Empirical Analysis of Oil Price Determination Based on Market Quality Theory
Since the first oil shock in 1973 oil prices began to increase drastically. The 1973 and 1979 oil price shocks can be explained by supply reasons, but since the 80's, oil prices came under another type of increasing pressure. We argue that this latter with the exception of first Gulf War (1990-1991) oil price shocks, had another reason which was not a supply reason, and we found it on the demand side. Between 1981-2011, the average oil prices accelerated from about $35/barrel in 1981 to beyond $111/barrel in 2011. At the same time average interest rates subsided from 16.7 percent per annum in 1981 to about 0.1 percent per annum in 2011. In this paper we will explain how this enduring price increase in most cases was caused by expansionary monetary policies that led to low interest rates, credit demand augmentation, and then aggregate demand which heightened crude oil prices. Simultaneously, this research looks at the time-series properties of crude oil and estimates a world demand-supply model and the determinants of crude oil prices along with price and income elasticities during 1960-2011 and compares findings with two sub-periods, 1960-1980 and 1980-2011. Results show that demand is price elastic and unlike some earlier literature, supply is also affected by changes in oil price; however, income elasticity was significant only during 1980-2011. World crude oil demand was significantly influenced by interest rate, but impact of exchange rate depreciations on oil demand was not significant. Aggressive monetary policies would stimulate oil demand, but it would be met with oil supply which is rigid to monetary policies and would blow up the crude oil prices which are troublesome to economic growth. In last section we will attempt to shed light on the hypothesis of equilibrium vs. disequilibrium in the oil market, showing results that crude oil prices adjust instantly, declaring the existence of equilibrium in oil market during 1960-2011.
|Date of creation:||Mar 2013|
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