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Modeling Oil Markets
Janie M. Chermak, University of New MexicoRobert H Patrick, Rutgers University
October 26, 2015
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Literature
• Medlock and Jaffe (2009) 2007-2008 speculation• Hamilton (2009) speculation, OPEC, scarcity rent• Dvir & Rogoff (2009) 1896-2008 price behavior• Kilian (2010) S&D shocks• Kellogg (2014) Impact of infill drilling on investment
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Components
• Demand (consumption, additions to storage)
• Supply (production, imports, withdrawals from storage)
• Futures
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Demand(consumption, storage in)
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Supply (base production, new production,
storage out, imports)
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Storage
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Futures(commercial and non-commercial traders)
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Futures Market
Commercial (arbitrage) traders are those whose primary businesses are exposed to oil price fluctuations and hedge risks in futures markets to stabilize cash flows.
Non-commercial (speculative) traders speculate on crude oil price movements.
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Contango/Backwardation
If C4>C1, then DIFF>0 – Contango
If C4<C1, DIFF<0 - Backwardation
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Market(s)
Demand for Crude Oil
Inverse Supply of Crude Oil
Futures Price
Data from EIA, Baker Hughes: Weekly 1/1/1986 – 10/1/2015
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Model (ARCH/GARCH- in means)
• Equation 1: Quantity Demanded is a function of:– WTI Spot Price [ -/- ] *– Prime Rate [+/+] *– + Change in Storage [ +/-] – S&P [+/+] *– Time [+/+] *– Binaries:
• Recession [-/-] *, 9/11[-/+] *
– Variance Terms• Recession (-/-)*; 9/11 (+/+)*
* Significant at 5% or greater
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MODEL (ARCH GARCH - in means)
• Equation 2: WTI Spot Price is a function of:– Futures Price (+/+)* – Oil Rig Count (+/+)*– Production (+/+)*– Change in Storage (-/-)*– Contango/Backwardation (+/-)*– Open Interest
• NC Short (+/+)*; NC Long (-/-)*: NC Spread (+/+)*; CS Short (+/+)*; CL (-/-)*
– Variance Terms• CFMA (+/+)*; 9/11 (+/+)*
* Significant at 5% or greater
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• Equation 3: Futures Price is a function of:– Open Interest (+/+)*– CFMA (+/+)*– S&P (+/+)*– Gold (-/+)*– Days of Storage (-/+)– Time (?/-)*– Variance Terms:
• 9/11 (+/+)*
MODEL (ARCH GARCH - in means)
* Significant at 5% or greater
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ConclusionsMarket Fundamentals are Significant
Storage Is Significant
Shocks Are Significant
Financial Markets and Rules are Significant
Significance of Relative Impacts Changes Over Time
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The Crude Oil Consumer’s Objective
Individual Demand for Crude
Individual Demand for Crude
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The Producer’s Objective:
Aggregate Supply:
Individual Producer’s Supply:
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Equilibrium without Storage or Futures
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Storage