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The Role of Speculation in Oil Markets: What Have We Learned So Far?

  • Fattouh, Bassam
  • Kilian, Lutz
  • Mahadeva, Lavan

A popular view is that the surge in the price of oil during 2003-08 cannot be explained by economic fundamentals, but was caused by the increased financialization of oil futures markets, which in turn allowed speculation to become a major determinant of the spot price of oil. This interpretation has been driving policy efforts to regulate oil futures markets. This survey reviews the evidence supporting this view. We identify six strands in the literature corresponding to different empirical methodologies and discuss to what extent each approach sheds light on the role of speculation. We find that the existing evidence is not supportive of an important role of speculation in driving the spot price of oil after 2003. Instead, there is strong evidence that the co-movement between spot and futures prices reflects common economic fundamentals rather than the financialization of oil futures markets.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8916.

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Date of creation: Mar 2012
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Handle: RePEc:cpr:ceprdp:8916
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  1. Christiane Baumeister & Lutz Kilian, 2011. "Real-Time Forecasts of the Real Price of Oil," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 30(2), pages 326-336, September.
  2. Chang, Eric C, 1985. " Returns to Speculators and the Theory of Normal Backwardation," Journal of Finance, American Finance Association, vol. 40(1), pages 193-208, March.
  3. de Roon, F.A. & Nijman, T.E. & Veld, C.H., 2000. "Hedging pressure effects in futures markets," Other publications TiSEM 3dfe2c9f-3194-4751-9b34-1, School of Economics and Management.
  4. Ron Alquist & Lutz Kilian, 2010. "What do we learn from the price of crude oil futures?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(4), pages 539-573.
  5. Luca Guerrieri & Martin Bodenstein, 2012. "Oil Efficiency, Demand, and Prices: a Tale of Ups and Downs," 2012 Meeting Papers 25, Society for Economic Dynamics.
  6. Christiane Baumeister & Gert Peersman, 2011. "The Role of Time-Varying Price Elasticities in Accounting for Volatility Changes in the Crude Oil Market," Working Papers 11-28, Bank of Canada.
  7. Ke Tang & Wei Xiong, 2010. "Index Investment and Financialization of Commodities," NBER Working Papers 16385, National Bureau of Economic Research, Inc.
  8. Erkko Etula, 2009. "Broker-dealer risk appetite and commodity returns," Staff Reports 406, Federal Reserve Bank of New York.
  9. Silvennoinen, Annastiina & Thorp, Susan, 2013. "Financialization, crisis and commodity correlation dynamics," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 24(C), pages 42-65.
  10. Giannone, Domenico & Reichlin, Lucrezia, 2006. "Does information help recovering structural shocks from past observations?," Working Paper Series 0632, European Central Bank.
  11. Jacks, David S., 2007. "Populists versus theorists: Futures markets and the volatility of prices," Explorations in Economic History, Elsevier, vol. 44(2), pages 342-362, April.
  12. 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.
  13. Hirshleifer, David, 1989. "Determinants of Hedging and Risk Premia in Commodity Futures Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 313-331, September.
  14. Irwin, Scott H. & Sanders, Dwight R. & Merrin, Robert P., 2009. "Devil or Angel? The Role of Speculation in the Recent Commodity Price Boom (and Bust)," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 41(02), August.
  15. Lombardi, Marco J. & Van Robays, Ine, 2011. "Do financial investors destabilize the oil price?," Working Paper Series 1346, European Central Bank.
  16. David Hirshleifer, 1988. "Residual Risk, Trading Costs, and Commodity Futures Risk Premia," Review of Financial Studies, Society for Financial Studies, vol. 1(2), pages 173-193.
  17. Q. Farooq Akram, 2008. "Commodity prices, interest rates and the dollar," Working Paper 2008/12, Norges Bank.
  18. Ron Alquist and Olivier Gervais, 2013. "The Role of Financial Speculation in Driving the Price of Crude Oil," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3).
  19. Lucas W. Davis & Lutz Kilian, 2011. "Estimating the effect of a gasoline tax on carbon emissions," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 26(7), pages 1187-1214, November.
  20. Renee Fry & Adrian Pagan, 2010. "Sign Restrictions in Structural Vector Autoregressions: A Critical Review," CAMA Working Papers 2010-22, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  21. Working, Holbrook, 1960. "Speculation on Hedging Markets," Food Research Institute Studies, Stanford University, Food Research Institute, issue 02, May.
  22. Kilian, Lutz & Murphy, Daniel P, 2009. "Why Agnostic Sign Restrictions Are Not Enough: Understanding the Dynamics of Oil Market VAR Models," CEPR Discussion Papers 7471, C.E.P.R. Discussion Papers.
  23. Alquist, Ron & Kilian, Lutz & Vigfusson, Robert J., 2011. "Forecasting the Price of Oil," CEPR Discussion Papers 8388, C.E.P.R. Discussion Papers.
  24. Eyal Dvir & Kenneth S. Rogoff, 2009. "Three Epochs of Oil," NBER Working Papers 14927, National Bureau of Economic Research, Inc.
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  28. repec:ner:tilbur:urn:nbn:nl:ui:12-83944 is not listed on IDEAS
  29. Bassam Fattouh & Pasquale Scaramozzino, 2011. "Uncertainty, expectations, and fundamentals: whatever happened to long-term oil prices?," Oxford Review of Economic Policy, Oxford University Press, vol. 27(1), pages 186-206, Spring.
  30. Apostolos Serletis & Govinda R. Timilsina & Olexandr Vasetsky, 2010. "International Evidence on Sectoral Interfuel Substitution," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 1-30.
  31. 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.
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