Risk Premium in the Era of Shale Oil

53 Pages Posted: 6 Aug 2019

See all articles by Fabrizio Ferriani

Fabrizio Ferriani

Bank of Italy

Filippo Natoli

Bank of Italy

Giovanni Veronese

Bank of Italy

Federica Zeni

Imperial College London; Bank of Italy

Date Written: April 29, 2019

Abstract

The boom in the production of shale oil in the United States has triggered a structural transformation of the oil market. We show, both theoretically and empirically, that this process has significant consequences for oil risk premium. We construct a model based on shale producers interacting with financial speculators in the futures market. Compared to conventional oil, shale oil technology is more flexible, but producers have higher risk aversion and face additional costs due to their reliance on external finance. Our model helps to explain the observed pattern of aggregate hedging by US oil companies in the last decade. The empirical analysis shows that the hedging pressure of shale producers has become more important than that of conventional producers in explaining the oil futures risk premium.

Keywords: shale oil, futures, risk premium, hedging, speculation, limits to arbitrage

JEL Classification: G00, G13, G32, Q43

Suggested Citation

Ferriani, Fabrizio and Natoli, Filippo and Veronese, Giovanni Furio and Zeni, Federica, Risk Premium in the Era of Shale Oil (April 29, 2019). Bank of Italy Temi di Discussione (Working Paper) No. 1215, April 2019, Available at SSRN: https://ssrn.com/abstract=3432429 or http://dx.doi.org/10.2139/ssrn.3432429

Fabrizio Ferriani

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Filippo Natoli (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Giovanni Furio Veronese

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy
+49 621 189 1886 (Phone)
+49 621 189 1884 (Fax)

Federica Zeni

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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