Modeling Oil Markets

Janie M. Chermak, University of New MexicoRobert H Patrick, Rutgers University

October 26, 2015

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

Components

• Demand (consumption, additions to storage)

• Supply (production, imports, withdrawals from storage)

• Futures

Demand(consumption, storage in)

Supply (base production, new production,

storage out, imports)

Storage

Futures(commercial and non-commercial traders)

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.

Contango/Backwardation

If C4>C1, then DIFF>0 – Contango

If C4<C1, DIFF<0 - Backwardation

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

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

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

• 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

ConclusionsMarket Fundamentals are Significant

Storage Is Significant

Shocks Are Significant

Financial Markets and Rules are Significant

Significance of Relative Impacts Changes Over Time

Thank You

jchermak@unm.edu

rhpatrick@rutgers.edu

The Crude Oil Consumer’s Objective

Individual Demand for Crude

Individual Demand for Crude

The Producer’s Objective:

Aggregate Supply:

Individual Producer’s Supply:

Equilibrium without Storage or Futures

Storage