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The Role of Financial Speculation in Driving the Price of Crude Oil

  • Ron Alquist
  • Olivier Gervais

Over the past 10 years, financial firms have increased the size of their positions in the oil futures market. At the same time, oil prices have increased dramatically. The conjunction of these developments has led some observers to argue that financial speculation caused the run-up in oil prices. Yet several arguments cast doubt on the validity of this claim. First, although the stock of open futures contracts is many times larger than the flow of oil consumption in the United States, comparing these two statistics is misleading. Stocks are not measured with respect to a specific unit of time but flows are, so the two are not directly comparable. Second, empirical analysis shows that changes in financial firms’ positions do not predict oil-price changes, but that oil-price changes predict changes in positions. Third, the evidence indicates that financial firms’ positions did not cause the market to expect persistent price increases during 2007/08. Other explanations for the increase in oil prices include macroeconomic fundamentals, such as interest rates and increased demand from emerging Asia. Of these two explanations, the one that seems most consistent with the facts explains oil-price fluctuations in terms of large and persistent demand shocks related to growth in global real activity in the presence of supply constraints.

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Paper provided by Bank of Canada in its series Discussion Papers with number 11-6.

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Length: 22 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:bca:bocadp:11-6
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  1. Sanders, Dwight R. & Irwin, Scott H. & Merrin, Robert P., 2008. "The Adequacy of Speculation in Agricultural Futures Markets: Too Much of a Good Thing?," Marketing and Outlook Research Reports 37512, University of Illinois at Urbana-Champaign, Department of Agricultural and Consumer Economics.
  2. Lutz Kilian & Bruce Hicks, 2013. "Did Unexpectedly Strong Economic Growth Cause the Oil Price Shock of 2003–2008?," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 32(5), pages 385-394, 08.
  3. Lutz Kilian & Daniel P. Murphy, 2014. "The Role Of Inventories And Speculative Trading In The Global Market For Crude Oil," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 29(3), pages 454-478, 04.
  4. James L. Smith, 2008. "World Oil: Market or Mayhem?," Working Papers 0815, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  5. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-69, June.
  6. Anzuini, Alessio & Lombardi, Marco J. & Pagano, Patrizio, 2010. "The impact of monetary policy shocks on commodity prices," Working Paper Series 1232, European Central Bank.
  7. C. Baumeister & G. Peersman & -, 2010. "Sources of the Volatility Puzzle in the Crude Oil Market," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 10/634, Ghent University, Faculty of Economics and Business Administration.
  8. Fung, William & Hsieh, David A., 2000. "Measuring the market impact of hedge funds," Journal of Empirical Finance, Elsevier, vol. 7(1), pages 1-36, May.
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