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The Role of Inventories and Speculative Trading in the Global Market for Crude Oil

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  • Kilian, Lutz
  • Murphy, Daniel P

Abstract

We develop a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to the flow demand and flow supply. The forward-looking element of the real price of oil is identified with the help of data on oil inventories. The model estimates rule out explanations of the 2003-08 oil price surge based on unexpectedly diminishing oil supplies and based on speculative trading. Instead, we find that this surge was caused by fluctuations in the flow demand for oil driven by the global business cycle. There is evidence, however, that speculative demand shifts played an important role during earlier oil price shock episodes including 1979, 1986, and 1990. Recently, it has been suggested that it is possible for speculative trading to occur even without any change in oil inventories, if the short-run price elasticity of oil demand is zero. Our structural model allows us to obtain an estimate of this elasticity based on shifts of the supply curve along the demand curve. We show that, even after accounting for the role of inventories in smoothing oil consumption, our estimate of the price elasticity of oil demand is not close to zero and much higher than traditional estimates from dynamic models that do not account for price endogeneity. This eliminates speculation as an explanation of the 2003-08 oil price surge.

Suggested Citation

  • Kilian, Lutz & Murphy, Daniel P, 2010. "The Role of Inventories and Speculative Trading in the Global Market for Crude Oil," CEPR Discussion Papers 7753, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:7753
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    References listed on IDEAS

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    1. Eyal Dvir & Kenneth S. Rogoff, 2009. "Three Epochs of Oil," NBER Working Papers 14927, National Bureau of Economic Research, Inc.
    2. Christiane Baumeister & Gert Peersman, 2013. "Time-Varying Effects of Oil Supply Shocks on the US Economy," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(4), pages 1-28, October.
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    8. Lutz Kilian, 2008. "Exogenous Oil Supply Shocks: How Big Are They and How Much Do They Matter for the U.S. Economy?," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 216-240, May.
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    13. Lutz Kilian & Daniel P. Murphy, 2012. "Why Agnostic Sign Restrictions Are Not Enough: Understanding The Dynamics Of Oil Market Var Models," Journal of the European Economic Association, European Economic Association, vol. 10(5), pages 1166-1188, October.
    14. Juan F. Rubio-Ramirez & Daniel F. Waggoner & Tao Zha, 2005. "Markov-switching structural vector autoregressions: theory and application," FRB Atlanta Working Paper 2005-27, Federal Reserve Bank of Atlanta.
    15. 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 1053-1069, June.
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    More about this item

    Keywords

    demand; fundamentals; gasoline demand elasticity; identification; inventories; oil demand elasticity; Oil market; peak oil; speculation; structural model; supply;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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