Abstract

http://ssrn.com/abstract=1578103
 
 

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The Role of Inventories and Speculative Trading in the Global Market for Crude Oil


Lutz Kilian


University of Michigan at Ann Arbor - Department of Economics; Centre for Economic Policy Research (CEPR)

Dan Murphy


University of Michigan at Ann Arbor

March 2010

CEPR Discussion Paper No. DP7753

Abstract:     
We develop a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to the flow demand and flow supply. The forward-looking element of the real price of oil is identified with the help of data on oil inventories. The model estimates rule out explanations of the 2003-08 oil price surge based on unexpectedly diminishing oil supplies and based on speculative trading. Instead, we find that this surge was caused by fluctuations in the flow demand for oil driven by the global business cycle. There is evidence, however, that speculative demand shifts played an important role during earlier oil price shock episodes including 1979, 1986, and 1990. Recently, it has been suggested that it is possible for speculative trading to occur even without any change in oil inventories, if the short-run price elasticity of oil demand is zero. Our structural model allows us to obtain an estimate of this elasticity based on shifts of the supply curve along the demand curve. We show that, even after accounting for the role of inventories in smoothing oil consumption, our estimate of the price elasticity of oil demand is not close to zero and much higher than traditional estimates from dynamic models that do not account for price endogeneity. This eliminates speculation as an explanation of the 2003-08 oil price surge.

Number of Pages in PDF File: 45

Keywords: demand, fundamentals, gasoline demand elasticity, identification, inventories, oil demand elasticity, Oil market, peak oil, speculation, structural model, supply

JEL Classification: D84

working papers series


Date posted: March 29, 2010  

Suggested Citation

Kilian, Lutz and Murphy, Dan, The Role of Inventories and Speculative Trading in the Global Market for Crude Oil (March 2010). CEPR Discussion Paper No. DP7753. Available at SSRN: http://ssrn.com/abstract=1578103

Contact Information

Lutz Kilian (Contact Author)
University of Michigan at Ann Arbor - Department of Economics ( email )
611 Tappan Street
Ann Arbor, MI 48109-1220
United States
734-764-2320 (Phone)
734-764-2769 (Fax)
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Dan Murphy
University of Michigan at Ann Arbor ( email )
701 Tappan St. Rm E2600
Ann Arbor, MI 48109
United States
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