutely irreplaceable assets, including peculiar problems of mineral wealth, free competition, maximum social value and state regulation, monopoly, value of a mine monopoly, retardation of production under monopoly, price effects from cumulated production, and the author's mathematically derived optimum solutions.
Abstract: The discussion is confined in scope to absolutely irreplaceable assets Topics include peculiar problems of mineral wealth, free competition, maximum social value and state regulation, monopoly, value of a mine monopoly, retardation of production under monopoly, price effects from cumulated production, and the author's mathematically derived optimum solutions (PCS)
3,508 citations
TL;DR: In this article, a structural decomposition of the real price of crude oil is proposed, based on a newly developed measure of global real economic activity, and the authors estimate the dynamic effects of these shocks on the real prices of oil.
Abstract: Using a newly developed measure of global real economic activity, a structural decomposition of the real price of crude oil into three components is proposed: crude oil supply shocks; shocks to the global demand for all industrial commodities; and demand shocks that are specific to the crude oil market. The latter shock is designed to capture shifts in the price of oil driven by higher precautionary demand associated with concerns about future oil supply shortfalls. The paper estimates the dynamic effects of these shocks on the real price of oil. A historical decomposition sheds light on the causes of the major oil price shocks since 1975. The implications of higher oil prices for U.S. real GDP and CPI inflation are shown to depend on the cause of the oil price increase. Changes in the composition of shocks help explain why regressions of macroeconomic aggregates on oil prices tend to be unstable. Evidence that the recent increase in crude oil prices was driven primarily by global aggregate demand shocks helps explain why this oil price shock so far has failed to cause a major recession in the U.S.
2,670 citations
TL;DR: This article explored similarities and differences between the run-up of oil prices in 2007-08 and earlier oil price shocks, looking at what caused these price increases and what effects they had on the economy.
Abstract: This paper explores similarities and differences between the run-up of oil prices in 2007–08 and earlier oil price shocks, looking at what caused these price increases and what effects they had on the economy. Whereas previous oil price shocks were primarily caused by physical disruptions of supply, the price run-up of 2007–08 was caused by strong demand confronting stagnating world production. Although the causes were different, the consequences for the economy appear to have been similar to those observed in earlier episodes, with significant effects on consumption spending and purchases of domestic automobiles in particular. Absent those declines, it is unlikely that the period 2007Q4–2008Q3 would have been characterized as one of recession for the United States. This episode should thus be added to the list of U.S. recessions to which oil prices appear to have made a material contribution.
1,314 citations
TL;DR: The authors examines the factors responsible for changes in crude oil prices and concludes that although scarcity rent made a negligible contribution to the price of oil in 1997, it could now begin to play a role.
Abstract: This paper examines the factors responsible for changes in crude oil prices. The paper reviews the statistical behavior of oil prices, relates this to the predictions of theory, and looks in detail at key features of petroleum demand and supply. Topics discussed include the role of commodity speculation, OPEC, and resource depletion. The paper concludes that although scarcity rent made a negligible contribution to the price of oil in 1997, it could now begin to play a role.
1,120 citations