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understand_public - Understanding Crude Oil Prices James D....

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Understanding Crude Oil Prices James D. Hamilton Dept. of Economics, UCSD
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Inflation-adjusted price of crude oil (West Texas Intermediate, 2008 dollars) 0 50 100 150 1945 1955 1965 1975 1985 1995 2005
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Question can be addressed in terms of: (1) Statistical predictability (2) Implications of theory (a) storage (b) futures markets (c) scarcity rent (d) role of speculation (3) Fundamentals of demand (4) Fundamentals of supply
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p t 1 x 1 t   2 x 2 t     k x kt   t x jt variable known at t 1 (1) Statistical predictability
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P-value that indicated variables are useful for predicting change in log of real oil price (p < 0.05 means statistically significant) Variable 1 lag 4 lags 8 lags real oil price change 0.69 0.88 0.62 U.S. nominal tbill rate 0.53 0.61 0.83 U.S. real GDP growth 0.24 0.48 0.49
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Dickey-Fuller test of null hypothesis of random walk against the alternative of stationary AR(1): accept H0 KPSS test of null hypothesis of stationary AR(1) against alternative of random walk: reject H0
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Conclusions: (1) Expected real oil price next month (or next year or next century) is exactly equal to its current value (2) The standard error on this forecast is huge
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Lower and upper 2.5% probability bounds on real oil price assuming a Gaussian random walk quarter forecast lower bound upper bound 2008:Q1 $115 2008:Q2 $115 $85 $156 2008:Q3 $115 $75 $177 2008:Q4 $115 $68 $195 2009:Q1 $115 $62 $212 2010:Q1 $115 $48 $273 2011:Q1 $115 $40 $273 2012:Q1 $115 $34 $391
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(1) Statistical predictability (2) Economic theory (a) Storable commodity
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Consider following strategy (1) Buy 1 barrel of oil today (Sept 2008) at today’s spot price P t (cover all expenses with borrowed money) (2) Sell oil next year (Sept 2009) at next year’s expected spot price E t ( P t +1 ) and repay loan
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Current receipts and expenditures = 0 • Next year’s receipts = E t ( P t +1 ) Next year’s expenditures = P t (1 + r t ) + X t (for X t physical storage costs) Let C t = P t r t + X t (carrying costs) Expected profits = E t ( P t +1 ) - P t - C t
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Expected profits = E t ( P t +1 ) - P t - C t If E t ( P t +1 ) > P t + C t then anyone with storage capacity could earn expected profit by buying oil today to put into storage. This would put upward pressure on today’s price ( P t ↑) and, as the stored oil is sold, downward pressure on next year’s price ( E t ( P t +1 ) ↓)
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Equilibrium with risk-neutral speculators: E t ( P t +1 ) = P t + C t Refinements to theory: (1) In any business, need to hold inventory (could think of as “convenience yield” to storage that enters negatively into C t ) (2) Risk aversion could be thought of as another factor affecting C t
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-60 -40 -20 0 20 40 60 80
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This note was uploaded on 03/02/2012 for the course ECON 2 taught by Professor Kim during the Fall '08 term at UCSD.

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understand_public - Understanding Crude Oil Prices James D....

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