Big Fish: Oil Markets and Speculation

45 Pages Posted: 9 Jun 2015

Date Written: June 8, 2015

Abstract

The role of speculators in the oil markets has been vastly investigated during the last few years. Several authors focused on the definition of speculation while others examined the relationship between oil prices and the behavior of trading actors. In this paper, we formulate a new theory able to describe “hedging needs” as well as the role of speculators in the crude oil market. According to our model, the different strategies of producers and consumers aimed at defending themselves against abrupt oil price changes can be satisfied only if speculators play a very active role. Due to the rapid growth in shale oil production, the importance of speculation in ensuring an equilibrium in the U.S. crude oil market has consequently grown noticeably. We estimate an econometric conditional Error Correction Model (ECM) applying Pesaran’s bound tests, over the sample February 2000 November 2014, using WTI and CFTC data. Our theory is well supported by econometric evidence. In other words, our model is suitable to demonstrate how commercial operators act on the market. In addition, the increasing importance of future contracts (also known as financialisation of crude oil market) helps in reaching a level of prices close to the equilibrium one. Finally, we are able to find evidence of a positive impact of the action of speculators on the efficiency of oil markets as they help stabilizing prices.

Keywords: Oil Price Dynamics, Speculation and Fundamentals, Conditional Error, Correction Models, Pesaran Bounds Testing Approach

JEL Classification: Q4, Q41, D84, G15

Suggested Citation

Cologni, Alessandro and Scarpa, Elisa and Sitzia, Francesco, Big Fish: Oil Markets and Speculation (June 8, 2015). FEEM Working Paper No. 052.2015, Available at SSRN: https://ssrn.com/abstract=2615868 or http://dx.doi.org/10.2139/ssrn.2615868

Alessandro Cologni

Edison S.p.A ( email )

Foro Buonaparte, 31
Milan, 20121
Italy

Elisa Scarpa (Contact Author)

Edison Trading ( email )

Foro Buonaparte, 31
Milan, 20121
Italy

Francesco Sitzia

Edison Trading ( email )

Foro Buonaparte, 31
Milan, 20121
Italy

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