41 Pages Posted: 23 Jun 2017
Date Written: June 23, 2017
This paper examines the dynamics of the relationship between the prices of crude oil and of refined products. Theory insinuates some kind of dynamic equilibrium to govern these relations but we suspect that this equilibrium condition may be subject to changes over time. In Brent-based spreads between refined products and crude oil, no time trend is discernible. Decomposing the spread to fixed and variable cost components, however, reveals a steady tendency toward a larger intercept and a smaller elasticity parameter. We subject the stability of the assumed cointegrating relations of crude/refined pairs to three different statistical procedures. Applying the first two of them, the Gregory-Hansen test and the Kejriwal-Perron procedure, reveals at least one break point in each crude/refined pair. The timing of most breakpoints matches major turns and historical incidents in the global energy markets. The third approach assumes two or three discrete unobserved states that are treated as first-order Markov processes, with time-constant probabilities of switches between states. We offer several economic conjectures that may explain the observed patterns. The findings suggest that applied econometric estimations in this domain should give a higher weight to more recent samples, rather than relying on a long time-series.
Keywords: Crude Oil, Gasoline Price, Structural Breaks, Cointegration
JEL Classification: Q40, Q43, N72
Suggested Citation: Suggested Citation
Afkhami, Mohamad and Kunst, Robert M. and Ghoddusi, Hamed, A Dynamic Relationship between Crude Oil and Refined Products Prices (June 23, 2017). Available at SSRN: https://ssrn.com/abstract=2991633