Speculation in Commodity Futures Markets, Inventories and the Price of Crude Oil

This paper examines the role of inventories in refiners' gasoline production and develops a structural model of the relationship between crude oil prices and inventories. Using data on inventories and prices of oil futures, I show that convenience yields decrease at a diminishing rate as inventories increase, consistent with the theory of storage. In addition to exhibiting seasonal and procyclical behaviors, I show that the historical convenience yield averages about 18 percent of the oil price from March 1989 to November 2014. Although some have argued that a breakdown of the relationship between crude oil inventories and prices following increased financial investors' participation after 2004 was evidence of a speculative effect, I find that the proposed price-inventory relationship is stable over time. The empirical evidence indicates that crude oil prices remained tied to oil-market fundamentals such as inventories, suggesting that the contribution of financial investors' activities was weak.