Modeling Oil Markets Janie M. Chermak, University of New Mexico Robert H Patrick, Rutgers University October 26, 2015

Literature Medlock and Jaffe (2009) speculation Hamilton (2009) speculation, OPEC, scarcity rent Dvir & Rogoff (2009) price behavior Kilian (2010) S&D shocks Kellogg (2014) Impact of infill drilling on investment

Components Demand (consumption, additions to storage) Supply (production, imports, withdrawals from storage) Futures

Demand (consumption, storage in)

Supply (base production, new production, storage out, imports)

Storage

Futures (commercial and non-commercial traders)

Futures Market Commercial (arbitrage) traders are those whose primary businesses are exposed to oil price fluctuations and hedge risks in futures markets to stabilize cash flows. Non-commercial (speculative) traders speculate on crude oil price movements.

Contango/Backwardation If C4>C1, then DIFF>0 – Contango If C4<C1, DIFF<0 - Backwardation

Market(s) Demand for Crude Oil Inverse Supply of Crude Oil Futures Price Data from EIA, Baker Hughes: Weekly 1/1/1986 – 10/1/2015

Model (ARCH/GARCH- in means) Equation 1: Quantity Demanded is a function of: – WTI Spot Price [ -/- ] * – Prime Rate [+/+] * – + Change in Storage [ +/-] – S&P [+/+] * – Time [+/+] * – Binaries: Recession [-/-] *, 9/11[-/+] * – Variance Terms Recession (-/-)*; 9/11 (+/+)* * Significant at 5% or greater

MODEL (ARCH GARCH - in means) Equation 2: WTI Spot Price is a function of: – Futures Price (+/+)* – Oil Rig Count (+/+)* – Production (+/+)* – Change in Storage (-/-)* – Contango/Backwardation (+/-)* – Open Interest NC Short (+/+)*; NC Long (-/-)*: NC Spread (+/+)*; CS Short (+/+)*; CL (-/-)* – Variance Terms CFMA (+/+)*; 9/11 (+/+)* * Significant at 5% or greater

Equation 3: Futures Price is a function of: – Open Interest (+/+)* – CFMA (+/+)* – S&P (+/+)* – Gold (-/+)* – Days of Storage (-/+) – Time (?/-)* – Variance Terms: 9/11 (+/+)* MODEL (ARCH GARCH - in means) * Significant at 5% or greater

Conclusions Market Fundamentals are Significant Storage Is Significant Shocks Are Significant Financial Markets and Rules are Significant Significance of Relative Impacts Changes Over Time

Thank You

The Crude Oil Consumer’s Objective Individual Demand for Crude

The Producer’s Objective: Aggregate Supply: Individual Producer’s Supply:

Equilibrium without Storage or Futures

Storage