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The Delaying Effect of Storage on Investment: Evidence from The Crude Oil Sector

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  • Elgouacem, Assia
  • Legrand, Nicolas

Abstract

Our paper provides a theoretical framework able to represent with accuracy a consistent relationship between fixed capital investment, storage and the term structure of prices in a storable commodity market. It aims at understanding the interaction of storage capacity with irreversible investment decisions in mediating investment and commodity price dynamics. The results show that the presence of storage, while smoothing the spot price tends also to channel volatility into the future, thereby raising the options value of waiting and eventually delaying and making lumpier the investment in fixed capital. The time-varying expected price volatility related to the inventory levels is a new channel we identify to show why irreversible investment decisions in a storable commodity market capture more accurately both price and investment dynamics observed in the data as compared to an irreversible investment setting without storage capacity.

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Handle: RePEc:ags:n13419:309626
DOI: 10.22004/ag.econ.309626
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