Why and when do spot prices of crude oil revert to futures price levels?
AbstractRecent studies of crude oil price formation emphasize the role of interest rates and convenience yield (the adjusted spot-futures spread), confirming that spot prices mean-revert and normally exceed discounted futures. However, these studies don't explain why such "backwardation" is normal. Also, models derived in these studies typically explain only about 1 percent of daily returns, suggesting other factors are important, too. In this paper, I specify a structural oil-market model that links returns to convenience yield, inventory news, and revisions of expected production cost (growth of which is related to backwardation). Although its predictive power is only a marginal improvement, the model fits the data far better. In addition, I find reversion of spot to futures prices only when backwardation is severe. Convenience yield behaves nonlinearly, but price response to convenience yield is also nonlinear. Equivalently, futures are informative about future spot prices only when spot prices substantially exceed futures.
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Bibliographic InfoPaper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2005-30.
Date of creation: 2005
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-10-04 (All new papers)
- NEP-ENE-2005-10-04 (Energy Economics)
- NEP-FMK-2005-10-04 (Financial Markets)
- NEP-MAC-2005-10-04 (Macroeconomics)
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