Terrorism and the Returns to Oil

Abstract

The effect of terrorism on global oil prices has been largely explained through demand-side effects. We develop a model to include important supply-side imperfections to re-examine the effect of terrorism on the price of global oil stocks. Our model finds that if two criteria are met, conflict can positively affect an oil company's stock price. First, oil firms must have some monopoly power. Second, the informational content of a terrorist or conflict event must be large enough to seriously affect investor perception of the market. We argue this is possible when capacity constraints are binding. If both of these prerequisites exist when a conflict occurs, then we predict that a positive stock price reaction can be expected for oil firms from such a shock. We exploit a rich new panel data set to investigate the predictions of our model, using conflict data from the top twenty oil producing and exporting countries in the world, and members of OPEC. We show that in the current era, as cartel behavior of OPEC member countries has diminished and as conflict has become more regular and thus the information surrounding it noisier, oil stock prices do not increase in response to conflict. However, using different time samples, we find that oil stocks can in fact increase in response to conflict. In some cases, the impact of conflict may cause the return of oil stocks to rise by as much as ten percentage points.

Keywords: Political Economy, Oil, Terrorism