do opec members know something the market doesn’t?

Do OPEC Members Know Something the Market Doesn’t?

Brunetti, Büyükşahin, Robe & Soneson – USAEE 2011

“Fair Price” Pronouncements and the Market Price of Oil

This presentation reflects the authors’ opinions only – not those of the International Energy Agency (IEA), its member governments, the U.S. Commodities Futures Trading Commission (CFTC), the Commissioners, or other staff at either institution.

Celso Brunett

i

Bahattin Büyükşahi

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Michel Robe

Kirsten Soneson


Background


“ ‘We expected at the start of the year oil prices between $75 and $80 a barrel, this is a fair price… Oil prices (…) might rise reasonably’, (Saudi Arabia’s King Abdullah) said. On Thursday, U.S. oil crude futures rose $1.38 to $78.05.”

Reuters, December 26, 2009

“WTI (prices) stabilized between $70 to $80 per barrel since the middle of last year. This range is consistent with the ‘fair price’ range for crude oil proposed by King Abdullah of Saudi Arabia at the beginning of 2009.”EIA Short-Term Energy Outlook, U.S. DoE, Feb. 2010

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Some Quotes


Does OPEC have Information the Market Doesn’t?

As these quotes illustrates, news agencies, market commentators and even oil analysts often make references to OPEC pronouncements about crude oil prices.

During the oil price surge of 2008, pundits and politicians instead used “fair price” statements by OPEC-linked officials as evidence that sky-high prices were “not caused by physical supply and demand factors”.

Implicit in such views is an implicit assumption that OPEC-related “fair price” pronouncements contain information not already reflected in market prices.

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I. Our Paper


OPEC “Fair Price” Announcements’ Impact on the Futures Market Price of Crude Oil

OPEC members, individually or collectively, often comment on what the “fair price” for crude oil should be We construct a sample of all fair price pronouncements in 2000-

10.

No definition of “fair price” in classical economics We define the “fair price” to be the price that a particular OPEC

producer would like to see prevail in the market.

We investigate whether “fair price” statements contain any new information (i.e., news content not already absorbed in the market) & the price effect of such pronouncements.

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Related Literature

1. OPEC’s ability to influence the price of crude oil Efficiency of OPEC’s “official prices” (1970’s to mid-1980s):

E.g., Gately et al, EER-77; Verleger, REStat-82; Hubbard, QJE-86, ... Impact of production-related OPEC conferences announcements

do they influence market prices, returns, or implied volatility? Loderer, JF-85; Wirl & Kujundzic, EnJ-04; Horan et al, EnJ-04; Wang et

al, JFutM-08; Demirer & Kutan, EE-10.2. Efficiency of energy-derivatives markets

Do energy futures market react to OPEC conference news? Draper, JFutM-84; Deaves & Krinsky, JFutM-92.

3. Impact of verbal interventions on markets Extant work focuses on communications in forex (see Blinder et

al, JEL-08) or on interest rate markets (e.g., Fratzscher, EJ-08, JIE-09)

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Our Paper

Contribution to the empirical literature

We focus on OPEC statements related to prices, not on statements related to production.

Whereas OPEC conferences and meetings are publicized ahead of time (and are thus predictable), “fair price” pronouncements are not timed with any predictability, and are thus not likely to be forecasted ahead of time.

Methodological contributions Adapt Kalman-filter and ADL methodologies to oil issues Enhance the event-study methodology used in extant oil literature.

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Our Findings in a Simple Picture

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Our Findings in Words

If “fair price” pronouncements contained news for non-OPEC market participants, e.g., signals of physical market conditions e.g., signals of a country’s or OPEC’s strategies

Then, we should observe an impact on crude oil futures prices.

In fact, we find that “fair price” announcements add little to pre-existing information in the market have little impact on the futures market price of crude oil.

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II. Data & Graphical Analysis


“Fair Price” Series

“Fair Price” Data – Hand-collected time series of quotes made by OPEC officials

or senior government officials from OPEC countries: Source: news articles in the Lexis-Nexis Academic and Westlaw databases

Search Criteria: “fair price” or “just price”; Over 1,000 articles returned over a 10-year period Total of 120+ events Filtering leaves 78 unique observations (1st, March 2000; last, Nov. 2010)

Information compiled (cross-checked with industry newsletters) Release date of the story Statement date (when the official stated the “fair price”) Country of origin of the OPEC official “Fair price” level or range When available –

whether the official agreed with the current market price of oil the benchmark crude referenced

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Market Price Series

Market Price Data – West Texas Intermediate (WTI) light sweet crude oil futures

contract traded on the NYMEX. World’s most liquid crude oil contract. Settlement price of the nearby-futures contract is used

= “closest-to-delivery contract with the highest open interest”. Sample period – January 2000 to December 2010.

Control Variables – Production announcements

Dates Direction of production announcement Only 13 of the 78 events had production announcements within 5 days of

(before or after) the “fair price” pronouncement. Survey of economists regarding production expectations

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Q1. Do “OPEC” Officials Agree with the Current Market Price?

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Cannot Tell


Explanation of Graphical Analysis 1

“Fair price” statements subdivided into 3 groups:

Official agrees with the market price 17 times (green triangles). Mostly after mid-2009

Official disagrees with the market price 25 times (red dots). Mostly before mid-2009

Official does not say 36 times (purple squares).

The graph suggests that, even when they are not explicit about it, officials often seemed to disagree with market prices before 2009

• From Summer 2003 to Summer 2008 – market price was viewed as “too high” • From Fall 2008 to Spring 2009 – market price was viewed as “too low”

(market price collapsed yet “fair price” remained in the $75-100 range).

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Q2. Heterogeneity within OPEC?

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VILAN

Saudi Arabia

Other OPEC/OPEC Consensus



Idea: Country-specific factors may influence which price an individual cartel member would like to see prevail in the market.

OPEC Member Classification - OPEC “hawks” (red): Venezuela, Algeria, Iran and Libya

Tend to advocate higher prices than current market prices? Saudi Arabia (green):

With ample oil reserves, tends to advocate lower prices? Others (purple): all remaining individual member countries or a “consensus” by

OPEC

The figure suggests that “hawks” do not make “fair price” statements more bullish than the other groups, yet: Hawks more vocal in support of higher prices after price collapse at the end of 2008 Venezuela –

Favored production cuts through most of sample period Exception – constant at $100 as “fair price” during price spike and crash of 2008

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Q3. Which moves first – “fair price” or market price?

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Fair Price Trend



We ask whether “fair price” statements lead or lag market prices.

The figure strongly suggests that “fair price” statements lag market prices Interpretation: they contain no new information.

We now turn to more formal analyses to test this apparent relationship between the two time series.

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III. Formal Methodologies


1st Methodology - Event Study

Event Study (see e.g. MacKinlay, JEL-97)

Our interest – Arrival of “true news” (information content into the market) Compare the nearby oil futures price before & after the event

We use two non-parametric tests of statistical significance

Event and event window – Event = “fair price” statement date. The event separates all preceding and succeeding observations

captures the normal performance and after-announcement performance of the price of oil.

We use windows of 2, 3, 4, and 5 days for robustness.

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Event Study continued

Non-parametric tests: Humpage, JMCB-99; Fatum and Hutchinson, EJ-03.

Criterion (1): “Direction Criterion” “Success” = “post-announcement market price moves in the direction suggested

by ‘fair price’ level”. Formally:

To test if the direction of futures prices is random or systematic following the event, we use a non-parametric sign test: • Null : the direction is random.• Equal probability that the post-event return is

positive or negative. X+ stands for the # of successes.

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Event Study continued

Non-parametric tests: Humpage, JMCB-99; Fatum and Hutchinson, EJ-03.

Criterion (2): “Smoothing Criterion” “Success” = “the ‘fair price’ pronouncement smoothes prior market-

price movements”. Formally: if it is successful according to “direction criterion” (1) or if :

Judging success on the “smoothing criterion” is only meaningful if the official marking the statement is “leaning against the wind”. • i.e., he is trying to reverse or to slow a prior market price trend.

First case: signal = “prices are too high or increasing too fast”.Second case: signal = “prices are too low or should not be falling”.

• Broad “smoothing criterion” – 75%; stricter “reversal criterion” – 50%.

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2nd Methodology - Kalman Filter

Question – How close is the “fair price” to the “true” (i.e., filtered) market price of crude oil? Filtering lets us separate the “true price” from the noise component in the

market price to answer the above question.

Results – Actual price and the forecasted price are nearly identical Until mid-2008, “fair price” levels fall within the confidence band

around the forecast - meaning “fair prices” reflect the same information as do market prices.

In mid-2008, “fair prices” trickled outside the band. But… “Fair price” statements during this period were worse forecasters

(of one-month ahead prices) than were market-price-based forecasts. Bottom line: “Fair price” statements contain no useful information

for improving market-price forecasts.

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3rd Methodology – ADL Model

Auto-Regressive Distributed Lag (ADL) process allows us to forecast crude oil futures prices from past market price

information. If “fair price” announcements do not provide any

additional news to the futures market, then the forecasted price and the “fair price” should be very close.

Two versions: “market only” vs. “market + FP”

We use weekly data (every Wednesday) and monthly data (the last observation of every month).

Rolling windows are 1 year (52 weeks) and 3 years (36 months). One-step-ahead forecasts with optimal lag length (q) selected by the Akaike

Information Criterion (AIC) and likelihood ratio tests.

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IV. Results


1. Event Study Analyses & Results

Results –

“Fair price” pronouncements are not successful (either at affecting the direction of the market or at slowing down the pace of prior market price movements).

We cannot reject (at any statistical significance level) the hypothesis that the post-pronouncement return is random.

Robust results regardless of: Divisions based on a concomitant OPEC oil-production announcement Who is making the statements Different event-window lengths (2- vs. 5- day) Different time periods (SPARE)

Tables –

Panel A - “direction criterion” Panel B - reversals (“leaning against the wind”) Panel C - “smoothing criterion”

Robust –

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Event Study Tables 2-Day Returns; No Concomitant Production News 2-Day Returns Amid News of

Production Changes

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Panel A

Nonparametric Sign Test – Direction Criteria: No production cut or increase (2 Day)

# of Events # of Success z-value p-value FP>P- 22 13 0.8528 0.1969 FP<P- 43 15 -1.9825 0.9763 Total 65 28 -1.1163 0.8679

Panel B

Reversal Criteria Test – Leaning Against the Wind: No production cut or increase (2 Day)


Panel C

Smoothing Criteria Test - Leaning Against the Wind: No production cut or increase (2 Day)



Event Study Tables cont. 5-Day Returns; No Concomitant Production News

5-Day Returns Amid News of Production Changes

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Panel A

Nonparametric Sign Test – Direction Criteria: No production cut or increase (5 Day)

# of Events # of Success z-value p-value FP>P- 21 10 -0.2182 0.5864 FP<P- 44 24 0.6030 0.2732 Total 65 34 0.3721 0.3549

Panel B

Reversal Criteria Test – Leaning Against the Wind: No production cut or increase (5 Day)

# of Events # of Success z-value p-value FP>P- 8 4 0.0000 0.5000 FP<P- 18 9 0.0000 0.5000 Total 26 13 0.0000 0.5000

Panel A

Smoothing Criteria Test – Leaning Against the Wind: No production cut or increase (5 Day)

# of Events # of Success z-value p-value FP>P- 8 7 0.4714 0.3187 FP<P- 18 14 0.1571 0.4376 Total 26 21 0.3922 0.3474


“Fair Price” Events, Production News, and Median Returns

Production News and Median Returns after all “Fair Price” Events, 2000-2009

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Different regimes? 31


Maybe – but Results are Robust 31

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2. ADL Analyses & Results

Analyses – We use monthly (rather than weekly) data

account for possibility that “fair price” pronouncements forecast supply and demand conditions over longer period of time than a few days.

Result #1 – “Model-free” specification We use past market prices only

R1: Actual and forecasted prices are nearly indistinguishable. i.e., ADL model produces good one-step-ahead forecasts.

R2: “Fair price” outside confidence interval in H2-2008/Q1-2009 YET– “fair price” levels in that period were worse forecasters

of 1-month-ahead prices than were market-based forecasts.

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ADL Graph

ADL-based Market Price Forecasts vs. “Fair Price” Levels (monthly)

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ADL Analyses & Results

Result #2 – beyond “Model-free” specification Add “fair price” surprise

Either FairPrice(t) – MarketPrice(t) Or FairPrice (t) – FairPrice(t-1)

to ADL model of oil market returns and see if it helps explain oil-market returns

R3: Statistically speaking, we again find that adding the fair price information does not help.

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V. Conclusions


No New Information

“Fair price” statements seem to have little influence on crude oil futures prices.

No evidence of price reversals (not even evidence of slowing down) when “fair price” announcements “lean against the wind” (differ from the current market trend).

“Fair price” events supply no extra news to oil futures market participants and no new information content to the market.

Going forward – Should commentators, reporters, and policy makers treat “fair price” pronouncements as informative when attempting to explain market prices or making policy decisions?

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The Road Ahead

Not so fast?

Where next? Testable theoretical model of “cheap talk” (price

statements) + costly signaling (output levels)?

“If Saudi Arabia wants to stabilize oil prices, (it) will have to back its verbal commitment to a target of $70-80 per barrel with adjustments in production. Verbal interventions alone will not be enough to anchor expectations or market prices (…) Saudi officials admit (…) expectations management on its own is not enough to stabilize prices.”Oil and Gas News, Dec. 28, 2010

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The End

do opec members know something the market doesn’t?

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