A statistical study of the short‐ and long‐term drivers of crude oil prices

• DOI: http://doi.org/10.1111/opec.12095
• Author: Hossein Hassani,Mouhamad Moudassir,Adedapo Odulaja,Pantelis Christodoulides
• Published date: 01 June 2017
• Date: 01 June 2017

A statistical study of the short- and

long-term drivers of crude oil prices

Hossein Hassani, Mouhamad Moudassir, Pantelis Christodoulides and

Adedapo Odulaja

Data Services Department, OPEC Secretariat, Helferstorferstrasse 17, 1010 Vienna, Austria. Email:

hhassani@opec.org

Abstract

The paper statistically examines whether the fluctuations in crude oil prices over the last 10 years are

due to speculative activities or changes in market fundamentals. Following a brief review of the oil

market developments and speculative activities in recent years, the paper employs two multivariate

time series models—the vector autoregressive model (VAR) and the vector error correction model

(VECM)—to evaluate observed fluctuations in crude oil prices. The VAR and its granger test allow

for the detection of factors responsible for fluctuations in crude oil prices, while the VECM tests the

co-integration of the variables. The VAR includes both fundamental and non-fundamental variables

as covariates. The VECM results show that in both the short- and long-term the significant variables

of the VAR model are co-integrated. The empirical results confirm that in the long-term the

fundamentals are the main drivers of crude oil prices. However, in the short term, both fundamentals

and speculative positions in the oil futures market differentially cause fluctuations in crude oil prices.

The effect of the fundamentals is more than double in the long term, when compared to the short-term.

1. Introduction

Over the last 10 years, fluctuations in crude oil prices have raised one key question

among oil market participants and observers: What are the factors responsible for these

fluctuations? [e.g. Singleton (2012), Fattouh et al. (2013), Pindyck and Knittel (2013),

and Yin and Zhou (2016)]. It is also worth noting that the crude oil price and its

movements are critical factors for macroeconomic aggregates [Dhaoui and Khraief

(2014), Jo (2014), Arora (2015) and Yin and Zhou (2016)].

At least three different answers to the question have been proposed. The first

suggested that fluctuations in crude oil prices are mainly driven by market supply and

Any views expressed are solely those of the author(s) and so cannot be taken to represent those of

the OPEC (Organization of the Petroleum Exporting Countries). This paper should therefore not be

reported as representing the views of the OPEC or its Member Countries.

©2017 Organization of the Petroleum Exporting Countries. Published by John Wiley & Sons Ltd, 9600 Garsington

Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

93

demand fundamentals (e.g. Hamilton, 2009). Hamilton (2009) reviewed the cause and

consequences of the oil shock of 2007–2008 and concluded that it was market

fundamentals—demand confronted with stagnant oil production—that led to the

fluctuations.

According to the second proposition, price fluctuations are mainly driven by

excessive speculative activities in the oil futures market (e.g. Masters, 2008; Upadhyay,

2016). However, B€

uy€

uksahin and Jeffrey (2011) discussed the role of speculators in

driving crude oil futures and found little evidence that non-commercial positions led to a

Granger-cause price change, but concluded that price changes preceded non-commercial

positions.

Finally, according to the third proposition, although the volatility of crude oil prices

is due to market fundamentals, speculative activities in the oil futures market amplify it

(Juvenal and Petrella, 2012). Juvenal and Petrella (2012) examined oil market

speculation and found that both fundamentals and speculative activities were supporting

fluctuations in crude oil prices between 2004 and 2012. Fattouh et al. (2013) reviewed

the existing papers related to the role of speculation in oil markets and concluded that

there was little evidence supporting the role of speculation as a driver of spot prices of oil

after 2003, and, instead, found evidence proving that fundamentals were the main trigger

behind spot and futures oil prices. Further reports, from the Commodity Futures Trading

Commission (2008) and the Bank of Canada (2011) have also raised and discussed this

subject. It has also been debated whether speculative activities have altered the nature of

risk premiums in the crude oil futures market, and, consequently, caused compensation

to the long position to became smaller, on average, and more volatile (Hamilton and Wu

2014). Furthermore, it is claimed that speculative activities impose a negative impact on

volatility in oil futures markets (Manera et al. 2016).

It is worth mentioning that the empirical studies confirmed that different types of oil

supply shocks have various effects on crude oil prices and fluctuations [e.g. Baumeister

and Peersman (2013), Kilian and Murphy (2014), L€

utkepohl and Net

Sunajev (2014)]. In

another study, the importance of global demand on crude oil prices has been investigated

for various geographical regions (Aastveit et al. 2014).

Given the divergent views cited, this study aims to investigate whether the volatility

in crude oil prices, reflecting a structural change in the oil market, is due to market

fundamentals or speculative activities for two different periods; from June 2006 to July

2014 and July 2014 to July 2016.

The report is organised into seven sections, including the introduction. The second

section examines the background of the oil market structure and speculative activities,

which is followed by a brief review of the methodology and data selection in Section 3.

Section 4 presents the vector autoregressive (VAR) model and the vector error

correction model (VECM) that test whether crude oil price movements are driven by

OPEC Energy Review June 2017 ©2017 Organization of the Petroleum Exporting Countries

94 Hossein Hassani et al.